The fast-growing luxury lifestyle brand easily breezed by both revenue and earnings estimates, and increased its fiscal 2015 revenue and earnings guidance. However, the market punished the stock, no doubt due to the forecast slowing for comparable-store sales growth for both the current quarter and the full year, as well as concerns about the company's margins.
Kors' earnings conference call provided some additional color on its results. Here are five things from the call you should know:
1. Kors sees significant opportunities in menswear
Fom CEO John Idol's prepared remarks:
And you will see [a greater emphasis on the men's business] clearly displayed in our new soon-to-open SoHo flagship store, which will feature an entire floor devoted to men's. From there we will begin to test freestanding men's stores next year and believe that there may be the potential for as many as 500 men's stores worldwide over the long term.
To lead the development of this important strategy we recently brought Mark Brashear on board ... Mark's background with Hugo Boss and Nordstrom makes him a perfect fit to lead our men's extension. With the right team in place I believe that we have the potential to be leading global menswear brand.
According to Kors' management, there's plenty of growth potential left on the women's side, both with new products and with the rather nascent international expansion. However, the company's long-term growth potential should be greatly enhanced if Kors is as successful on the men's side as it has been with high-end women's fashions and accessories.
Later in the call Idol revealed that the flagship store in the SoHo section of New York City mentioned above is slated to open in October.
2. Management wants investors to understand that gross margins were unsustainable
There was a lot of back-and-forth on the call about the company's margins. This is a key issue for investors to understand, so let's take a look at gross margin and operating margin separately (in the next section). The following quote is from Idol's response to an analyst's request that the company clarify the main driver for the expected decline in fiscal 2015 gross margin.
As we said earlier on the call we believe that there's just some more normalized selling rates that are happening inside the stores. Those [previous margins] were unsustainable gross margins. We told everyone that for multiple quarters.
Kors' guidance for both its fiscal second quarter and its full-year 2015 calls for gross margin to drop 50 basis points -- half a percentage point -- from the respective year-ago periods. The company's gross margins have been running in the low 60% range, so half a percentage point is nothing to be concerned about, but a faster than expected reduction in gross margin, in my opinion, could be cause for concern.
The discounting of merchandise is usually the main driver of reduced gross margins in a retail environment, and merchandise is usually discounted when it isn't selling as well as anticipated. Fashion is an especially fickle business, and what's "hot" can turn rather quickly into what's passe -- at least among a certain sizable segment of the population. Most indications are that Kors has plenty of time to shine, but it's always smart to monitor gross margins.
Kors' gross margin actually expanded a bit in the first quarter to 62.2%, up from 62% in the year-ago period.
3. Management wants investors to understand that operating margins were unsustainable
Idol's response to an analyst's question:
[W]e have said all along from again, the day we went public. We never believed that a 30% operating margin was a sustainable margin for the company. And by the way, we don't want that. ... we don't think that's the right way to run our business.
Idol elaborated on the importance of investing in the business and the company's plans to continue doing so. Long-term investors should be OK with a slightly decreased operating margin, as long as the reduction comes from spending intended to fuel long-term growth. Kors has been increasing its store base, expanding select stores, converting to or expanding existing shops-in-shops, and improving its distribution centers and technology. Additionally, it now plans to more aggressively enter the men's market. So it shouldn't surprise anyone that operating expenses as a percentage of revenue have ticked up, and that the company foresees that continuing.
Kors expects second-quarter operating margin to decrease 200 basis points -- or 2% -- from the year-ago period, and for full-year margin to decrease 150 to 200 basis points from fiscal 2014. The company's operating margin was 30.1% in the first quarter, down from 30.8% in the year-ago period.
As for the long-term operating margin, Idol said "we think that 28% to 29% range is a more sustainable range for us." He also noted that this is still "best in class" -- and he's right. For context, Coach, the company most similar to Kors in terms of product lines, sports a 26% trailing-12-month operating margin -- and Coach is well-known for its fat margin. Ralph Lauren has a 15% margin.
4. More emphasis will be put on jewelry and watches, which are powering results
This quote is from Idol's prepared remarks:
[We] rolled out an additional 30 watch and jewelry shop-in-shops in department stores worldwide during the first quarter.
We now have 155 watch and jewelry shops globally and continue to believe that there is an opportunity for approximately 500 shop-in-shops globally over the long term.
The company cites strength in jewelry and watches for helping to drive strong results across all segments -- retail, wholesale, and licensing. Idol added that jewelry has been the main driver in increasing the average transaction size.
Later in the call, Idol added:
We're going to upsize approximately 41 stores and the primary reason we're doing that is really we're enlarging the handbag spaces in the stores, we're enlarging watches and jewelry, footwear and our women's ready-to-wear and the early results of that are quite strong.
Investors should get a better idea over the next couple of quarters as to how well these strategies are paying off.
5. Kors believes its e-commerce site can significantly help grow the brand
This quote is from Idol's prepared remarks:
We are also on track to bring our North American e-commerce site in-house this fall which we see as a tremendous opportunity to grow our brand.
In response to an analyst's question, Idol further expounded:
We're on track to launch the e-commerce site in the beginning of September ... This site looks phenomenal and as I said to you previously, we really did not think we were best-in-class in our current e-commerce experience.
... I just might add that we view this as very substantial for the business long term. We ultimately think that this can be up to 20% of our global revenues generated in the retail side from e-commerce.
I'm on board with the company's optimism about the potential of its relatively new e-commerce site. Statistics show that consumers are increasingly embracing online shopping, and this is generally more true of affluent shoppers.
Foolish final thoughts
There's a wealth of information an investor can glean from tuning into conference calls, as the numbers in earnings releases never tell the entire story. In Kors' case, the news about how Kors plans to keep its growth game intact over the long-term doesn't show up in the current numbers, but was discussed at length during the call.
Beth McKenna has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Coach and Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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