Prior to Kate Spade & Company's (NYSE:KATE) quarterly earnings release, I had expected continued operating losses. To my surprise, the company outperformed expectations. Revenue of $266 million was 49% higher than the $179 million recorded a year ago. Analysts were expecting $238 million for the quarter. Sales in the North American segment and international segment increased 55% and 54% year-over-year, respectively. Net loss was $4.4 million ($0.03 per share) versus $43.1 million ($0.36 per share) in the same period a year ago. Excluding non-recurring items, adjusted net profit was $0.05 per share; the consensus estimate was for Kate Spade to break-even during the quarter. Below are the company's historical financial results:
Selling Lucky Brand and Juicy Couture earlier this year allowed the company to reduce losses and focus on the Kate Spade brand. Gross profit margin during the quarter was 59% versus 64% for the same period last year. However, Kate Spade reduced SG&A expense as a percentage of revenue to 55% from 64% during the same period last year. Operating income came in at about $10 million versus a $4 million loss a year ago. The market was ecstatic, sending the stock up 10% in the pre-market.
Shares Routed Due To Discounting
However, on the earnings conference call, management admitted that it had to resort to discounting to clear excess inventory related to the Kate Spade Saturday brand. This caused the decrease in the gross margin from 62% to 59% year-over-year. The problem with discounting is that once a retailer starts, it is difficult to wean customers off of it. The threat of continued discounts has also affected the shares of competitor Michael Kors (NYSE:KORS). According to the Wall Street Journal,
Kate Spade executives said broader discounting in the industry was fiercer than they had expected. The company, which is trying to move away from using promotions to drive sales, said it was forced to move sales earlier to compete. "We're not going to sit on the sidelines while there's promotional activity amongst retailers and competitors," said George Carrara, Kate Spade's chief operating officer.
The shares did an immediate reversal after the call. By 11am the stock was back to break-even. From noon to 2pm the stock hovered around $30 per share. At 2pm the stock finally capitulated, closing down $9.87 (over 25%) to $29 per share. Below is the one day stock chart.
The shares may recover somewhat today. However, the damage has been done. The specter of luxury retailers having to discount wares in the face of a declining global economy will linger. I have closed out part of my short position. I do not see a compelling reason to own the stock prior to next quarter's earnings. I think the shares are a sell from here.
Disclosure: The author is short KATE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.