Skechers USA’s shares fell $6.95, or 20.9 percent, to $26.30 on Friday after the company reported second-quarter earnings that fell well short of guidance and provided a soft outlook for the third quarter. Investors were reportedly frustrated that Skechers’ focus on funding long-term expansion efforts is coming at the expense of near-term earnings improvement.

In the Q&A session on the company’s call with analysts, David Weinberg, EVP and COO, said Skechers had no current plans to pull back on funding any projects that may decelerate top-line growth but boost the bottom-line.

Said Weinberg, “We just don’t necessarily think that way. We’re going to grow. We think that transition-sacrificing top-line growth for EBIT will happen when the marketplace tells us we’re getting too close to a saturation point. Right now, we are built for growth; we have the capital for growth; we wouldn’t leave anything on the table.”

Weinberg said the company still believes “significant areas” remain under-penetrated by the brand, mentioning South America, Japan and India. The most significant investments in the latest quarter came in China and Weinberg said current investments, such as in a distribution center in China, will improve efficiencies and eventually trickle down to the bottom line.

Said Weinberg, “So we still got some ways to go. But we do think as we get through the end of this year into next year, we should start to leverage unless there’s some outgrowth opportunities in a couple of big territories that we have to invest in.”

On the quarter, Weinberg said that the quarter missed guidance because of three factors: a tax rate that was higher than anticipated due to the tax change, foreign-currency fluctuations and a lawsuit settlement. Said Weinberg, “If we put that all together, we’re pretty much on target to what we had said on the Q1 conference call, and we think we had a pretty good quarter.”

He did note, however, that business was “a little tougher in the U.S. than we had thought.” He said the core business in the U.S. that sells at higher margins is “performing quite well and our margins are holding up quite well” with no inventory challenges. The challenging area is the non-core business that features lower-priced styles and has been hurt by an abnormal number of closeouts in the marketplace. Said Weinberg, “We do anticipate that business can start to come back next year depending on what’s available in the marketplace and we’re certainly looking forward to it. But our core business with the higher margins and where we sell the most should continue to grow.”

In the quarter ended June 30, earnings sunk 23.9 to $45.3 million, or 29 cents a share. Sales rose 10.6 percent to $1.13 billion.

On April 19, when the company reported first-quarter results, Skechers said the company expected earnings to range between 38 to 43 cents a share. Sales were expected in the range of $1.120 billion to $1.145 billion. Skechers had warned that quarterly sales would include an expected shift in shipments from the second quarter to the back half of the year for several key international distributors and domestic accounts.

In early afternoon trading, shares of Skechers were trading down about 22 percent to about $26. The stock began the year at $37.84 and has also been hurt by disappointing guidance that arrived with first-quarter results.

Among the company’s segments, domestic wholesale revenues in the second quarter decreased 7 percent, which Skechers said was in line with expectations. Domestic wholesale sales are now up 1 percent in the six months. Said Weinberg, “Our business within our core accounts remain solid during the quarter.”

Men’s and women’s sport, work and golf, as well as women’s sandals, are “all performing particularly well,” said Weinberg. He added that Skechers remains the number one men’s and women’s work, men’s and women’s casual lifestyle footwear brand and the number one walking brand.

The trend toward chunky sneakers also has been beneficial to Skechers, with the Energy helping launch the trend in 1999 and D’Lites in 2007 also gaining popularity on the trend. Said Weinberg, “As an originator of this look, we are receiving a great deal of press coverage and capturing attention of a younger demographic.”

Weinberg concluded on the domestic wholesale business, “While we will face some tough comparisons in the third quarter from last year’s growth, we believe our product and marketing are both on point. Based on our meetings with accounts and backlogs, we believe our core wholesale business remain strong and we will achieve positive results in the back half of the year.”

International wholesale revenues gained 24.9 percent as a result of a 34 percent growth in the company’s subsidiary and joint venture businesses, which was slightly offset by a 6 percent decrease in the company’s distributor business. Skechers had previously warned that weakness in the Middle East would impact distributor sales in the current quarter.

Wholly-owned international subsidiary sales grew 23.1 percent while joint venture sales jumped 42.6 percent. All but one of the company’s subsidiaries achieved growth in the quarter with Germany, Canada, U.K. and Spain generating the highest dollar gains.

China “remains a dominant force in our international business” and saw sales climb 44.1 percent with approximately 5.6 million pairs shipped in the quarter. China has a retail base of approximately 775 Skechers stores along with 2,350 points of sale and delivered double-digit e-commerce increases in the quarter. South Korea and Singapore each saw ”considerable dollar and percentage” sales gains in the quarter.

Among the company’s distributors, Russia, Scandinavia, Turkey, Indonesia and Taiwan bucked the trend with strong growth.

In the company’s company-owned global retail business, sales increased 12.8 percent in the quarter, which was the result of a sales increase of 25.5 percent in international stores and 7.2 percent in domestic retail stores. This included worldwide positive comp store sales of 4.5 percent in the quarter, including 2.2 percent domestically and a 11.3 percent internationally.

Gross margins improved 180 basis points to 49.4 percent. This improvement was attributable to strength in Skechers’ international business due in part to favorable foreign exchange rates.

SG&A as a percent of sales, however, increased to 42.7 percent from 39.5 percent. Selling expenses increased 30 basis points to 10 percent of sales due to higher international advertising expenses to support overseas growth. Domestic selling expenses were down slightly in the quarter.

Total general and administrative expenses jumped to 32.7 percent of sales, compared to 29.8 percent in the prior year period, reflecting growth investments that included $29.4 million to support growth in China. The line item also included an increase of $11.7 million associated with 54 additional company-owned Skechers stores, of which 12 opened in the second quarter and $19.8 million related to corporate and domestic expenses, of which $7 million related to increased domestic warehouse and distribution costs and $6.2 million related to certain legal costs.

Total inventory, including merchandise in transit, increased 22.8 percent to $822.4 million, an increase of $152.7 million, which included an increase of $90 million in China alone. John Vandemore, CFO, said on the call, “We believe that our inventory levels are in line with our growth expectations for our global business.”

For the third quarter, Skechers projected sales would arrive in the range of $1.2 billion to $1.23 billion and EPS between 50 to 55 cents. In the year-ago quarter, sales were $1.095 billion and EPS was 59 cents. Skechers said the company expects domestic wholesale and international distributor sales will return to growth in the second-half and retail comps will remain positive. Continued strong performance were also projected for the company’s international subsidiaries and joint venture businesses and company-owned stores.

Sam Poser at Susquehanna Financial Group reduced his rating on Skechers from “Positive” to “Neutral” and his price target from $40 to $26. In a note, the reasons cited for the downgrade include a lack of clarity on when SG&A leverage from investment would pay off, a worse-than-expected outlook and an “apparent lack of alignment” with shareholders with management putting a greater priority on top-line growth ahead of improving profitability.

Wrote Poser, “While we are confident that management continues to work to improve the Skechers’ brand, we believe it would be prudent to better align shareholders’ and management’s interests.”

While adjusting his EPS targets and lowering his price target to $32, John Kernan at Cowen still has an “Outperform” rating on the stock. In a note, Kernan writes that Skechers’ shares are “entirely too cheap, in our view, given quality of the brand.” Based on conversations with investors, Cowen believes sales growth and distribution growth over profits and free cash flow are the biggest points of contention with the investor community.

Kernan suggested that additional compensation incentives tied to profits, the release of annual guidance, stock buyback increases and younger board members may be some steps to regain the confidence of investors and reduce the stock’s volatility. Kernan also said Skechers could better spell out the long-term margin benefits from the G&A spending. Wrote Kernan, “At the current valuation there is clearly concern that G&A growth is being done to sell units into new distribution rather than build the brand and that sales will moderate significantly if management slows spending. Management will need to overcome this to see valuation expand.”

Photo courtesy Skechers