Fossil Group Beats on Q3 Earnings, Tweaks 2014 View

Fossil Group Inc. (FOSL) reported better-than-expected third quarter 2014 results, but tightened its earnings guidance and slightly lowered revenues and margin expectations for 2014. Share price grew more than 10% in the pre-market trading because of the renewed license with Michael Kors Holdings Ltd. (KORS) and aggressive share buyback activity.

In the third quarter of 2014, Fossil’s earnings of $1.96 cents per share beat the Zacks Consensus Estimate of $1.82 by 7.7% and exceeded the company’s guided range of $1.77-$1.84 per share. Earnings also increased a significant 24.1% from the prior-year earnings of $1.58 per share driven by higher sales, improved operating income and lower outstanding share count.

Fossil, Inc - Earnings Surprise | FindTheBest

Quarter in Detail

This global consumer fashion accessories maker reported net sales of $894.5 million and managed to beat the Zacks Consensus Estimate of $879 million by 1.8%. Net sales increased 10% year over year and also exceeded the company’s guided growth range of 7.5%-9%, reflecting sales increase across all geographies, particularly in Europe and Asia.

The increase was driven by 12% growth in the multi-brand global watch portfolio as well as growth in the Fossil and Skagen brands. The company also witnessed gains in jewelry, which made up for the sales decline in the leather business, which still remains highly competitive and promotional in the wholesale channel. Across categories, jewelry delivered the highest growth rate driven by Michael Kors, owing to continuous innovation and the growing demand for branded jewelry around the world.

A comparatively weaker U.S. dollar contributed $2.8 million to the company’s sales in the reported quarter. On a constant currency basis, net sales increased 10% to $891.7 million in the quarter.

Gross margin declined 50 basis points (bps) to 56.9% due to higher promotional expenses, which partially offset the favorable distribution mix owing to higher growth in international markets.

Interest expenses increased 26.7% in the quarter to $3.8 million. Moreover, operating expenses increased during the quarter, as the company spent heavily on the expansion of retail stores, infrastructure investments, marketing displays and advertising royalties.

Operating income rose 10% to $154.9 million owing to higher sales. However, operating margin decreased 10 basis points to 17.3% in the quarter due to higher costs. Operating margin was however marginally ahead of management’s expectation of 16.7% to 17.2%.

Segment Details

The company’s net sales comprise wholesale net sales (including North America wholesale, Europe wholesale, Asia Pacific wholesale) and direct to consumer sales (including company-owned retail stores, e-commerce sales and catalog activities).

Wholesale net sales, on a constant currency basis, increased 10.2% to $675.8 million in the third quarter, driven by increases in all wholesale segments.

Net sales from the North American wholesale segment increased 6% year over year on a constant currency basis to $319.8 million, primarily driven by growth in watches and jewelry, partially offset by a decline in sales of leather products. Wholesale shipments increased in the United States in the quarter.

Net sales in Europe grew 15% year over year on a constant currency basis to $240 million, driven by high-teen growth in watch and jewelry categories, partially offset by a decline in leather. Strong performance in the United Kingdom, France and Germany boosted sales in the region during the quarter.

Net sales in the Asia-Pacific segment increased 11% on a constant currency basis to $116.0 million, driven by double-digit increases in the company’s watches and a slight increase in leather business. Almost every market contributed to sales, with India and Japan contributing significantly.

Net sales of the Direct-to-Consumer segment grew 10.8% year over year on a constant currency basis to $215.9 million, primarily attributable to global retail store sales growth. Comp sales slightly declined in the quarter. Comp sales increased in Asia Pacific and Europe but were offset by a decrease in North America due to a decline in mall traffic. Comparable sales were relatively flat in watches and jewelry with a slight decline in leathers.

Share Buyback Update

During the third quarter, Fossil bought back 1.3 million shares at a total cost of $133.8 million. As of Oct 4, 2014, Fossil had $175 million left under its present share repurchase plan.

In addition, on Nov 10, 2014, Fossil’s board authorized a new $1 billion share repurchase program, which will expire in Dec 2018.

Renewed License with Michael Kors

During the quarter, Fossil announced that it has renewed its global licensing agreement with Michael Kors through 2024. Fossil and Michael Kors have come a long way together since the brands first inked an agreement in 2004, whereby Fossil would design, develop and distribute watches under the Michael Kors label. The relationship expanded to encompass jewelry in 2010 and the two companies are currently collaborating to expand the men's watch business.

The renewal of partnership will further bolster the Michael Kors brand and the extensive line of watches and jewelry and enable the companies to explore other opportunities in the accessories category.

Fourth-Quarter 2014 Guidance

For the fourth-quarter of 2014, Fossil expects earnings in the range of $2.91 - $3.21 per share, higher than $2.68 per share reported last year. The Zacks Consensus Estimate for the fourth quarter was pegged at $3.12 per share, which falls toward the higher end of the company’s expectation.

The company expects sales to increase approximately 3% to 6%, which includes currency headwinds of 250 bps. The net sales growth guidance is however much lower than the prior year quarter’s sales growth of 12.1%. The company expects operating margin in the range of 19.8% to 21.3% for the fourth quarter, as against 20.6% margin in the fourth quarter of 2013.

2014 Guidance

Fossil has raised the lower end of its earnings guidance for 2014. The company now expects earnings in the range of $7.00 – $7.30 per share compared with the prior expectation of $6.95 – $7.35 per share. The company had raised its earnings guidance for 2014 last quarter. The current guidance marks an increase of 6.7% to 11.3% from $6.56 per share reported in 2013. The Zacks Consensus Estimate for the year 2014 is pegged at $7.14 per share, which falls within the company’s expected range.

However, the guidance for sales and margins slightly reduced for 2014. Fossil expects sales growth in the range of 8.5% to 9.5% versus the prior expectation of 8.75% to 10% growth for 2014. Operating margin is likely to be in the range of 15.8% - 16.4% in 2014 versus the prior expectation of 16.2% - 17%.

We believe that though lower outstanding share count owing to share buybacks will continue to support earnings, a sluggish leather business and higher operating expenses might diminish the impact of higher sales coming from a solid portfolio of watches.

Fossil carries a Zacks Rank #3 (Hold).

Other Stocks to Consider

Some better-ranked diversified retail wholesalers worth considering include Citi Trends Inc. (CTRN) and L Brands, Inc. (LB), both holding a Zacks Rank #2 (Buy).

Read the Full Research Report on FOSL
Read the Full Research Report on CTRN
Read the Full Research Report on KORS
Read the Full Research Report on LB


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