Fossil Lags but Ups 2011 Estimates

Fossil Inc. (FOSL - Analyst Report) reported third-quarter 2011 adjusted earnings of $1.00 per share, which was in-line with the year-ago adjusted earnings. However, it lagged the Zacks Consensus Estimate by 3 cents.

Adjusted earnings in the reported quarter exclude a gain related to foreign currency of 9 cents per share. On a reported basis, earnings exceeded the prior-year results by 2.1% to $1.09 per share.

Fossil’s profits were driven by double-digit sales growth across its major brands, product categories, and geographies, and a double-digit comparable store sales increase. Furthermore, continuous innovation in the assortments, implementation of growth strategies and efficient utilization of the global distribution infrastructure led to solid performance in the quarter.

For the fourth quarter of 2011, Fossil has reduced its earnings guidance to a range of $1.75 to $1.78 per share, owing to strengthening of dollar over the last quarter. The previous guidance was in the range of $1.78 to $1.82 for the fourth quarter 2011. However, the strong third quarter 2011 earnings led to the increased of the company’s full-year 2011 guidance in a range of $4.50 to $4.53 from $4.44 to $4.50 expected previously.

Revenue Details

Worldwide net sales of Fossil during the quarter grew 22.7% to $642.9 million, exceeding the Zacks Consensus Revenue Estimate of $640.0 million, reflecting sales growth in the company's watch and leather product categories.

On a constant currency basis, all major watch brands reported strong double-digit sales growth of 20.3%, whereas the leathers business sales climbed 21.8% in the wholesale and retail segments in the third quarter 2011.

Net sales of FOSSIL branded products also expanded by 13.7%.

For the fourth quarter 2011, the company expects its net sales to increase approximately 20% with constant dollar net sales increasing by approximately 19%.

Segment Sales

Net sales from the North America wholesale segment increased 15.8% to $240.6 million, primarily driven by increase in the watch sales and leathers business. Further, wholesale shipments to U.S. and to third party distributors serving the South American market and shipments from the company’s Canadian and Mexican subsidiaries, also contributed to the sales growth in the quarter.

European wholesale net sales grew 30.1% year over year to $178.3 million, as all the major watch brands experienced sales volume gains in all the key markets. The leather businesses also gained in the quarter as the company continues to expand its retail stores and launch new websites in Europe to continue to build awareness for the FOSSIL brand. Jewelry product shipments and sales to third party distributors also contributed in the sales growth.

Net sales in the Asia-Pacific wholesale segment increased 44.2% to $210.7 million driven by increases in the company’s watch sales.

Direct-to-Consumer segment net sales grew 23.0% year over year to $145.4 million, primarily due to gains in the constant dollar comparable store sales and an increase in the average number of company-owned stores open in the quarter. The company’s e-commerce Business segment revenues remained unchanged in the quarter.

Margins

Fossil’s gross margin in the quarter contracted 110 basis points (bps) to 55.9% in the reported quarter. The downswing in gross profit margin was largely due to increased production costs. Moreover, a higher percentage of lower margin sales to third party distributors and off-price retailers adversely impacted the gross profit margin.

Fossil expects its production costs to remain stable over the remainder of fiscal year 2011. However, the stronger U.S. dollar is expected to negatively impact the company’s previous expectations regarding fourth quarter 2011 gross profit margins.

On the other side, the company expects the increased sales mix of higher margin international wholesale sales and direct to consumer sales along with price increases across selected number of styles during the fourth quarter 2011 to partially offset the impact of the strengthening U.S. dollar. However, the company still expects its fourth quarter 2011 gross profit margin to be slightly less than the comparable prior year period.

Operating margin also declined 270 bps to 18.5% in the third quarter 2011 on the back of an increase in infrastructure spending and gross profit margin declines.

Other Financial Update

The company had cash, cash equivalents and securities of $239.6 million at the end of third quarter 2011 compared with $371.6 million at the end of the prior year period. Fossil also had $14.9 million of debt at the end of the reported quarter.

Inventory was $511.7 million in the quarter, up 31.8% from $388.3 million at the end of the prior third quarter. Fossil expects inventory increases to be in-line with the fourth quarter sales increases.

Accounts receivable increased by 5.8% to $273.3 million at the end of the reported quarter compared with $258.4 million at the end of the prior-year quarter, primarily due to an increase in wholesale shipments. Days sales outstanding for the wholesale segment was 49 days in comparison to 57 days in the prior-year quarter.

Till the end of the third quarter 2011 results, Fossil had invested approximately $383.6 million to repurchase approximately 5.4 million shares of its common stock under the company’s $750 million buyback authorization in August of 2010.

Recommendation

We are encouraged by Fossil’s in-house team of dedicated designers and product specialists who help steer the company ahead by following emerging lifestyle and fashion trends to bring innovative and unique products to its customers. However, stiff competition from Guess? Inc. (GES - Analyst Report) and difficult macroeconomic conditions are matters of concern.

The company currently retains a Zacks #3 Rank on Fossil shares, which translates into a short-term Hold rating. On a long-term basis, we provide a Neutral recommendation on the stock.

Read the full analyst report on FOSL