Fossil Retained at Neutral

We are maintaining our Neutral recommendation on Fossil, Inc. (FOSL - Analyst Report) following appraisal of its second quarter 2012 results.

Fossil posted earnings of 93 cents per share in the second quarter exceeding the prior-year earnings by 16.3%, driven by double-digit sales growth in all the geographic regions. The results also exceeded the Zacks Consensus Estimate by 19.2% and were above management’s guidance of 77–79 cents per share.

Net sales during the quarter increased 14.3% to $636.1 million, beating the Zacks Consensus Estimate of $634 million. The year-on-year increase was aided by a 23.2% jump in worldwide sales of watches and gains from the Skagen acquisition. On an organic basis, excluding sales related to Skagen-branded products, revenue increased 13.5%, reflecting 17.1% growth in all major watch brands and 8.2% sales growth in the leather business.

The company has a wide portfolio, which includes recognized brand names such as Adidas, Armani Exchange, Burberry, Diesel, DKNY, Emporio Armani, Marc by Marc Jacobs, Michele, Michael Kors, Relic and Zodiac. The company has regularly extended its product categories with the introduction of jewelry collections under some of its brands. Apart from that, it has also introduced soft accessories under its Fossil brand name.

Fossil has significant exposure to international markets, which has been driving its long-term growth. The recent acquisition of privately-held Nevada-based Skagen Designs, Ltd. and certain subsidiaries in August 2012 has helped Fossil to expand its brands in the European markets and other emerging markets of East Asia, where Skagen has significant presence.

Despite robust watch sales, Fossil experienced a rise in costs of watch components and labor costs resulting in weak gross margins. Increasing currency headwinds also negatively impacted sales and gross margins in the quarter. In addition, an uncertain economic environment in Europe might pose a threat to the expanding brands in European markets.

Further, a difficult macro-economic environment, reflected in interest rate hikes, credit availability, unemployment levels, and high household debt levels is expected to continue in the rest of 2012. The company remains exposed to unfavorable foreign currency translations and faces the risk of import restrictions such as antidumping or countervailing duties, and tariffs or other restrictions due to international transactions. The weak economy and rising costs keep us on the sidelines.