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Fossil Beats on Q1 Earnings; Provides Weak Q2 View

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Fossil Group Inc. (FOSL - Free Report) started the year 2014 on a strong note with its first quarter earnings exceeding both the Zacks Consensus Estimate as well as the company’s expectations. Revenue growth was at the higher end of the company’s expectations and managed to beat the consensus mark by a slight margin. Though first quarter results were strong, the company provided a weak guidance for the second quarter.  

This global consumer fashion accessories maker and distributor reported first-quarter 2014 earnings of $1.22 per share, which beat the Zacks Consensus Estimate of $1.19 per share by 2.5% and surpassed management’s guidance range of 99 cents to $1.07 per share. Earnings also increased 10.9% year over year from $1.10 per share, which excludes a benefit of 11 cents related to the acquisition of the company's Spanish joint venture.

Higher revenues, increased operating income and lower share count boosted earnings in the quarter.

Quarter in Detail

Fossil’s net sales during the quarter increased 14% year over year to $776.5 million, marginally beating the Zacks Consensus Estimate of $776 million, reflecting sales growth in each of the company's wholesale segments and direct to consumer segment. The year-over-year increase was at the higher end of management’s expectation of approximately 12.5% to 14.0% growth.

Revenues increased on the back of continued growth in the watch portfolio, driven by Fossil and Skagen brands. A comparatively weaker U.S. dollar contributed $1.4 million to the company’s sales in the reported quarter. On a constant currency basis, net sales increased 13.8% in the quarter.

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 12.8% to $582 million in the first quarter. This sales increase was driven by 17% growth in the multi-brand global watch portfolio. The Fossil and Skagen brands grew modestly by 5% and 2%, respectively, while sales of jewelry increased significantly in the quarter. Sales of leather products declined slightly as the category remained highly competitive and promotional in the wholesale channel.

Gross margin increased 150 basis points (bps) to 57.1% driven by a favorable distribution mix owing to growth in international markets, greater sales of higher margin products, prior year acquisition of distributors in Latin America and Spain as well as improvements in freight and other costs. These benefits were partially offset by higher promotional activity associated with the leather business.

Operating margin however declined 40 bps to 13.5% due to higher operating expenses in the quarter, led by expansion of retail stores and concession base, infrastructure investments and higher advertising royalties. However, operating margins exceeded management’s expectation of 12.5% to 13.0%.

Segment Details

Net sales from the North American wholesale segment increased 7.5% year over year on a constant currency basis to $274.3 million, primarily driven by double-digit growth in watches and jewelry partially offset by a decline in sales of leather products. Wholesale shipments increased in the United States, while those to Mexico and Canada declined in the quarter.

Net sales in Europe grew 14.5% year over year on a constant currency basis to $199.1 million, driven by double-digit increases in watch and jewelry categories, partially offset by a decline in leather. Strong performance in United Kingdom, France and the Middle East boosted sales of the European region during the quarter.

Net sales in the Asia-Pacific segment increased 23.6% on a constant currency basis to $107.3 million, driven by double-digit increases in the company’s watches, partially offset by a decline in leathers. Almost every market contributed to sales, with China, India, Korea and Japan contributing significantly.

Net sales in Direct-to-Consumer segment grew 18% year over year on a constant currency basis to $194.4 million, primarily attributable to global retail store sales growth, partially offset by a 2.4% decrease in same store sales. Comp sales declined in North America due to a decline in mall traffic. Same store sales of jewelry were strongest in the quarter. Watches however posted a slight decline and leathers performed below the company's overall same store sales result.

Other Financial Updates

During the first quarter, Fossil bought back 1.0 million shares at a total cost of $117.0 million. As of Apr 5, 2014, Fossil had $376 million left under its present share repurchase plan.

During the quarter, the company closed 1 store, bringing the company-owned store count to 542 at quarter end.

Weak Second Quarter 2014 Guidance

For the second-quarter 2014, Fossil expects sales to increase approximately 8.0% to 9.5%, lower than the prior year sales growth of 11.4%. The company expects earnings in the range of 90 cents to 97 cents per share, lower than $1.15 per share reported last year. The company expects operating margin in the range of 10.5% to 11.0% for the second quarter, much lower than 15.1% margin in the second quarter 2013.

We believe that a highly volatile retail environment in the U.S. and a sluggish leathers business led to the soft forecast for the second quarter on a year-over-year basis.

2014 Guidance

Fossil continues to expect 2014 earnings in the range of $6.90 – $7.30 per share, up 5.2% to 11.3% from $6.56 in full year 2013. Fossil expects sales to increase in the range of 8.0% to 10% in full year 2014. Operating margin is likely to be in the range of 16.5% to 17.0% in 2014.

Fossil carries a Zacks Rank #3 (Hold).

Other Stocks to Consider

Other better-ranked diversified retail wholesalers worth considering include Citi Trends Inc. , Foot Locker Inc (FL - Free Report) and Genesco Inc (GCO - Free Report) . While Citi Trends sports a Zacks Rank #1 (Strong Buy), Foot Locker and Genesco hold a Zacks Rank #2 (Buy).

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