Fossil Group Inc. (FOSL - Free Report) delivered better-than-expected earnings in the third quarter of fiscal 2016. However, its sales marginally lagged the Zacks Consensus Estimate. Shares were down 4% after market close on Nov 3, after the company narrowed its fiscal 2016 outlook due to economic, competitive and consumer headwinds.
In the third quarter of fiscal 2016, Fossil reported adjusted earnings of 42 cents per share, which exclude 16 cents per share benefit from real estate transactions, offset by 22 cents per share restructuring charge, primarily associated with accelerated store closings.
The bottom line surpassed the Zacks Consensus Estimate of 30 cents by 40% but plunged 66.1% from the prior-year adjusted figure of $1.24 per share due to a decline in sales and operating income and higher tax rate. Adverse currency movements lowered third-quarter earnings by 15 cents.
Quarter in Detail
This global consumer fashion accessories maker’s net sales of $738.0 million in the third quarter marginally lagged the Zacks Consensus Estimate of $739.7 million. Net sales decreased 4% from the prior-year quarter, primarily due to currency headwinds, a decline in the company's multi-brand licensed watch portfolio and challenging environment for the traditional watch category. The sales decline was in line with the company’s expectation of a 2%−6% decline. Adverse currency movements had a negative impact of $3.9 million on third-quarter sales.
Despite a challenging and a disruptive environment, Fossil and Skagen brands both grew during the quarter. The wearables product category also had a steady stream of customers which drove growth.
On a constant currency basis, net sales declined 4%. Sales declined, on a constant currency basis, in the two regions of Americas and Europe. Sales gained in Asia. Category wise, the company witnessed declines in watches, leather and jewelry business.
Total watch business declined 2% in constant dollars compared to last year, marking a sequential improvement from the 9% decline in the second quarter, a change in trajectory driven by the latest wearables launches with even more launches to follow in the fourth quarter.
Of late, Fossil has been witnessing general weakness in the watches category. The company noticed that tech-enabled watches have been significantly affecting traditional watch sales. The company benefited from newer brands such as kate spade new york and Tory Burch during the quarter. While overall launches declined in the quarter, the sequential trend improved significantly with the expanding wearables offering. The company continues to expect weakness in this category.
Jewelry and leathers declined 9% and 11%, respectively, during the quarter with the performance in leathers largely due to a weaker customer response to the new fall assortment.
Global retail comps dropped 3% year over year during the quarter with declines in all product categories. Positive comps in Asia were more than offset by flat comps in Europe and a decline in the Americas.
Gross margin declined 200 basis points (bps) to 52.2% due to unfavorable currency impact and higher promotional activity, primarily in the outlet stores, higher mix of lower-margin product and a higher level of off-price sales.
Moreover, operating margin declined to 4.2% in the quarter, down 460 bps from 9.5% in the year-ago period, primarily due to lower sales and gross margin, currency headwinds and higher operating expenses driven by an increase in expenses associated with Misfit and wearables infrastructure.
Other Financial Update
At the end of the third quarter, the company had roughly $236 million in cash compared to $302 million last year, and debt of $723 million compared to $807 million a year ago. Third-quarter ending inventory was $700 million, down 6% from last year with a significant double-digit reduction in traditional watch inventory, offset by inventory growth in connected accessories as the company prepares for the holiday selling season.
During the third quarter, the company commenced a multi-year profit improvement initiative to reinvent Fossil Group designed to strengthen its foundation for the future and support long-term sales growth and profitability objectives. The company estimates that the plan can achieve annualized operating profit improvements in excess of $200 million over current levels. It anticipates that the plan will result in restructuring charges of up to $150 million to be recorded predominantly in 2017 and 2018, with some charges recognized in 2016.
In the reported quarter, the company recorded $15 million in restructuring charges, primarily asset impairment charges related to plans to close underperforming stores.
For the fourth-quarter of fiscal 2016, Fossil expects adjusted earnings in the range of $1.07 to $1.57 per share. This excludes 38 cents of charges related to the Misfit acquisition.
The company expects net sales in a range of down 2% to up 4%, bearing a roughly 80 bps negative impact from currency headwind. Operating margin is estimated in a range of 8.5% to 11.0% for the fourth quarter, which excludes 260 bps from Misfit acquisition expenses.
The company expects fourth-quarter gross margins to be down from last year due to higher impact of wearables mix, which currently deliver lower margins than traditional watches.
2016 Guidance Updated
Fossil continues to expect a challenging retail environment and pressure on the traditional watch category to persist.
The company now expects adjusted earnings in a range of $1.80–$2.30 per share for 2016 compared with $1.80–$2.65 expected earlier. Sales are now expected to decline in the range of 3% to 5%, compared with the previous guidance of a 1.5% to 5% fall. Operating margin is now estimated in the range of 5%−6.0%, narrower than the previous guidance of 5%−6.5%.
The company expects full-year gross margin to decline compared to last year, given the weaker currencies, greater reliance on off-price channels and promotions, and the impact from wearables, which carry slightly lower margins. These will more than offset the favorable benefits from international mix and margin improvement initiative.
Nevertheless, the company continues to focus on reducing overhead and infrastructure expenses to improve the profitability of its core business.
Fossil carries a Zacks Rank #2 (Buy).
Stocks to Consider
Some well-ranked stocks in the retail/apparel sector are American Eagle Outfitters, Inc. (AEO - Free Report) , Boot Barn Holdings, Inc. (BOOT - Free Report) and Tilly’s, Inc. (TLYS - Free Report) .
Tilly’s sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
American Eagle and Boot Barn hold the same Zacks Rank as that of Fossil.
While Tilly’s carries an expected long-term earnings growth of 15.5%, American Eagle and Boot Barn have an expected earnings growth of 11.8% and 14.5%, respectively, for the next three to five years.
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