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Fossil (FOSL) Stock Up on Q2 Earnings Beat, Watch Sales Drop

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Fossil Group Inc. (FOSL - Free Report) released second-quarter 2018 results yesterday after the closing bell, with earnings beating the Zacks Consensus Estimate for the fifth straight time and improving year over year. Consequently, shares of the company gained 4.4% during yesterday’s after-market trading session.

However, the top line declined from the year-ago quarter’s figure, thanks to dismal traditional watch sales. Also, sales in the leather and jewelry categories failed to impress.

Nonetheless, the company’s expanding wearables portfolio and focus on the improvement of traditional watch business is encouraging. These endeavors have also helped this Zacks Rank #3 (Hold) company’s shares to surged 46.8% in the past three months compared with the industry’s 9.5% growth.



Q2 in Detail

Fossil delivered adjusted earnings of 17 cents per share, which fared better than the Zacks Consensus Estimate as well as the year-ago period’s loss of 48 cents. Earnings in this quarter include a gain of about 13 cents from favorable currency movements.

Net sales of $576.6 million in the second quarter beat the Zacks Consensus Estimate of $571.2 million. However, the top line declined 3.4% from the prior-year quarter’s tally, primarily due to sluggishness in the company's traditional watch portfolio. On a constant-currency basis, sales tumbled 6% during the quarter, with soft watch sales across Americas and Europe, partly offset by an increase in Asia.

Underlying weakness in the company’s traditional watch category across all geographies along with soft leather and jewelry business marred the top-line performance.

Moreover, global retail comps were flat year over year, as positive comps in the watch category were offset by sluggishness in the leather and jewelry businesses. Further, comps decline in Europe and Asia more than offset the same in the Americas.

Nevertheless, connected watch sales remained robust, surging 91% year over year. Fossil progressed quite well in the digital space, as e-commerce sales surged 25% in the quarter.

Moving on, gross profit increased 2.6% to $309 million. Gross margin expanded 310 basis points (bps) to 53.6%, courtesy of favorable currency fluctuations, margin enhancement efforts stemming from the New World Fossil initiative, lower markdowns and promotional discounts. These were partly negated by greater sales mix of low-margin connected products, increased off-price sales volumes and unfavorable factory cost absorption.

The company posted an operating income of $1 million, which improved significantly from the year-ago quarter’s figure of a loss of $429.8 million, owing to lower operating expenses and enhanced gross margins. These upsides were offset by lower sales.

Fossil Group, Inc. Price, Consensus and EPS Surprise

Performance Based on Business Categories

Category-wise, sales in the watches segment declined 1.4% (down 4% on constant-currency basis) to $463 million in the quarter. Sales in the jewelry and leather businesses also fell 2.4% (down 5% on constant-currency basis) to $67.9 million and 25.3% (down 29% on constant-currency basis) to $33.1 million, respectively.

Region-Wise Performance

Region wise, sales dropped 3% (on a constant currency basis) in the Americas to $279 million, mainly driven by weak sales in the United States. Also, the region witnessed sales decline in all three product categories, thanks to soft wholesale channels and store closures. Nevertheless, higher sales of connected watches offered some respite.

Sales fell almost 10% in Europe (down 15% on a constant-currency basis) to $176 million. The downside was mainly caused by weak sales in France and Germany as well as moderate sales declines in Eurozone, distributor markets in Eastern Europe as well as Middle East. Sales were soft across all three product categories.

Net sales from Asia grew 7% (up 5% on a constant-currency basis) to $122 million owing to strength across all sales channels. Sales growth was witnessed in India, China, South Korea and Hong Kong, countered by dismal performance in Japan as well as in the distributor markets.

Other Updates

At the end of the quarter, the company had cash and cash equivalents of $241.8 million, long-term debt of $268.4 million and shareholders’ equity of $516.8 million. Additionally, the company incurred capital expenditures of $2 million and made debt payments of $67 million. Capital expenditures are anticipated to be roughly $25 million in 2018.

Fossil operated 497 stores as of Jun 30, 2018, including 241 full priced accessory stores, 10 full priced multi-brand stores and 246 outlet stores. Out of all Fossil stores, 221 are located in America while 178 and 98 are located in Europe and Asia, respectively.

Outlook

Management is focused on strategic initiatives directed toward accelerating business transformation and positioning Fossil for long-term growth. Also, the company is on track with its goals of achieving growth through innovation in the connected and traditional watches portfolio. Further, the company continues to stay focused on increasing digital capabilities to drive e-commerce as well as achieving cost reductions and efficiencies through the ongoing New World Fossil plan.

However, negative impacts stemming from store closures, termination of licensing agreements and business exists are likely to dent top line in 2018. Evidently Fossil Group expects net sales to decline in the range of 10-6% compared with a decline in the range of 12-5% projected earlier.

Nonetheless, the company expects gross margin in the range of 51-52% for 2018, reflecting an expansion of 250-350 bps from the year-ago figure, on the back of New World Fossil plan, greater connected margins and favorable currency. Operating margin is envisioned in a range of 1-3%, up from the previous range of 0.5-4.5%.

For third-quarter 2018, the company expects net sales to decline in the range of 16-10%, considering the negative impacts of business exits of approximately 6% and unfavorable currency movements of 1%. Further, for the fourth quarter, management projects net sales to decline in the range of 14-8%, including unfavorable currency impacts of 1% as well as negative impacts from business exits of close to 5%. Gross margin for both the third and fourth quarters is predicted in the range of 50-52%.

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