Fossil Beats, Slashes Guidance

Zacks

Fossil Inc. (FOSL) reported first quarter 2012 earnings of 93 cents per share, which exceeded both the year-ago earnings of 86 cents and the Zacks Consensus Estimate of 92 cents per share. The results in the quarter also outperformed management’s guidance of 90-92 cents per share.

The earnings in the quarter was benefited by the foreign currency gains and due to a favorable increase related to a lower outstanding share count as a result of the company's ongoing stock repurchase program.

Revenue Details

Worldwide net sales of Fossil during the quarter grew 9.8% to $589.5 million. However, sales lagged the Zacks Consensus Revenue Estimate of $618 million. The company also missed the management’s expectations of a 15% growth in sales in the quarter.

The increase from the prior year quarter reflects double-digit sales growth across all of the company's operating segments. On a constant currency basis, sales increased 11.1%, reflecting strong double-digit sales growth of 13.7% in all major watch brands and a growth of 15.8% in the leather business.

However, the company suffered from a 25.6% decline in eyewear sales and a 4.8% decrease in the company's jewelry category. Net sales of Fossil branded products also expanded 5.4% in the first quarter of 2012.

Segment Sales

Net sales from the North America wholesale segment increased 9.3% on a constant currency basis, primarily driven by increase in the watch and jewelry sales volumes, partially offset by a decline in eyewear sales. Further, the company experienced sales growth in U.S. and in the company's subsidiaries in Canada and Mexico. Shipments to third party distributors, located primarily in South America also contributed to the sales growth in the quarter.

Wholesale net sales in Europe grew 4.7% year over year on a constant currency basis, on the back of increases in watch shipments and in the leather business. Sales to third party distributors contributed to the sales growth, whereas the repositioning of the Fossil branded jewelry business negatively impacted the jewelry sales volumes.

Net wholesale sales in the Asia-Pacific segment increased 18.8% on a constant currency basis, driven by increases in the company’s watch and leather sales.

Direct-to-Consumer segment net sales grew 18.7% year over year on a constant currency basis, primarily due to profits in the comparable store sales and an increase in the average number of company-owned stores in the quarter. The company’s e-commerce business also gained momentum in the quarter.

Margins

Fossil’s gross margin in the quarter contracted 40 basis points (bps) to 55.8% in the reported quarter. The downswing in gross profit margin was partially driven by increase in factory labor and certain component costs and a higher sales percentage to third party distributors, offset by increases in the sales mix of higher margin watch products, Direct to consumer sales and Asia Pacific wholesale sales. Foreign currency changes also resulted in the decline in margins by 20 bps.

Operating margin also declined 310 bps to 14.1% in the first quarter 2012 on the back of a decrease in gross profit margin and operating expense leverage.

Other Financial Update

The company had cash, cash equivalents and securities of $260.7 million at the end of March 31, 2012 as compared to $287.7 million at the end of December 31, 2011.

The company repurchased approximately 2.4 million shares for $235.6 million of its common stock in the first quarter, under the company's $750 million buyback authorization announced in August 2010. With this, the company has completed the repurchase of approximately 6.8 million of shares worth 509.4 million under the authorization, till date.

Guidance

For the second quarter of 2012, Fossil expects net sales to increase approximately 16%. On a constant currency basis, the company expects net sales to increase 19% in the next quarter. The sales increase estimate includes 6% sales growth from the acquisition of Nevada-based Skagen Designs, Ltd. which was acquired in February.

For the second quarter of 2012, Fossil expects earnings in the range of 77 – 79 cents per share, including Skagen. Skagen will benefit the company with earnings of 3 cents per share, while it will negatively impact with the transaction-related costs of approximately 7 cents in the second quarter.

For fiscal year 2012, the company expects net sales to increase approximately 16%. On a constant currency basis, net sales will increase approximately 18%, including the 5% sales contribution from the acquisition of Skagen.

For fiscal year 2012, Fossil expects earnings per share in a range of $5.30 to $5.40, lower than the previous guidance of $5.40 - $5.50 per share. Including in the current earnings guidance is the earnings per share benefit of 22 cents related to Skagen operational activities, partially offset by transaction and other transition costs of 15 cents per share.

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) and difficult macroeconomic conditions in Europe are matters of concern.

Nevertheless, we are encouraged by the continued strength in watch sales and the integration of Skagen Designs, Ltd., which is expected to drive sales and earnings in 2012.

The company currently retains a Zacks #2 Rank (short-term Buy rating) on Fossil shares. On a long-term basis, we provide a Neutral recommendation on the stock.

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