Fossil Group Inc.’s (FOSL) second quarter 2014 earnings of 98 cents per share beat the Zacks Consensus Estimate of 96 cents by 2.1% and exceeded the company’s guided range of 90-97 cents per share.
However, earnings declined significantly from the prior-year earnings of $1.15 per share as planned increases in operating expenses more than offset the benefit of higher sales and lower share count.
Quarter in Detail
This global consumer fashion accessories maker reported net sales of $773.8 million and managed to beat the Zacks Consensus Estimate of $773 million by a slight margin. Net sales increased 10% from the prior-year sales results and also exceeded the company’s guided growth range of 8%-9.5%, reflecting sales growth across all geographies, notably in Europe and Asia.
This sales increase was driven by 12% growth in the multi-brand global watch portfolio, driven by the Fossil and Skagen brands. The company also witnessed 19% gain in jewelry, which made up for the sales decline in the leather business, which still remains highly competitive and promotional in the wholesale channel.
A comparatively weaker U.S. dollar contributed $11.3 million to the company’s sales in the reported quarter. On a constant currency basis, net sales increased 8% in the quarter.
Gross margin declined 40 basis points (bps) to 57.5% due to unfavorable product mix, which partially offset the favorable distribution mix owing to growth in international markets.
Interest expenses increased in the quarter. Moreover, operating expenses as a percentage of revenue increased 370 basis points to 46.5%, as the company spent heavily on the expansion of retail stores, infrastructure investments, marketing displays and advertising royalties.
Operating margin therefore declined significantly by 410 bps to 11%. Operating margins were at the higher end of management’s expectation of 10.5% to 11%.
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 9% to $573.3 million in the second quarter, with increases in all wholesale segments.
Net sales from the North American wholesale segment increased 2% year over year on a constant currency basis to $265.2 million, primarily driven by growth in watches and jewelry partially offset by a decline in sales of leather products. Wholesale shipments increased in the United States in the quarter.
Net sales in Europe grew 13% year over year on a constant currency basis to $202.4 million, driven by double-digit increases in watch and jewelry categories, partially offset by a decline in leather. Strong performance in the United Kingdom and Middle East boosted sales of the European region during the quarter.
Net sales in the Asia-Pacific segment increased 9% on a constant currency basis to $105.7 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 India, Taiwan and Japan contributing significantly. However, the jewelry business declined in this region.
Net sales in Direct-to-Consumer segment grew 11% year over year on a constant currency basis to $200.5 million, primarily attributable to global retail store sales growth, which made up for flat same store sales growth. Comp sales increased in Asia Pacific and Europe offset by a decrease in North America, due to a decline in mall traffic. Same store sales of jewelry were strongest in the quarter. The leather business improved slightly, while watches posted in-line results compared with the company's overall same store sales result.
Other Financial Update
During the second quarter, Fossil bought back 0.6 million shares at a total cost of $67.3 million. As of Jul 5, 2014, Fossil had $309 million left under its present share repurchase plan.
On Aug 12, Fossil also extended its global watch licensing agreement with Giorgio Armani S.p.A through 2023. The Armani Group is a leading fashion and luxury goods group and first collaborated with Fossil in 1997 to design, develop and distribute watches under the Emporio Armani label.
Third Quarter 2014 Guidance
For the third-quarter of 2014, Fossil expects earnings in the range of $1.77 - $1.84 per share, higher than $1.58 per share reported last year. The Zacks Consensus Estimate for the third quarter is pegged at $1.83 per share, which falls at the higher end of the company’s expectation.
The company expects sales to increase approximately 7.5% to 9%, much lower than the prior year sales growth of 18.4%. The company expects operating margin in the range of 16.7% to 17.2% for the third quarter, lower than 17.4% margin in the third quarter of 2013.
We believe that the company will continue to face a volatile retail environment in the near term. Also, the sluggish leather business is expected to remain a headwind.
Fossil continues to expect 2014 earnings in the range of $6.95 – $7.35 per share, up from the prior expectation of $6.90 - $7.30 per share. This also marks an increase of 5.9% to 12% from $6.56 per share reported in 2013. Fossil expects sales growth in the range of 8.75% to 10%, versus prior expectation of 8% to 10% growth for 2014. Operating margin is likely to be in the range of 16.2% - 17% in 2014 versus the prior expectation of 16.5% - 17%.
We believe that though lower outstanding share count owing to share buyback will continue to support earnings, higher operating expenses will diminish the impact of higher sales coming from a solid portfolio of watches.
Fossil carries a Zacks Rank #4 (Sell).
Other Stocks to Consider
Some better-ranked diversified retail wholesalers worth considering include Citi Trends Inc. (CTRN), Mens Wearhouse Inc. (MW) and Buckle Inc. (BKE). While Citi Trends and Mens Wearhouse sport a Zacks Rank #1 (Strong Buy), Buckle Inc holds a Zacks Rank #2 (Buy).