Fossil (FOSL) Q2 Loss Narrower Than Expected, Stock Down

Fossil Group Inc. (NASDAQ:FOSL) reported narrower-than-expected loss in the second quarter of fiscal 2017, while sales lagged the Zacks Consensus Estimate. Shares plummeted 21.9% in after-hours trading on Aug 8, as the watchmaker gave a bleaker outlook and slashed its earnings, sales and operating income guidance in response to weak results. Adding to the upheaval, the company’s Chief Financial Officer Dennis Secor also announced its resignation due to personal reasons.

Adjusted loss of 23 cents per share was narrower than the Zacks Consensus Loss Estimate of 28 cents. However, it was unfavorable from the last year’s earnings of 9 cents per share, largely due to decline in top line, lower gross margin and currency headwinds.

Fossil Group, Inc. Price, Consensus and EPS Surprise

Fossil Group, Inc. Price, Consensus and EPS Surprise | Fossil Group, Inc. Quote

Quarter in Detail

This global consumer fashion accessories maker’s net sales of $596.8 million in the second quarter lagged the Zacks Consensus Estimate of $619 million by 3.6%. We note that the company has lagged the Zacks Consensus Estimate in nine out of the last 11 straight quarters, including the current one. Though connected watches helped in growing the company’s sales, overall net sales decreased 13% from the prior-year quarter, primarily due to a decline in the company's multi-brand licensed watch portfolio and challenging environment for the traditional watch category. The decline in sales was wider than the 8–11.5% decline expected by the management. Declines in leather and jewelry business as well as unfavorable currency also led to the decline. Category-wise, watches declined 9.3% in the quarter, while jewelry and leather business declined 22% and 25.3%, respectively. Notably the sales of leathers have persistently been weak as customer response to the assortment continues to put pressure on results. On the other hand, wearables represented roughly 9% of the total sales in the second quarter, a sequential improvement from the 7% in the first quarter.

Excluding $8.3 million adverse impact from currency, sales declined 12% in the quarter. Region-wise, sales declined 16% in Americas, 7% in Europe, and 8% in Asia, on a constant currency basis.

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. Moreover, the watch industry has become highly competitive and the company is facing competition from Apple (NASDAQ:AAPL) and other technology companies. Though Fossil has been expanding into smartwatches and wearable devices, the efforts are yet to turnaround results.

Global retail comps, including e-Commerce, dropped 11% year over year during the quarter with declines in all product categories and in all regions. Positive comps in Asia were more than offset by declines in Europe and the Americas.

Despite margin improvement initiatives and higher mix of international sales, gross margin declined 180 basis points (bps) to 50.5% due to lower retail margins, higher promotional activity, primarily in the outlet stores and higher mix of lower-margin connected product and unfavorable currency.

In the quarter, the Richardson, Texas-based company reported operating loss margin of 1.4%, compared with operating margin of 2.3% in the year-ago quarter, primarily due to lower sales and gross margin, currency headwinds, despite lower operating expenses.

We note that Fossil has been delivering sluggish results for a long time now. If we analyse the last six months’ performance of the company, we note that Fossil’s shares have declined 48.3% as compared with the industry, which has declined around 21.0% in the said time frame. On the other hand, the broader Retail and Wholesale sector has gained 12.5% in the last six months. Notably, the industry is part of the bottom 37% of the Zacks Classified industries (166 out of the 265).

Other Financial Update

At the end of the second quarter, the company had cash and cash equivalents of $319.8 million and long-term debt of $613.6 million and shareholders’ equity of $654.8 million.

Outlook

For 2017, Fossil expects net sales to decline in the range of 4.5–8.5%, more than the previous range of down 1.5–6.0%. The company also expects adjusted operating margin in the range of 2.0–3.5%, unfavorable than the previously anticipated adjusted operating margin range of 3.0–4.5%. Further, it projects 2017 adjusted earnings in the range of 35 cents to $1.15 per share, as compared with previously expected band of 80 cents–$1.50. In fact, the company posted adjusted earnings of $1.80 in fiscal 2016. The Zacks Consensus Estimate for fiscal 2017 is currently pegged at 93 cents per share that is within the company’s guided range.

For the third-quarter of fiscal 2017, Fossil expects loss of 26 cents to earnings of 7 cents per share and adjusted operating margin in a range of 1.2–2.0%. The company expects net sales to decline in the range of 8.0–14.0%.

Fossil continues to expect a challenging retail environment and pressure on the traditional watch category to persist. Currency will also continue to remain a headwind in 2017. Nevertheless, as demand for technology in wrist wear is increasingly rising among consumers, this Zacks Rank #1 (Strong Buy) company expects to capitalize the demand for wearables through a significant number of new products expected to launch in September and continue through the holiday season. The company has also connected celebrities with the wearable brands to reintroduce customers to the Fossil brand. The company expects to increase its marketing spending by over 40% in fiscal 2017 on wearables in order to build awareness for the new functionality available in these fashion-first technology accessories. Furthermore, it is on track to double the SKU count to nearly 300 this year and will add five more brands including DKNY, Marc Jacobs, MICHELE, Relic and Tory Burch, joining the already nine brands in its wearables platform. In fact, the company remains confident that wearables have the ability to help mitigate the ongoing softness in the traditional watch category.

Moving ahead, Fossil continues to focus on the New World Fossil restructuring program along with growth in the company’s core watch business and product expansion. This restructuring initiative is likely to create a better operating platform that will cater to its customers efficiently in a tough retail landscape. Owing to the efforts, the company expects to deliver roughly 40% of the program's overall $200 million profit improvement in 2017 results.

The company is also making efforts to relocate its resources to drive growth. As a result, the company is looking for store closures to drive savings this year and will remain focused to exit underperforming locations, primarily through natural lease expirations. For fiscal 2017, the company expects to close nearly 50 stores in addition to the 50 stores closed last year.

Other Key Picks

Some other top-ranked stocks in the apparel industry include The Children’s Place, Inc. (NASDAQ:PLCE) , Canada Goose Holdings Inc. (NYSE:GOOS) and The Gap, Inc. (NYSE:GPS) . All the stocks carry a Zacks Rank #2 (Buy). You can seethe complete list of today’s Zacks #1 Rank stocks here.

While The Children’s Place has an expected long-term earnings growth of 8.0%, Canada Goose and Gap have an expected earnings growth of 47.0% and 8.0%, respectively, for the next three to five years.

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