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Wearables Drives Fossil (FOSL) in Q4 Earnings, Stock up 80%

Zacks

Fossil Group Inc. FOSL saw its shares soar as much as 80% during yesterday’s after-market trading session following the company’s fourth-quarter 2017 results. Notably, both the top and bottom line came ahead of the Zacks Consensus Estimate and comparable store sales (comps) also increased year over year. Sturdy e-commerce business and wearables sales remained major drivers, especially during the holiday season.

Fossil’s focus on expanding its wearables portfolio seems to be appeasing investors for a while now. Evidently, the company’s shares have gained 26.3% in the past three months, surpassing the industry’s 18.3% growth.



Q4 in Detail

Adjusted earnings came in at 64 cents per share, which beat the Zacks Consensus Estimate of 39 cents. However, the bottom line declined significantly from $1.21 reported in the year-ago period. The slump can be attributed to lower sales and margins.


Fossil Group, Inc. Price, Consensus and EPS Surprise

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

Including one-time items like tax and restructuring charges, the company reported a loss of $1.65, as against earnings of $1.03 reported in the year-ago period. We note that during the quarter, Fossil’s bottom-line growth gained 9 cents from favorable foreign currency movements.

Net sales of $921 million surpassed the Zacks Consensus Estimate of $890 million. Though connected watches boosted sales, overall net sales declined about 4% from the prior-year quarter, primarily due to sluggishness in the company's traditional watch portfolio. However, Fossil progressed quite well in the digital space, as its e-commerce sales surged 31% in the fourth quarter.

On a constant-currency basis, sales tumbled 7% during the quarter, with soft watch sales across all regions. Underlying weakness in the company’s leather and jewelry businesses across all geographies also marred the top-line performance during the quarter. Management stated that dismal results in United States, Eastern Europe, Middle East and most Asian countries (especially Japan) led to the weakness.

Global retail comps climbed 2% year over year, courtesy of positive comps in the watch category, which was partly countered by sluggish comps at leather and jewelry. Region-wise, Americas and Europe delivered favorable comps, whereas Asia remained disappointing.

Gross profit tumbled 8.4% to $448.1 million. Gross margin contracted 230 basis points (bps) to 48.7% due to greater sales mix of low-margin connected products and increased product valuation reserves. These downsides were partly compensated by favorable currency fluctuations; shift in mix toward international and e-commerce sales (with higher margins); margin enhancement efforts stemming from the New World Fossil initiative and reduced markdowns in wholesale channels.

Operating expenses declined 6.2% to $396.8 million, thanks to lower store costs owing to considerable store closures; a fall in regional overhead expenses and curtailed marketing costs. However, battered by soft sales and gross margin, operating income slumped 22.5% to $51.3 million, with the operating margin contracting 130 bps to 5.6%.

Performance Based on Business Categories

Category-wise, sales in the watches segment declined 3% (down 6% on constant-currency basis) to $728 million in the quarter. Sales at Jewelry and leather businesses also went down 6% (down 9% on constant-currency basis) to $108 million and 10% (down 14% on constant-currency basis) to $72 million, respectively.

Region-Wise Performance

Region wise, sales dropped 8% (down 9% on a constant currency basis) in the Americas to $442 million owing to sales decline in the United States and sluggish performance of traditional watches. This was marginally offset by sales growth in connected watches. The region also witnessed weakness in the leather and jewelry businesses.

Sales improved 1% in Europe (down 6% on a constant-currency basis) to $337 million. Constant-currency decline was mainly led by weakness in Eastern Europe and the Middle East, and a modest fall in Eurozone.

Net sales from Asia slipped 1% (down 3% on a constant-currency basis) to $142 million. Sales growth was mainly witnessed in India and China, countered by dismal performance from all other regions, particularly Japan.

Other Financial Updates

At the end of the quarter, the company had cash and cash equivalents of $231.2 million, long-term debt of $443.9 million and shareholders’ equity of $580.9 million.

Since the prior-year quarter, the company has undertaken several store closures. At the end of 2017, the company’s total store count was 544 compared with 585 stores in the year-ago period.

On Jan 29, Fossil entered into a Second Amended and Restated Credit Agreement, which is due and payable on Dec 31, 2020. The agreement offers revolving credit loans of $325 million (subject to certain borrowing conditions) and a term loan of $425 million.

2017 Overview

Adjusted earnings for fiscal 2017 came in at 5 cents a share, considerably down from $2.00 recorded in the year-ago period. This fares way better than the consensus mark of a loss of 73 cents. Net sales descended 8.3% to $2,788 million, with declines across all regions and categories. On a constant currency basis, sales fell 9% year over year. However, top line beat the Zacks Consensus Estimate of $2,758 million. Global retail comps for fiscal 2017 dipped 6% owing to declines across all regions.

During fiscal 2017, the company undertook various strategic initiatives directed toward speeding up business evolution and positioning Fossil for long-term growth. Although the company continued with soft sales and earnings, it remains well on track with its goals of boosting growth in its wearables portfolio; utilizing scale to curtail supply-chain expenses; increasing digital capacities and continuing with business transformation through the ongoing New World Fossil plan.

Progressing on these lines, Fossil almost doubled 2017 wearables sales to more than $300 million, which formed roughly 14% of total watch sales. Also, this helped the company witness a rise in Fossil brand watch sales in the second half of 2017, largely driven by positive comps in the company’s direct business during the holiday quarter. This in turn was backed by significant wearable launches ahead of the holiday season, which enhanced sales of watches of Michael Kors KORS and Armani. Notably, the company introduced several hybrid and display smartwatches across 14 brands during the year. Management believes that such efforts, along with constant focus on innovations in the traditional watch space places the company well for growth and stability in future.

Moreover, the Zacks Rank #3 (Hold) company’s wearable product costs were on par with margin goals toward 2017-end, making it hopeful of gross margin expansion in 2018. Fossil is also in line with its New World Fossil plan which helped it cut costs by $95 million in 2017, keeping it on track to achieve its profit improvement target of $200 million. All these factors, along with constant focus on improving handbag and jewelry sales and augmenting digital sales bodes well for 2018. However, management expects the retail environment in North America to remain challenged owing to changing consumer trends. Thus, the company expects its traditional watch category in the wholesale business to remain pressurized in 2018. Nevertheless, Fossil remains optimistic about enhancing bottom line by cutting cost through its New World Fossil plan and lowering sourcing expenses.

Outlook

All said, management issued its outlook for 2018. Fossil Group expects net sales to decline in the range of 14-6%. The company expects gross margin in a range of 51-53%, while operating margin is envisioned in a range of flat to 4%. Further, Fossil expects interest expense and restructuring charges of approximately $50 million each, and adjusted EBITDA in a band of $150 million to $200 million.

For first-quarter 2018, the company expects net sales to decrease in the range of 12-6%. Gross margin is anticipated in the range of 50-52%. Fossil expects restructuring charges of approximately $20 million, and adjusted EBITDA in a band of negative $15 million to $10 million.

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