Fossil's (FOSL) Q2 Loss Narrower Than Expected, Sales Beat

Fossil Group, Inc. (NASDAQ:FOSL) released second-quarter 2019 results, wherein both top and bottom lines surpassed the Zacks Consensus Estimate. However, sales declined year over year. Results were hurt by store closures, a decline in off-price and liquidation sales, and licensed brand exits.

Moreover, management issued a muted sales outlook for 2019, as it expects currency headwinds and business exits to impede results. The company expects net sales to decline in the third quarter as well.

We note that in the past six months, Fossil’s stock has tumbled 34.6% compared with the industry’s decline of 24.7%.

Nevertheless, sales grew sequentially with solid performance across all regions. Sturdy sales in Asia were driven by China and India. The Fossil brand witnessed robust growth and Emporio Armani retained its solid run. Moreover, the company reported global e-commerce sales growth.

Q2 in Detail

Fossil reported an adjusted loss of 4 cents per share against adjusted earnings of 17 cents in the prior-year quarter. However, the figure was narrower than the Zacks Consensus Estimate of a loss of 7 cents. The bottom line was negatively impacted by 6 cents due to adverse currency fluctuations. However, lower interest expenses provided some cushion to the bottom line.

Worldwide net sales of $501 million surpassed the Zacks Consensus Estimate of $496 million. Overall net sales declined about 13% from the prior-year quarter, primarily due to dismal sales in the company’s watches segment in the Americas and Europe. Nevertheless, the company’s sales increased in Asia. Currency negatively impacted net sales by $14 million.

On a constant-currency (cc) basis, worldwide net sales decreased 11% year over year. Sales were down in Europe, with the U.K. declining the most. Distributor markets performance in Eastern Europe, the Middle East and Germany was also poor.

Global retail comps declined 4%, owing to softness across all categories and geographies. Sluggishness in retail stores more than offset strong e-commerce comps.

Fossil’s gross margin contracted 70 basis points (bps) to 52.9%, courtesy of foreign-currency headwinds, negative impact from factory cost absorption and royalty expenses related to lower sales volumes. On the flip side, favorable region and product mix from advanced margin Asia sales stemming from the company’s New World Fossil (“NWF”) plan and reduced off-price sales mix were positives.

The company posted an operating income of $1.7 million compared with $1 million in the year-ago period. The improvement was due to lower operating expenses. This was somewhat negated by lower sales and adverse currency impacts. The company also stated that the figure was at the higher end of its expectations.

Performance Based on Business Categories

Category-wise, sales in the watches segment declined 11% to $413 million in the quarter. Sales in the jewelry and leather businesses also fell 23% to $53 million and 37% to $21 million, respectively. Sales in Other business came in at $14 million.

Region-Wise Performance

Region-wise, sales dropped approximately 20% in the Americas to $223 million, mainly due to reduced sales in off-price channels.

Sales declined around 16% in Europe to $147 million. The downside was mainly caused by weak Eurozone sales and softness in Eastern Europe and the Middle East distributor markets. Germany and the U.K. witnessed maximum downsides.

Net sales from Asia increased 11% to $126 million as improvements in China and India continued. These apart, sales in Hong Kong were also a major driver. Emporio Armani traditional watches recorded double-digit growth. Further, Fossil watches witnessed decent growth, with increased sales in both the connected and traditional watch categories.

Other Updates

At the end of the quarter, the company had cash and cash equivalents of $226.6 million, long-term debt of $162 million and shareholders’ equity of $539.6 million. Additionally, it expects to incur capital expenditures of nearly $30 million in 2019.

The company operated 456 stores as of Jun 30, 2019, including 223 full-priced accessory, 7 full-priced multi-brand and 246 outlet stores. Out of all Fossil stores, 202 are located in the Americas, while 165 and 89 are located in Europe and Asia, respectively.

Fossil Group, Inc. Price, Consensus and EPS Surprise

Outlook

This Zacks Rank #3 (Hold) company anticipates top-line challenges to continue due to store closures and business exits. However, it expects this impact to gradually decrease in the second half of 2019.

Fossil is committed toward transforming its business model to keep pace with consumers’ changing preferences. Also, it is on track with the New World Fossil 2.0 - Transform to Grow initiative that will help enhance efficiencies across the company. This along with solid free cash flow will provide the company with an opportunity to reinvest in innovation and digital initiatives.

Management is also committed toward leveraging opportunities in the connected watch space, stabilizing sales of its traditional and connected watches along with jewelry and leather. All said, Fossil is focused on expanding market share in the growing global watch space.

2019 Guidance

For 2019, Fossil expects net sales to decline 8-12%. This includes negative impacts of 2.5% and 2% stemming from business exits and currency movements, respectively.

The company now expects gross margin to be 52-53% compared with the previous guidance of 52-53.5%. Operating margin is now anticipated to be 2.5-3.5% compared with the prior view of 1.5-3.0%. Interest expenses are still projected to be roughly $31 million.

Q3 & Q4 Forecasts

The guidance includes strengthening of the dollar. For third-quarter 2019, the company expects net sales to decline 6-13%, considering the negative impacts of approximately 2.5% from business exits and around 1.8% due to unfavorable currency movements. Gross margin is predicted to be 52-54%. Interest expenses are expected to be roughly $8 million.

For fourth-quarter 2019, the company expects net sales to be down 5% to up 1%, considering the negative impacts of approximately 1.8% from business exits and around 1% due to unfavorable currency movements. Gross margin is predicted to be 50-53%. Interest expenses are expected to be roughly $8 million.

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