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FOSL: 1Q12 Report Card

Conclusion: FOSL results this morning are the latest to reflect slowing demand out of Europe, but are also one of the more bearish we’ve seen quarter-to-date. While FOSL is considered a fringe player in luxury accessories at best, lackluster jewelry sales were highlighted as a key drag on European wholesale putting other luxury players on notice. This is inconsistent with continued strength through Q1 out of mainstream European luxury brands (Hermes, PPR, Burberrry, etc.), but noteworthy nonetheless. 


What Drove the Miss?

Although FOSL reported a head line beat ($0.93 vs. $0.92E), adjusted 1Q12 EPS was actually $0.84 after accounting for a $0.09 discreet tax benefit. As such, the miss was due primarily to the top line growing only 10% vs. +15E with Europe (27% of sales) accounting for 3pts of FOSL’s 5pt top-line shortfall. While performance in France and the UK were strong in Q1, Germany was flat with Spain & Italy down double digits resulting in total European wholesale revenues +1% vs. +12E. It’s worth noting that Europe is also FOSL’s most profitable region (see table below). Although Inventory growth improved sequentially down 4 points to +27%, the slowing top line drove the SIGMA further into the danger zone. Despite management pointing to trends in Germany improving slightly in April, 9 weeks remain in Q2 and continued weakness in Spain and Italy resulted in management reducing expectations in Europe to +LSD-MSD growth in F12 from the prior low to mid teen outlook. With GM and SG&A assumptions largely unchanged, full year organic EPS expectations (ex Skagen) are now $5.23-$5.33, down $0.17 vs. prior $5.40-$5.50. FOSL expects Skagen to add a net $0.07 to earnings in 2012.  


FOSL: 1Q12 Report Card - FOSL EBIT


FOSL: 1Q12 Report Card - FOSL SIGMA


Deltas in Forward Looking Commentary?


In order to properly measure performance relative to original expectations, we look at management’s 2012 guidance headed into the quarter as well as the key deltas in Q1 results vs. expectations. Comments in red reflect any changes to future outlook:



First Quarter Guidance:

  • Revenue expected to grow 15% (slightly higher constant currency) MISS: Revenues came in +10% vs +15E with shortcomings in Europe (+1% vs +12E) contributing 3 points to the 5 points top line growth miss
  • 1Q12 EPS expected to be $0.90-$0.92 MISS: Although headline EPS was $0.93 vs $0.92E,  adjusted for the $0.09 tax benefit, EPS was $0.84 vs. $0.92   

Full Year Guidance:

  • EPS $5.40-$5.50 (ex Skagen) REDUCED: now $5.23 to $5.33 ex Skagen (FOSL guided to $5.30-5.40 incl $0.07 net benefit from Skagen)
  • Revenues: +15% (constant currency higher, ex Skagen) REDUCED: organic growth expected to be +11% overall (guided to +16% with 5% contribution from Skagen) driven primarily by softness in Europe
  • Europe Revenues: +low to mid teens REDUCED: now LSD-MSD
  • Gross margin to be slightly below last year’s 56.1% UNCHANGED
  • Expecting FX to impact GM most severely in Q2 & Q3 UNCHANGED
  • Expect slight Operating expense deleverage UNCHANGED
  • Expect to open 70-75 stores with equal distribution in the US and International UNCHANGED
  • Plan to close ~18 stores INCREASED: Planning 18 closures in addition to 5 in 1Q12
  • Focus on opening accessory stores, outlet stores and watch station stores UNCHANGED
  • Currently committed to 49 locations in 2012 with 21 signed leases ON TRACK: 65 lease commitments to date


Highlights from the Call:


Revenues: +10%

Fossil Brand watches +11%

Handbags +9%

  • Missed some business due to lack of spring color in watch/accessory offering

Jewelry comp'd negative due to repositioning especially in Europe

Eyewear negative resulting from pullback on distribution to US Dept stores and frames biz in Europe


Segment Performance

Direct to Consumer: +18% (+18.7% ex FX)

  • Comps: +8%
  • Asia Comp +18%
  • North America comp +11%
  • Europe comp (-5%) driven largely by repositioning of jewelry where Europe is the most penetrated in that business

 North America Wholesale: +9%

  • Watches: +14%
  • Men's Leather: +14%
  • Partially offset by decline in women's leather & eyewear

 Asia-Pacific Wholesale: +20% (+18.8% ex FX)

  • China drove growth +57%
  • Korea +14%
  • Japan: soft economic conditions resulted in 6% decline in shipments- significant opportunity remains to increase concessions in Japan
  • Overall concession comps (-1%) due to 6% comp decline in Korea

 Europe Wholesale: +1% (+4.7% ex FX)

  • UK: DD Growth
  • Softness in Germany and continued weakening environment in Italy & Spain

Overall Watch Business: +14% Globally

  • Fossil +11%
  • Licensed watches +20% (Michael Kors +48%, Marc by Marc Jacobs +67%, Armani Exchange +46%, Diesel +23%, Burberry +14%)

Overall Leather Business: +14.9% (+15.8% ex FX)


Overall Jewelry Business: (-7.1%) (-4.8% ex FX)

  • KORS added $4mm to jewelry which was offset by Fossil Jewelry decline

 Overall Eyewear Business: (-26.8%) (-25.6% ex FX)


Gross Margin: -40 bps

  • Principally driven by an increase in the cost of factory labor and certain watch components and a higher percentage of sales to third-party distributors
  • Foreign currency rate changes negatively impacted gross profit margin by approximately 20 basis points for the quarter
  • Partially offset by the sales mix of higher margin watch products, direct consumer sales in Asia Pacific wholesale sales in comparison with Q1 last year.


  • $120mm in sales in 2011
  • OM just above 17%
  • Currently 13 locations globally

Capex: $18mm in Q1

  • Expect full year Capex of $120mm

Real Estate:

  • Ended Q1 with 398 stores (190 outside North America) @ 700K square feet
  • Opened 5 in 1Q12
  • 65 lease commitments to date
  • Remain on track to opening 70-75 new stores (outlet & accessory concept, splits between US/overseas)
  • Closed 5 stores in Q1, planning additional 18 for remainder of the year
  • Targeting to end the year with ~280 concessions based on an additional 65-70 through the remainder of this year




  • Revenues to increase 16%, +19% ex FX
  • Skagen expected to benefit sales growth by 6% in 2Q
  • 2Q EPS (including Skagen) expect to be $0.77-$0.79
  • Skagen expected to deliver $0.03 in operational earnings however costs related to the transition are expected to negatively impact EPS by $0.07
  • Stronger U.S. dollar is negatively impacting Q2 earnings by about $0.02

Full year

  • Revenues of +16%, +18% excluding FX
  • Skagen expected to contribute 5% to overall growth
  • Expect GM to be slightly below 56.1% achieved last year
  • Ex Skagen, expecting slight deleverage of operating expenses for the full year
  • Expect full year tax rate of 32% for the balance of the year
  • Diluted EPS expect to be $5.30-$5.40 (including Skagan)
  • Skagen expected to deliver $0.22 in operational activities with a $0.15 impact from transaction related costs
  • Stronger U.S. dollar is negatively impacting Q2 earnings by about $0.02 and the full year by $0.07.
  • Expect Fossil brand sales to deliver double digit growth for remainder of the year driven by new jewelry offering, strong watch & accessory momentum and expanded retail/concession store base

Miscellaneous Full year Commentary

  • Michael Kors Jewelry launch going well and expected to reach $30mm in sales this year
  • Expect more than 25% growth from Asia for the remainder of the year driven by multi-brand watch sale growth
  • Europe guidance reduced to +LSD-MSD from Low-mid teens
  • FX will have biggest impact in Q2 and Q3
  • FX will be partially offset by higher sales mix from Asia wholesale and DTC in additional to select price increases
  • Expect full year Capex of $120mm





Jewelry Repositioning:

  • Previously offered 2 Jewelry assortments (US & Europe)- now consolidating into 1 global assortment
  • Greatest impact in Europe bc European sales mix more penetrated in Jewelry vs. other segments

US Business:

  • 1Q is the smallest quarter of the year
  • Retail sales of watches and Fossil brand continue to be strong in the US
  • Expect to continue to gain US market share- still a big runway for opportunity
  • Most of the wholesale business in department stores where sell through statistics are in line with inventory- no imbalance in terms of performance at retail
  • Seeing US continue to grow at HSD rate, North America slight better given 20%-30% growth in Canada/Mexico
  • Kors does not seem to be cannibalizing in the US, just growing the business


  • Korean concession comps -6%
  • Believe Korean operational potential to be huge long term
  • China comps +17.3%
  • Japan comps +18% (18 Fossil stores)
  • Refining Japan wholesale business
  • Transitioning Japan to be more concession based
  • Expecting Asia to increase 25% for the year with additional concessions being added in
  • Continue to see the opportunity to double the size of the business over 5-6 years


  • Strong growth in both UK and France
  • Germany was flattish
  • Italy and Spain were down DD
  • Expect LSD-MSD growth ex Skagen for the full year in Europe
  • Have seen slight improvements in Europe in April though still 9 weeks to go
  • Still seeing weakness in Italy and Spain but Germany has recovered slightly with similar results in the rest of the countries in that market
  • Planning an increased number of store/concession openings


  • Missed Q1 sales expectations by $35mm which resulted in $10mm-$12mm in inventory cost at Q end
  • Component inventories +40% creating $5-$6mm in inventory addition
  • Continue to open outlet stores to clear inventory going forward
  • Skagen inventories: preparing to increase the amount of quantities to the rest of the year in both the US and internationally

JC Penney:

  • Have seen no change in strategy on that the RELIC business would be going forward
  • Expecting business as usual in that environment


  • Planning on launching first quarter 2013
  • Working on product development
  • Price points similar to Michael Kors
  • Seeing a lot of interest in Asia and Europe

Store Opening Plan:

  • Opened net just over 30 in 2011
  • Quarterly cadence expected to be similar to last year
  • Expecting a ramp in openings in the back half


  • Effected price increases on new and certain core items March 1st (on going)
  • Looking to bring back some opening price points in various categories


Here are some thoughts on the PENN deal to acquire the Harrah’s property in St. Louis



We are moderately positive on the transaction:

  • Accretive:  With goodwill accounting and low borrowing rates, EPS accretion ain’t what it used to be.  However, we calculate about $0.20 in annual EPS accretion from the deal.
  • Deferred Capex:  This situation could be worse considering it is a Caesar’s property.  We think they will need to spend about $50MM over the first few quarters on new slots, renovating the casino, rebranding, and a new IT system.  Rooms and restaurants are in pretty good shape.
  • Multiple looks ok:  The EBITDA multiple looks to be 7.4x – not a steal but not bad.
  • Is it better than buying stock? – Not right away since PENN’s multiple is lower (after Ohio opens) but probably over the long term.  PENN still needs to add a Strip property to get the cross marketing benefits of a big regional property like this.  Given the cash accretion, either option is a positive relative to status quo.
  • Total Rewards:  This is a big wildcard.  It is unclear how much the most effective loyalty program out there has contributed to EBITDA and how much goes away without it.  History is on the side of a huge impact but there are a few mitigating factors:  the closest CZR property is 120 miles away, there are marketing restrictions put in place, and the St. Louis market is well-established.  An additional negative:  would existing St. Louis customers prefer to cash in rewards benefits at Wynn (from PNK), MGM’s Strip properties (from ASCA), or PENN (M Resort)?
  • Cost Savings?  Not really a lot here although we would expect to see less promotional activity.  With rational competitors ASCA and PNK in the market, there could be some savings.




Stock vs. Asset acquisition

  • The acquisition is structured as a purchase of all the stock in the Harrah's St. Louis subsidiary.  Contrary to an asset acquisition, this allows them to step into their shoes on day one.  However, since both parties agreed, the IRS allows Penn to treat the acquisition as an asset sale, which means that they can depreciate roughly $428MM of the purchase price over 15 years, which results in a $10MM/ annual tax shield.  Penn estimates that the present value of this tax shield is worth $79MM.


  • In terms of slots, the 300 slots that are leased at the property will be replaced immediately since those are costly and then roughly 200 more will get replaced in short order
  • Penn will also reduce the number of games on participation
  • After replacing 500 slots off the bat, PENN will likely replace about 1/7th of the slots annually on a go-forward basis, which is in-line with their normal replacement cycle of 7-8 years


  • The Maryland Heights property’s margins are in the 29% range.  PENN believes that there is an opportunity to improve margins by a few hundred basis points over the course of a few years by removing costly slot leases,  lowering the participation percentage, hiring cheaper on-site property management in the fields of accounting, marketing, etc where Harrah’s used a centralized system and then allocated costs to the property, and optimizing marketing spend. 
  • Margin improvement will take some time to materialize since they need to get their new systems, marketing tools, and people in place.  PENN pointed to ASCA’s 37% property margin as an example of being able to achieve better than 29% margins.  However, comparisons to ASCA’s 37% are not apples to apples, since ASCA allocates less overhead to the property level than most companies.

Deal Closing

  • PENN hasn’t even gotten in front of the regulators yet.  They are already licensed in the state so that should make it faster.  Late 3Q/early 4Q is probably doable.  


In preparation for MPEL's FQ1 2012 earnings release Wednesday morning, we’ve put together the recent pertinent forward looking company commentary.




  • "We are optimistic regarding GGR growth for 2012, particularly in relation to the highly profitable mass market segment, which continues to be strong, as evident in the increased visitations and strong mass table growth rate."
  • "Total deprecation and amortization expense is expected to be approximately $90 million to $95 million, corporate expense is expected to come in at $18 million to $20 million and net interest expense is expected to be approximately $25 million to $30 million."
  • "In the future, couple of months, we have put in place a program to improving, expand our VIP gaming facilities in COD, and we should be able to add another three junket operators in next three months time."
  • "As a policy, and it has served us very well over the last few years, we do not intend to compete on price or credit in the rolling chip segment."
  • "I think our hypothesis for a 15%, 20% growth in the gross gaming revenue overall in the market for this year is based on around 8% GDP growth. So we are pretty comfortable with the budget that we had set last year and with the current trading rate in Macau."
  • "We have to really yield up our table productivity.  We allocate quite a lot of tables in Altira because of the history of Altira. Per table productivity, compared to COD or Cotai standard, it's a little bit low."
  • "We're hopeful and optimistic that we can stick by the schedule that we had previously guided and so the next official announcement from us regarding Studio City as the designs are all done now would be a restart of construction."
  • "Based on our current cash balances and future expected cash flow, we do not envisage a requirement to raise equity capital for Studio City."
  • "I think you will start to see mass represent a larger and larger part of our mix of EBITDA."

LIZ: Top Long

LIZ remains one of our top longs for 2012. As such, with Trade support broken, we view this morning’s drawdown as a buying opportunity as the stock nears its intermediate term TREND support of $11.58 based on Keith’s quantitative levels.


As a reminder, while LIZ’s 1Q12 earnings came in light, top line strength exceeded expectations with April-to-date comps suggesting an acceleration in underlying demand at Kate Spade and Lucky. In addition, with FOSL results out this morning suggesting accelerated weakness in European jewelry sales, we remind investors that while LIZ has nearly 20% of sales generated in international markets, less than half of that is derived in Europe. No change to our thesis here- LIZ remains on track to double in 2012.


See our 4/26 note "LIZ: On Track to Double Again" for additional detail on our thesis and thoughts headed out of the quarter. 


LIZ: Top Long - LIZ TTT

Oversold, but Bearish: SP500 Levels, Refreshed

POSITIONS: Long Healthcare (XLV), Short Industrials (XLI)


Our call for Growth Slowing is finally morphing its way into consensus expectations. Not clear why it took so long (Global Growth Slowing has been plainly obvious in the Global Macro data since March), but most things in life aren’t crystal clear until we see them in the rear-view.


The other big thing going on out there is that the US Dollar is having its 5th consecutive up day. That drives The Correlation Risk which, in turn, drives a stiff Deflating of The Inflation (Gold, Oil, Copper, etc). When Growth Slows AND Commodities Deflate, “cheap” mining and energy stocks get cheaper, fast.


All of this is obviously good, in the end, for the 71% of America that matters to GDP – Consumption. So my long-term TAIL of 1281 in the SP500 should hold, provided that we keep Bernanke’s iQe4 upgrade of oil prices out of the way.


In terms of the lines, across risk management durations, that matter most: 

  1. Immediate-term TRADE resistance = 1388
  2. Intermediate-term TREND resistance = 1365
  3. Long-term TAIL support = 1281 

In other words, once we snapped my 1388 and 1365 TRADE and TREND lines, the market snapped. Don’t freak-out down here though. Let people who didn’t prepare for this do that. Unless we crash, there’s an immediate-term TRADE line of support at 1349 that should hold today and the mean reversion bounce back up toward 1364 could happen very quickly.


Trade this aggressively from a net exposure perspective. Keep your gross exposures low.



Keith R. McCullough
Chief Executive Officer


Oversold, but Bearish: SP500 Levels, Refreshed - SPX


McDonald’s reported a global comparable sales rise of 3.3% in April, which represented a slowdown from March on a two-year average basis.  Four weeks ago, management told us that it expected global comps to come in at 4%.  The 3.3% print suggests that the last ten days of the month fell below management expectations.


MCD SALES SLOWING - mcd global1


This was a disappointing number for McDonald’s.  The Hedgeye Macro Team’s “Global Growth Slowing” theme is being confirmed by this April number as the U.S. and APMEA missed expectations.  This disappointment is driving the stock lower.  Given the significant calendar adjustment, the underlying trends may not be quite as significant as the headline numbers suggest but clearly these numbers are calling for a resetting of investor expectations; McDonald’s is unlikely to astound the investment community with its same-store sales numbers this summer.  We still see McDonald’s as the QSR leader in the U.S. but, even in that position of power, the company is having difficulty maintaining its traffic trends.


With inflation pressuring margins, particularly in the United States, and 3% of price flowing through the P&L, sales trends are taking on a higher degree of importance for investors.  We are looking for management to offer some more definite guidance on how it will comp the comps this summer. 



United States


U.S. comparable sales rose 3.3% in April versus +4.8% consensus as the company had its first full month of the Extra Value Menu.  With price running at 3%, traffic trends are weak in McDonald’s domestic business.  The calendar impact (one less Friday and one less Saturday than April 2011) seems to have dressed down the headline numbers but we remain concerned about whether the company can comp the comps this summer.  As we wrote on 4/23: “The evidence suggests that beverages are increasingly becoming a less important part of the vocabulary from McDonald’s’ management team.  With that in mind, foremost in our thoughts is what the company’s strategy will be to maintain top-line momentum over the next few months.”







Europe exceeded analyst expectations in April, coming in at 3.5% versus +3.2% consensus.  Macro continues to be the most important factor in Europe.  Europe represents 40% of total revenues and 39% of total operating profit for McDonald’s.   While the print exceeded expectations, the two-year average did decline and continuing turmoil in Europe remains a business risk for the company.







Positive results in China were offset by negative comps in Japan as APMEA reported 1.1% same-store sales versus 1.9% consensus.  Much of McDonald’s long-term growth hinges on its APMEA division but, in the near-term, we expect the company’s fortunes in U.S. and Europe to dictate the stock’s performance.


MCD SALES SLOWING - mcd apmea 1



Howard Penney

Managing Director


Rory Green



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