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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.

Skagen:

  • $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

Guidance:

2Q12

  • 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

Q&A:

 

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

Asia:

  • 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

Europe:

  • 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

Inventories:

  • 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

Lagerfield:

  • 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

Pricing:

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