Fossil Retro Timer

Fossil's new Retro Timer watch. Source: Fossil

Shares of watchmaker Fossil (NASDAQ:FOSL) gained 9% on Tuesday after the company reported sales and earnings that beat Wall Street's expectations. Coming off a rather lackluster summer, Fossil could be finding its groove just in time for the holiday rush.

Fossil's core product categories -- watches and jewelry -- posted healthy growth in the previously lackluster North American market. Meanwhile, gross profit margins contracted slightly year over year, but not enough to dampen the effect of higher sales. Analysts were expecting $879 million in sales and $1.82 in earnings per share for the quarter. Fossil jumped over these two hurdles handily:

Metric 

Q3 2014

YOY Variance

Sales

 $894 million

10%

Net income

 $103.7 million

15.6%

EPS

 $1.96

24%

­­Source: Fossil's Q3 2014 press release and author's calculations.

In a volatile retail environment, Fossil's built some momentum heading into the all-important holiday season. At the same time, management discussed two key relationships that show this company's investing for long-term growth -- a good sign for Foolish shareholders.

The highs and lows of Fossil's report
First, let's delve into the recent results a bit more. If we look back to the second quarter, there were a couple of weak spots in Fossil's earnings. North American sales were sluggish and profit margins declined significantly versus the prior-year period. Fossil was able to make headway in addressing these two issues in the third quarter:

  • North American wholesale increased 6% year over year, improving on the second quarter's 2% increase.
  • Operating margins fell 10 basis points, from 17.4% in the year prior to 17.3%, but this was a much smaller decline compared with the 410-basis-point drop in the second quarter of this year.

On the conference call, management noted that growth would be tough to come by in the American market, simply because of Fossil's large established presence and the fact that retail foot traffic has been sluggish for many fashion-centric outlets.

To counter this challenge, Fossil's investing "a small amount of money" into its omnichannel efforts -- online plus bricks-and-mortar -- and believes this will be the emphasis going forward. Marketing costs will increase but could potentially pay off in higher revenue.

The rest of the regions and sales channels performed well, on the whole:

  • Europe wholesale net sales jumped 15%.
  • Asia-Pacific wholesale net sales rose 11%.
  • Direct-to-consumer net sales increased 11%, driven by new retail stores and growth in Europe and Asia, which offset a decline in North America.

One of the soft spots was China, which grew by double digits but is expanding slower than expected because of a "softening retail environment" and some growing pains as Fossil builds out its infrastructure to broaden its footprint in that country.

What's around the corner
Looking to the fourth quarter, management expects sales growth of 3% to 6%, including a negative-250-basis-point (2.5%) growth rate impact because of the effects of currency translation. On the bottom line, management expects earnings per share to come in between $2.91 and $3.21 for the final quarter of 2014. That would imply year-over-year earnings growth of somewhere between 8% and 17%.

Finally, management elaborated on a couple of recent positive announcements that will boost Fossil's presence in wearable computing and high-end fashion. First off, the company is working with Intel to develop what have come to be known as "smart" or "connected" watches and accessories. Management suggested that products along these lines could come to market in the next year.

In the high-fashion space, Fossil announced on Tuesday that it has renewed its licensing agreement with Michael Kors for watches and jewelry for 10 years. Michael Kors continues to bolster Fossil's sales internationally, particularly in the jewelry segment. In addition, Fossil launched its Tory Burch collection during the quarter, introducing a new line of products that management noted "is doing very well."

Where does Fossil go from here?
It will take some more strong results to consider this a trend for Fossil, but overall the company seems to be well positioned even in a challenging retail market. Fossil continues to leverage its reputation as a watchmaker to make inroads in jewelry and accessories, particularly in international markets that offer much greater potential for growth than the United States. Further, the combination of its brand with other strong brands such as Tory Burch, Michael Kors, Google, and Intel should attract fanfare abroad.

After a rough start in 2014, Fossil rebounded nicely in the third quarter. The outlook's not too shabby, either, but the next few months will tell us a lot more about what this company's made of. 

Isaac Pino, CPA, has no position in any stocks mentioned. The Motley Fool recommends Apple, Fossil, Google (A and C shares), Intel, and Michael Kors Holdings and owns shares of Apple, Google (A and C shares), Intel, and Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.