Fosl Watches
Image: Fossil.

In the fashion industry, trends can change in a heartbeat, and what seems to be the most popular products can go out of style so quickly that a shareholder hardly has time to react. Watch and accessories maker Fossil Group (NASDAQ:FOSL) has had to deal with the ups and downs of the fashion industry lately, with its stock taking a hit on concerns about the entry of competitors' smartwatches into its key segment and general macroeconomic headwinds weighing on upscale fashion. Coming into its second-quarter financial report, Fossil investors were already expecting a slight drop in sales and earnings, but they wanted to see some signs of future recovery. Fossil's results were actually quite a bit better than many anticipated on the bottom line, but troubling guidance for the remainder of the year led to an after-hours sell-off that took the shares to new five-year lows. Let's look more closely at how Fossil Group did during the quarter and why investors are worried.

Fossil makes the most of a tough situation
Fossil Group's second-quarter results were a mixed bag for investors. Revenue sank more than 4% to $740 million, which was about $10 million less than the consensus forecast among those following the stock. Yet net income defied expectations for a substantial drop, instead climbing 4% to $54.6 million and working out to $1.12 per share, topping estimates by $0.30.

Looking more closely at Fossil Group's results, a couple of major factors had a big influence on the numbers. First, comparable store sales growth of 2% helped the company keep its overall revenue up despite downward pressure from foreign currency weakness. Yet more importantly, other income that came from net gains on foreign-currency contracts and from interest rate hedges came to $14.3 million, or about $0.29 per share. If you adjust Fossil's results to treat those gains as extraordinary one-time items, then the resulting adjusted earnings per share come a lot closer to merely matching the consensus forecast.

Most of the weakness in Fossil's sales came from its key watch segment, where sales declined nearly 6%. By contrast, leather product sales rose slightly, and revenue from jewelry and from Fossil's "Other" category inched down by less than 1% each. Geographically, Fossil did well in the Americas, with sales rising about 1.4%, but a double-digit percentage decline in European revenue and a sizable drop in business from its Asian segment combined to pull down the company's overall sales.

CEO Kosta Kartsotis highlighted Fossil's success in constant-currency terms, noting that "sales were strong for both Fossil and Skagen in all regions, with early indications that our demand creation initiatives are working." Kartsotis also pointed to branded jewelry as a high-growth opportunity, even as he expressed disappointment with its licensed-watch portfolio business."

Is Fossil winding down?
Looking forward, Kartsotis believes that Fossil is still on the right track. "We will continue to invest in our owned brands, create a greater consumer connection and enhance our digital capabilities, while driving our category leadership with our world-class portfolio of licensed brands," Kartsotis said, and with new products coming out this fall, Fossil Group is excited about its future prospects.

Investors, though, weren't so happy about Fossil's expectations for the immediate future. The watchmaker's guidance included projections for third-quarter revenue to fall between 10%-15%, with earnings of between $1.03-$1.28 per share, both of which were worse than what most investors expected to see. For the full fiscal year, sales declines of 4%-8% and earnings of $4.80-$5.60 per share similarly undershot the consensus forecasts for Fossil's results. Although Fossil has higher hopes for its results when adjusted for currency fluctuations, the news nevertheless came as an unwelcome surprise for those hoping for a quicker recovery.

In response to the poor news, Fossil Group shares fell sharply, with the stock losing almost 6% of its value in the first half-hour of after-market trading following the announcement. There's no disputing that Fossil has put together an impressive collection of owned and licensed luxury brands for its products. What remains to be seen, though, is whether Fossil can take full advantage of its opportunities at the same time that it seeks to open up new growth prospects and move back to its winning ways.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Fossil. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.