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Shares of Fossil (FOSL) fell 10.5% in Tuesday's trading session. The designer, marketer and distributor of fashion and accessories, reported its third quarter results on Tuesday before the market open.

Third Quarter Results

Fossil reported third quarter revenues of $684.2 million, up 6.4% on the year. The acquisition of Skagen contributed $25.2 million in revenues during the quarter. Organic sales rose by 5.9% driven by strong sales of watches. Revenues fell short of analysts consensus of $713.1 million.

Gross profits rose 6.1% to $381.5 million, for a gross margin of 55.8% of net sales. Gross margins fell by 10 basis points on the year. Operating income fell by 4.8% to $113.1 million, to 16.5% of net sales.

Fossil reported a net income of $76.8 million, up 10.3% on the year. Diluted earnings per share rose 15.6% to $1.26 per diluted share. Adjusted earnings per share came in at $1.29, beating analysts consensus of $1.16 per share.

Fossil, which sells large brands including Diesel, DKNY, Emporio Armani and Michael Kors has repositioned its jewelry which underperformed during the quarter.

CFO Mike Kover commented on the results, "Double-digit growth in our direct to consumer business and Asia Pacific region, coupled with expense management and improved gross margin resulted in Third Quarter earnings surpassing our initial guidance. Incremental sales from our recently acquired SKAGEN® brand additionally helped fuel top line sales growth despite an overall challenging sales environment in Europe. In addition, we continued to experience double-digit increases in the sales of watches against a backdrop of sizeable growth over the last two years. "

Segmental Information

Wholesale sales increased by 3.5% to $515.1 million. Growth was driven by a 9.5% increase in global watch sales. Leather revenues increased by 0.9% on the year, offset by a decline of 9.8% in the jewelry business.

Growth was driven by a solid performance of the North American division, which reported a 5.6% increase in revenues to $254.0 million. The Asia-Pacific division reported a 24.2% increase in revenues to $97.6 million. The impact of a strong dollar and weak consumer spending resulted in a 8.3% drop in European revenues. Revenues in the continent fell to $163.5 million.

Direct to consumer sales rose by 16.3% to $169.1 million.

Investors are not too pleased with the performance of the European division. The fact that inventories rose by 15.1% to $589.0 million, which surpassed revenue growth, caused nerves among investors.

Outlook

For the fourth quarter of 2012, Fossil guides for net sales to increase by approximately 12%. Fossil previously guided for 16% revenue growth and attributes the slowdown to a slowing European wholesale business.

Diluted GAAP earnings per share are expected to increase by 21-22% to $2.26-$2.29 per share. The guidance is in line with analysts consensus of $2.27 per share.

For the full year of 2012, Fossil expects to report annual earnings per diluted share of $5.42-$5.45 on a GAAP basis.

Valuation

Fossil ended its third quarter with $143.0 million in cash, equivalents and securities available for sale. The company operates with $184.9 million in short and long term debt, for a net debt position of $41.9 million.

For the first nine months of 2012, Fossil generated revenues of $1.91 billion. Net income attributable to shareholders came in at $192.3 million, or $3.11 per diluted share. Full year revenues could come in around $2.9 billion. The company is on track to earn roughly $335 million, or $5.45 per share.

After Tuesday's 10% drop, shares are valued at roughly $5.1 billion. This values Fossil at 1.8 times annual revenues and roughly 15 times annual earnings.

Fossil does not pay a dividend at the moment.

Investment Thesis

Year to date, shares of Fossil are trading largely unchanged. Shares rose from $80 in January and hit highs of $140 in April. A disastrous profit send shares back to levels around $80, followed by new lows of $65 later this summer. Shares recovered to the mid-nineties in recent months, currently exchanging hands at $85 per share.

Shares rose from lows of $12 in the beginning of 2009 to a peak of $140 earlier this year. Between 2008 and 2012, Fossil increased annual revenues from $1.6 billion in 2008, to an estimated $2.9 billion this year. Earnings rose from $138 million in 2008 to an estimated $335 million this year.

Fossil bought Danish watch manufacturer Skagen earlier this year. The $232 million transaction added roughly $25.2 million in quarterly revenues.

I see few reasons to hold Fossil shares at the moment. Shares are valued at roughly 15 times earnings if the company maintains its high gross margins. I see few reasons for an acceleration in revenue growth, which could drive profits into 2013. I remain on the sidelines given the little appealing valuation and the lack of short term triggers.

Source: Fossil - Shares Are Falling On Continuous Worries About Europe