Business context and reporting period
Fossil Group, Inc. designs, markets and distributes watches, smartwatches and other fashion accessories through wholesale, company-operated retail and e-commerce channels. The supplied filing is a Form 10-K for the fiscal year ended December 29, 2018—not a 2017 Q4 filing, as the request metadata indicates. Fiscal 2018 had 53 weeks; fiscal 2017 had 52 weeks.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $2,541.5 million | $2,788.2 million |
| Gross profit / margin | $1,340.1 million / 52.7% | $1,358.8 million / 48.7% |
| Operating income (loss) | $62.7 million | $(424.3) million |
| Net income (loss) attributable to Fossil Group | $(3.5) million; $(0.07) diluted EPS | $(478.2) million; $(9.87) diluted EPS |
| Operating cash flow | $248.1 million | $179.5 million |
| Cash and cash equivalents at year-end | $403.4 million | $231.2 million |
| Working capital | $652.8 million | $781.9 million |
| Debt at year-end | $392.7 million net of issuance costs | $441.2 million |
Net sales fell 8.8% (9.6% in constant currency). Gross profit declined 1.4%, as the higher margin rate partly offset lower sales. Operating cash flow benefited from working-capital reductions, particularly a $153.4 million inventory decrease. Inventory ended the year at $377.6 million, down 34.2%; accounts receivable was $328.0 million, down 10.6%.
Fiscal 2018 fourth-quarter sales were $786.9 million versus $920.8 million a year earlier. The quarter reported $47.6 million of income attributable to Fossil Group, compared with a $79.9 million loss in Q4 2017; gross margin was 53.0% versus 48.7%.
Material changes and management commentary
- Watches remained the core business, accounting for 80.0% of sales. Watch revenue fell 7.5%; jewelry fell 20.7%, and leathers fell 11.1%.
- Americas sales declined 10.6% and Europe sales declined 11.9%; Asia sales rose 1.8%. E-commerce sales increased 16%, while global comparable retail sales declined 2%.
- Connected watches generated $395 million, 19% of watch sales, up 32% year over year. Growth was offset by ongoing declines in traditional watches.
- Gross margin improved 400 basis points, reflecting lower promotions and markdowns, favorable mix, currency and New World Fossil (NWF) sourcing and design-to-value initiatives. The comparison also benefited from an approximately $40 million connected-product inventory valuation reserve recorded in 2017.
- Operating income improved substantially, but the comparison was heavily affected by FY2017 goodwill and trade-name impairment charges of $407.1 million, versus $6.2 million in FY2018. Management also reported an $84.5 million improvement in operating income excluding intangible impairment and restructuring charges.
- Restructuring charges were $46.6 million in FY2018, compared with $48.2 million in FY2017. Management said NWF remained on track for $200 million of annualized savings by the end of 2019.
Outlook, risks and unusual items
- The filing provides no specific FY2019 revenue or earnings guidance. Management planned approximately $30 million of FY2019 capital expenditures, anticipated about $50 million of restructuring charges, and expected to open approximately 10 stores and close approximately 30, subject to lease negotiations.
- In January 2019, Fossil received $40 million from Google for smartwatch-related intellectual property. The company also announced a Citizen partnership to expand hybrid smartwatches; management expects these arrangements to support innovation and reduce wearables costs.
- Debt principal of $400 million was outstanding at year-end, with a $125 million scheduled term-loan payment due March 2019. Fossil made that $125 million payment on January 4, 2019. The revolving facility had $322.3 million of availability, and the company reported compliance with its covenants at year-end. The credit agreement includes leverage, EBITDA and minimum-liquidity tests and restricts open-market share repurchases.
- Income-tax expense was $21.1 million on $20.2 million of pretax income, producing a 104.7% effective tax rate. Valuation allowances and U.S. taxation of foreign earnings, including GILTI, were significant factors.
- Material exposures include continued traditional-watch weakness, fashion and technology obsolescence, promotional pricing and margin pressure, license renewals and minimum royalties, and tariffs or other trade restrictions affecting China-related sourcing. Licensed products represented 46.6% of sales; the filing identifies important license expirations beginning in 2019.
- Contractual obligations included $646.8 million of operating lease payments, $170.3 million of minimum royalties and $370.9 million of purchase obligations. Fossil also guaranteed up to 4.4 million Swiss francs of an investee’s credit facility. Management did not expect pending legal matters to have a material effect.
- Fossil adopted the new revenue standard in FY2018; it reduced opening retained earnings and FY2018 reported sales by $10.5 million relative to the prior accounting treatment. Adoption of the new lease standard in FY2019 was expected to recognize $330 million–$430 million of lease assets and liabilities.
Most important facts for investors to verify
- Confirm the reporting-period mismatch: this is the FY2018 10-K, not a 2017 Q4 filing.
- Assess whether revenue declines are stabilizing and whether connected-watch growth can offset traditional-watch weakness without eroding margins.
- Track inventory, cash conversion and the sustainability of the improved gross margin and operating results after separating prior-year impairments and inventory-reserve effects.
- Verify covenant headroom, remaining term-loan repayments, borrowing availability and the effect of the January 2019 $125 million repayment.
- Monitor execution of the $200 million NWF savings target, restructuring costs, license renewals and the financial contribution of the Google and Citizen arrangements.
- Evaluate the ongoing effects of tax provisions, tariffs, leases and minimum royalty commitments on earnings and cash flow.