Fossil Group, Inc. — Form 10-Q Summary
Period: The filing covers the 13 weeks ended March 31, 2018, compared with the 13 weeks ended April 1, 2017. The request metadata says 2017 Q1, but the supplied filing is for 2018 Q1.
Business: Global designer, marketer and distributor of fashion accessories, including watches, jewelry and leather goods, sold through wholesale, retail and e-commerce channels.
Key financial results
Amounts below are in millions of U.S. dollars, except per-share data. Fiscal-quarter results are not necessarily indicative of full-year results.
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $569.2 | $581.8 |
| Gross profit / margin | $287.7 / 50.5% | $289.5 / 49.8% |
| Operating loss / margin | $(28.3) / (5.0)% | $(45.3) / (7.8)% |
| Net loss attributable to Fossil | $(48.3) | $(48.2) |
| Diluted loss per share | $(0.99) | $(1.00) |
| Cash from (used in) operations | $(4.3) | $51.4 |
| Capital expenditures | $3.8 | $4.4 |
- Sales declined 2.2% as reported and 7.3% in constant currency. Foreign-currency translation added approximately $30.1 million to reported sales.
- SG&A was $294.7 million, down $13.8 million. Restructuring charges were $21.3 million, versus $26.3 million. Together with lower SG&A and improved gross margin, these reduced the operating loss by $17.0 million.
- Interest expense increased to $10.7 million from $8.4 million. Other expense was $1.9 million, compared with $5.6 million of other income, mainly reflecting foreign-exchange hedge losses versus gains. Income tax expense was $6.6 million, compared with a $1.2 million benefit.
- Cash and cash equivalents were $229.9 million at quarter-end; cash, cash equivalents and restricted cash totaled $231.8 million. The company used $4.3 million in operating cash, and financing activities provided $12.0 million.
- Inventory was $530.7 million, down from $573.8 million at December 30, 2017; management also reported it was down 7.1% from the prior-year quarter. Net working capital was $632.5 million.
Material changes and operating trends
- Constant-currency sales declined in the Americas (10.9%) and Europe (8.1%); Asia grew 3.2%. Reported Europe and Asia sales rose due to currency translation.
- By product, reported watch sales were down 0.5%, leathers down 4.7% and jewelry down 12.7%. Connected watches grew strongly: the category nearly doubled globally, while Fossil-branded watch sales rose 10% as reported. Traditional watch sales remained pressured.
- Company-owned e-commerce sales grew 49% globally in constant dollars; global comparable retail sales, including company stores and e-commerce, rose 5%. Store closures reduced direct-channel sales by more than 300 basis points. The company closed 32 stores and opened none during the quarter.
- Gross margin improved 70 basis points to 50.5%, supported by currency, restructuring-related improvements and lower markdowns. Currency contributed 150 basis points; lower factory-cost absorption, connected-product mix and off-price sales were offsets.
- Segment operating income was $18.1 million in the Americas, $26.1 million in Europe and $13.4 million in Asia; corporate costs were $85.8 million. The Americas segment’s operating income declined from $25.7 million.
Debt, liquidity and capital resources
- Under a new credit agreement entered into January 29, 2018, the company has a $425 million term loan and a $325 million asset-based revolving facility, both due December 31, 2020. At March 31, $400 million was outstanding on the term loan and $67 million on the revolver; stated available revolver capacity was $216.8 million.
- Balance-sheet debt, net of debt issuance costs, was $462.6 million: $127.1 million current and $335.5 million long-term. The filing reports $467.0 million of principal outstanding. Term-loan principal repayments include $125 million due March 31, 2019 and $75 million due March 31, 2020, with the remaining balance due at maturity.
- The term loan’s stated rate is LIBOR plus 7%, rising to LIBOR plus 8% after the first anniversary and plus 9% after the second. The company reported an 8.6% average annual rate on term-loan borrowings during the quarter. A 100-basis-point increase in rates would add approximately $4.7 million to annual interest expense.
- The agreement requires minimum liquidity of $160 million, includes leverage and fixed-charge covenants, caps annual capital expenditures at $35 million and restricts share repurchases. The company reported compliance with all debt covenants at quarter-end. It expects approximately $25 million of fiscal 2018 capital expenditures and believes available cash, operating cash flow and credit capacity will fund needs for the next 12 months.
Outlook, management commentary and risks
- Management’s 2018 priorities are to become a smaller, more profitable company; develop traditional and connected products; expand digital and e-commerce capabilities; and continue the New World Fossil restructuring program. The filing does not provide a clear full-year revenue or earnings forecast.
- The company estimates approximately $55 million of restructuring charges for fiscal 2018. It says the initial New World Fossil phase is projected to deliver $200 million in gross-margin and efficiency benefits through 2019; the first quarter benefited from nearly $20 million of benefits and savings. Management expects a further multi-year phase with margin and cost savings, but gives no quantified target for that phase.
- Management cites changing retail channels and consumer preferences, wholesale weakness, competition from wearables, fashion and product-acceptance uncertainty, supply interruptions, foreign-currency movements, global economic conditions, customer financial difficulties, and license terminations or non-renewals as risks. It is also working to clear previous-generation connected products.
- Tax expense reflected valuation allowances on certain U.S. and foreign loss carryforwards, the Tax Cuts and Jobs Act’s GILTI provisions and a $2.5 million revision to the estimated one-time repatriation tax. The company expects further estimate updates as it receives guidance and refines calculations.
- The company adopted the new revenue-recognition standard in Q1 using the modified retrospective method. Adoption reduced opening retained earnings by $26.5 million, primarily related to markdown timing. The filing reports Q1 sales were $1.2 million higher and cost of sales $4.9 million higher than they would have been without adoption. The new lease standard is expected to materially affect the balance sheet when adopted.
- Management reported routine litigation as not material. The company mutually agreed to terminate its Karl Lagerfeld watch license effective April 1, 2018, subject to a sell-off period.
Most important facts for investors to verify
- Whether the operating-loss improvement and stated restructuring benefits persist as sales remain weak, particularly in wholesale and traditional watches.
- Whether inventory reductions and clearance of older connected products avoid additional markdowns or margin pressure.
- Liquidity and covenant headroom under the borrowing-base facility, including the effects of seasonal cash needs and scheduled term-loan repayments.
- Exposure to variable interest rates and foreign exchange: the filing estimates a $12.9 million net loss on settlement of specified hedges and a $10.5 million pretax-income reduction under a 10% unfavorable currency move affecting transactional exposures.
- Tax estimates, including valuation allowances, unrecognized tax benefits and the provisional repatriation-tax calculation.
- The eventual balance-sheet impact of lease-accounting adoption and the results of the next phase of the restructuring program.