Business context and reporting period
Fossil Group, Inc. designs, markets and distributes fashion accessories, including watches, jewelry, leather goods and sunglasses, through wholesale, retail and e-commerce channels. This filing covers the 13 weeks ended March 30, 2019, compared with the 13 weeks ended March 31, 2018. Although the request identifies 2018 Q1, the filing is for 2019 Q1.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net sales | $465.3 million | $569.2 million |
| Gross profit / margin | $247.9 million / 53.3% | $287.7 million / 50.5% |
| Operating loss | $19.9 million | $28.3 million |
| Net loss attributable to Fossil Group | $12.2 million | $48.3 million |
| Diluted loss per share | $0.25 | $0.99 |
| Operating cash flow | $7.6 million | $(4.3) million |
| Capital expenditures | $6.6 million | $3.8 million |
- Sales declined 18.3% reported and 15.2% in constant currency. Watches fell 18.2%, leather goods 22.2% and jewelry 25.4% reported.
- Gross margin expanded 280 basis points, driven by lower off-price mix, fewer promotions and markdowns, favorable mix and restructuring benefits; lower-volume factory cost absorption and currency partly offset the improvement.
- SG&A decreased to $257.7 million from $294.7 million, but rose to 55.4% of sales from 51.8%. Restructuring charges were $10.2 million versus $21.3 million.
- Q1 included a $21.6 million gain on the sale of smartwatch-related intellectual property to Google. The filing attributes the narrower net loss mainly to lower expenses and this gain; the gain contributed $0.33 per diluted share, while restructuring charges reduced EPS by $0.16.
- Cash and cash equivalents were $271.4 million at quarter-end, down from $403.4 million at fiscal 2018 year-end. Cash, cash equivalents and restricted cash totaled $279.1 million. The quarter’s net decrease in cash, cash equivalents and restricted cash was $131.8 million.
- Debt carrying amounts were $65.9 million short-term and $161.1 million long-term. The company made approximately $170 million of net term-loan payments and reported $211.1 million of available revolver capacity, with no revolver borrowings. Debt covenant compliance was reported at March 30, 2019.
- Current assets were $988.5 million and current liabilities $496.5 million. Inventory was $384.1 million, down 27.6% from the prior-year quarter, but up from $377.6 million at fiscal year-end.
- Lease accounting adoption added $312.0 million of operating lease right-of-use assets and $380.8 million of operating lease liabilities at quarter-end. These balance-sheet additions reflect adoption of the new standard.
Changes, outlook, commentary and risks
- Sales declined across the Americas and Europe; Asia sales were down 0.8% reported but up 4.1% in constant currency. Management cited weak traditional wholesale demand, store closures, licensed-brand exits, lower liquidation sales and delayed connected/display-watch inventory. Connected-watch sales were $62 million, or 17% of watch sales.
- Management said sales were at the higher end of expectations and expected constrained display-watch inventory to normalize during Q2. It did not provide a full-year revenue or earnings forecast in the supplied filing text.
- Management estimated fiscal 2019 capital expenditures of approximately $30 million and stated that operating cash flow, cash on hand and credit availability should fund working capital and planned capital expenditures for the next 12 months.
- The company launched New World Fossil 2.0 to improve efficiency, decision-making and customer focus, pursue further gross-margin gains, and redirect investment toward digital capabilities and marketing. It recorded $0.8 million of charges for the new program; the earlier NWF 1.0 program remains underway.
- Debt carries significant interest costs: the term loan rate increased to LIBOR plus 8% (or base rate plus 6.5%) in January 2019, with further increases scheduled in January 2020. The credit agreement includes leverage, EBITDA, liquidity and capital-expenditure covenants, as well as restrictions on share repurchases. A $64.1 million term-loan repayment is due March 2020, with the remaining balance due December 2020.
- Key risks include further declines in consumer demand, competition and changing shopping patterns, supply interruptions, foreign-exchange movements, licensed-brand changes and tariffs on Chinese imports. The filing highlights possible increases in U.S. tariffs, including potential coverage of China-assembled smartwatches, which could require price increases or sourcing changes.
- Other notable items: the company adopted lease accounting and updated hedge accounting; the latter moved $2.5 million of hedge settlement gains into cost of sales. Management reported no material pending legal proceedings and no material change to other risk factors during the quarter. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether sales declines stabilize, particularly in wholesale, Americas and Europe, and whether the expected Q2 inventory recovery materializes.
- How much of reported earnings improvement is sustainable after excluding the Google divestiture gain and restructuring charges.
- Cash generation, seasonal working-capital needs, inventory levels and ability to maintain liquidity while making scheduled term-loan repayments.
- Compliance with debt covenants and the impact of high borrowing costs and scheduled interest-rate increases.
- The effect of potential tariffs, especially any expansion to smartwatch imports, and the cost and timing of alternative sourcing.
- Progress and costs of NWF 2.0, store closures, and planned digital and marketing investments.