Fossil Group, Inc. — Form 10-K Summary
Period clarification: The supplied filing is the annual report for the fiscal year ended December 30, 2017, not a 2016 Q4 filing. It includes unaudited quarterly results for FY2017, including Q4.
Business context and reporting period
Fossil designs, markets and distributes watches, connected accessories, jewelry, leather goods and other fashion accessories through wholesale, company-operated stores and e-commerce. It reports three geographic segments: Americas, Europe and Asia. Watches generated 78.9% of FY2017 sales; 58.5% of sales came from outside the U.S.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $2,788.2 million | $3,042.4 million |
| Gross profit / margin | $1,358.8 million / 48.7% | $1,578.2 million / 51.9% |
| Operating income (loss) / margin | $(424.3) million / (15.2)% | $127.1 million / 4.2% |
| Net income (loss) attributable to Fossil / diluted EPS | $(478.2) million / $(9.87) | $78.9 million / $1.63 |
| Cash from operations | $179.5 million | $210.1 million |
| Cash and cash equivalents at year-end | $231.2 million | $297.3 million |
| Working capital | $781.9 million | $932.7 million |
| Debt, approximately | $445.9 million | $630.9 million |
Capital expenditures were $25.5 million. Cash from operations less capital expenditures was approximately $154.0 million. Year-end inventory rose 5.8% to $573.8 million, primarily due to connected products. The company reported $199.8 million of availability under its then-current revolving facility and said cash, operating cash flow and available facilities were expected to cover working capital and planned capital expenditures for the next 12 months.
FY2017 Q4: Net sales were $920.8 million versus $959.2 million in FY2016 Q4; gross margin was 48.7% versus 51.0%. Net loss attributable to Fossil was $79.9 million, or $(1.65) per diluted share, compared with net income of $49.7 million, or $1.03 per diluted share.
Material changes versus the prior comparable period
- Annual sales declined 8.4% as reported (9.1% in constant currency). Americas sales fell 13.7%; Europe fell 2.8%; Asia fell 3.4%.
- Watch sales declined 5.6%, leather sales 17.3% and jewelry sales 15.8%. Connected-product sales nearly doubled and represented about 11% of revenue, but growth did not offset traditional-watch declines.
- Gross margin contracted 320 basis points. Management attributed the decline to the connected-product mix and about $40 million of connected-inventory valuation charges, as well as increased promotions; supply-chain savings partly offset these pressures.
- Operating results included $407.1 million of non-cash goodwill and trade-name impairment charges. Goodwill was fully impaired; additional charges affected the SKAGEN, MISFIT and MICHELE trade names.
- Interest expense rose $16.3 million to $43.2 million. The company recorded $19.8 million of income tax expense despite a pre-tax loss, reflecting tax-reform effects, valuation allowances and non-deductible impairment charges.
- Stores totaled 544 at year-end, down from 585. Comparable retail sales, including e-commerce, declined 6% for the year, while Q4 comparable sales increased 2%.
Outlook, commentary, risks and unusual items
- Management expects sales to contract in the near term, citing store closures and the non-renewal or expiration of ADIDAS and BURBERRY licenses. For FY2018 it planned to open about five stores and close 60–80, depending on lease negotiations.
- The New World Fossil restructuring program targets approximately $150 million of total charges. Charges were $48.2 million in FY2017 and $27.8 million in FY2016; management estimated about $50 million of FY2018 charges. It reported approximately $80 million of benefits in FY2017 and expects benefits to reach $200 million when the program is completed in 2019.
- Management is investing in wearables, e-commerce and supply-chain efficiencies, while acknowledging connected products currently carry lower gross margins and higher warranty costs than traditional products.
- On January 29, 2018, the company entered a new credit agreement with a $425 million term loan and a $325 million asset-based revolving facility, due December 31, 2020. The debt is secured by substantially all domestic assets, with guarantees and financial covenants, including minimum liquidity requirements. Term-loan interest rates start at LIBOR plus 7% and step up over time.
- The Tax Cuts and Jobs Act generated provisional accounting effects, including a repatriation-tax charge and deferred-tax-asset adjustments. Management said it had not yet reasonably estimated the impact of GILTI provisions, which may increase future effective tax rates.
- Key risks include continued traditional-watch and retail weakness, fashion and technology execution, license renewal and sales-threshold requirements, promotional pricing and margin pressure, inventory exposure, foreign exchange, sourcing concentration, and compliance with debt covenants. No pending legal matter was believed likely to have a material effect. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether FY2018 sales trends and connected-product demand improve enough to offset traditional-watch declines, and whether connected inventory is cleared without further material margin charges.
- Progress and realized savings from the restructuring plan, including actual charges, store closures and the timing of the stated $200 million benefit target.
- Liquidity, borrowing-base availability, interest costs and compliance with the new credit agreement’s leverage, fixed-charge-coverage and minimum-liquidity covenants.
- Final tax-reform accounting, cash payments for the repatriation tax and the eventual effect of GILTI and valuation allowances.
- Exposure to licensed brands and minimum royalty commitments, particularly the sales thresholds and renewal terms for major licenses.