Fossil Group, Inc. — Form 10-Q Summary
Period note: The request metadata says 2015 Q2, but the filing provided is for the 13 and 26 weeks ended July 2, 2016, compared with periods ended July 4, 2015. Figures below reflect the filing’s actual period. Dollar amounts are in millions unless stated otherwise.
Business context and reporting period
Fossil designs, markets and distributes fashion accessories, including watches, jewelry and leather goods, through wholesale, retail and e-commerce channels worldwide. It reports the Americas, Europe and Asia as geographic segments. The quarter included completion of the acquisition of the remaining 50% of Fossil Spain, making it wholly owned; Misfit had been acquired in December 2015.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $685.4 | $740.0 | $1,345.2 | $1,465.1 |
| Gross profit / margin | $355.8 / 51.9% | $409.5 / 55.3% | $704.1 / 52.3% | $810.2 / 55.3% |
| Operating income / margin | $15.5 / 2.3% | $70.4 / 9.5% | $29.9 / 2.2% | $126.6 / 8.6% |
| Net income attributable to Fossil | $6.0 | $54.6 | $11.8 | $92.7 |
| Diluted EPS | $0.12 | $1.12 | $0.24 | $1.87 |
| Operating cash flow | Not separately reported | Not separately reported | $71.9 | $162.5 |
| Capital expenditures | Not separately reported | Not separately reported | $39.3 | $32.5 |
First-half operating cash flow less capital expenditures was approximately $32.6 million. At July 2, 2016, cash was $231.8 million, current assets were $1,312.4 million and current liabilities were $411.7 million. Debt totaled approximately $735.0 million: $26.3 million short-term/current and $708.7 million long-term. Cash less reported debt was approximately negative $503.1 million. Working capital was $900.7 million; available revolver capacity was approximately $133.0 million. Cash included $223.3 million held outside the U.S.
Material changes versus the prior comparable periods
- Q2 sales fell 7.4% (6% in constant currency); first-half sales fell 8.2% (7% in constant currency). Watches were the main source of weakness, declining 10.1% in both periods. Leathers rose 4.3% in Q2 and 1.8% year to date.
- Q2 gross margin contracted 340 basis points; first-half gross margin contracted 300 basis points. Management attributed pressure to promotions, off-price sales to manage inventory, and currency effects.
- Operating income fell 78.0% in Q2 and 76.4% year to date. Q2 SG&A and restructuring-related operating expenses were broadly flat in total, but expenses rose relative to lower sales. Misfit purchase-accounting costs and strategic digital investments contributed to expense pressure.
- Other income was lower, reflecting reduced foreign-currency gains and the absence of a $5.2 million prior-year interest-rate-hedge settlement gain. Interest expense increased with debt levels.
- First-half net income attributable to Fossil fell 87.3%. Management cited stronger-dollar translation and lower hedge-related gains, as well as Misfit intangible amortization and related contingent equity costs; nonrecurring prior-year restructuring charges partly offset the decline.
Outlook, management commentary, risks and unusual items
- Management described traditional watches and U.S. department-store wholesale demand as challenging. Q2 global comparable-store sales declined 3%; full-price stores performed better than outlets. FOSSIL and SKAGEN brands and women’s leather goods showed relative strength.
- Fossil said it was on track to begin delivering connected accessories in the third quarter of 2016, with broader launches across its brands planned for the second half. It continued investing in wearables, e-commerce, omni-channel capabilities and CRM. No specific revenue or earnings guidance was provided.
- Fiscal 2016 capital expenditures were estimated at $70 million to $80 million, with approximately 65% directed to strategic growth, 20% to store expansion and renovation, and 15% to technology and facilities maintenance. Management said cash, operating cash flow and credit availability were expected to cover working capital and planned capital expenditures for the next 12 months.
- On August 8, 2016, after quarter-end, the company amended its credit agreement. The amendment increased applicable borrowing margins by 25 basis points, changed the leverage covenant ceiling to 3.25:1.00 for quarters beginning June 30, 2016, and added liens on substantially all domestic assets and subsidiary guarantees. The interest-coverage covenant remained at least 3.50:1.00. The company reported covenant compliance at July 2.
- Key risks include weak consumer discretionary spending, continuing pressure on traditional watches, fashion and product-acceptance uncertainty, supply interruptions, foreign-exchange exposure and competition. A 10% unfavorable currency move was estimated to reduce pretax income by $12.1 million and stockholders’ equity by $64.9 million; a 100-basis-point increase in rates was estimated to add $5.3 million to annual interest expense on unhedged variable-rate debt.
- Management reported routine litigation as not material and stated disclosure controls were effective. First-half stock repurchases were $5.2 million; $824.2 million of authorization remained.
Important facts for investors to verify
- Confirm the intended reporting period: the supplied filing is Q2 2016, not Q2 2015.
- Track watch-category sales, department-store demand, comparable-store trends and whether connected-product launches gain meaningful customer acceptance.
- Assess whether margin recovery is possible without continued promotional or off-price selling, and monitor inventory and wholesale receivables; wholesale days sales outstanding rose to 46 from 41 year over year.
- Review debt costs, revolver availability, covenant compliance and the implications of the August amendment’s higher margins and expanded collateral and guarantees.
- Monitor cash generation against planned capital spending, foreign-currency movements, Misfit-related costs and the company’s ability to meet its stated liquidity expectations.