FOSL

Business Context and Reporting Period

Fossil Group, Inc. (Fossil, Inc.) is a global design, marketing, and distribution company specializing in consumer fashion accessories, including watches, jewelry, handbags, and apparel. The company operates through five segments: United States Wholesale, Europe Wholesale, Other International Wholesale, Direct to Consumer (retail, catalog, e-commerce), and Corporate. This Form 10-K covers the fiscal year ended January 3, 2009.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 10.5% year-over-year, driven by organic growth of 9.4% and a 1.1% favorable impact from foreign exchange rates. International wholesale sales grew significantly, while U.S. wholesale sales remained relatively flat.
• Profitability: Operating income rose 10.3% to $205.8 million. Gross margin expanded 200 basis points to 53.8%, aided by a favorable sales mix (higher margin direct-to-consumer and international segments) and a weaker U.S. dollar in the prior year comparison.
• Expense Increases: Operating expenses increased 16.2% to $645.4 million, primarily due to the opening of 80 net new retail stores and associated back-office infrastructure expansion. This included $10.6 million in non-cash impairment charges (fixed assets and intangibles).
• Segment Performance: The Direct to Consumer segment saw a 21.2% sales increase. International wholesale segments (Europe and Other) grew 9.5% and 16.3% respectively. U.S. Wholesale grew only 2.6%.
• Stock Repurchases: The company repurchased and retired 3.6 million shares of common stock for approximately $105.9 million during the fiscal year.

Guidance, Outlook, and Risks

• Economic Outlook: Management anticipates a negative impact on revenues and earnings for fiscal 2009 due to the deteriorating global economic environment, reduced consumer confidence, and a strengthening U.S. dollar. The company expects reported net sales and operating income to be negatively impacted in the first three quarters of 2009 compared to the prior year.
• Store Expansion: Fossil plans to open 40 to 50 additional FOSSIL branded stores in 2009, with approximately 90% located outside the United States.
• Key Risks:
  • License Agreements: The DKNY watch license expires December 31, 2009. The EMPORIO ARMANI jewelry license expired December 31, 2008, though distribution continues during negotiations.
  • Foreign Currency: A strengthening U.S. dollar is expected to reduce translated sales and operating income from international subsidiaries.
  • Inventory: Inventory levels increased 17.5% to $292 million due to lower fourth-quarter sales than projected and accelerated purchases ahead of the Chinese New Year.
  • Impairments: The company recorded $7.9 million in impairment charges related to MICHELE and ZODIAC trade names.

Investor Verification Checklist

• License Renewals: Verify the status of negotiations for the DKNY watch license (expiring end of 2009) and the new EMPORIO ARMANI jewelry agreement.
• Inventory Valuation: Monitor inventory levels and potential write-downs given the 17.5% increase in inventory and the weak economic environment.
• Currency Impact: Assess the sensitivity of future earnings to the strengthening U.S. dollar, which is expected to negatively impact reported results in 2009.
• Store Economics: Review the performance of the 80 new stores opened in 2008 to ensure they meet the targeted 15% pretax margin and sales per square foot goals.
• U.S. Wholesale Trends: Track the performance of the U.S. Wholesale segment, which showed minimal growth (2.6%) and a decline in FOSSIL watch sales, indicative of broader department store weakness.