Fossil Group, Inc. — Form 10-Q Summary
Period: The filing covers the 13 and 26 weeks ended July 1, 2023, compared with the periods ended July 2, 2022. Although the request metadata says 2022 Q2, the filing itself is for the second quarter of 2023. Figures below are unaudited and in U.S. dollars unless stated otherwise.
Business context
Fossil designs, markets and distributes fashion accessories, principally watches and jewelry, alongside leather goods and other products. It reports by the Americas, Europe and Asia. Sales come from wholesale, company-operated stores and e-commerce.
Key financial results
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Net sales | $322.0m | $371.2m | $647.0m | $747.0m |
| Gross profit | $156.7m | $191.3m | $317.4m | $375.7m |
| Gross margin | 48.7% | 51.6% | 49.1% | 50.3% |
| Operating income (loss) | $(35.3)m | $(10.9)m | $(72.6)m | $(25.2)m |
| Net loss attributable to Fossil | $(26.5)m | $(19.1)m | $(67.8)m | $(40.6)m |
| Diluted loss per share | $(0.51) | $(0.37) | $(1.30) | $(0.78) |
| Adjusted EBITDA (non-GAAP) | $(15.4)m | $(0.3)m | $(31.8)m | $(2.0)m |
Q2 operating expenses were $192.0m, or 59.6% of sales, versus $202.3m, or 54.5%, a year earlier. Interest expense was $5.3m in Q2 and $10.4m year to date; other income was $7.2m and $9.9m, respectively, mainly reflecting currency gains. The company recorded income tax benefits of $7.2m in Q2 and $5.6m year to date.
Cash flow and liquidity: First-half operating cash outflow was $83.0m, compared with $165.8m in the prior-year period; investing cash outflow was $4.7m. The filing attributes the lower operating cash use chiefly to working-capital use of $52.0m versus $184.8m, including active inventory reduction. Cash and equivalents were $132.1m at July 1, 2023; cash plus revolver availability totaled $204.6m. Net working capital was $476.0m.
Debt: At July 1, 2023, $150.0m principal was outstanding on the 7.00% senior notes due 2026 and $99.0m on the asset-based revolving facility. The company reported $72.5m of available revolver capacity and was in compliance with debt covenants. Balance-sheet debt was $243.5m, including short-term debt and reported carrying amounts. The notes are unsecured; the revolver is secured and its availability depends on the borrowing base.
Changes versus comparable periods
- Q2 sales fell 13.3% reported and 12.6% in constant currency; first-half sales fell 13.4% reported and 11.7% in constant currency. All three regions declined.
- Q2 wholesale sales declined 18.5%; direct-to-consumer sales declined 4.9%. Management cited cautious wholesale ordering, retailer inventory discipline and softer end-consumer demand. Global comparable retail sales rose 3% in Q2 and 8% year to date, supported by owned e-commerce.
- Q2 smartwatch sales fell 46.7%; traditional watch sales fell 8.7%. First-half total watch sales declined 14.8%. The company said smartwatch declines reflected weaker demand and its reduced emphasis on the category.
- Q2 gross margin declined 2.9 percentage points, with increased promotions, unfavorable currency effects, hedge losses and restructuring charges related to product exits partly offset by lower freight costs. Operating losses widened, primarily as lower sales reduced expense leverage.
- Cash and equivalents declined from $198.7m at December 31, 2022 to $132.1m. Inventory declined from $376.0m to $323.9m. The store base declined by 34 net locations, or 10%, year over year, to 315.
Outlook, management commentary and risks
- Transform and Grow (TAG): Expanded restructuring and business review aims to exit or reduce selected products, brands and distribution, improve gross margin and reduce operating expenses and working capital. Management estimates approximately $300m of annualized operating-income benefits by the end of 2025, versus the prior plan’s $100m target by the end of 2024. Estimated total charges are $100m–$120m over the program, including approximately $35m in fiscal 2023. Goals include adjusted gross margins in the low-to-mid 50% range and adjusted operating margin of approximately 10%. These are targets, not reported results.
- Growth priorities are revitalizing the Fossil brand, maximizing licensed watch and jewelry brands, and growing premium watches, enabled in part by digital, marketing and technology investment. The company expects fiscal 2023 capital expenditures of approximately $15m.
- Management expects inflation, higher interest rates, recession concerns and restrained consumer spending to continue affecting demand and wholesale ordering. Retailers are managing inventory cautiously; the company is reducing its own inventory purchases and improving assortment management.
- China supplies a substantial majority of imports. Supply interruptions, component concentration, transportation or product-cost increases could affect sales and margins. Other cited risks include foreign-exchange movements, competition, license renewals, cybersecurity and information-system incidents, and successful execution of TAG. Russia sales are on hold through a distributor and were described as immaterial.
- Currency sensitivity disclosures: a 10% unfavorable strengthening of the U.S. dollar would reduce pre-tax income by an estimated $8.6m for transactional exposures and reduce equity by approximately $29.9m through translation. A 100-basis-point rise in rates would increase annual interest expense by about $1.0m on variable-rate debt.
- The company reported no material pending litigation. It had $23.3m of unrecognized tax benefits, excluding interest and penalties; $8.5m was expected to settle within 12 months. Management said no tax benefit was recorded for U.S. and certain foreign losses because future use was uncertain.
Most important facts for investors to verify
- Whether TAG delivers the stated savings and margin objectives, and how much of the estimated charges and benefits are realized.
- Whether demand, wholesale orders and comparable sales stabilize, particularly across Europe and Asia and in watches and licensed brands.
- Whether gross margin improves as promotions, foreign-exchange effects, hedging outcomes and product-exit costs change.
- Whether cash generation and seasonal inventory needs remain manageable given operating cash outflow, debt service and $72.5m of revolver availability.
- Whether the business maintains covenant compliance and sufficient liquidity while carrying the 7.00% notes and variable-rate revolver borrowings.