Fossil Group, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the 13 and 26 weeks ended June 29, 2019, not 2018 Q2. Comparisons are with periods ended June 30, 2018. Dollar figures are in millions unless otherwise stated.
Business context and reporting period
Fossil designs, markets and distributes watches, jewelry, leather goods and other fashion accessories through wholesale, retail and e-commerce channels. Its reportable segments are Americas, Europe and Asia. The filing reports unaudited second-quarter and first-half fiscal 2019 results.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $501.4 | $576.6 | $966.7 | $1,145.7 |
| Gross profit | $265.1 | $309.0 | $513.0 | $596.7 |
| Gross margin | 52.9% | 53.6% | 53.1% | 52.1% |
| Operating income (loss) | $1.7 | $1.0 | $(18.3) | $(27.3) |
| Net income (loss) attributable to Fossil | $(7.3) | $(7.8) | $(19.6) | $(56.1) |
| Diluted EPS | $(0.15) | $(0.16) | $(0.39) | $(1.15) |
- Q2 sales fell 13.0% reported and 10.6% in constant currency; first-half sales fell 15.6% reported and 12.9% in constant currency. Management attributed weakness mainly to wholesale and off-price channel pressure, store closures, lower liquidation sales and licensed-brand exits.
- Q2 gross margin declined 70 basis points, principally due to approximately 90 basis points of unfavorable currency impact and lower-volume factory-cost absorption and royalty costs. First-half margin improved 100 basis points, aided by mix, fewer off-price sales and restructuring benefits, partly offset by currency and lower-volume costs.
- First-half operating cash flow was a use of $26.1, compared with $77.4 provided in the prior-year period. Investing cash flow provided $30.4, including $41.6 of asset-divestiture proceeds; financing cash flow used $178.4, including $173.4 of debt payments. Cash, cash equivalents and restricted cash ended at $234.5; cash and cash equivalents alone were $226.6.
- At June 29, 2019, cash and cash equivalents were $226.6, current assets $1,015.5 and current liabilities $527.6. Net working capital was $488.0. Inventory was $460.3, up from $377.6 at fiscal year-end, although down 7.5% from the prior-year quarter-end.
- Balance-sheet short- and long-term debt totaled $228.3; the filing separately reports $229.8 outstanding under the term loan before unamortized debt costs. Revolver borrowings were zero, with $220.7 of available borrowing capacity. The term loan bears a high variable rate; first-half average interest rate was 10.4%. The company was in compliance with debt covenants at quarter-end.
- Operating lease liabilities totaled $375.2, recognized following adoption of the new lease standard. The company reported $305.4 of operating lease right-of-use assets.
Material changes and unusual items
- Q2 sales declined across watches, leathers and jewelry; Asia was the only reportable segment with sales growth. Q2 Asia sales rose 4.5% reported and 9.0% constant currency, while Americas sales fell 20.0% and Europe sales fell 16.3% reported.
- First-half operating loss improved by $9.0 year over year, reflecting lower operating expenses and improved gross margin, partly offset by lower sales and gross profit. First-half net loss also benefited from a $21.6 gain on the January sale of smartwatch-technology intellectual property to Google.
- Q2 restructuring charges were $7.3, versus $14.5 in the prior-year quarter. First-half charges were $17.5, versus $35.9. The company expects to spend up to $20 million in the second half of 2019 to complete its NWF 1.0 program; management says the program is expected to deliver $200 million of run-rate profitability improvements over three years. NWF 2.0, launched in 2019, targets operating efficiencies, margin opportunities and funding for digital and consumer-facing investment.
- Adoption of the lease standard added lease assets and liabilities and reduced opening retained earnings by approximately $29.5; management said adoption did not materially affect results of operations or cash flows.
Outlook, commentary and risks
- Management said Q2 sales were in line with expectations, cited sequential improvement in core sales contraction and continued strength in Asia, but noted ongoing wholesale and consumer-shopping challenges. It described new connected-watch products and an e-commerce/marketing platform planned for launch in Q3 2019.
- Fiscal 2019 capital expenditures were estimated at approximately $30 million. Management said cash on hand, operating cash flows and credit availability should fund working capital and planned capital expenditures over the next 12 months.
- The filing estimates gross exposure of approximately $5–$10 million from an additional 10% tariff in the second half of 2019, assuming no pricing, sourcing or other offsets. New U.S. tariffs announced August 1, 2019 could affect smartwatches and traditional watches or components.
- Other key risks include continued weakness in consumer spending and wholesale channels, changing fashion preferences and product acceptance, supply interruptions, foreign-exchange movements, license terminations, restructuring execution and covenant or refinancing pressure. The term loan has scheduled repayment of $64.1 million on March 31, 2020 and the remaining balance due December 31, 2020; its interest margin rises further in January 2020.
- Unrecognized tax benefits were $39.9 million, excluding interest and penalties; $18.1 million was expected to settle within 12 months. The company reported no material pending litigation and stated disclosure controls were effective.
Important facts for investors to verify
- Whether sales declines in the Americas and Europe stabilize and Asia growth continues, including the trend in wholesale, e-commerce and comparable retail sales.
- Whether NWF 1.0 and NWF 2.0 deliver the stated cost and profitability improvements without impairing growth or execution.
- Available liquidity, borrowing-base capacity and compliance with all credit covenants, especially as seasonal inventory needs rise and term-loan maturities approach.
- The actual cost and commercial impact of tariffs, including whether sourcing changes or price increases offset the estimated exposure.
- Cash conversion and inventory levels, given first-half operating cash outflow and the inventory build from fiscal year-end.
- Performance and adoption of connected products and the planned e-commerce and marketing platform, and the impact of renewed DKNY and Tory Burch watch licenses.