Fossil Group, Inc. — Form 10-Q Summary
Period: Fiscal third quarter ended September 29, 2018; comparative quarter ended September 30, 2017. The request metadata says “2017 Q3,” but the supplied filing is for 2018 Q3. Financial amounts below are in U.S. dollars.
Business context and results
Fossil designs, markets and distributes fashion accessories, principally watches, through wholesale, retail and e-commerce channels. It reports Americas, Europe and Asia segments. Management’s strategy emphasized profitability, store and business exits, connected-product innovation, e-commerce and the New World Fossil (NWF) restructuring program.
| Metric | 13 weeks ended Sep. 29, 2018 | 13 weeks ended Sep. 30, 2017 | 39 weeks ended Sep. 29, 2018 | 39 weeks ended Sep. 30, 2017 |
|---|---|---|---|---|
| Net sales | $608.8 million | $688.7 million | $1,754.6 million | $1,867.4 million |
| Gross profit / margin | $326.5 million / 53.6% | $319.9 million / 46.4% | $923.2 million / 52.6% | $910.8 million / 48.8% |
| Operating income (loss) | $22.7 million | $(0.5) million | $(4.6) million | $(475.5) million |
| Net income (loss) attributable to Fossil | $5.0 million | $(5.4) million | $(51.1) million | $(398.3) million |
| Diluted EPS | $0.10 | $(0.11) | $(1.04) | $(8.22) |
| Operating cash flow | Not presented by quarter in this filing text | $72.4 million | $60.2 million |
Liquidity, debt and balance sheet
- At September 29, 2018, cash and cash equivalents were $236.1 million; $214.3 million was held outside the U.S. Cash, cash equivalents and restricted cash totaled $237.8 million.
- Reported debt was $128.0 million short-term and $269.1 million long-term. The company separately disclosed $400.0 million principal outstanding on the term loan, reduced on the balance sheet by $8.6 million of unamortized issuance costs; there were no revolver borrowings.
- Revolver capacity available was $283.8 million, after borrowing-base limits and $2.7 million of standby letters of credit. The credit agreement matures December 31, 2020; term-loan principal repayments of $125 million and $75 million are due March 2019 and March 2020, respectively, with the remaining balance due at maturity.
- Operating cash flow of $72.4 million, investing cash use of $10.5 million and financing cash use of $60.4 million produced a $6.1 million increase in cash, cash equivalents and restricted cash year to date.
- Inventory was $521.3 million, down from $573.8 million at fiscal year-end and 23.7% below the prior-year quarter-end. Management reported working capital of $577.3 million, versus $732.8 million a year earlier.
- The company said it was compliant with all debt covenants at quarter-end. Covenants include minimum liquidity of $160 million and a $110 million minimum trailing-12-month EBITDA test beginning in the quarter ending December 29, 2018; leverage limits tighten over time. The credit agreement restricts share repurchases.
Material changes and management commentary
- Quarterly sales fell 11.6% reported (10.6% constant currency); year-to-date sales fell 6.0% reported (8.0% constant currency). Management attributed weakness chiefly to traditional watch declines, store closures, and the exits of the Burberry and Adidas licenses. Exits and closures reduced quarterly sales by approximately 600 basis points.
- Quarterly gross margin expanded 720 basis points to 53.6%, reflecting lower promotions and markdowns, favorable mix, NWF sourcing and design-to-value benefits, currency effects, and comparison with a prior-year inventory reserve. Quarterly operating income improved to $22.7 million, while SG&A fell to $297.8 million from $314.6 million.
- Connected watches generated $90 million of quarterly sales, 18% of watch sales and up 13% year over year. Company e-commerce comparable sales grew 15% globally; total global comparable retail sales declined 3%.
- The year-to-date operating loss improved substantially from the prior year, primarily because 2017 included $407.1 million of goodwill and trade-name impairment charges. Fiscal 2018 included a $6.2 million SKAGEN trade-name impairment.
- Year-to-date restructuring charges were $41.9 million. Management estimated approximately $50 million of NWF charges for fiscal 2018 and expected $170 million of annual run-rate savings by year-end, toward $200 million of gross-margin and efficiency benefits by the end of 2019.
Outlook, risks and unusual items
- Management expected sales to contract as it exited unprofitable stores, businesses and product lines, while targeting improved operating income. No specific full-year revenue or earnings forecast is stated in the supplied filing text.
- Fiscal 2018 capital expenditures were estimated at approximately $20 million. Management said operating cash flow, cash on hand and available credit were expected to fund working capital and planned capital expenditures for the next 12 months.
- Income-tax results were affected by valuation allowances on U.S. and certain foreign deferred tax assets and net operating losses, as well as the Tax Cuts and Jobs Act’s GILTI provision. Year-to-date tax expense was $7.2 million despite a consolidated pretax loss.
- Management identified potential U.S.-China tariffs as a material risk. Certain packaging and handbag products faced an additional 10% tariff beginning September 2018; the filing warned this could rise to 25% from January 1, 2019 if no trade agreement was reached. Smartwatches manufactured in China were excluded from the tariffs then in effect.
- License risk is notable: the Michael Kors and Armani agreements could be terminated at the end of 2019 if 2018 sales thresholds are not met. Fossil also agreed to terminate its Marc Jacobs watch license effective June 30, 2019, subject to a sell-off period.
- Other disclosed risks include consumer and fashion trends, competition, supply interruptions, foreign-exchange exposure and connected-product acceptance. A 10% strengthening of the U.S. dollar was estimated to reduce pretax income by $22.0 million and stockholders’ equity by $51.6 million; a 100-basis-point increase in interest rates was estimated to raise annual interest expense by $4.1 million.
- The company expected the new lease standard to significantly increase balance-sheet right-of-use assets and lease liabilities. It reported no material pending litigation and concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether operating improvement and higher gross margins persist as traditional watch sales decline and total revenue contracts.
- Progress against NWF savings and restructuring targets, including realized savings versus announced run-rate goals.
- Cash generation, revolver availability, covenant headroom and ability to meet the March 2019 term-loan payment and subsequent debt maturities.
- Impact of tariffs, license sales thresholds and scheduled license terminations on future revenue and margins.
- Tax valuation allowances and the effects of GILTI, foreign exchange and adoption of lease accounting on reported results and the balance sheet.