Fossil Group, Inc. — Form 10-Q Summary
Period clarification: Although the request metadata says 2019 Q2, this filing covers the 13 weeks ended July 4, 2020, and compares them with the 13 weeks ended June 29, 2019. Year-to-date periods are 27 weeks in 2020 versus 26 weeks in 2019. Figures below are in U.S. dollars; financial amounts are in millions unless stated otherwise.
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 worldwide. The company reported that COVID-19 materially affected second-quarter and year-to-date operations, including store closures, lower retail traffic and disruption to wholesale partners. By quarter-end, 407 global stores had reopened, generally with reduced traffic or operating capacity.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Year to date 2020 | Year to date 2019 |
|---|---|---|---|---|
| Net sales | $259.0 | $501.4 | $649.7 | $966.7 |
| Gross profit / margin | $140.6 / 54.3% | $265.1 / 52.9% | $281.0 / 43.2% | $513.0 / 53.1% |
| Operating income (loss) | $(36.8) | $1.7 | $(171.1) | $(18.3) |
| Net income (loss) attributable to Fossil | $(22.5) | $(7.3) | $(108.1) | $(19.6) |
| Diluted EPS | $(0.44) | $(0.15) | $(2.13) | $(0.39) |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $11.6 | $(26.1) |
- Quarterly sales declined 48.3% (47.4% in constant currency); year-to-date sales declined 32.8% (31.7% in constant currency). Sales fell across all three geographic segments and major product categories. Watches remained the largest category.
- Q2 gross margin improved year over year, helped by e-commerce mix and lower minimum licensor royalty costs, partly offset by promotions and higher freight and duty. Year-to-date margin fell sharply, primarily due to liquidation and inventory valuation adjustments for older connected products, largely in Q1.
- Q2 operating expenses fell 32.7% to $177.4 million, but expenses remained high relative to sales. The Q2 operating loss reflected the steep sales decline despite lower compensation, marketing and discretionary spending.
- Year-to-date operating cash flow was $11.6 million, versus an outflow of $26.1 million in the prior-year period. Cash and cash equivalents were $277.6 million at July 4, 2020; cash, cash equivalents and restricted cash totaled $284.7 million. Net working capital was $417.9 million.
- At quarter-end, balance-sheet short-term and current debt was $25.2 million and long-term debt was $243.9 million. Separately, the company disclosed $170.0 million outstanding under its term loan and $123.8 million under its revolving facility, with $32.5 million of remaining revolving capacity. Debt carrying values reflect unamortized issuance costs.
- Inventory was $375.9 million, down 18.3% from the prior-year comparable quarter. Accounts receivable was $130.1 million; wholesale days sales outstanding increased to 72 from 50 year over year.
Material changes versus prior comparable periods
- Q2 revenue contracted by nearly half as COVID-19 closures and reduced store traffic affected retail and wholesale channels. Strong e-commerce growth partially offset declines.
- Year-to-date gross margin fell 9.9 percentage points, and the operating loss widened substantially.
- Year-to-date other income/expense shifted from $26.4 million of income to $6.4 million of expense. The prior-year period included a $21.6 million gain on intellectual-property sales; the current period included net foreign-currency losses.
- Q2 included $10.5 million of restructuring charges; year-to-date restructuring charges were $19.9 million versus $17.5 million. Year-to-date results also included $20.3 million of property, equipment and other long-lived asset impairment losses and $2.5 million of trade-name impairment.
- The CARES Act enabled U.S. net operating loss carrybacks, contributing to income-tax benefits of $20.8 million in Q2 and $84.5 million year to date. The company said it could not reliably estimate a full-year effective tax rate amid pandemic uncertainty.
Outlook, management commentary and risks
- Management expected revenue declines to continue in retail and wholesale as consumers responded to the pandemic. Store reopening pace depended on restrictions and safety measures; the company could not reasonably estimate the impact of remaining closures on results. E-commerce trends were expected to continue.
- Fiscal 2020 capital expenditures were expected to be approximately $9 million, reduced from original guidance of approximately $25 million. SG&A was expected to be several million dollars below 2019 and the original 2020 plan. No specific revenue or earnings guidance was provided.
- The expanded New World Fossil 2.0 program was expected to generate an additional $50 million in benefits during 2020 and 2021. Total program charges were estimated at $50 million to $70 million, with approximately $25 million in fiscal 2020.
- Debt amendments increased term-loan interest rates to adjusted LIBO plus 8.50% or alternate base rate plus 7.50%, raised scheduled amortization, and changed covenant terms. The company said it was in compliance at quarter-end. Leverage testing was waived through the first three fiscal quarters of 2021, subject to specified EBITDA requirements; monthly minimum liquidity was reduced to $125 million through November 2020.
- Management believed cost reductions, cash on hand and credit availability would support operations and covenant compliance for the next 12 months, but warned that further revenue or cash-flow declines, or failure to achieve savings, could threaten covenant compliance. The company had $17.4 million of deferred rent payments outstanding and received $3.6 million of rent forgiveness in Q2.
- Key risks include the duration and severity of COVID-19, consumer demand and traffic, supply-chain disruption, customer collections, foreign exchange, licensed-brand relationships, and successful execution of restructuring and cost reductions. Management reported no material pending litigation and said disclosure controls were effective.
Important facts for investors to verify
- Whether sales, store traffic and wholesale collections recover as reopenings progress, and whether e-commerce can continue to offset in-store weakness.
- Whether the company achieves its cost-reduction targets and stays within the amended EBITDA, liquidity and other debt-covenant requirements.
- How much borrowing capacity remains available as the borrowing base changes, and the effect of higher term-loan interest rates and required amortization on cash.
- Whether inventory levels and gross margins stabilize after connected-product liquidation and impairment charges.
- The timing and cash realization of CARES Act tax refunds, and the assumptions underlying management’s 12-month liquidity assessment.