Fossil Group, Inc. — Form 10-Q Summary
Period clarification: The request labels this as 2014 Q3, but the filing is for the 13 weeks ended October 3, 2015. The quarterly comparison is the 13 weeks ended October 4, 2014; year-to-date figures compare 39 weeks with 40 weeks because the prior fiscal year included an extra week.
Business context
Fossil designs, markets and distributes fashion accessories, including watches, leather goods and jewelry, through wholesale, company-operated retail and e-commerce channels. Its reportable regions are the Americas, Europe and Asia. Management described weak traditional watch demand, difficult economic conditions in several markets and ongoing effects from foreign currency movements.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Year to date 2015 | Year to date 2014 |
|---|---|---|---|---|
| Net sales | $771.3 million | $894.5 million | $2,236.4 million | $2,444.8 million |
| Gross profit | $417.7 million | $509.0 million | $1,227.9 million | $1,396.9 million |
| Operating income | $75.7 million | $154.9 million | $202.3 million | $344.4 million |
| Net income attributable to Fossil | $57.5 million | $103.7 million | $150.3 million | $222.6 million |
| Diluted EPS | $1.19 | $1.96 | $3.06 | $4.15 |
- Q3 sales fell 13.8% reported and 8% in constant currency. Year-to-date sales declined 8.5% reported; management said they were flat on a constant-currency, comparable-calendar basis.
- Q3 gross margin was 54.2%, down from 56.9%; operating margin was 9.8%, down from 17.3%. Year-to-date gross and operating margins were 54.9% and 9.0%, versus 57.1% and 14.1%.
- Watches were the main source of weakness: Q3 watch sales fell 16.6% reported (11% constant currency). Q3 sales of Fossil-branded products declined 6% reported, while Skagen increased 1%; the multi-brand global watch portfolio declined 17%.
- Q3 sales declined in all regions: Americas 11.3%, Europe 14.6% and Asia 19.3% reported. Currency translation reduced Q3 sales by about $55.7 million and operating income by about $33.0 million.
- Q3 other income was $6.8 million, primarily reflecting foreign-currency gains on hedging and other transactions. The effective tax rate fell to 22.3% from 30.6%, mainly due to foreign tax credits and lower foreign earnings subject to U.S. tax.
Cash flow, liquidity and debt
- Year-to-date operating cash flow was $134.5 million, compared with $197.9 million in the prior-year 40-week period. Investing cash outflow was $52.8 million; financing cash outflow was $61.3 million. Cash increased $25.3 million to $301.6 million.
- Cash and cash equivalents were $301.6 million at October 3, including $298.3 million held outside the U.S. Working capital was approximately $1.1 billion.
- Balance-sheet debt was $807.4 million: $21.7 million short-term/current and $785.7 million long-term. The credit facility disclosures report $220.3 million outstanding on the term loan and $577.0 million on the revolver, with approximately $472.1 million of revolver capacity available. The company was in compliance with debt covenants.
- Year-to-date inventory rose $149.1 million from the fiscal-year-end balance to $746.3 million. Management attributed the operating cash outflow from working capital largely to higher inventory, including a $172.7 million cash use.
- Fossil repurchased $231.2 million of stock and effectively retired 2.7 million shares year to date. Remaining repurchase authorization was $829.3 million.
Changes, outlook and notable items
- Management attributed weaker profitability to lower sales, currency headwinds, fixed-cost deleveraging, higher marketing and strategic investment, retail mix and restructuring costs. In constant currency, Q3 gross margin improved, supported by pricing and lower product costs, but higher markdowns partly offset those gains.
- The company began a restructuring program in Q1 2015 to realign operations and improve retail profitability. Year-to-date charges were $21.7 million; management expected about $2.0 million of additional charges in Q4 2015.
- Management expected fiscal 2015 capital expenditures of $80–$90 million and planned approximately 18 additional store openings and nine closures for the rest of the year. It stated that operating cash flow, cash on hand and revolver availability should fund working capital, repurchases and planned capital expenditures for the next 12 months. No earnings or revenue guidance was provided.
- On November 11, 2015, after quarter-end, Fossil agreed to acquire wearable-device company Misfit for approximately $250 million in cash, subject to customary closing conditions and regulatory approval. Funding was expected from cash and revolver borrowings.
- Key stated risks include discretionary consumer spending and fashion preferences, sluggish watch demand and competition from technology-enabled devices, foreign exchange exposure, supply interruptions, customer and product acceptance, and integration of acquisitions. The filing reported no material pending litigation.
Important facts for investors to verify
- Whether the sales and margin declines persist, particularly in watches and the multi-brand licensed portfolio, and whether Fossil and Skagen growth continues.
- How much reported performance remains affected by currency movements and how constant-currency trends compare with reported results.
- Inventory levels, seasonal sell-through, markdowns and operating cash conversion, given the substantial inventory build.
- Debt, covenant headroom and the effects of continued repurchases and the proposed Misfit acquisition on liquidity and leverage.
- The timing and total cost of restructuring, planned store changes and capital spending, and whether the expected savings or returns materialize.