Business context and reporting period
Fossil Group designs, markets and distributes fashion accessories, including watches, leather goods and jewelry, through wholesale, retail and e-commerce channels. This 10-Q covers the 13 weeks ended July 4, 2015 and year-to-date 26 weeks; the comparable prior-year year-to-date period was 27 weeks. The filing metadata says “2014 Q2,” but the filing itself is for the second quarter of fiscal 2015.
Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless noted. The company reorganized its reporting segments as Americas, Europe and Asia, with historical segment data recast.
Financial performance and liquidity
| Metric | Second quarter | Year to date |
|---|---|---|
| Net sales | $740.0 million, down 4.4% reported; up 2% in constant currency | $1,465.1 million, down 5.5% reported; up 4% in constant currency and comparable calendar |
| Gross profit / margin | $409.5 million / 55.3%, versus 57.5% | $810.2 million / 55.3%, versus 57.3% |
| Operating income / margin | $70.4 million / 9.5%, versus $84.8 million / 11.0% | $126.6 million / 8.6%, versus $189.5 million / 12.2% |
| Net income attributable to Fossil Group | $54.6 million, versus $52.5 million | $92.7 million, down 22% from $118.9 million |
| Diluted EPS | $1.12, versus $0.98 | $1.87, versus $2.20 |
| Operating cash flow | Not separately reported for the quarter | $162.5 million, versus $155.5 million |
Second-quarter gross margin contracted 220 basis points, primarily due to currency effects; operating margin fell 150 basis points. Management estimated currency translation reduced second-quarter sales by $50.9 million and operating income by $27.6 million. Other income was $14.3 million, reflecting foreign-exchange gains and a gain related to an interest-rate hedge settlement; the lower tax rate also benefited from tax-audit settlements. These items and lower average shares helped lift quarterly attributable net income despite weaker operating income. Year-to-date operating income also faced currency headwinds, restructuring costs and prior-year store investments.
Year-to-date operating cash flow of $162.5 million funded, together with cash and net borrowings, $218.7 million of share repurchases and $32.5 million of capital expenditures. Investing cash flow was negative $32.7 million and financing cash flow negative $160.0 million. Cash declined $26.4 million to $249.9 million from fiscal year-end; $245.0 million was held outside the U.S. Working capital was $984.4 million. Accounts receivable was $254.5 million, down 16.4% year over year, and wholesale days sales outstanding improved to 41 from 46. Inventory was $669.3 million, up 0.8% year over year.
At July 4, 2015, short-term and current debt was $20.3 million and long-term debt was $674.4 million. The company reported $225.0 million outstanding under its term loan and $458.7 million under its revolving facility, with approximately $590.4 million of revolver borrowing capacity available. It was in compliance with debt covenants. The credit agreement matures May 17, 2018 and requires leverage no greater than 2.50-to-1.00 and interest coverage of at least 3.50-to-1.00.
Material changes and management commentary
- Second-quarter sales grew modestly on a constant-currency basis across regions, but reported sales declined. Watches remained the largest category and fell 5.8% reported; leather sales rose 2.4% and jewelry declined 0.7%.
- Reported second-quarter Europe sales fell 12.0% and Asia sales fell 6.0%; both were slightly positive in constant currency. Americas sales rose 1.4% reported. Year-to-date reported sales declined in all three regions.
- Global comparable-store sales increased 2.4% in the quarter and 2.1% year to date, with Asia weaker than the Americas and Europe. The company operated 608 stores at quarter-end, versus 558 a year earlier.
- Management said pricing initiatives supported gross margin excluding currency effects, while outlet promotions continued. It cited challenging U.S. department-store conditions, declining traffic in outlet retail, and weaker South Korean demand.
- Year-to-date restructuring charges were $18.6 million, including organizational realignment and retail profitability actions. The company also recorded $6.6 million of impairment charges related to retail-store assets and key money.
- The company repurchased $218.7 million of shares year to date, including $102.5 million for 1.3 million shares in the quarter. It had $841.7 million of repurchase authorization remaining.
Outlook, risks and contingencies
The filing provides no full-year revenue or earnings guidance. Management expected fiscal 2015 capital expenditures of approximately $100 million to $110 million, primarily for store expansion and renovation and technology infrastructure. It anticipated opening about 34 additional stores and closing about 19 during the remainder of the fiscal year, and stated that operating cash flow, cash on hand and available credit should fund needs for the next 12 months.
Key risks identified include foreign-exchange movements, discretionary consumer spending, changing fashion preferences and product acceptance, competition, supply interruptions and reliance on key components, customer financial difficulties, material-license renewals, acquisition integration, and changes in material, labor and advertising costs. A 10% unfavorable currency move was estimated to reduce pretax income by $13.3 million and stockholders’ equity by $89.4 million. A 100-basis-point increase in rates on unhedged variable-rate debt was estimated to add about $4.7 million to annual interest expense.
The company said routine litigation was not expected to have a material effect. Tax audit outcomes remain uncertain; $13.1 million of unrecognized tax benefits were reported, of which $10.3 million could favorably affect future effective tax rates if recognized. Management reported effective disclosure controls as of July 4, 2015.
Important facts for investors to verify
- Confirm the period: the filing is for fiscal 2015 Q2, despite the request metadata identifying 2014 Q2.
- Assess the extent to which constant-currency growth translates into reported revenue and operating profit if exchange rates remain unfavorable.
- Monitor margin recovery, watch-category demand, outlet promotions, and regional retail and wholesale trends.
- Evaluate the sustainability of earnings after separating operating performance from foreign-exchange gains, hedge-settlement gains and tax-audit benefits.
- Track debt, covenant headroom, liquidity, planned capital spending and share repurchases, particularly given cash held outside the U.S.
- Review execution and costs of restructuring, store openings and closures, and the recorded retail impairment.