Fossil, Inc. — Form 10-Q Summary
Period clarification: The supplied filing is for the 13 weeks ended March 31, 2012, not 2011 Q1 as stated in the request metadata. The comparable period is the 13 weeks ended April 2, 2011. The company designs, markets and distributes fashion accessories through wholesale, company-operated stores and e-commerce.
Financial performance and position
| Metric | Q1 2012 | Q1 2011 | Change / context |
|---|---|---|---|
| Net sales | $589.5 million | $537.0 million | Up 9.8% reported; up 11.1% excluding currency effects |
| Gross profit / margin | $329.0 million / 55.8% | $301.8 million / 56.2% | Profit up 9.0%; margin down 0.4 percentage points |
| Operating income / margin | $82.9 million / 14.1% | $92.6 million / 17.2% | Down 10.5%; margin down 3.1 percentage points |
| Net income attributable to Fossil | $58.1 million | $55.8 million | Up 4.2% |
| Diluted EPS | $0.93 | $0.86 | Up 8.1%; benefited from currency gains and fewer shares |
| Operating cash flow | $35.5 million | $53.1 million | Down $17.6 million |
Cash and cash equivalents were $260.5 million at March 31, 2012, versus $287.5 million at December 31, 2011. Cash declined $27.0 million during the quarter. Capital expenditures were $10.0 million; share repurchases used $67.9 million of cash. Working capital was $860.6 million, compared with $782.7 million at the prior-year quarter end.
Total debt at quarter-end was approximately $20.6 million: $12.9 million short-term and $7.7 million long-term. No borrowings were outstanding under the revolving facility at March 31; $0.9 million of letters of credit reduced availability. Inventory was $512.1 million, up 27.2% from the prior-year quarter, which management attributed to lower-than-expected first-quarter sales and higher watch-component inventory.
Material changes and drivers
- Sales growth was led by watches, up 13.7%, and leather goods, up 15.8%. Direct-to-consumer sales rose 18.7%, including comparable-store growth of 7.7%; Asia Pacific wholesale sales grew 18.8% organically.
- Operating costs rose faster than sales: selling and distribution expense increased 14.6%, and general and administrative expense increased 27.1%. Total operating expenses rose from 39.0% to 41.7% of sales.
- Management cited higher factory labor and component costs, foreign exchange effects and a greater share of third-party distributor sales as pressures on gross margin. Increased investment in Asia Pacific infrastructure, store growth, corporate staffing and incentive compensation contributed to expense growth.
- The effective tax rate fell to 27.8% from 34.9%, helped by discrete items and a $2.8 million release of deferred tax liabilities following a change in reinvestment plans for certain foreign earnings.
- Reported results included more favorable foreign-currency gains than the prior-year quarter; management estimated these gains added $0.03 per diluted share versus the prior-year comparison.
Outlook, risks and unusual items
- No full-year earnings or revenue guidance is provided. Management said operating results for the quarter are not necessarily indicative of full-year results and expects seasonal cash needs to increase from Q2, typically peaking in September–November.
- For the remainder of 2012, management anticipated opening approximately 70–75 stores and closing 17, with openings split roughly evenly between the U.S. and international markets and focused on outlet and accessory stores.
- On April 2, 2012, after quarter-end, Fossil completed the Skagen Designs acquisition for $231.7 million cash and 150,000 Fossil shares valued at $19.9 million. Sellers may receive up to 100,000 additional shares if sales thresholds are met. Purchase-price allocation and pro forma combined results were not yet available in this filing.
- In connection with the acquisition, the revolving credit commitment was increased from $300 million to $350 million, with an additional uncommitted $50 million and maturity extended to December 2014. Fossil borrowed $214 million in April; in May, $38 million was repaid and $176 million was renewed at approximately 1.5%.
- Key risks cited include discretionary consumer demand and economic conditions, changing fashion preferences, competition, supply interruptions or component shortages, foreign-exchange movements, customer financial difficulties, and integrating acquired businesses. A 10% adverse currency move was estimated to reduce pre-tax income by $10.8 million and stockholders’ equity by $30.8 million.
- Tax matters include $18.0 million of unrecognized tax benefits, excluding interest and penalties; $12.7 million could favorably affect future effective tax rates if recognized. An IRS appeal concerning 2005–2006 tax years may be resolved within 12 months. Management did not expect pending litigation to have a material effect.
- Fossil repurchased approximately 597,000 shares under its announced program for $59.3 million during the quarter and effectively retired 6.8 million previously repurchased shares. Management stated that cash, operating cash flows and remaining revolver availability should fund anticipated working capital, repurchases and capital expenditures for the next 12 months.
Important facts for investors to verify
- Confirm the reporting period: this is Q1 2012, despite the request metadata identifying 2011 Q1.
- Track whether inventory growth and slower operating cash flow translate into sales, cash conversion and lower inventory levels in subsequent quarters.
- Assess whether operating-expense growth moderates and gross and operating margins recover as sales scale.
- Review Skagen’s final purchase-price allocation, pro forma results, integration costs and the effect of acquisition borrowing on liquidity and interest expense.
- Monitor the IRS appeal and other uncertain tax positions, currency exposure and the pace and funding of share repurchases and planned store openings.