Fossil, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the 13 weeks ended April 2, 2011 (fiscal first quarter), compared with the 13 weeks ended April 3, 2010. Fossil designs, markets and distributes fashion accessories, with wholesale and direct-to-consumer operations across North America, Europe and Asia Pacific. The filing states that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $537.0 million | $393.2 million | +36.6% |
| Gross profit / margin | $301.8 million / 56.2% | $219.4 million / 55.8% | +37.6%; +0.4 percentage points |
| Operating income / margin | $92.6 million / 17.2% | $51.3 million / 13.0% | +80.6% |
| Net income attributable to Fossil | $55.8 million | $35.9 million | +55.5% |
| Diluted EPS | $0.86 | $0.53 | — |
| Operating cash flow | $53.1 million | $54.8 million | — |
Sales growth was broad-based: North America wholesale +34.5%, Europe wholesale +34.9%, Asia Pacific wholesale +65.9%, and direct to consumer +29.5%, including currency effects. Watches were the largest product category at $372.7 million, versus $254.9 million a year earlier.
Cash and cash equivalents were $346.7 million at quarter-end, down $46.1 million from fiscal year-end. Current assets were $1.089 billion and current liabilities $306.6 million. Total debt was approximately $9.7 million ($5.2 million short-term and $4.5 million long-term); no borrowings were outstanding on the $300 million revolving facility, with $1.5 million of standby letters of credit reducing availability. Working capital was $782.7 million. Inventory rose to $402.6 million from $371.9 million at fiscal year-end; management reported a 60.9% increase from the prior-year quarter’s $250.3 million.
Material changes versus the prior comparable period
- Operating margin expanded to 17.2% from 13.0%, reflecting gross-margin improvement and operating expense leverage; operating expenses fell to 39.0% of sales from 42.8%.
- Effective tax rate increased to 34.9% from 29.9%; management attributed the prior-year lower rate to recognition of previously unrecognized tax benefits.
- Other expense was $3.1 million, versus other income of $2.5 million, mainly due to foreign-currency mark-to-market losses versus gains in the prior-year quarter.
- Operating cash flow was slightly lower despite higher earnings, with increased inventory and reductions in accrued expenses among the working-capital movements. Repurchases of common stock used $94.5 million in cash; 1.25 million shares were repurchased during the quarter.
Outlook, commentary, risks and unusual items
- Fiscal 2011 guidance: sales growth of 21%–23% and diluted EPS of $4.44–$4.54. Management expected operating margins slightly above its prior 17.0%–17.5% outlook, while forecasting full-year gross margin slightly below 57% due to component and labor cost increases.
- Q2 2011 guidance: sales growth of 28%–30%, operating income growth of 15%–18%, and diluted EPS of $0.70–$0.73. Management said the higher expected tax rate would reduce comparable-quarter EPS by about $0.26.
- Management expected approximately 80–85 additional store openings and 26–28 closures in fiscal 2011, subject to suitable locations and acceptable terms.
- Currency exposure is material: outstanding forward contracts had a net fair-value liability of $14.8 million; a 10% unfavorable currency move was estimated to reduce pre-tax income by $8.9 million and stockholders’ equity by about $35.4 million. The estimated loss expected to be reclassified into earnings within 12 months was $11.9 million.
- Management reported that Japan’s earthquake and tsunami temporarily disrupted watch-movement production, but supply had recovered close to prior levels and the company did not expect a significant sales impact. Sole- or limited-source components, currency changes, consumer spending, fashion trends, input costs and competition remain risks.
- After quarter-end, Fossil Korea entered a $20 million credit facility and drew $10.1 million on April 22, 2011. A shareholder derivative lawsuit settlement received preliminary court approval in May: insurers would pay the company about $8.7 million, while plaintiff counsel would receive about $7.8 million in shares and an option for up to 32,000 shares. Final approval was pending a June 30 hearing; the filing said the settlement had no material impact on the quarter’s financial statements.
- The company said cash on hand and operating cash flows should fund working capital, planned repurchases and capital expenditures for the next 12 months. It was in compliance with debt covenants at quarter-end.
Important facts for investors to verify
- Whether sales momentum, especially watch growth and comparable-store gains, persisted after Q1.
- Inventory growth, sell-through and the projected fiscal year-end inventory level, given management’s expectations for slower inventory increases.
- Whether margin guidance held as component and labor costs rose, and how foreign-exchange movements affected earnings and hedge losses.
- Actual fiscal-year sales, EPS, tax-rate and store-opening results versus management’s forecasts.
- Final court approval and accounting or dilution effects of the derivative lawsuit settlement, as well as subsequent share repurchases and Korean facility borrowing.