Business context and reporting period
Fossil, Inc. (the filing names the registrant as Fossil, Inc., not Fossil Group, Inc.) filed this unaudited Form 10-Q for the 13 and 26 weeks ended July 3, 2010, compared with the periods ended July 4, 2009. This does not match the request metadata’s “2009 Q2” period. Fossil designs, markets and distributes fashion accessories through wholesale, company-owned retail and e-commerce channels.
Financial performance and position
- Second-quarter revenue and earnings: Net sales rose 30.6% to $412.6 million. Gross profit was $236.9 million; operating income was $64.3 million; net income attributable to Fossil was $54.5 million, or $0.80 per diluted share, versus $16.6 million, or $0.25, a year earlier.
- Margins: Gross margin increased to 57.4% from 52.9%; operating margin increased to 15.6% from 7.1%. Selling and distribution and G&A expenses rose in dollars, but total operating expenses fell to 41.8% of sales from 45.8%.
- First-half results: Net sales increased 26.1% to $805.8 million. Operating income was $115.6 million versus $46.3 million; net income attributable to Fossil was $90.4 million, or $1.33 per diluted share, versus $33.9 million, or $0.51.
- Cash flow: First-half operating cash flow was $70.6 million, down from $116.3 million. Capital expenditures were $17.6 million; cash increased $29.4 million to $434.5 million. Management cited working-capital uses, including inventory, prepaid assets and tax payments, and an $18.0 million adverse currency translation effect on cash.
- Liquidity and debt: Current assets were $1.005 billion and current liabilities $215.8 million; working capital was $788.8 million. Short-term debt was $3.8 million and long-term debt $4.1 million. No borrowings were outstanding under the $100 million U.S. revolving facility, although $39.5 million of letters of credit reduced availability. Fossil said it complied with facility covenants.
- Balance-sheet movements: Cash was $434.5 million versus $405.2 million at fiscal year-end; inventory rose to $297.5 million from $245.7 million. Total assets were $1.314 billion and stockholders’ equity $1.037 billion at July 3, 2010.
Material changes versus the prior comparable periods
- Second-quarter sales growth was broad-based: North America wholesale +37.8%, Europe wholesale +22.1%, Asia Pacific wholesale +36.5%, and Direct to Consumer +27.3% as reported. Management attributed growth to product demand, inventory replenishment and retail/e-commerce expansion; consolidated organic growth was 31.9%, offset by a 1.3% adverse currency effect.
- Direct-to-consumer comparable store sales increased 15.5% in the quarter; e-commerce sales rose 44.2%. The company had 354 stores at quarter-end, compared with 329 a year earlier.
- Management attributed gross-margin expansion mainly to a higher mix of higher-margin watches and fewer low-margin off-price sales. Operating expenses increased 20.2%, slower than sales growth.
- Quarterly other income fell to $0.2 million from $4.6 million, principally reflecting less favorable foreign-currency transaction and hedging results. Currency translation and hedging also contributed to significant movements in other comprehensive income.
- The effective tax rate was 12.3% for the quarter and 20.3% year to date, versus 36.0% and 35.0%. The lower rates reflected recognition of previously unrecognized tax benefits following audit settlements; management quantified a $0.22 per-share quarterly benefit and a $0.26 first-half benefit.
Outlook, commentary, risks and unusual items
- Guidance: For Q3 fiscal 2010, Fossil forecast reported sales growth of 25%–27%, constant-dollar growth of 27%–29%, and diluted EPS of $0.68–$0.72. For Q4 it forecast reported sales growth of 14%–16%, constant-dollar growth of 18%–20%, and diluted EPS of $1.12–$1.18. Full-year diluted EPS guidance was $3.13–$3.23, versus fiscal 2009 actual EPS of $2.07. Guidance assumed prevailing exchange rates.
- Management expected gross margins to remain near Q2 levels in the second half, with possible modest Q4 improvement from seasonal direct-to-consumer mix. It anticipated about 20 store openings and 11 closures in the second half.
- Unusual items include $2.5 million of first-half impairment charges ($1.0 million for property and equipment and $1.5 million for intangible assets) and the tax benefit from audit settlements. The filing reports $9.6 million of unrecognized tax benefits; $6.7 million could favorably affect future effective tax rates if recognized. An IRS audit dispute remained under review by the IRS Office of Appeals.
- Fossil repurchased shares for $11.2 million during the first half. After quarter-end it completed the existing $20 million authorization and approved an additional $30 million repurchase program.
- Three shareholder derivative lawsuits concerning historical stock-option grants remained pending. The company said the loss range could not be estimated, but did not expect the matters to materially affect financial condition, operations or liquidity.
- Key risks include economic and discretionary-spending conditions, fashion and product acceptance, customer financial health, competition, foreign exchange, licensing and supply costs, and litigation. A hypothetical 10% adverse currency move was estimated to reduce pretax income by $9.8 million and equity by about $35.0 million.
Most important facts for investors to verify
- Confirm the intended period: the supplied filing is for the quarter ended July 3, 2010, not 2009 Q2.
- Assess how much reported earnings growth depended on the unusually low tax rate and whether comparable growth persists absent audit-settlement benefits.
- Track inventory growth, operating cash flow and seasonal working-capital needs against sales and holiday demand.
- Evaluate the sustainability of margin gains, sales growth across regions and channels, and the assumptions underlying fiscal 2010 guidance.
- Review revolver availability after letters of credit, debt-facility renewal terms, currency exposures, and developments in the IRS audit and shareholder litigation.