Fossil, Inc. — Form 10-Q Summary
Period: The filing covers the 13 weeks ended October 2, 2010 and the 39 weeks ended October 2, 2010, compared with the periods ended October 3, 2009. The request metadata says 2009 Q3, but the filing itself reports 2010 Q3. Amounts below are in U.S. dollars; financial statement amounts have been converted from thousands to millions where appropriate.
Business context and reporting period
Fossil designs, markets and distributes fashion accessories, including watches, jewelry, leather goods, sunglasses, footwear and apparel. It sells through wholesale, company-owned retail stores and e-commerce, with operations across North America, Europe and Asia Pacific. The filing reports unaudited interim results.
Financial performance
| Metric | Q3 2010 | Q3 2009 | 39 weeks 2010 | 39 weeks 2009 |
|---|---|---|---|---|
| Net sales | $523.8 million | $381.4 million | $1,329.6 million | $1,020.3 million |
| Gross profit | $298.7 million | $210.7 million | $755.0 million | $547.3 million |
| Gross margin | 57.0% | 55.3% | 56.8% | 53.6% |
| Operating income | $111.3 million | $57.4 million | $226.9 million | $103.6 million |
| Operating margin | 21.2% | 15.1% | 17.1% | 10.1% |
| Net income attributable to Fossil | $68.2 million | $35.3 million | $158.5 million | $69.2 million |
| Diluted EPS | $1.00 | $0.52 | $2.33 | $1.03 |
| Operating cash flow | Not separately shown for the quarter | $42.5 million | $153.0 million |
- Q3 sales grew 37.4%; year-to-date sales grew 30.3%. Management attributed Q3 growth to 40.0% organic growth, partly offset by a 2.6% unfavorable currency impact.
- Q3 net income attributable to Fossil rose 93.2%; year-to-date net income rose 129.1%. Q3 diluted EPS increased from $0.52 to $1.00.
- Q3 gross margin expanded 170 basis points, chiefly from a favorable mix of higher-margin watches and jewelry. The stronger U.S. dollar reduced Q3 gross margin by an estimated 75 basis points.
- Q3 external segment sales increased across North America wholesale (50.0%), Europe wholesale (23.3%), Asia Pacific wholesale (51.9%) and Direct to Consumer (28.9%). Direct-to-consumer comparable store sales rose 19.9%; e-commerce sales rose 63.4%.
- Watches were the largest product category: Q3 sales were $372.0 million versus $253.7 million; year-to-date sales were $914.7 million versus $660.7 million.
Balance sheet, liquidity and capital allocation
- At October 2, 2010, cash and cash equivalents were $362.2 million, down from $405.2 million at January 2, 2010. Current assets were $1,109.6 million and current liabilities $293.0 million; reported working capital was $816.6 million.
- Inventory rose to $388.3 million from $245.7 million at fiscal year-end; accounts receivable increased to $258.4 million from $209.8 million. Management linked higher receivables primarily to increased wholesale shipments.
- Total short- and long-term debt was approximately $8.4 million. The company had no borrowings under its $100 million U.S. revolver, but $37.1 million of letters of credit reduced availability; Japanese facility borrowings were approximately $3.6 million. The filing says the company complied with its debt covenants.
- Year-to-date operating cash flow of $42.5 million was below net income of $165.2 million, with working-capital changes using $184.0 million. Capital expenditures were $32.0 million. Cash used in financing was $59.1 million, including $77.1 million for share repurchases.
- The company repurchased approximately 1.35 million shares during Q3. It reported completing a $130 million repurchase plan, totaling 2.4 million shares, by November 4, 2010; this includes purchases after the quarter-end.
Outlook, commentary and risks
- For fiscal Q4 2010, management expected reported net sales growth of 21%–23% and diluted EPS of $1.26–$1.30. The EPS outlook included an estimated $0.02 unfavorable currency effect, a $0.04 share-buyback benefit and an estimated $0.01 dilution impact from share-based awards. Full-year diluted EPS guidance was $3.59–$3.63, versus $2.07 in fiscal 2009.
- Management expected Q4 gross margin to improve slightly from Q3, partly due to a higher Direct to Consumer sales mix, while operating expenses as a percentage of sales were expected to be slightly higher year over year. It cited increased marketing, IT investment and spending normalization.
- Management said operating cash, existing cash and available credit were expected to fund working capital, planned repurchases and capital expenditures for the next 12 months. The U.S. revolver was due to expire November 17, 2010; the company was seeking an extension while negotiating a new facility.
- Key risks cited include economic and discretionary-spending conditions, fashion trends and product acceptance, competition, customer financial health, foreign exchange, input and labor costs, licenses, intellectual property and litigation. A 10% unfavorable U.S. dollar move was estimated to reduce pretax income by $14.0 million and equity by $39.1 million.
- Foreign-exchange forward contracts had a net liability fair value of $13.1 million and an estimated $5.0 million net loss expected to be reclassified into earnings within 12 months. Management estimated an approximately $8.0 million after-tax loss if specified hedging contracts were settled at quarter-end.
- Year-to-date impairment charges were $2.7 million, including $1.2 million related to company-owned retail store assets and $1.5 million for a trade name. Three shareholder derivative lawsuits concerning historical stock-option grants remained pending; the company said the loss range could not be estimated and did not expect a material impact on its financial condition, operations or liquidity.
- Management reported disclosure controls were effective at October 2, 2010. Implementation of an SAP enterprise resource planning system in the U.K. subsidiary materially affected, or could reasonably be expected to affect, internal control over financial reporting.
Important facts for investors to verify
- Confirm the intended reporting period: the supplied metadata says 2009 Q3, while this filing is for the quarter ended October 2, 2010.
- Review subsequent results against Q4 and full-year sales and EPS guidance, including currency and share-repurchase effects.
- Track inventory and receivables growth, and whether working-capital investment converts into operating cash flow.
- Check the status and terms of the expiring U.S. revolver and any replacement credit facility.
- Assess the sustainability of sales and margin growth, particularly the effects of product mix, consumer demand, currency movements and increased marketing costs.
- Monitor completion and financing of repurchases, as well as litigation, tax-audit and foreign-exchange exposures.