Fossil, Inc. — Form 10-Q Summary
Period: Quarter and six months ended June 30, 2012; prior-year comparisons are to the periods ended July 2, 2011. The request metadata says “2011 Q2,” but the filing covers 2012 Q2.
Business context
Fossil designs, markets and distributes fashion accessories, led by watches, through wholesale, company-operated retail and e-commerce channels. The interim statements are unaudited. Results include Skagen Designs from its April 2, 2012 acquisition.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $636.1 million | $556.7 million | $1,225.6 million | $1,093.6 million |
| Gross margin | 56.0% | 56.0% | 55.9% | 56.1% |
| Operating income | $88.1 million | $86.3 million | $171.0 million | $178.8 million |
| Net income attributable to Fossil | $57.3 million | $51.4 million | $115.5 million | $107.2 million |
| Diluted EPS | $0.92 | $0.80 | $1.86 | $1.66 |
| Operating cash flow | — | — | $136.4 million | $83.2 million |
- Reported sales increased 14.3% in Q2 and 12.1% year to date. Management reported Q2 growth of 18.1% excluding currency effects; organic growth excluding Skagen was 13.5% on the filing’s stated basis.
- Operating margin fell to 13.8% from 15.5% in Q2 and to 13.9% from 16.4% year to date, as operating expenses grew faster than sales. Selling and distribution and general and administrative expenses rose year over year.
- Cash and equivalents were $138.8 million at June 30, down from $287.5 million at December 31, 2011. Inventory was $524.4 million, versus $489.0 million at year-end.
- Balance-sheet debt was $113.1 million: $7.2 million short term and $105.9 million long term. The company reported $97 million outstanding on its revolver and approximately $252.1 million in available revolver borrowings. It was in compliance with debt covenants.
Material changes and notable items
- Fossil acquired Skagen for cash, shares and contingent consideration; preliminary total transaction consideration was $258.9 million. Skagen contributed $25.2 million of Q2 sales and $1.0 million of operating income. The purchase added $137.4 million of goodwill and significant intangible assets; purchase accounting and the working-capital adjustment remained preliminary.
- Investing cash use was $263.4 million, primarily due to $229.1 million of acquisitions and $30.1 million of capital expenditures. Financing cash use was $23.1 million, including $127.0 million of share repurchases, partly offset by net borrowings.
- Q2 operating expenses included $5.6 million of Skagen acquisition and integration costs, partly offset by a $4.4 million favorable revaluation of contingent consideration, for a net $1.2 million impact. The quarter also included $4.7 million of expense related to expected settlement of routine business litigation.
- Foreign-currency translation reduced Q2 operating income by approximately $9.2 million; year-to-date operating income included approximately $12.2 million of net currency losses. Other income improved versus the prior year, primarily due to currency gains.
- The effective tax rate declined to 31.4% in Q2 and 29.7% year to date, attributed to foreign income taxed at lower rates, rate reductions in some countries and the decision to indefinitely reinvest certain foreign earnings, partly offset by discrete items.
Outlook, commentary and risks
- Management expected to open approximately 50–55 additional stores globally and close 16 more in the second half of 2012, with openings split roughly between the U.S. and international markets and focused on outlet and accessory stores. No full-year earnings or revenue guidance is provided in the supplied filing text.
- Management said operating cash flows, cash on hand and revolver availability were expected to fund working capital, repurchases and planned capital expenditures for the next 12 months. Cash needs typically rise ahead of the holiday season.
- Management cited consumer discretionary spending, fragile European conditions, fashion and product acceptance, competition, supply interruptions, input costs, foreign exchange and integration of acquired businesses as risks. Europe represented 24.5% of six-month sales.
- The company used forward contracts to hedge forecast intercompany inventory purchases. A 10% unfavorable currency move was estimated to reduce pretax income by $4.8 million and stockholders’ equity by $53.1 million. These are sensitivities, not forecasts.
- Management reported disclosure controls were effective as of June 30, 2012. Its control assessment excluded Skagen’s internal control over financial reporting.
Investor verification priorities
- Confirm reported versus constant-currency and organic sales growth, and assess how much growth is attributable to Skagen and watches.
- Review operating-expense growth, segment profitability, and whether margins recover as acquisition and store-related costs evolve.
- Track cash, inventory, revolver borrowings, planned share repurchases and the final Skagen purchase-price allocation.
- Verify the expected store openings and closures, the litigation settlement outcome, and the status of tax audits and unrecognized tax benefits.
- Assess European demand, currency exposure and the realization of expected Skagen synergies; management’s forward-looking statements are subject to the risks described in the filing.