Fossil Group, Inc. — Form 10-Q Summary
Period clarification: The request identifies 2018 Q3, but the supplied filing is for the 13 weeks ended September 28, 2019, compared with the 13 weeks ended September 29, 2018. Year-to-date figures cover 39 weeks. Financial statement amounts below are in millions of dollars unless otherwise noted.
Business context and reporting period
Fossil designs, markets and distributes watches, jewelry, leather goods and other fashion accessories globally. It sells through wholesale, company-operated retail and e-commerce channels. The company reported three geographic segments: Americas, Europe and Asia. The financial statements are unaudited.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | 39 weeks 2019 | 39 weeks 2018 |
|---|---|---|---|---|
| Net sales | $539.5 | $608.8 | $1,506.1 | $1,754.6 |
| Gross profit | $278.5 | $326.5 | $791.6 | $923.2 |
| Gross margin | 51.6% | 53.6% | 52.6% | 52.6% |
| Operating income (loss) | $(9.2) | $22.7 | $(27.4) | $(4.6) |
| Net income (loss) attributable to Fossil | $(25.9) | $5.0 | $(45.5) | $(51.1) |
| Diluted EPS | $(0.51) | $0.10 | $(0.91) | $(1.04) |
- Q3 operating margin was (1.7%), versus 3.7% a year earlier; year-to-date operating margin was (1.8%), versus (0.3%).
- Year-to-date other income included a $21.6 million gain from selling smartwatch technology intellectual property to Google. The company also recorded a $3.0 million loss on extinguishment of prior debt.
- Operating cash flow was $(138.2) million for the 39 weeks, versus $72.4 million provided in the prior-year period. Investing activities provided $26.2 million, including $41.6 million of divestiture proceeds; financing activities used $142.2 million.
- Cash and cash equivalents were $147.5 million at September 28, down from $403.4 million at December 29, 2018. Inventory was $570.3 million, up from $377.6 million at year-end. Management attributed the increase in part to earlier production of the holiday collection.
- At quarter-end, reported debt carrying amounts were $21.9 million current and $242.1 million long-term. The new credit facilities had $200 million of term loans and $87 million of revolver borrowings outstanding, with $98.4 million of revolver capacity available. The company reported compliance with its debt covenants.
- Current assets were $1,091.7 million and current liabilities were $529.1 million. Operating lease liabilities totaled $357.1 million, recognized following adoption of the new lease standard.
Material changes versus the comparable period
- Q3 sales declined 11.4% reported and 9.7% in constant currency; year-to-date sales declined 14.2% reported and 11.8% in constant currency.
- Q3 sales fell in the Americas by 18.2% and Europe by 16.0%, while Asia grew 9.0% reported. Wholesale weakness in mature markets, store closures, lower off-price and liquidation sales, and licensed-brand exits weighed on results. E-commerce grew at a double-digit rate in Q3, according to management.
- Watches remained the largest category, contributing 82.6% of Q3 sales. Q3 watch sales declined 8.4%, leather sales 17.4%, and jewelry sales 32.5%.
- Q3 gross margin contracted 200 basis points. Management cited inventory valuation adjustments for older connected watches and licensed-brand exits, currency headwinds and lower factory cost absorption, partly offset by mix and restructuring benefits.
- Q3 SG&A declined $33.7 million year over year, but included a $16.6 million non-cash impairment of the SKAGEN trade name. Restructuring charges were $7.0 million for the quarter and $24.5 million year to date.
Outlook, commentary, risks and unusual items
- Management said cash on hand, operating cash flow and credit availability should be sufficient for working capital and planned capital expenditures over the next 12 months. Fiscal 2019 capital expenditures were estimated at approximately $20 million. The filing does not provide a clear quantitative sales or earnings forecast.
- The company completed its NWF 1.0 restructuring program in Q3 and reported approximately $200 million of run-rate profitability improvements over three years. NWF 2.0 is intended to improve efficiency and fund digital, marketing and direct-to-consumer investment; management said its early workstreams indicated potential profit improvement generally consistent with NWF 1.0, but did not provide a formal target.
- Management estimated gross-profit exposure from tariffs effective September 1 and scheduled for December 15, 2019, of $10 million in Q4 2019 and an additional $5 million to $10 million in fiscal 2020, assuming no offsets from pricing, sourcing changes or regulatory developments. The company was contesting a customs ruling affecting watches with China-origin components.
- Other risks highlighted include weak consumer demand and wholesale trends, changing fashion preferences, supply interruptions, foreign-currency movements, license terminations, competition and the execution of restructuring initiatives. Management noted continued growth in mainland China and India and better-than-expected initial performance for its Gen Five display watch.
- The September 2019 refinancing replaced the prior credit agreement with a $275 million asset-based revolver and a $200 million term loan. The term loan carries a 6.50% spread over adjusted LIBO for Eurodollar loans, plus original issue discount and other costs; facility availability depends on eligible inventory and receivables. A fixed-charge coverage covenant applies if revolver availability falls below specified thresholds.
- The SKAGEN trade name was written down from $21.1 million to $4.5 million and changed from an indefinite to a six-year useful life. Adoption of lease accounting added $292.1 million of operating lease right-of-use assets at quarter-end and resulted in a $29.5 million opening retained-earnings adjustment.
Most important facts for investors to verify
- Whether revenue and wholesale trends in the Americas and Europe stabilize, and whether Asia and e-commerce growth can offset continued declines in developed markets.
- Whether inventory levels convert to holiday-season sales without further markdowns or valuation adjustments.
- The realized impact of China-related tariffs, including the outcome of the customs ruling challenge and the company’s ability to offset duties.
- Cash generation, borrowing-base availability and covenant headroom under the new credit facilities, especially given the year-to-date operating cash outflow.
- Whether NWF 2.0 delivers measurable savings without impairing sales, and whether connected-watch launches sustain the initial momentum described by management.
- The effect of the SKAGEN impairment, restructuring and other non-recurring items on future reported earnings and margins.