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FOSL > SEC Filings for FOSL > Form 10-Q on 10-Nov-2011All Recent SEC Filings

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Form 10-Q for FOSSIL INC


10-Nov-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the financial condition and results of operations of Fossil, Inc. and its wholly and majority-owned subsidiaries for the thirteen and thirty-nine week periods ended October 1, 2011 (the "Third Quarter" and "Year To Date Period," respectively) as compared to the thirteen and thirty-nine week periods ended October 2, 2010 (the "Prior Year Quarter" and "Prior Year YTD Period," respectively). This discussion should be read in conjunction with the condensed consolidated financial statements and the related notes thereto.

General

We are a global design, marketing and distribution company that specializes in consumer fashion accessories. Our principal offerings include an extensive line of men's and women's fashion watches and jewelry, handbags, small leather goods, belts, sunglasses, soft accessories, shoes and clothing. In the watch and jewelry product category, our offerings include a diverse portfolio of globally recognized owned and licensed brand names under which our products are marketed. Our products are distributed globally through various distribution channels including wholesale in countries where we have a physical presence, direct to the consumer through our retail stores and commercial websites and through third-party distributors in countries where we do not maintain a physical presence. Our products are offered at varying price points to service the needs of our customers, whether they are value-conscious or luxury oriented. Based on our extensive range of accessory products, brands, distribution channels and price points, we are able to target style-conscious consumers across a wide age spectrum on a global basis.

Domestically, we sell our products through a diversified distribution network that includes department stores, specialty retail locations, specialty watch and jewelry stores, owned retail and factory outlet stores, mass market stores and through our FOSSIL® catalog and website. Our wholesale customer base includes, among others, Neiman Marcus, Nordstrom, Saks Fifth Avenue, Macy's, Dillard's, JCPenney, Kohl's, Sears, Wal-Mart and Target. We also sell our products in the United States through a network of Company-owned stores that included 118 retail stores located in premier retail sites and 74 outlet stores located in major outlet malls as of October 1, 2011. In addition, we offer an extensive collection of our FOSSIL brand products through our catalogs and on our website, www.fossil.com, as well as proprietary and licensed watch and jewelry brands through other managed and affiliated websites.

Internationally, our products are sold to department stores, specialty retail stores and specialty watch and jewelry stores in approximately 120 countries worldwide through 23 Company-owned foreign sales subsidiaries and through a network of approximately 60 independent distributors. Our products are distributed in Africa, Asia, Australia, Europe, Central and South America, Canada, the Caribbean, Mexico and the Middle East. Our products are offered on airlines, cruise ships and in international Company-owned retail stores, which included 161 retail stores located in premier retail sites and 26 outlet stores in select international markets as of October 1, 2011. Our products are also sold through licensed and franchised FOSSIL retail stores and kiosks in certain international markets. In addition, we offer an extensive collection of our FOSSIL brand products on our websites in certain countries.

Our business is subject to global economic cycles and retail industry conditions. Purchases of discretionary fashion accessories, such as our watches, handbags, sunglasses and other products, tend to decline during recessionary periods when disposable income is low and consumers are hesitant to use available credit. If economic conditions worsen or if the global or regional economies slip back into a recession, our revenues and earnings for fiscal year 2011 or beyond could be negatively impacted.

Our business is also subject to the risks inherent in global sourcing of supply. Certain key components in our products come from sole or limited sources of supply, which exposes us to potential supply shortages that could disrupt the manufacture and sale of our products. Any interruption or delay in the supply of key components could significantly harm our ability to meet scheduled product deliveries to our customers and cause us to lose sales. Interruptions or delays in supply may be caused by a number of factors that are outside of our and our contractor manufacturers' control, such as natural disasters like the earthquake and tsunami in Japan.

Future sales and earnings growth are also contingent upon our ability to anticipate and respond to changing fashion trends and consumer preferences in a timely manner while continuing to develop innovative products in the respective markets in which we compete. As is typical with new products, market acceptance of new designs and products that we may introduce is subject to uncertainty. In addition, we generally make decisions regarding product designs several months in advance of the time when consumer acceptance can be measured. We believe the double-digit net sales growth we have experienced over the last several fiscal quarters is a result of our ability to design innovative watch products incorporating a number of new materials that not only differentiate us from our competition but also continues to provide a solid value proposition to consumers across all of our brands.


The majority of our products are sold at price points ranging from $50 to $600. Although the current economic environment continues to weigh on consumer discretionary spending levels, we believe that the price/value relationship and the differentiation and innovation of our products, in comparison to those of our competitors, will allow us to maintain or grow our market share in those markets in which we compete. Historically, during recessionary periods, the strength of our balance sheet, our strong operating cash flow and the relative size of our business with our wholesale customers, in comparison to that of our competitors, have allowed us to weather recessionary periods for longer periods of time and generally resulted in market share gains to us.

Our international operations are subject to many risks, including foreign currency. Generally, a strengthening of the U.S. dollar against currencies of other countries in which we operate will reduce the translated amounts of sales and operating expenses of our subsidiaries, which results in a reduction of our consolidated operating income. We manage these currency risks by using derivative instruments. The primary risks managed by using derivative instruments are the future payments by non-U.S. dollar functional currency subsidiaries of intercompany inventory transactions denominated in U.S. dollars. We enter into forward contracts to manage fluctuations in global currencies that will ultimately be used to settle such U.S. dollar denominated inventory purchases.

For a more complete discussion of the risks facing our business, see "Part I, Item 1A. Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended January 1, 2011.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the periods reported. On an on-going basis, we evaluate our estimates and judgments, including those related to product returns, bad debt, inventories, long-lived asset impairment, impairment of goodwill and trade names, income taxes, warranty costs, hedge accounting, litigation reserves and stock-based compensation. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. Our estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There have been no changes to the critical accounting policies disclosed in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year ended January 1, 2011.

Recently Issued Accounting Standards

In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-04 Fair Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs ("ASU 2011-04"). FASB intends the new guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. The amended guidance changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 assets and liabilities for which we will be required to disclose quantitative information about the unobservable inputs used in fair value measurements. These changes become effective for us on January 1, 2012. The adoption of ASU 2011-04 is not expected to have a material impact on our condensed consolidated results of operations and financial position.

In September 2011, FASB issued ASU 2011-08 Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"). ASU 2011-08 simplifies the assessment of goodwill for impairment by allowing companies the option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a company concludes from the qualitative assessment that impairment is more likely than not, the entity is required to perform the two-step quantitative impairment test. These changes become effective for us for the first fiscal year beginning after December 15, 2011. We are currently evaluating the effect of early adopting this guidance on our condensed consolidated results of operations and financial position.


Results of Operations

The following tables set forth, for the periods indicated, (i) the percentages
of our net sales represented by certain line items from our condensed
consolidated statements of income and comprehensive income and (ii) the
percentage changes in these line items between the periods indicated.



                                                  Percentage of Net Sales                         Percentage
                                                   For the 13 Weeks Ended                        Change  from
                                       October 1, 2011               October 2, 2010                 2010
Net sales                                         100.0 %                        100.0 %                  22.7 %
Cost of sales                                      44.1                           43.0                    25.9

Gross profit                                       55.9                           57.0                    20.3
Operating expenses:
Selling and distribution                           26.8                           26.4                    24.4
General and administrative                         10.6                            9.4                    39.7

Operating income                                   18.5                           21.2                     6.8
Interest expense                                    0.0                            0.0                       *
Other (expense) income - net                       (1.1 )                          0.0                       *

Income before income taxes                         17.4                           21.2                     0.5
Provision for income taxes                          6.1                            7.7                    (2.6 )

Net income                                         11.3                           13.5                     2.3
Net income attributable to
noncontrolling interest                             0.5                            0.5                     5.3

Net income attributable to
Fossil, Inc.                                       10.8 %                         13.0 %                   2.1 %

* Not meaningful.

                                                  Percentage of Net Sales                         Percentage
                                                   For the 39 Weeks Ended                        Change  from
                                       October 1, 2011               October 2, 2010                 2010
Net sales                                         100.0 %                        100.0 %                  30.6 %
Cost of sales                                      44.0                           43.2                    32.8

Gross profit                                       56.0                           56.8                    28.9
Operating expenses:
Selling and distribution                           28.5                           29.5                    26.2
General and administrative                         10.4                           10.2                    33.0

Operating income                                   17.1                           17.1                    31.2
Interest expense                                    0.0                            0.0                       *
Other (expense) income - net                       (0.8 )                          0.2                       *

Income before income taxes                         16.3                           17.3                    23.2
Provision for income taxes                          5.7                            4.9                    52.5

Net income                                         10.6                           12.4                    11.8
Net income attributable to
noncontrolling interest                             0.4                            0.5                    18.1

Net income attributable to
Fossil, Inc.                                       10.2 %                         11.9 %                  11.5 %

* Not meaningful.


Net Sales. The following tables set forth consolidated net sales by segment and the percentage relationship of each segment to consolidated net sales for the periods indicated (in millions, except percentage data):

                                                 Amounts                                       Percentage of Total
                                         For the 13 Weeks Ended                              For the 13 Weeks Ended
                                October 1, 2011           October 2, 2010          October 1, 2011             October 2, 2010
Wholesale:
North America                  $           240.6         $           207.7                      37.4 %                     39.6 %
Europe                                     178.3                     137.0                      27.8                       26.2
Asia Pacific                                78.6                      60.9                      12.2                       11.6

Total wholesale                            497.5                     405.6                      77.4                       77.4
Direct to consumer                         145.4                     118.2                      22.6                       22.6

Total net sales                $           642.9         $           523.8                     100.0 %                    100.0 %

                                                  Amounts                                        Percentage of Total
                                           For the 39 Weeks Ended                              For the 39 Weeks Ended
                                 October 1, 2011            October 2, 2010          October 1, 2011             October 2, 2010
Wholesale:
North America                   $            660.4         $           517.3                      38.0 %                     38.9 %
Europe                                       471.9                     357.2                      27.2                       26.9
Asia Pacific                                 210.7                     146.1                      12.1                       11.0

Total wholesale                            1,343.0                   1,020.6                      77.3                       76.8
Direct to consumer                           393.5                     309.0                      22.7                       23.2

Total net sales                 $          1,736.5         $         1,329.6                     100.0 %                    100.0 %

The following tables illustrate by factor the total year-over-year percentage change in net sales by segment and on a consolidated basis:

Analysis of Percentage Change in Net Sales during the Third Quarter Versus Prior Year Quarter

                Attributable to Changes in the Following Factors



                                   Exchange        Organic
                                     Rates         Change         Total Change
         North America wholesale         0.4 %         15.4 %              15.8 %
         Europe wholesale                9.6           20.5                30.1
         Asia Pacific wholesale          8.6           20.5                29.1
         Direct to consumer              3.3           19.7                23.0
         Consolidated                    4.4 %         18.3 %              22.7 %

Analysis of Percentage Change in Net Sales during the Year To Date Period Versus Prior Year YTD Period

                Attributable to Changes in the Following Factors



                                   Exchange        Organic
                                     Rates         Change         Total Change
         North America wholesale         0.5 %         27.2 %              27.7 %
         Europe wholesale                8.3           23.8                32.1
         Asia Pacific wholesale          9.2           35.0                44.2
         Direct to consumer              3.2           24.1                27.3
         Consolidated                    4.2 %         26.4 %              30.6 %

The following net sales discussion excludes the impact on sales growth attributable to foreign currency exchange rate changes as noted in the above tables.

Consolidated Net Sales. We believe watch sales across all of our operating segments are benefiting from a resurgence in the watch category in general, resulting in consumers allocating more of their discretionary spending to this fashion category. We also believe our results are outpacing those of our competitors as consumers respond positively to our innovative product offerings and


focused presentations at retail. We attribute this favorable consumer response to our designs, which incorporate newer materials into the construction of the watch while also maintaining a very strong price to value relationship. With respect to the FOSSIL brand, we believe our strategy of focusing our marketing efforts on point-of-sale presentations, our catalog and web-based marketing initiatives as well as the growth of our Fossil store and e-commerce footprint is clearly communicating the aspirational lifestyle image of the brand and is resonating strongly with consumers around the world. Net sales of FOSSIL branded products increased by 13.7% and 16.5% during the Third Quarter and Year To Date Period, respectively, as compared to the respective prior fiscal year periods.

North America Wholesale Net Sales. Net sales from the North America wholesale segment increased 15.4%, or $32.0 million, during the Third Quarter in comparison to the Prior Year Quarter. This sales growth was primarily attributable to a 19.8%, or $29.3 million, increase in watch sales led by MICHAEL KORS ®, $12.9 million, FOSSIL, $4.8 million, DIESEL®, $4.0 million, MICHELE®, $3.6 million and ARMANI EXCHANGE®, $3.1 million. These increases were partially offset by sales volume decreases in RELIC® and mass market watches of $2.3 million and $1.6 million, respectively. Additionally, during the Third Quarter, sales to foreign distributors, located primarily in Latin America and to a lesser extent the Caribbean, increased 40.6%, or $8.5 million. MICHAEL KORS and ARMANI EXCHANGE sales volume increases were primarily driven by door expansion and increased case space allocated by retailers in the department store channel as a result of increased sell-through rates. Increased MICHELE sales volumes were principally attributable to a timing shift in shipments that have historically occurred during the fourth quarter into the Third Quarter, which totaled approximately $2.0 million, and new door growth. DIESEL sales volumes benefitted from an increase in the number of doors with existing customers in the department store channel as well as a shift in the sales mix to higher price points. We believe the decrease in RELIC sales volumes was a result of reduced replenishment shipments as retailers balanced their inventory levels. Although RELIC watch sales declined 25.6% during the Third Quarter, Year To Date Period net sales increased 27.0%. In addition to increased watch sales, Third Quarter net sales were also favorably impacted by a 4.2%, or $1.9 million, increase in our leathers business as compared to the Prior Year Quarter. This increase was primarily a result of increased sales volumes in FOSSIL men's and women's leather products partially offset by decreased sales volumes in RELIC women's handbags. The increase in the FOSSIL leathers business was principally driven by increased sell-through rates at retail and increased average unit retail prices as a result of introducing a growing selection of higher quality details and fabrications in our leather products. For the Year To Date Period, North America wholesale net sales increased 27.2%, or $140.5 million, as compared to the Prior Year YTD Period. This sales growth was principally driven by a 34.2%, or $121.2, million increase in watch sales representing sales growth across all major watch brands, and a 12.3%, or $14.9 million, increase in our leathers business.

Europe Wholesale Net Sales. Europe wholesale net sales rose 20.5%, or $28.1 million, during the Third Quarter in comparison to the Prior Year Quarter. This growth was broad-based across all key markets and largely attributable to an 18.6%, or $19.1 million, increase in watch shipments. All major watch brands contributed to the sales volume growth during the Third Quarter with increases of $5.6 million in MICHAEL KORS, $3.3 million in DIESEL, $2.5 million in FOSSIL, $2.1 million in BURBERRY® and $2.0 million in DKNY® representing the greatest gains. Sales growth in MICHAEL KORS resulted from the broader launch of the brand in Europe, leveraging the phenomenal success of the brand in the U.S. as well as the continuing brand building initiatives by the licensor. We believe the growth in all of our other watch brands resulted from the innovation of our product offerings and the strong price to value relationship and lifestyle imaging of our brands in comparison to other brands distributed in the European market. The leathers and jewelry categories also favorably impacted Third Quarter net sales increasing 116.7%, or $6.6 million, and 12.2%, or $2.8 million, respectively. We believe the sales volume increase in our leathers category was primarily driven by our initiative to expand our leather offerings in our wholesale channel in this region and the increased brand and broader category awareness generated by the increased number of FOSSIL retail stores and websites in the region. Third Quarter sales to third-party distributors increased 27.7%, or $7.7 million, as compared to the Prior Year Quarter. Europe wholesale net sales increased 23.8%, or $84.9 million, for the Year To Date Period as compared to the Prior Year YTD Period. The primary components of the increase during the Year To Date Period, were generally consistent from a brand and category perspective with those experienced during the Third Quarter.

Asia Pacific Wholesale Net Sales. Asia Pacific wholesale net sales increased 20.5%, or $12.5 million, during the Third Quarter in comparison to the Prior Year Quarter primarily the result of a 23.5%, or $12.4 million, increase in watch sales. EMPORIO ARMANI®, MARC BY MARC® and BURBERRY contributed the greatest watch sales gains during the Third Quarter with increases of $5.4 million, $3.7 million and $1.4 million, respectively. During the Third Quarter, the leathers business also experienced sales growth of 67.3%, or $2.0 million, as compared to the Prior Year Quarter. Similar to our experience in Europe, we believe the sales growth in our leathers business was a result of increased brand awareness generated by the expansion of our FOSSIL accessory store concept. These sales volume increases were partially offset by a 55.7%, or $2.0 million, decrease in our jewelry category primarily as a result of discontinuing a non-strategic local jewelry brand in India. At the end of the Third Quarter, we operated 205 concession locations in the Asia Pacific region with a net 62 new concessions opened during the last twelve months. For the Third Quarter,


concession sales increased by 72.5% with comp sales growing 19.9% in comparison to the Prior Year Quarter. For the Year To Date Period as compared to the Prior Year YTD Period, Asia Pacific wholesale net sales rose 35.0%, or $51.1 million, principally as a result of the same factors experienced during the Third Quarter.

Direct to Consumer Net Sales. Direct to consumer net sales for the Third Quarter increased 19.7%, or $23.3 million, in comparison to the Prior Year Quarter, primarily the result of comparable store sales gains of 14.1% and a 4.8% increase in the average number of company-owned stores open during the Third Quarter. Net sales from the Company's e-commerce businesses remained relatively unchanged for the Third Quarter in comparison to Prior Year Quarter. For the Year To Date Period, net sales from our Direct to consumer segment increased 24.1%, or $74.5 million, in comparison to the Prior Year YTD Period, primarily as a result of comparable store sales increases of 18.8% and a 5.3% increase in the average number of stores open. Net sales from our e-commerce businesses increased 14.5%, or $3.2 million, for the Year To Date Period in comparison to the Prior Year YTD Period. Comparable store sales related to our global full price accessory concept increased by 8.2% and 12.8% for the Third Quarter and Year To Date Period, respectively, in comparison to the respective prior fiscal year periods. Global outlet comparable store sales increased 20.9% and 26.7% for the Third Quarter and Year To Date Period, respectively, in comparison to the respective prior fiscal year periods.

We ended the Third Quarter with 379 stores, including 236 full price accessory stores, 134 of which were outside of North America; 100 outlet locations, including 25 outside of North America; 32 clothing stores, including four outside of North America; and 11 full price multi-brand stores, including 10 outside of North America. This compares to 358 stores at the end of the Prior Year Quarter, which included 226 full price accessory stores, 123 located . . .

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