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FOSL > SEC Filings for FOSL > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for FOSSIL INC


8-Nov-2012

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 September 29, 2012 (the "Third Quarter" and "Year To Date Period," respectively) as compared to the thirteen and thirty-nine week periods ended October 1, 2011 (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 categories, we have 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 meet 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, Company-owned retail and factory outlet stores, mass market stores, and through our FOSSIL® catalogs 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. In the United States, our network of Company-owned stores included 123 retail stores located in premier retail sites and 85 outlet stores located in major outlet malls as of September 29, 2012. 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 affiliate 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 over 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 and cruise ships and in international Company-owned retail stores, which included 183 retail stores and 53 outlet stores in select international markets as of September 29, 2012. Our products are also sold through licensed and franchised FOSSIL retail stores, retail concessions operated by us 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 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 2012 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 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 in early fiscal 2011.

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 net sales growth we have experienced over the last several fiscal quarters is the 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 continue 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 $85 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 consolidated 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 foreign exchange 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 December 31, 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 December 31, 2011.

Recently Issued Accounting Standards

In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2012-02. The amendments in this update permit an entity to make a qualitative assessment to determine if it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired. If an entity concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset, other than goodwill, exceeds its carrying amount, it is not required to perform the quantitative impairment test for that asset. This ASU aligns the guidance of impairment testing for indefinite-lived intangible assets, other than goodwill, with that in ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"). The guidance in ASU 2012-02 will be effective for us for annual and interim periods for fiscal years beginning after September 15, 2012, and is not expected to have a material impact on our condensed consolidated results of operations and financial position.

Recently Adopted Accounting Standards

In May 2011, FASB issued ASU 2011-04, Fair Value 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 the fair value measurements. These changes became effective for us on January 1, 2012. The adoption of ASU 2011-04 did not have a material impact on our condensed consolidated results of operations and financial position.

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (Topic 220):
Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 eliminates the option to report other comprehensive income and its components in the consolidated statement of shareholder's equity and comprehensive income and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. The amendments in the update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This amendment also required an entity to present on the face of the financial statements adjustments for items that are reclassified from accumulated other comprehensive income to net income. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05 ("ASU 2011-12"). ASU 2011-12 defers the specific requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income while FASB further deliberates this aspect of the proposal. ASU 2011-05, as amended by ASU 2011-12, became effective for us on January 1, 2012. The adoption of ASU 2011-05 did not have a material impact on our condensed consolidated results of operations and financial position.


In September 2011, FASB issued ASU 2011-08, which 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 became effective for us on January 1, 2012. The adoption of ASU 2011-08 did not have a material impact 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 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
                                         September 29, 2012    October 1, 2011       2011

Net sales                                             100.0 %            100.0 %          6.4 %
Cost of sales                                          44.2               44.1            6.8
Gross profit                                           55.8               55.9            6.1
Operating expenses:
Selling and distribution                               28.3               26.8           12.2
General and administrative                             11.0               10.6            9.7
Operating income                                       16.5               18.5           (4.8 )
Interest expense                                        0.2               (0.0 )              *
Other income (expense)-net                              0.3               (1.1 )              *
Income before income taxes                             16.6               17.4            1.8
Provision for income taxes                              4.9                6.1          (13.5 )
Net income                                             11.7               11.3           10.2
Net income attributable to
noncontrolling interest                                 0.5                0.5            6.6
Net income attributable to Fossil,
Inc.                                                   11.2 %             10.8 %         10.3 %



* Not meaningful

                                                Percentage of Net Sales           Percentage
                                                For the 39 Weeks Ended            Change from
                                         September 29, 2012    October 1, 2011       2011

Net sales                                             100.0 %            100.0 %         10.0 %
Cost of sales                                          44.1               44.0           10.4
Gross profit                                           55.9               56.0            9.6
Operating expenses:
Selling and distribution                               29.9               28.5           15.3
General and administrative                             11.1               10.4           17.4
Operating income                                       14.9               17.1           (4.6 )
Interest expense                                        0.2               (0.0 )              *
Other income (expense)-net                              0.3               (0.8 )              *
Income before income taxes                             15.0               16.3            1.3
Provision for income taxes                              4.5                5.7          (13.2 )
Net income                                             10.5               10.6            9.1
Net income attributable to
noncontrolling interest                                 0.4                0.4           16.1
Net income attributable to Fossil,
Inc.                                                   10.1 %             10.2 %          8.8 %



* 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
                                    September 29, 2012      October 1, 2011     September 29, 2012    October 1, 2011
Wholesale:
North America                      $              254.0    $           240.6                  37.1 %             37.4 %
Europe                                            163.5                178.3                  23.9               27.8
Asia Pacific                                       97.6                 78.6                  14.3               12.2
Total wholesale                                   515.1                497.5                  75.3               77.4
Direct to consumer                                169.1                145.4                  24.7               22.6
Consolidated                       $              684.2    $           642.9                 100.0 %            100.0 %




                                                   Amounts                              Percentage of Total
                                            For the 39 Weeks Ended                    For the 39 Weeks Ended
                                   September 29, 2012      October 1, 2011     September 29, 2012    October 1, 2011
Wholesale:
North America                      $             728.8    $           660.4                  38.2 %             38.0 %
Europe                                           464.1                471.9                  24.3               27.2
Asia Pacific                                     258.7                210.7                  13.5               12.1
Total wholesale                                1,451.6              1,343.0                  76.0               77.3
Direct to consumer                               458.2                393.5                  24.0               22.7
Consolidated                       $           1,909.8    $         1,736.5                 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   Total
                           Rates      Acquisitions   Change    Change
North America wholesale       (0.3 )%          4.9 %     1.0 %    5.6 %
Europe wholesale              (8.7 )           5.4      (5.0 )   (8.3 )
Asia Pacific wholesale        (2.4 )           2.0      24.6     24.2
Direct to consumer            (2.7 )           1.6      17.4     16.3
Consolidated                  (3.5 )%          4.0 %     5.9 %    6.4 %

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   Total
                           Rates      Acquisitions   Change    Change
North America wholesale       (0.5 )%          3.4 %     7.5 %   10.4 %
Europe wholesale              (7.6 )           4.0       1.9     (1.7 )
Asia Pacific wholesale        (1.7 )           2.2      22.3     22.8
Direct to consumer            (2.1 )           1.1      17.4     16.4
Consolidated                  (2.9 )%          2.9 %    10.0 %   10.0 %

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. Net sales rose 9.9% as a result of sales growth across each of our wholesale and direct to consumer businesses in comparison to the Prior Year Quarter. Our acquisition of Skagen Designs, Ltd. and certain of its international affiliates ("Skagen Designs") on April 2, 2012 contributed $25.2 million towards overall sales during the Third Quarter. On an organic basis, excluding sales related to SKAGEN® branded products, worldwide net sales increased 5.9% for the Third Quarter. Global watch sales were the key driver, increasing 9.5%, or $44.1 million. Third Quarter leathers product sales remained relatively unchanged from the Prior Year Quarter, increasing 0.9%, or $1.0 million. These sales gains were partially offset by sales decreases in jewelry of 9.8%, or $4.6 million, and eyewear of 43.1%, or $3.3 million. Jewelry and eyewear sales have declined throughout the year as a result of repositioning and market changes impacting FOSSIL® branded products in these categories. For the Year To Date Period, consolidated net sales increased by 12.9%, or $224.3 million, representing sales growth in each of our global wholesale and direct to consumer businesses.

North America Wholesale Net Sales. Net sales from the North America wholesale segment increased 5.9%, or $14.2 million, during the Third Quarter in comparison to the Prior Year Quarter. The increase in North American sales was primarily attributable to a 9.9%, or $17.5 million, increase in watch sales, including $11.7 million of sales related to SKAGEN branded products, and a 14.6%, or $1.3 million, increase in our jewelry business. While global jewelry sales decreased, North American jewelry sales continued to benefit from the roll-out of the MICHAEL KORS® jewelry line. Total wholesale shipments in the U.S. were relatively unchanged in comparison to the Prior Year Quarter. Shipments from our Canadian and Mexican subsidiaries and shipments to third party distributors in this segment, primarily serving the South American market, increased 11.6% on a combined basis during the Third Quarter as compared to the Prior Year Quarter. These sales volume increases in watches and jewelry were partially offset by decreases in our leather and eyewear categories of 3.3%, or $1.6 million, and 81.7%, or $1.2 million, respectively. The decrease in our leathers business was primarily attributable to decreased sell-through rates in our FOSSIL women's and men's categories, partially offset by sales volume increases in our RELIC® leather products in the department store channel. The Third Quarter was also negatively impacted by a 92.4%, or $1.7 million, decrease in our cold weather accessories business as a result of this category being discontinued. Third Quarter North American sales were negatively impacted by a slight shift in the retail calendar in addition to the impact of certain U.S. wholesale customers delaying initial holiday receipts from late Third Quarter to the fourth quarter of fiscal 2012. We expect that U.S. wholesale shipments in the fourth quarter of fiscal 2012 will benefit from these negative influences on Third Quarter sales. For the Year To Date Period, North America wholesale net sales increased 10.9%, or $72.2 million, compared to the Prior Year YTD Period. This increase was principally driven by the same categories and factors as were experienced during the Third Quarter and included $22.9 million of SKAGEN branded products.

Europe Wholesale Net Sales. Europe wholesale net sales during the Third Quarter rose 0.4%, or $0.8 million, including a $9.8 million contribution from sales of SKAGEN branded products, in comparison to the Prior Year Quarter. Excluding SKAGEN branded products, European wholesale sales decreased 5.0%, largely a result of a 25.0%, or $7.0 million, decrease in our jewelry business, partially offset by a slight increase in watch sales. Additionally, the Third Quarter was unfavorably impacted by reduced wholesale shipments of leather products of $2.0 million. We believe a weakening macro environment in Europe was a contributing factor to the reduction in Third Quarter sales growth in addition to the impact of repositioning the FOSSIL jewelry brand. Sales to third party distributors in this segment favorably impacted the Third Quarter, increasing 3.9%, or $1.4 million, as compared to the Prior Year Quarter. Europe wholesale net sales increased 5.9%, or $27.8 million, for the Year To Date Period as compared to the Prior Year YTD Period, led by a 11.6%, or $39.6 million increase, in watch sales and 5.9%, or $1.9 million, increase in the leathers business. These sales gains were partially offset by decreases in the jewelry and eyewear categories of 16.6%, or $12.9 million, and 21.4%, or $2.1 million, respectively.

Asia Pacific Wholesale Net Sales. Asia Pacific wholesale net sales rose 26.6%, or $20.9 million, during the Third Quarter in comparison to the Prior Year Quarter, including $1.7 million of sales of SKAGEN branded products. Excluding sales of SKAGEN branded products, Asia Pacific wholesale net sales grew 24.6%, primarily attributable to increased watch sales of $20.0 million. At the end of the Third Quarter, we operated 247 concession locations in Asia, with a net 43 new concessions opened during the last twelve months. For the Third Quarter, concession sales increased by 23.5%, with comp sales growing 4.9% in comparison to the Prior Year Quarter. The Third Quarter concession sales comp growth was a marked improvement from a comp sales increase of 1.0% during the second quarter of fiscal 2012. For the Year To Date Period as compared to the Prior Year YTD Period, Asia Pacific wholesale net sales rose 24.5%, or $51.6 million, principally as a result of the same factors experienced during the Third Quarter. Concession sales increased by 25.9%, with comp sales growing 2.2% in the Year To Date Period in comparison to the Prior Year YTD Period.


Direct to Consumer Net Sales. Direct to consumer net sales for the Third Quarter increased by 19.0%, or $27.6 million, in comparison to the Prior Year Quarter, primarily the result of a 15.7% increase in the average number of company-owned stores open during the Third Quarter and comparable store sales gains of 1.8%. The 1.8% comparable store sales gain represents the 18th consecutive quarter of comparable store sales increases and follows comparable store sales gains of 14.1% and 19.9% in the third quarter of fiscal 2011 and 2010, respectively. Additionally, net sales from our e-commerce businesses increased by 4.0%, or $0.3 million. For the Year To Date Period, net sales from our Direct to consumer segment increased 18.5%, or $72.7 million, in comparison to the Prior Year YTD Period, primarily as a result of a 12.5% increase in the average number of stores open and comparable store sales increases of 3.4%. Net sales from our e-commerce businesses increased 8.8%, or . . .

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