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FOSL > SEC Filings for FOSL > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for FOSSIL GROUP, INC.

Form 10-K for FOSSIL GROUP, INC.


Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations


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 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 outlet stores, mass market stores and through our FOSSIL website. Our wholesale customer base includes, among others, Dillard's, JCPenney, Kohl's, Macy's, Neiman Marcus, Nordstrom, Saks Fifth Avenue, Target and Wal-Mart. In the United States, our network of Company-owned stores included 123 retail stores located in premier retail sites and 119 outlet stores located in major outlet malls as of December 28, 2013. In addition, we offer an extensive collection of our FOSSIL brand products on our website,, 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 150 countries worldwide through 25 Company-owned foreign sales subsidiaries and through a network of over 60 independent distributors. Internationally, our network of Company-owned stores included 214 retail stores and 87 outlet stores as of December 28, 2013. 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 consolidated gross profit margin is impacted by our diversified business model that includes but is not limited to: (i) a significant number of product categories we distribute, (ii) the multiple brands we offer within several product categories, (iii) the geographical presence of our businesses, and
(iv) the different distribution channels we sell to or through. The components of this diversified business model produce varying ranges of gross profit margin. Generally, on a historical basis, our fashion branded watch, jewelry and sunglass offerings produce higher gross profit margins than our leather goods offerings. In addition, in most product categories that we offer, brands with higher retail price points generally produce higher gross profit margins compared to those of lower retail priced brands. From a segment standpoint, our Direct to consumer business generally produces the highest gross profit margin as a result of these sales being direct to the ultimate consumer. Gross profit margins related to sales in our international wholesale segments are historically lower than our Direct to consumer segment, but historically higher than our North America wholesale segment primarily due to the following factors:
(i) premiums charged in comparison to retail prices on products sold in the U.S.; (ii) the product sales mix in our international wholesale segments, in comparison to our North America wholesale segment, are comprised more predominantly of watches and jewelry that generally produce higher gross profit margins than leather goods; (iii) the watch sales mix in our international wholesale segments, in comparison to our North America wholesale segment, are comprised more

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predominantly of higher priced licensed brands; and (iv) concessions sales in our Asia Pacific wholesale segment where we capture the full retail price.

Our business is subject to the risks inherent in global sourcing 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.

This discussion should be read in conjunction with our consolidated financial statements and the related notes included therewith.

Critical Accounting Policies and Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing 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. We believe the following critical accounting policies require the most significant estimates and judgments.

Product Returns. We accept limited returns and may request that a customer return a product if we feel the customer has an excess of any style that we have identified as being a poor performer for that customer or geographic location. We monitor returns and maintain a provision for estimated returns based upon historical experience and any specific issues identified. While returns have historically been within our expectations and the provisions established, future return rates may differ from those experienced in the past. In the event that our products are performing poorly in the retail market and/or we experience product damages or defects at a rate significantly higher than our historical rate, the resulting returns could have an adverse impact on the operating results for the period or periods in which such returns occur.

Bad Debt. We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information. We monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues identified. Additionally, we secure credit insurance policies for certain receivables. While such credit losses have historically been within our expectations and the provisions established, future credit losses may differ from those experienced in the past. As a result of the difficult economic environment, some of our domestic and international customers have experienced financial difficulties, including bankruptcy. Due to the purchase of additional credit insurance, we were able to reduce our bad debt allowance in fiscal year 2013. Our policy is to maintain reserve balances for bankruptcies until the bankruptcies are actually settled.

Inventories. Inventories are stated at the lower of average cost, including any applicable duty and freight charges, or market. We account for estimated obsolescence or unmarketable inventory equal to

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the difference between the average cost of inventory and the estimated market value based upon assumptions about future demand, market conditions and available liquidation channels. If actual future demand or market conditions are less favorable than those projected by management, or if liquidation channels are not readily available, additional inventory valuation reductions may be required. We assess our off-price sales on an ongoing basis and update our estimates accordingly. Revenue from sales of our products that are subject to inventory consignment agreements is recognized when title and risk of loss transfers, delivery has occurred, the price to the buyer is determinable and collectability is reasonably assured. Inventory held at consignment locations is included in our finished goods inventory.

Long-lived Asset Impairment. We test for asset impairment of property, plant and equipment and other long-lived assets whenever events or conditions indicate that the carrying value of an asset might not be recoverable based on expected undiscounted cash flows related to the asset. We apply Accounting Standards Codification ("ASC") 360, Property, Plant and Equipment ("ASC 360"), in order to determine whether or not an asset is impaired. In evaluating long-lived assets for recoverability, we use our best estimate of future cash flows expected to result from the use of the asset and its eventual disposition. When undiscounted cash flows estimated to be generated through the operations of our Company-owned retail stores are less than the carrying value of the underlying assets, the assets are impaired. If it is determined that assets are impaired, an impairment loss is recognized for the amount the asset's book value exceeds its fair value. Impairment losses are recorded in selling, general and administrative expenses. In addition, impairment losses resulting from property, plant and equipment in our corporate costs area are recorded in selling, general and administrative expenses. Should actual results or market conditions differ from those anticipated, additional losses may be recorded. We recorded impairment losses of $5.8 million, $1.2 million and $1.0 million in fiscal years 2013, 2012 and 2011, respectively.

Impairment of Goodwill and Trade Names. We evaluate goodwill for impairment annually as of the end of the fiscal year by comparing the fair value of the reporting unit to its recorded value. Additionally, if events or conditions were to indicate the carrying value of a reporting unit may not be recoverable, we would evaluate goodwill for impairment at that time. We have three reporting units for which we evaluate goodwill for impairment, North America wholesale, Europe wholesale and Asia Pacific wholesale. The fair value of each reporting unit is estimated using market comparable information. If the estimated fair value of a reporting unit exceeds its carrying value, no impairment charge is recorded. As of December 28, 2013, the fair value of each of these reporting units exceeded their carrying value by over 25%.

Judgments and assumptions are inherent in our estimate of future cash flows used to determine the estimate of the reporting unit's fair value. The most significant assumptions associated with the fair value calculations include net sales growth rates and discount rates. If the actual future sales results do not meet the assumed growth rates, future impairments of goodwill may be incurred.

We evaluate trade names by comparing the fair value of the asset to its recorded value annually as of the end of the fiscal year and whenever events or conditions indicate that the carrying value of the trade name may not be recoverable. The fair value of the asset is estimated using discounted cash flow methodologies. The MICHELE trade name represented approximately 22% of our total trade name balances at the end of fiscal years 2013 and 2012, and 98% of our total trade name balances at the end of fiscal year 2011. The SKAGEN trade name represented approximately 77% of our total trade name balance at the end of fiscal years 2013 and 2012. We performed the required annual impairment test and recorded no impairment charges in fiscal years 2013, 2012 and 2011. As of December 28, 2013, the fair values of the MICHELE and SKAGEN trade names both exceeded their carrying values by over 25%. Due to the inherent uncertainties involved in making the estimates and assumptions used in the fair value analysis, actual results may differ which could alter the fair value of the trade names and possibly cause impairment charges to occur in future periods.

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Income Taxes. We record valuation allowances against our deferred tax assets, when necessary, in accordance with ASC 740, Income Taxes ("ASC 740"). Realization of deferred tax assets (such as net operating loss carryforwards) is dependent on future taxable earnings and is therefore uncertain. At least quarterly, we assess the likelihood that our deferred tax asset balance will be recovered from future taxable income. To the extent we believe that recovery is not likely, we establish a valuation allowance against our deferred tax asset, increasing our income tax expense in the period such determination is made. In addition, we have not recorded U.S. income tax expense for foreign earnings that we have determined to be indefinitely reinvested outside the U.S. On an interim basis, we estimate what our effective tax rate will be for the full fiscal year. The estimated annual effective tax rate is then applied to the year-to-date pre-tax income excluding unusual or infrequently occurring items, to determine the year-to-date tax expense. The income tax effects of infrequent or unusual items are recognized in the interim period in which they occur. As the fiscal year progresses, we continually refine our estimate based upon actual events and earnings by jurisdiction during the year. This continual estimation process periodically results in a change to our expected effective tax rate for the fiscal year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision equals the expected annual rate excluding the impact of infrequent or unusual items.

Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense. As required under applicable accounting rules, we accrue an amount for our estimate of additional income tax liability which we believe we are more likely than not to incur as a result of the ultimate resolution of tax audits ("uncertain tax positions"). We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax audits, upon expiration of statutes of limitation, or upon occurrence of other events. The results of operations and financial position for future periods could be impacted by changes in assumptions or resolutions of tax audits.

Warranty Costs. Our FOSSIL watch products sold in the U.S. are covered by a limited warranty against defects in materials or workmanship for a period of 11 years from the date of purchase. RELIC watch products sold in the U.S. are covered by a comparable 12 year limited warranty, while all other watch brands sold in the U.S. are covered by a comparable two year limited warranty. SKAGEN branded watches are covered by a lifetime warranty against defects due to faulty material or workmanship, subject to normal conditions of use. Generally, all of our watch products sold in Canada, Europe and Asia are covered by a comparable two year limited warranty. We determine our warranty liability using historical warranty repair experience. As changes occur in sales volumes and warranty experience, the warranty accrual is adjusted as necessary. The year end warranty liability for fiscal years 2013, 2012 and 2011 was $15.7 million, $13.4 million and $11.0 million, respectively.

Hedge Accounting. We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. We have entered into certain foreign currency forward contracts ("forward contracts") to hedge the risk of foreign currency rate fluctuations. Our objective is to hedge the variability in forecasted cash flows due to the foreign currency risks primarily associated with certain anticipated inventory purchases. Changes in the fair value of forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income within stockholders' equity, and are recognized in other income (expense)-net in the period which approximates the time the hedged inventory is sold. Also, the Company has entered into an interest rate swap agreement to effectively convert a portion of variable rate debt obligations from a floating rate to a fixed rate. Changes in the fair value of the interest rate swap are recorded as a component of accumulated other comprehensive income within stockholders' equity, and are recognized in interest expense in the period in which the payment is settled. We have elected to apply the hedge accounting rules as required by ASC 815, Derivatives and Hedging, for these hedges.

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Litigation Reserves. Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in our consolidated balance sheet. The likelihood of a material change in these estimated reserves would be dependent on new claims that may arise, changes in the circumstances used to estimate amounts for prior period claims and favorable or unfavorable final settlements of prior period claims. As additional information becomes available, we assess the potential liability related to new claims and existing claims and revise estimates as appropriate. As new claims arise or circumstances change relative to prior claim assessments, revisions in estimates of the potential liability could materially impact our consolidated results of operations and financial position.

Stock-Based Compensation. We account for stock-based compensation in accordance with the provisions of ASC 718, Compensation-Stock Compensation ("ASC 718"). We utilize the Black-Scholes model to determine the fair value of stock options and stock appreciation rights on the date of grant. The model requires us to make assumptions concerning (i) the length of time employees will retain their vested stock options and stock appreciation rights before exercising them ("expected term"), (ii) the volatility of our common stock price over the expected term, and (iii) the number of stock options and stock appreciation rights that will be forfeited. Changes in these assumptions can materially affect the estimate of fair value of stock-based compensation and, consequently, the related expense amounts recognized on our consolidated statements of comprehensive income.

Results of Operations

Executive Summary

During fiscal year 2013, sales rose 14% representing growth across each of our geographic regions as compared to fiscal year 2012. Each of our core businesses contributed to the growth, with our FOSSIL and SKAGEN lifestyle brands increasing 7% and 41%, respectively, and our global watch portfolio rising 17%. Our FOSSIL brand growth was led by the continued strength of watches combined with favorable responses to our new jewelry line, while leathers experienced only a slight increase. Our acquisition of Skagen Designs on April 2, 2012 contributed $29.1 million towards overall sales in fiscal 2013 prior to anniversarying. The SKAGEN brand continued to benefit from integration into our global network, with stronger overall sales and expanded distribution through new doors in Europe, Asia and North America. Our Direct to consumer business grew during fiscal year 2013 as we expanded our owned store base globally. Fiscal 2013 global comps in our owned retail stores were relatively flat, driven by the challenging retail environment in the U.S., which offset increases in our international stores highlighted by improved store productivity in Europe. Even though we experienced lower traffic in our U.S. full price stores, conversion rates were up showing the strength of our assortment. Our retail store expansion continued with an emphasis on outlets, where we introduced "made for" product as we looked to present a consistent brand image across channels.

Building on our sales growth, gross margins and operating margins also expanded. Gross margins benefitted from a greater sales mix of higher margin watch and jewelry products, growth in our international markets and direct distribution in Latin America, Spain and Portugal as a result of acquisitions during fiscal year 2013. Partially offsetting these increases were the unfavorable impacts of promotional activities to drive traffic and clear prior seasons' products, especially in U.S. outlet stores. Our strong gross margins more than offset our operating expense deleveraging as we continued to invest in initiatives to support long-term growth. Our operating margin was relatively flat even as we made investments in corporate and global infrastructure as well as improved marketing programs and added stores around the globe.

During fiscal year 2013, we invested $574.8 million to repurchase 5.3 million shares of our common stock. Our financial performance combined with our repurchase activity resulted in earnings of $6.56 per diluted share.

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Fiscal Year 2013 Compared to Fiscal Year 2012

Consolidated Net Sales. Net sales increased 14.1%, representing sales growth across each of our global wholesale and Direct to consumer businesses. Global watch sales made the most significant contribution, increasing $371.6 million or 17.4%, in fiscal year 2013. We believe that we continue to gain market share in the watch category as we maximize the potential for our brands with our global distribution infrastructure and design innovation. Our jewelry product category also contributed favorably to the current fiscal year net sales growth, increasing $47.2 million, or 26.0%, as our new global assortment has resonated well with consumers. Our leather business decreased slightly during the year and represents an area of opportunity for the business as we work towards improving our assortments.

We believe our diverse global distribution network, including owned distribution in 25 countries, combined with our design and marketing capabilities, will allow us to continue to take shelf space from lesser known local and regional brands as we continue to increase brand awareness through the growth of our retail stores and introduction of new websites in many of the countries in which we operate. We also believe that investments we have made in certain emerging markets will allow us to experience higher levels of growth in our international wholesale segments in comparison to our North America wholesale segment. Net sales information by product category is summarized as follows (dollars in millions):

                                    Fiscal Year
                          2013                       2012                 Growth (Decline)
                             Percentage                 Percentage
                 Amounts      of Total      Amounts      of Total      Dollars      Percentage
 Watches        $ 2,513.1           77.1 % $ 2,141.5           74.9 %  $   371.6           17.4 %
 Leathers           436.3           13.4       440.1           15.4         (3.8 )         (0.9 )
 Jewelry            228.8            7.0       181.6            6.4         47.2           26.0
 Other               81.8            2.5        94.3            3.3        (12.5 )        (13.3 )

 Total net
 sales          $ 3,260.0          100.0 % $ 2,857.5          100.0 %  $   402.5           14.1 %

As a multinational enterprise, we are exposed to changes in foreign currency exchange rates. The translation of the operations of our foreign-based entities from their local currencies into U.S. dollars is sensitive to changes in foreign currency exchange rates. In general, our overall financial results are affected positively by a weaker U.S. dollar and are affected negatively by a stronger U.S. dollar as compared to the foreign currencies in which we conduct our business. In fiscal year 2013 the translation of foreign-based net sales into U.S. dollars reduced reported net sales by approximately $0.6 million including a favorable impact of $18.3 million in our Europe wholesale segment offset by unfavorable impacts of $17.1 million and $1.8 million in our Asia Pacific wholesale and Direct to Consumer businesses, respectively.

The following table sets forth consolidated net sales by segment (dollars in millions):

                                        Fiscal Year
                              2013                       2012                     Growth
                                 Percentage                 Percentage
                     Amounts      of Total      Amounts      of Total     Dollars    Percentage
 North America      $ 1,216.6           37.3 % $ 1,083.5           37.9 %  $ 133.1          12.3 %
 Europe                 828.1           25.4       697.0           24.4      131.1          18.8
 Asia Pacific           396.7           12.2       361.5           12.7       35.2           9.7

 Total wholesale      2,441.4           74.9     2,142.0           75.0      299.4          14.0
 Direct to
 consumer               818.6           25.1       715.5           25.0      103.1          14.4

 Total net sales    $ 3,260.0          100.0 % $ 2,857.5          100.0 %  $ 402.5          14.1 %

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North America Wholesale Net Sales. Net sales in the North America wholesale segment increased $133.1 million or 12.3% during fiscal year 2013, representing growth across the U.S., Canada and Latin America. Watch sales led the growth, increasing $142.3 million or 16.9%, while jewelry sales also contributed favorably, increasing $11.5 million or 30.2%. These sales gains were partially offset by sales volume declines in our leathers products of $12.0 million or 6.6% as a result of decreased sell-through rates at retail. The discontinuation of our footwear line and, as we transitioned to a licensing model, eyewear line also negatively impacted fiscal year 2013 net sales by $5.3 million and $5.0 million, respectively. Additionally, fiscal year 2013 was negatively impacted by approximately $10 million as a result of the misalignment of our fiscal calendar with the National Retail Federation ("NRF") calendar, on which many of our customers operate. The NRF calendar included an extra week in January 2013 as compared to our fiscal calendar. The extra week on our fiscal calendar will take place in January 2014 at which time our fiscal calendar will re-align with the NRF calendar.

Europe Wholesale Net Sales. Europe wholesale net sales rose $131.1 million . . .

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