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FOSL > SEC Filings for FOSL > Form 10-Q on 15-May-2014All Recent SEC Filings

Show all filings for FOSSIL GROUP, INC.

Form 10-Q for FOSSIL GROUP, INC.


15-May-2014

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 Group, Inc. and its wholly and majority-owned subsidiaries for the fourteen week period ended April 5, 2014 (the "First Quarter") as compared to the thirteen week period ended March 30, 2013 (the "Prior Year Quarter"). 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 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 FOSSILŽ catalogs and 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 121 retail stores located in premier retail sites and 121 outlet stores located in major outlet malls as of April 5, 2014. In addition, we offer an extensive collection of our FOSSIL brand products 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 150 countries worldwide through 25 Company-owned foreign sales subsidiaries and through a network of over 60 independent distributors. Our products are offered on airlines and cruise ships and in international Company-owned retail stores. Internationally, our network of Company-owned stores included 212 retail stores and 88 outlet stores in select international markets as of April 5, 2014. Our products are also sold through licensed and franchised FOSSIL retail stores, retail concessions operated by us and kiosks in certain international markets, as well as 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 year 2014 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 contract manufacturers' control, such as natural disasters like the earthquake and tsunami in Japan in early fiscal year 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 our historical sales growth is the result of our ability to design innovative watch products 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 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 28, 2013.

Results of Operations

Executive Summary. During the First Quarter, sales rose 14% as compared to the Prior Year Quarter with each of our geographic regions contributing to the sales increase and included an extra week as fiscal 2014 is a 53-week year as compared to a 52-week year for fiscal 2013. Each of our core businesses experienced growth with our multi-brand global watch portfolio increasing 17% and our FOSSIL and SKAGENŽ branded products growing 5% and 2%, respectively. Growth in our multi-brand global watch portfolio was balanced with double-digit increases in all regions and with multiple brands posting gains. Our FOSSIL brand growth was led by a double-digit increase in watches and modest growth in jewelry while sales in our leather category were relatively flat compared to the Prior Year Quarter. Strong SKAGEN brand sales growth in Europe and Asia was partially offset by a decline in the Americas as a result of discontinuing business with certain customers that we consider inconsistent with our overall brand strategy. Our Direct to Consumer business grew during the First Quarter as a result of store expansion as positive comparable store sales results in Europe and Asia were offset by a decline in North America, primarily as a result of traffic declines in the U.S. that were only partially offset by higher conversion rates.

Gross margin also expanded during the First Quarter primarily driven by the impact of a greater sales mix of higher margin products, improvements in freight and other costs, prior year acquisitions and a favorable regional distribution mix given the growth in international markets. Partially offsetting these increases were the unfavorable impacts of increased promotional activity in outlet stores and reserves associated with leathers. Our increases in gross margins were offset by our planned operating expense deleveraging as we continued to invest in initiatives to support long-term growth, resulting in a slight contraction in our operating margin.

During the First Quarter, we invested $117.3 million to repurchase 1.0 million shares of our common stock. Our financial performance combined with our repurchase activity resulted in earnings of $1.22 per diluted share.

Consolidated Net Sales. Net sales increased $95.6 million or 14.0% for the First Quarter as compared to the Prior Year Quarter, representing sales growth in all of our business segments. Watch sales continued to deliver strong year-over-year growth with an increase of $88.4 million or 17.2%. 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 First Quarter net sales growth, increasing $14.2 million or 33.6%, with particular strength in our licensed portfolio. Our leather business decreased $3.1 million or 3.0%, during the First Quarter and represents an area of opportunity for the business as we work towards elevating our assortments and brand presentation especially within U.S. department stores. Net sales information by product category is summarized as follows (dollars in millions):

                      For the 14 Weeks Ended        For the 13 Weeks Ended
                           April 5, 2014                March 30, 2013             Growth (Decline)
                                   Percentage                    Percentage
                     Amounts        of Total       Amounts        of Total       Dollars     Percentage

Watches             $    601.4             77.5 % $    513.0             75.3 % $     88.4         17.2 %
Leathers                  99.7             12.8        102.8             15.1         (3.1 )       (3.0 )
Jewelry                   56.5              7.3         42.3              6.2         14.2         33.6
Other                     18.9              2.4         22.8              3.4         (3.9 )      (17.1 )
Total net sales     $    776.5            100.0 % $    680.9            100.0 % $     95.6         14.0 %


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 the First Quarter, the translation of foreign-based net sales into U.S. dollars increased reported net sales by approximately $1.4 million including a favorable impact of $6.6 million in our Europe wholesale segment partially offset by unfavorable impacts of $3.8 million and $1.4 million in our Asia Pacific wholesale and North America wholesale businesses, respectively.

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

                       For the 14 Weeks Ended        For the 13 Weeks Ended
                            April 5, 2014                March 30, 2013                  Growth
                                    Percentage                    Percentage
                      Amounts        of Total       Amounts        of Total       Dollars     Percentage
Wholesale:
North America        $    272.8             35.1 % $    255.2             37.5 % $     17.6          6.9 %
Europe                    205.7             26.5        173.9             25.6         31.8         18.3
Asia Pacific              103.5             13.4         86.8             12.7         16.7         19.2
Total wholesale           582.0             75.0        515.9             75.8         66.1         12.8
Direct to consumer        194.5             25.0        165.0             24.2         29.5         17.9
Total net sales      $    776.5            100.0 % $    680.9            100.0 % $     95.6         14.0 %

North America Wholesale Net Sales. North America wholesale net sales increased $17.6 million or 6.9% during the First Quarter in comparison to the Prior Year Quarter. Our multi-brand watch portfolio led the growth, increasing $20.9 million or 10.5%, followed by our jewelry category, increasing $3.9 million or 50.8%. Sales increased in the U.S. while Mexico and Canada both experienced sales decreases. Sales growth in the U.S. was driven by boutiques, specialty accounts and off-price partners. The wholesale department store business was challenging as many of our U.S. department store partners remained highly promotional during the First Quarter, unfavorably impacting our business. The First Quarter was also unfavorably impacted by a $4.9 million or 11.3%, sales decrease in our leather products as the leathers category remains highly competitive and promotional in the wholesale channel.

Europe Wholesale Net Sales. Europe wholesale net sales increased $31.8 million or 18.3% ($25.2 million or 14.5% in constant currency) representing balanced growth across the region. We experienced particularly strong sales growth in established markets such as the United Kingdom and France and in our distributor markets in the Middle East. Germany also increased slightly despite the negative short-term impact of exiting doors that are not consistent with our overall regional brand strategy. Italy experienced a modest sales decline in the First Quarter and continues to be our most challenging European market. On a constant currency basis, product category sales growth was primarily driven by an increase of $23.1 million or 17.3%, in our watch category and jewelry contributed an increase of $4.8 million or 20.9%. Our leathers business declined $2.7 million or 24.3% during the First Quarter.

Asia Pacific Wholesale Net Sales. Asia Pacific wholesale net sales expanded by $16.7 million or 19.2% ($20.5 million or 23.7% in constant currency). Our watch category made the greatest contribution, increasing $21.0 million or 26.7% partially offset by a $0.7 million or 14.6% decrease in leathers in constant currency. The sales growth was across virtually all of our markets in the region with Japan, China, India and South Korea delivering the strongest performances. At the end of the First Quarter, we operated 315 concession locations in Asia, with a net six new concessions opened during the First Quarter. For the First Quarter, concession sales increased double-digits primarily as a result of new door growth.

Direct to Consumer Net Sales. Direct to consumer net sales for the First Quarter increased by $29.5 million or 17.9%, in comparison to the Prior Year Quarter, primarily as a result of store expansion partially offset by comparable store sales decreases of 2.4%, based on a fourteen week calendar. Positive comparable store sales results in Europe and Asia were offset by a decline in North America, primarily driven by the U.S. stores, as traffic declines were only partially offset by higher conversion rates. The comparable store sales were also negatively impacted by the later timing of Easter in fiscal year 2014 as compared to the prior year. Comparable store sales in jewelry increased in the First Quarter, while sales of watches and leathers declined based on a fourteen week comparison.


The following table sets forth the number of stores by concept on the dates indicated below:

                                April 5, 2014                        March 30, 2013
                      North         Other                    North        Other
                     America    International     Total     America   International   Total
Full price
accessory                 111             160         271       106             153      259
Outlets                   127              82         209       103              61      164
Clothing                   30               2          32        31               2       33
Full priced
multi-brand                 6              24          30         4              17       21
Total stores              274             268         542       244             233      477

During the First Quarter, we opened eight new stores and closed nine stores. For fiscal year 2014, we anticipate opening a total of approximately 55 net new retail stores globally.

A store is included in comparable store sales in the thirteenth month of operation. Stores that experience a gross square footage increase of 10% or more due to an expansion and/or relocation are removed from the comparable store sales base, but are included in total sales. These stores are returned to the comparable store sales base in the thirteenth month following the expansion and/or relocation.

Gross Profit. Gross profit increased by 17.1% to $443.2 million in the First Quarter compared to $378.5 million in the Prior Year Quarter as a result of increased sales and gross profit margin expansion. Gross profit margin increased 150 basis points to 57.1% in the First Quarter compared to 55.6% in the Prior Year Quarter. Gross profit margin expansion was primarily driven by the impact of a greater sales mix of higher margin products, improvements in freight and other costs, prior year acquisitions and a favorable regional distribution mix given the growth in international markets. Partially offsetting these increases was the unfavorable impacts of increased promotional activity in outlet stores and reserves associated with leathers.

Selling, General and Administrative Expenses ("SG&A"). Total SG&A expenses in the First Quarter increased as planned by $54.4 million and, as a percentage of net sales, increased to 43.6% as compared to 41.7% in the Prior Year Quarter. The translation of foreign-denominated expenses in the First Quarter increased SG&A expenses by approximately $1.5 million as a result of the weaker U.S. dollar. SG&A expense increases were primarily attributable to continued investments in our retail store and concession expansion, infrastructure investments to support growth and global initiatives, higher advertising royalties and the additional week of operations incurred in the First Quarter. Additionally, the Prior Year Quarter was favorably impacted by the acquisition of credit insurance which reduced SG&A expenses in the period.

Operating Income. Operating income increased $10.4 million or 11.0%, in the First Quarter compared to the Prior Year Quarter. As a percentage of net sales, operating income decreased to 13.5% in the First Quarter compared to 13.9% of net sales in the Prior Year Quarter. During the First Quarter, the translation of foreign-based sales and expenses into U.S. dollars was neutral to consolidated operating income. Operating income was favorably impacted by gross margin expansion in our Europe wholesale and North America wholesale businesses, partially offset by decreased gross margins in our Asia Pacific wholesale business, primarily a result of the currency impact of the weaker Japanese Yen and Australian Dollar. The Europe wholesale gross margin was favorably impacted by the currency impact of a stronger Euro. Excluding foreign currency, gross margin in all of our segments benefitted from an increase in sales mix to sales of higher margin watch and jewelry products. As planned, operating income was negatively impacted by decreased SG&A expense leverage primarily in our North America wholesale, Corporate and Asia Pacific wholesale segments as we continued to make investments to support growth and global initiatives. Furthermore, many of our infrastructure investments were made in the latter part of fiscal year 2013 and will negatively impact our SG&A expense leverage in fiscal year 2014 until they are anniversaried towards the end of the fiscal year. Operating income was favorably impacted by SG&A expense leverage in our Europe wholesale segment primarily as a result of efforts to manage spending in our more established markets. Operating income by segment is summarized as follows (dollars in millions):


                           For the 14         For the 13
                           Weeks Ended       Weeks Ended         Growth (Decline)
                          April 5, 2014     March 30, 2013     Dollars    Percentage
Wholesale:
North America            $          52.9   $           60.4   $    (7.5 )      (12.4 )%
Europe                              52.0               38.5        13.5         35.1
Asia Pacific                        31.1               27.6         3.5         12.7
Total wholesale                    136.0              126.5         9.5          7.5
Direct to consumer                  16.2                7.1         9.1        128.2
Corporate                          (47.5 )            (39.3 )      (8.2 )       20.9
Total operating income   $         104.7   $           94.3   $    10.4         11.0 %

Interest Expense. Interest expense increased by $2.5 million during the First Quarter primarily as a result of increased debt levels in comparison to the Prior Year Quarter.

Other (Expense) Income-Net. Other (expense) income-net changed unfavorably by $10.1 million in comparison to the Prior Year Quarter. This decrease was primarily driven by a $6.4 million non-cash, mark-to-market valuation gain recognized in the Prior Year Quarter related to our right to acquire in 2015 the outstanding 50% of Fossil, S.L., our Spanish joint venture 50% owned by General De Relojeria, S.A. Additionally, the First Quarter included net foreign currency losses resulting from mark-to-market hedging and other transactional activities as compared to net gains in the Prior Year Quarter.

Provision for Income Taxes. Income tax expense for the First Quarter was $31.5 million, resulting in an effective income tax rate of 31.3%. For the Prior Year Quarter, income tax expense was $28.9 million, resulting in an effective income tax rate of 28.1%. The Prior Year Quarter was favorably impacted by discrete items which included the recognition of income tax benefits from the settlement of income tax audits of previous years.

Net Income Attributable to Fossil Group, Inc. First Quarter net income attributable to Fossil Group, Inc. decreased by 8.1% to $66.3 million, or $1.22 per diluted share, in comparison to $72.2 million, or $1.21 per diluted share, in the Prior Year Quarter which included an $0.11 benefit related to the acquisition of the Company's Spanish joint venture. The growth in diluted earnings per share resulted from operating income growth and a reduction in average shares outstanding, which more than offset the impact of a higher tax rate, increased interest expense and lower non-operating income.

Liquidity and Capital Resources

Historically, our business operations have not required substantial cash during the first several months of our fiscal year. Generally, starting in the third quarter, our cash needs begin to increase, typically reaching a peak in the September-November time frame as we increase inventory levels in advance of the holiday season. Our quarterly cash requirements are also impacted by the number of new stores we open, other capital expenditures and strategic investments such as acquisitions and stock repurchases. Our cash and cash equivalents balance at the end of the First Quarter was $303.4 million, including $299.2 million held in banks outside the U.S., in comparison to cash and cash equivalents of $241.4 million at the end of the Prior Year Quarter and $320.5 million at the end of fiscal year 2013.

For the First Quarter, we generated operating cash flow of $97.0 million. This operating cash flow combined with $33.7 million in net borrowings on our credit facilities was utilized to fund repurchases of our common stock of $119.7 million and capital expenditures of $21.5 million, primarily to support new and remodeled stores along with information technology and other system investments. The increase in operating cash flows was largely due to a $167.8 million decrease in accounts receivable and $69.2 million in net income, partially offset by a net increase of $164.6 million in other working capital items.

Accounts receivable, net of allowances, increased by 6.3% to $290.1 million at the end of the First Quarter compared to $272.9 million at the end of the Prior Year Quarter, primarily as a result of increased wholesale sales. Days sales outstanding for our wholesale segments for the First Quarter increased to 47 days compared to 46 days in the Prior Year Quarter.

Inventory at the end of the First Quarter was $601.9 million, representing an increase of 15.7% from the Prior Year Quarter inventory balance of $520.3 million. Our inventory growth was primarily driven by investment in stronger inventory positions to ensure availability in our best-selling watch brands as well as higher levels of leathers inventory.


The following tables reflect our common stock repurchase activity under our repurchase programs for the periods indicated (in millions):

                                                      For the 14 weeks Ended             For the 13 weeks Ended
                                                           April 5, 2014                     March 30, 2013
                                                    Number of                          Number of
Fiscal Year    Dollar Value                           Shares        Dollar Value        Shares          Dollar Value
Authorized      Authorized     Termination Date    Repurchased       Repurchased      Repurchased       Repurchased
2012          $      1,000.0    December 2016                1.0    $       117.3               0.2    $         18.0
2010          $         30.0         None                    0.0    $         0.0               0.0    $          0.0
2010          $        750.0   December 2013(1)              0.0    $         0.0               0.4    $         38.6



(1) In the Prior Year Quarter, we completed this repurchase plan.

We effectively retired 1.0 million shares of the common stock repurchased under our repurchase programs during the First Quarter. We account for the retirements by allocating the repurchase price, which is based upon the equity contribution associated with historical issuances, to common stock, additional paid-in capital and retained earnings. The effective retirement of common stock repurchased during the First Quarter decreased common stock by approximately $10,000, additional paid-in capital by $0.8 million, retained earnings by $116.5 million and treasury stock by $117.3 million. We effectively retired 0.6 million shares of our common stock during the Prior Year Quarter that were repurchased under our repurchase programs. The effective retirement during the Prior Year . . .

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