UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 30, 2013
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 000-19848
FOSSIL, INC.
(Exact name of registrant as specified in its charter)
Delaware
75-2018505
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
901 S. Central Expressway, Richardson, Texas
75080
(Address of principal executive offices)
(Zip Code)
(972) 234-2525
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of the registrant’s common stock outstanding as of May 3, 2013: 58,672,408.
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
IN THOUSANDS
March 30, 2013
December 29, 2012
Assets
Current assets:
Cash and cash equivalents
$
241,396
177,236
Securities available for sale
56
127
Accounts receivable - net of allowances of $75,762 and $82,362, respectively
272,860
363,456
Inventories
520,306
506,314
Deferred income tax assets-net
31,442
34,238
Prepaid expenses and other current assets
81,598
62,741
Total current assets
1,147,658
1,144,112
Investments
0
6,965
Property, plant and equipment - net of accumulated depreciation of $269,411 and $262,041, respectively
329,223
335,446
Goodwill
201,356
184,793
Intangible and other assets-net
178,332
170,673
Total long-term assets
708,911
697,877
Total assets
1,856,569
1,841,989
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
124,859
149,561
Short-term debt
1,600
2,794
Accrued expenses:
Compensation
50,044
55,563
Royalties
29,819
53,547
Co-op advertising
15,048
24,500
Transaction taxes
17,908
27,973
Other
56,733
61,575
Income taxes payable
18,307
31,265
Total current liabilities
314,318
406,778
Long-term income taxes payable
10,172
8,662
Deferred income tax liabilities
87,292
79,756
Long-term debt
151,129
75,140
Other long-term liabilities
48,304
31,189
Total long-term liabilities
296,897
194,747
Commitments and contingencies (Note 12)
Stockholders’ equity:
Common stock, 59,203 and 59,631 shares issued at March 30, 2013 and December 29, 2012, respectively
592
596
Additional paid-in capital
140,083
138,097
Retained earnings
1,083,717
1,066,082
Accumulated other comprehensive income
12,243
28,760
Total Fossil, Inc. stockholders’ equity
1,236,635
1,233,535
Noncontrolling interest
8,719
6,929
Total stockholders’ equity
1,245,354
1,240,464
Total liabilities and stockholders’ equity
See notes to the condensed consolidated financial statements.
2
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
IN THOUSANDS, EXCEPT PER SHARE DATA
For the 13 Weeks Ended
March 31, 2012
Net sales
680,899
589,533
Cost of sales
302,428
260,553
Gross profit
378,471
328,980
Operating expenses:
Selling and distribution
203,189
181,438
General and administrative
80,961
64,681
Total operating expenses
284,150
246,119
Operating income
94,321
82,861
Interest expense
1,231
814
Other income-net
9,784
2,549
Income before income taxes
102,874
84,596
Provision for income taxes
28,894
23,524
Net income
73,980
61,072
Less: Net income attributable to noncontrolling interest
1,794
2,932
Net income attributable to Fossil, Inc.
72,186
58,140
Other comprehensive (loss) income, net of taxes:
Currency translation adjustment
(19,837
)
10,071
Unrealized (loss) gain on securities available for sale
(71
50
Forward contracts hedging intercompany foreign currency payments-change in fair values
3,391
(1,349
Total other comprehensive (loss) income
(16,517
8,772
Total comprehensive income
57,463
69,844
Less: Comprehensive income attributable to noncontrolling interest
Comprehensive income attributable to Fossil, Inc.
55,669
66,912
Earnings per share:
Basic
1.22
0.94
Diluted
1.21
0.93
Weighted average common shares outstanding:
59,393
61,859
59,783
62,459
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating Activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion
18,758
15,227
Stock-based compensation
2,546
3,144
Decrease in allowance for returns-net of inventory in transit
(238
(2,917
Loss on disposal of assets
266
517
Equity in income of joint venture
(270
Gain on equity method investment
(6,410
Decrease in allowance for doubtful accounts
(4,202
(1,396
Excess tax benefits from stock-based compensation
(4,082
(9,901
Deferred income taxes and other
8,292
3,919
Changes in operating assets and liabilities:
Accounts receivable
99,403
88,197
(11,507
(19,355
(14,721
(5,527
(20,369
(45,310
Accrued expenses
(49,000
(60,930
(6,813
9,029
Net cash provided by operating activities
85,903
35,499
Investing Activities:
Additions to property, plant and equipment
(19,485
(10,029
Increase in intangible and other assets
(723
(27
Net change in restricted cash
452
(157
Business acquisitions-net of cash acquired
(15,165
Net cash used in investing activities
(34,921
(10,213
Financing Activities:
Acquisition of common stock
(61,188
(67,878
Distribution of noncontrolling interest earnings
(4
(3,786
4,082
9,901
Debt borrowings
218,098
3,899
Debt payments
(142,718
Proceeds from exercise of stock options
1,991
4,352
Net cash provided by (used in) financing activities
20,261
(53,516
Effect of exchange rate changes on cash and cash equivalents
(7,083
1,210
Net increase (decrease) in cash and cash equivalents
64,160
(27,020
Cash and cash equivalents:
Beginning of period
287,498
End of period
260,478
4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL STATEMENT POLICIES
Basis of Presentation. The condensed consolidated financial statements include the accounts of Fossil, Inc., a Delaware corporation, and its wholly and majority-owned subsidiaries (the “Company”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to present a fair statement of the Company’s financial position as of March 30, 2013, and the results of operations for the thirteen week periods ended March 30, 2013 (“First Quarter”) and March 31, 2012 (“Prior Year Quarter”), respectively. All adjustments are of a normal, recurring nature.
These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Annual Report on Form 10-K filed by the Company pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for the fiscal year ended December 29, 2012 (the “2012 Form 10-K”). Operating results for the First Quarter are not necessarily indicative of the results to be achieved for the full fiscal year.
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which require the Company 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. Actual results could differ from those estimates. The Company has not made any changes in its significant accounting policies from those disclosed in the 2012 Form 10-K.
Business. The Company is a global design, marketing and distribution company that specializes in consumer fashion accessories. Its 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, the Company has a diverse portfolio of globally recognized owned and licensed brand names under which its products are marketed. The Company’s products are distributed globally through various distribution channels, including wholesale in countries where it has a physical presence, direct to the consumer through its retail stores and commercial websites and through third-party distributors in countries where the Company does not maintain a physical presence. The Company’s products are offered at varying price points to meet the needs of its customers, whether they are value-conscious or luxury oriented. Based on its extensive range of accessory products, brands, distribution channels and price points, the Company is able to target style-conscious consumers across a wide age spectrum on a global basis.
Foreign Currency Hedging Instruments. The Company’s foreign subsidiaries periodically enter into foreign exchange forward contracts to hedge the future payment of intercompany inventory transactions denominated in U.S. dollars. If the Company’s foreign subsidiaries were to settle their contracts designated as cash flow hedges that were denominated in Euros, British Pounds, Mexican Pesos, Australian Dollars, Canadian Dollars and Japanese Yen, the net result would have been a gain of approximately $4.4 million, net of taxes, as of March 30, 2013. The Company applies the hedge accounting rules as required by Accounting Standard Codification (“ASC”) 815, Derivatives and Hedging (“ASC 815”). See “Note 8—Derivatives and Risk Management” for additional disclosures about the Company’s use of forward contracts.
Earnings Per Share (“EPS”). Basic EPS is based on the weighted average number of common shares outstanding during each period. Diluted EPS adjusts basic EPS for the effects of dilutive common stock equivalents outstanding during each period using the treasury stock method.
5
The following table reconciles the numerators and denominators used in the computations of both basic and diluted EPS (in thousands except per share data):
Numerator:
Denominator:
Basic EPS computation:
Basic weighted average common shares outstanding
Basic EPS
Diluted EPS computation:
Stock options, stock appreciation rights and restricted stock units
390
600
Diluted weighted average common shares outstanding
Diluted EPS
Approximately 201,000 and 237,000 shares issuable under stock-based awards were not included in the diluted EPS calculation at the end of the First Quarter and Prior Year Quarter, respectively, because they were antidilutive.
Restricted Cash. As of March 30, 2013 and December 29, 2012, the Company had short-term restricted cash balances of $0.2 million and $0.3 million, respectively, and long-term restricted cash balances of $0.7 million and $1.0 million, respectively, primarily pledged as collateral to secure bank guarantees for the purpose of obtaining retail space. Short-term restricted cash is reported in prepaid expenses and other current assets in the Company’s condensed consolidated balance sheets as a component of current assets. Long-term restricted cash is reported in intangible and other assets-net in the Company’s condensed consolidated balance sheets as a component of long-term assets.
Recently Issued Accounting Standards. In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (“ASU 2013-05”). ASU 2013-05 addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The guidance outlines the events when cumulative translation adjustments should be released into net income and is intended by FASB to eliminate some disparity in current accounting practice. The guidance in ASU 2013-05 will become effective for the Company for annual and interim periods beginning after December 15, 2013. The Company will apply the guidance prospectively to any derecognition events that may occur after the effective date, and does not expect the adoption of ASU 2013-05 to have a material impact on the Company’s condensed consolidated results of operations or financial position.
In February 2013, the FASB issued ASU 2013-04, Liabilities (Topic 405): Obligations Resulting From Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (“ASU 2013-04”). The update requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed as of the reporting date. The amount is equal to the sum of the obligation the entity agreed to pay among its co-obligors and any additional amount the entity expects to pay on behalf of its co-obligors. ASU 2013-04 will become effective for the Company for annual and interim periods beginning after December 15, 2013 and is required to be applied retrospectively to all prior periods presented for obligations that existed upon adoption of ASU 2013-04. The Company does not expect the adoption of ASU 2013-04 to have a material impact on the Company’s condensed consolidated results of operations or financial position.
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”), to address certain comparability issues between financial statements prepared in accordance with GAAP and those prepared in accordance with International Financial Reporting Standards. In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01”), which clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU 2011-11. ASU 2011-11 will require an entity to provide enhanced disclosures about certain financial instruments and derivatives, as defined in ASU 2013-01, to enable users to understand the effects of offsetting in the financial statements as well as the effects of master netting arrangements on an entity’s financial condition. The amendments in ASU 2011-11 and ASU 2013-01 are effective for annual and interim reporting periods beginning on or after January 1, 2013, with respective disclosures required for all comparative periods presented. The Company does not expect the adoption of ASU 2011-11 and ASU 2013-01 to have a material impact on the Company’s condensed consolidated results of operations or financial position.
6
Recently Adopted Accounting Standards. In July 2012, the FASB issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“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 is less than its carrying amount, it is 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 was effective for the Company beginning December 30, 2012 and did not have a material impact on the Company’s condensed consolidated results of operations or financial position.
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). FASB issued ASU 2013-02 to improve the transparency of changes in other comprehensive income (“OCI”) and items reclassified out of accumulated other comprehensive income (“AOCI”) in financial statements. ASU 2013-12 requires an entity to provide information about amounts reclassified out of AOCI by component. In addition, an entity must present either on the face of the income statement or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income. See “Note 6—Stockholders’ Equity and Benefit Plans” for additional disclosures about the Company’s OCI. The guidance in ASU 2013-02 became effective for the Company on December 30, 2012 and did not have a material impact on the Company’s condensed consolidated results of operations or financial position.
2. ACQUISITIONS AND GOODWILL
Skagen Designs, Ltd. Acquisition. On April 2, 2012, the Company acquired Skagen Designs, Ltd. and certain of its international affiliates (“Skagen Designs”). Skagen Designs was a privately held Nevada-based company that globally marketed and distributed contemporary Danish design accessories including watches, clocks, jewelry and sunglasses. The primary purpose of the acquisition was to add an attractive brand to the Company’s portfolio that the Company could grow using its established distribution channels. The purchase price was $231.7 million in cash and 150,000 shares of the Company’s common stock valued at $19.9 million based on the mean between the highest and lowest sales price of the Company’s common stock on NASDAQ on April 2, 2012. To fund the cash purchase price, the Company utilized approximately $200 million of availability under its $350 million revolving line of credit and excess cash available in its international subsidiaries to fund the international portion of the purchase price. In addition, subject to the purchase agreement, the sellers could have received up to 100,000 additional shares of the Company’s common stock if the Company’s net sales of SKAGEN® branded products exceeded certain thresholds over a defined period of time (the “Earnout”).
The Company recorded the Earnout as a $9.9 million contingent consideration liability in accrued expenses-other in the Company’s condensed consolidated balance sheets as of the acquisition date. As of December 29, 2012, the contingent consideration liability was remeasured at zero, which resulted in a decrease in operating expenses of $9.9 million during fiscal year 2012. During the First Quarter, the contingent consideration liability remained valued at zero. The results of Skagen Designs’ operations have been included in the Company’s consolidated financial statements since April 2, 2012.
Prior to closing the Skagen Designs acquisition, the Company incurred approximately $600,000 of acquisition-related expenses for legal, accounting and valuation services during fiscal year 2011 and the Prior Year Quarter. The Company incurred additional acquisition and integration related costs of approximately $8.2 million in fiscal year 2012, subsequent to the closing date. Acquisition and integration costs were reflected in general and administrative expenses on the Company’s consolidated statements of comprehensive income. There were no acquisition and integration costs incurred during the First Quarter.
The Company’s consolidated statements of comprehensive income for fiscal year 2012 included $93.8 million of net sales and $11.2 million of operating income, related to the results of operations of Skagen Designs since April 2, 2012. Operating income for fiscal year 2012 was favorably impacted by $10.0 million related to Skagen Designs’ ongoing operations.
During the First Quarter, the purchase accounting was finalized with no change since fiscal year end December 29, 2012. Assets acquired and liabilities assumed in the transaction were recorded at their acquisition date fair values, while transaction costs associated with the acquisition were expensed as incurred. Because the total purchase price exceeded the fair values of the tangible and intangible assets acquired, goodwill was recorded equal to the difference. The element of goodwill that is not separable into identifiable intangible assets represents expected synergies. The following table summarizes the allocation of the purchase price to the fair value of the assets acquired and the liabilities assumed as of April 2, 2012, the effective date of the acquisition (in thousands):
7
Cash paid, net of cash acquired
229,012
Value of common stock issued
19,899
Contingent consideration
9,950
Total transaction consideration
258,861
16,595
22,638
3,306
Property, plant and equipment
4,232
140,387
Trade name
64,700
Customer lists
24,400
Patents
1,500
Noncompete agreement
1,900
Other long-term assets
2,972
Current liabilities
(20,840
Long-term liabilities
(2,929
Total net assets acquired
The goodwill and trade name assets recognized from the acquisition have indefinite useful lives, were tested for impairment at fiscal year end 2012 and will continue to be tested for impairment annually. The amortization periods for the acquired customer lists, patents and noncompete agreements have amortization periods of three years to nine years. Approximately $133.8 million of the goodwill recognized in the acquisition is expected to be deductible for tax purposes.
The following unaudited pro forma information presents the combined results of operations of Fossil, Inc. and Skagen Designs as if the acquisition had occurred at the beginning of each period presented below. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the acquisition been completed at the beginning of each period presented below. In addition, the unaudited pro forma financial information is not indicative of, nor does it purport to project, the future financial position or operating results of Fossil, Inc. The unaudited pro forma information does not give effect to any potential cost savings or other operating efficiencies that could result from the acquisition. The following table presents the unaudited pro forma financial information (in thousands, except per share data):
619,977
58,637
0.95
Fossil Spain Acquisition. On August 10, 2012, the Company’s joint venture company, Fossil, S.L. (“Fossil Spain”) entered into a Framework Agreement (the “Framework Agreement”) with several related and unrelated parties, including General De Relojeria, S.A. (“General De Relojeria”), the Company’s joint venture partner. Pursuant to the Framework Agreement, Fossil Spain was granted the right to acquire the outstanding 50% of its shares owned by General De Relojeria upon the expiration of the joint venture agreement on December 31, 2015.
Effective January 1, 2013, pursuant to the Framework Agreement, the Company assumed control over the board of directors and the day-to-day management of Fossil Spain. As a result of this change, the Company now controls Fossil Spain and began consolidating it in accordance with ASC 810, Consolidation, instead of treating it as an equity method investment. In accordance with ASC 805, Business Combinations, the Company remeasured its preexisting investment in Fossil Spain to fair value as of January 1, 2013, resulting in a gain of $6.4 million, which was recorded in other income-net on the Company’s condensed consolidated statements of comprehensive income. The results of Fossil Spain’s operations have been included in the Company’s condensed consolidated financial statements since January 1, 2013. The Company recorded approximately $10.7 million of goodwill related to the acquisition.
8
The purchase price for the shares has a fixed and variable component. The fixed portion is based on 50% of the net book value of Fossil Spain as of December 31, 2012. The fixed portion was measured at 5.1 million Euros (approximately $6.7 million at December 31, 2012). The Company recorded a contingent consideration liability of 5.9 million Euros (approximately $7.8 million) related to the variable portion of the purchase price as of January 1, 2013. The variable portion will be determined based on Fossil Spain’s aggregated results of operations less dividends distributed by Fossil Spain to General De Relojeria with a minimum annual variable price of 2.0 million Euros (approximately $2.6 million at March 30, 2013) and a maximum annual variable price of 3.5 million Euros (approximately $4.5 million at March 30, 2013) for each of the calendar years 2013, 2014, and 2015.
Both the fixed and variable portions of the purchase price were recorded in other long-term liabilities in the condensed consolidated balance sheets at March 30, 2013.
Bentrani Watches, LLC Acquisition. On December 31, 2012, the Company purchased substantially all of the assets of Bentrani Watches, LLC (“Bentrani”). Bentrani was a distributor of watch products in 16 Latin American countries and was based in Miami, Florida. Bentrani was the Company’s largest third-party distributor and had partnered with the Company for ten years. The purchase price was $26.0 million, comprised of $18.7 million in cash and $7.3 million in forgiveness of a payable to the Company. The Company recorded approximately $8.1 million of goodwill related to the acquisition. The results of Bentrani’s operations have been included in the Company’s condensed consolidated financial statements since the acquisition date.
Goodwill is the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The changes in the carrying amount of goodwill, which is not subject to amortization, were as follows (in thousands):
North America wholesale
Europe wholesale
Asia Pacific wholesale
Total
Balance at December 29, 2012
109,270
63,884
11,639
Acquisitions
8,130
10,723
18,853
Foreign currency changes
102
(2,306
(86
(2,290
Balance at March 30, 2013
117,502
72,301
11,553
3. INVENTORIES
Inventories consisted of the following (in thousands):
Components and parts
60,566
62,731
Work-in-process
6,757
8,071
Finished goods
452,983
435,512
4. WARRANTY RESERVE
The Company’s warranty liabilities are primarily related to watch products. The Company’s 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 warranty, while certain other watches sold by the Company 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. The Company’s warranty liability is recorded using historical warranty repair expense and is recorded in accrued expenses-other in the condensed consolidated balance sheets. As changes in warranty costs are experienced, the warranty accrual is adjusted as necessary. Warranty liability activity consisted of the following (in thousands):
9
Beginning balance
13,383
10,996
Settlements in cash or kind
(2,461
(993
Warranties issued and adjustments to preexisting warranties (1)
2,396
2,085
Liabilities assumed in acquisition
340
Ending balance
13,658
12,088
(1) Changes in cost estimates related to preexisting warranties are aggregated with accruals for new standard warranties issued and foreign currency changes.
5. INCOME TAXES
The Company’s income tax expense and related effective rate were as follows (in thousands, except percentage data):
Income tax expense
Income tax rate
28.1
%
27.8
The lower effective tax rate in the Prior Year Quarter was attributable to management’s decision to indefinitely reinvest the undistributed earnings of certain foreign subsidiaries. The First Quarter effective tax rate was favorably impacted by audit settlements.
As of March 30, 2013, the total amount of unrecognized tax benefits, excluding interest and penalties, was $9.2 million, of which $6.0 million would favorably impact the effective tax rate in future periods, if recognized. The U.S. Internal Revenue Service completed its examination of the Company’s 2007-2009 federal income tax returns, and the Company has settled all outstanding federal income tax liabilities for those years. The Company is subject to examinations in various state and foreign jurisdictions for its 2005-2012 tax years, none of which the Company believes are individually significant. Audit outcomes and timing of audit settlements are subject to significant uncertainty.
The Company has classified uncertain tax positions as long-term income taxes payable, unless such amounts are expected to be paid within twelve months of the condensed consolidated balance sheet date. As of March 30, 2013, the Company had recorded $0.1 million of unrecognized tax benefits, excluding interest and penalties, for positions that could be settled within the next twelve months. Consistent with its past practice, the Company recognizes interest and/or penalties related to income tax overpayments and income tax underpayments in income tax expense and income taxes receivable/payable, respectively. The total amount of accrued income tax-related interest and penalties included in the condensed consolidated balance sheets at March 30, 2013 was $0.8 million and $0.3 million, respectively. For the First Quarter, the Company accrued income tax-related interest expense of $0.1 million.
6. STOCKHOLDERS’ EQUITY AND BENEFIT PLANS
Common Stock Repurchase Programs. Purchases of the Company’s common stock are made from time to time pursuant to its repurchase programs, subject to market conditions and at prevailing market prices, through the open market. Repurchased shares of common stock are recorded at cost and become authorized but unissued shares which may be issued in the future for general corporate or other purposes. The Company may terminate or limit its stock repurchase program at any time. In the event the repurchased shares are cancelled, the Company accounts for retirements by allocating the repurchase price to common stock, additional paid-in capital and retained earnings. The repurchase price allocation is based upon the equity contribution associated with historical issuances. The repurchase programs are conducted pursuant to Rule 10b-18 of the Exchange Act. During the First Quarter, the Company completed its $750 million buyback plan authorized in August 2010. The Company repurchased 9.6 million shares of common stock under that plan, of which $38.6 million, or 0.4 million shares, were repurchased during the First Quarter. In addition, the Company repurchased $18.0 million of its common stock in the First Quarter, or 0.2 million shares, under the Company’s $1 billion repurchase plan, which was authorized in 2012. As of March 30, 2013, the Company had $1.0 billion of repurchase authorizations remaining under the combined repurchase plans.
During the First Quarter, the Company effectively retired 0.6 million shares of common stock repurchased under its repurchase programs. The effective retirement of repurchased common stock decreased common stock by $6,000, additional paid-in capital by $2.0 million, retained earnings by $54.6 million and treasury stock by $56.5 million.
10
At December 29, 2012 and March 30, 2013, all treasury stock had been effectively retired.
The following table reflects the Company’s common stock repurchase activity for the periods indicated (in millions):
For the 13 Weeks Ended March 30, 2013
For Fiscal Year 2012
Fiscal Year Authorized
Dollar Value Authorized
Termination Date
Number of Shares Repurchased
Dollar Value Repurchased
2012
1,000.0
December 2016
0.2
18.0
0.0
2010
30.0
None
750.0
December 2013
0.4
38.6
3.0
261.3
Stock-Based Compensation Plans. The Company accounts for stock-based compensation in accordance with the provisions of ASC 718, Compensation-Stock Compensation (“ASC 718”), using the Black-Scholes option pricing model to determine the fair value of stock options and stock appreciation rights at the date of grant. The Company’s grants under its current stock-based compensation plans generally include: (i) stock options and restricted stock for its international employees, (ii) restricted stock units for its non-employee directors and (iii) stock appreciation rights, restricted stock and restricted stock units for its U.S.-based employees. There have been no significant changes to the Company’s stock-based compensation plans since the 2012 Form 10-K.
The following table summarizes stock options and stock appreciation rights activity during the First Quarter:
Stock Options and Stock Appreciation Rights
Number of Shares
Weighted- Average Exercise Price
Weighted- Average Remaining Contractual Term (Years)
Aggregate Intrinsic Value
in thousands
Outstanding at December 29, 2012
1,039
63.56
6.4
36,708
Granted
32
105.47
Exercised
(101
32.99
6,844
Forfeited or expired
(12
82.79
Outstanding at March 30, 2013
958
67.97
35,658
Exercisable at March 30, 2013
617
51.21
5.6
30,582
Nonvested at March 30, 2013
341
98.23
7.8
5,076
Expected to vest
309
4,618
The aggregate intrinsic value shown in the table above is before income taxes and is based on (i) the exercise price for outstanding and exercisable options/rights at March 30, 2013 and (ii) the fair market value of the Company’s common stock on the exercise date for options/rights that were exercised during the First Quarter.
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Stock Options and Stock Appreciation Rights Outstanding and Exercisable. The following table summarizes information with respect to stock options and stock appreciation rights outstanding and exercisable at March 30, 2013:
Stock Options and Stock Appreciation Rights Outstanding
Stock Options and Stock Appreciation Rights Exercisable
Weighted-
Average
Remaining
Number of
Exercise
Contractual
Range of Exercise Prices
Shares
Price
Term (Years)
$13.65 - $26.29
223
17.87
3.9
180
18.81
$26.29 - $39.44
216
34.79
5.3
215
34.78
$39.44 - $52.58
30
43.15
4.8
$65.73 - $78.88
68.59
8.4
69.53
$78.88 - $92.02
196
81.46
7.6
106
81.23
$92.02 - $105.17
99.37
9.3
1
93.29
$105.17 - $118.31
25
106.40
8.0
0.00
$118.31 - $131.46
253
128.02
8.5
82
127.93
Restricted Stock and Restricted Stock Units. The following table summarizes restricted stock and restricted stock unit activity during the First Quarter:
Restricted Stock and Restricted Stock Units
Weighted-Average Grant-Date Fair Value
Nonvested at December 29, 2012
277
68.69
104
106.22
Vested
(139
53.62
Forfeited
(7
72.73
235
94.09
The total fair value of restricted stock and restricted stock units vested during the First Quarter was approximately $14.7 million.
Accumulated Other Comprehensive Income. The following table illustrates changes in the balances of each component of accumulated other comprehensive income, net of taxes (in thousands):
Unrealized
Currency
Gains (Losses) on
Gains
Translation
Securities Available
(Losses) on
Adjustments
for Sale
Forward Contracts
30,181
(475
(946
Other comprehensive (loss) income before reclassifications, net of tax expense of $3,474
3,345
(16,563
Amounts reclassed from accumulated other comprehensive income, net of tax expense of $87
(46
10,344
(546
2,445
12
For the 13 Weeks Ended March 31, 2012
18,953
(446
3,673
22,180
Other comprehensive income (loss) before reclassifications, net of tax benefit of $1,081
(497
9,624
Amounts reclassed from accumulated other comprehensive income, net of tax expense of $444
852
Total other comprehensive income (loss)
29,024
(396
2,324
30,952
7. SEGMENT INFORMATION
The Company manages its business primarily on a geographic basis. The Company’s reportable operating segments are comprised of North America wholesale, Europe wholesale, Asia Pacific wholesale and Direct to consumer. The North America wholesale, Europe wholesale and Asia Pacific wholesale segments do not include activities related to the Direct to consumer segment. The North America wholesale segment primarily includes sales to wholesale or distributor customers based in Canada, Mexico, the United States and countries in South America. The Europe wholesale segment primarily includes sales to wholesale or distributor customers based in European countries, the Middle East and Africa. The Asia Pacific wholesale segment primarily includes sales to wholesale or distributor customers based in Australia, China (including the Company’s assembly and procurement operations), India, Indonesia, Japan, Malaysia, New Zealand, Singapore, South Korea, Taiwan and Thailand. The Direct to consumer segment includes Company-owned retail stores, e-commerce sales and catalog activities. Each reportable operating segment provides similar products and services.
The Company evaluates the performance of its reportable segments based on net sales and operating income. Net sales for geographic segments are generally based on the location of the customers. Operating income for each segment includes net sales to third-parties, related cost of sales and operating expenses directly attributable to the segment. General corporate expenses, including certain administrative, legal, accounting, technology support costs, equity compensation costs, payroll costs attributable to executive management and amounts related to intercompany eliminations are not allocated to the various segments. Intercompany sales of products between segments are referred to as intersegment items.
Summary information by operating segment was as follows (in thousands):
13
Net Sales
Operating Income
North America wholesale:
External customers
255,165
60,408
225,000
53,509
Intersegment
45,946
42,826
Europe wholesale:
173,906
38,547
152,950
31,098
40,688
34,561
Asia Pacific wholesale:
86,776
27,550
76,709
25,243
202,196
166,293
Direct to consumer
165,052
7,112
134,874
8,382
Intersegment items
(288,830
(243,680
Corporate
(39,296
(35,371
Consolidated
The following tables reflect net sales for each class of similar products in the periods presented (in thousands except percentage data):
Percentage of Total
Watches
513,017
75.3
418,432
71.0
Leathers
102,788
15.1
104,047
17.7
Jewelry
42,314
6.2
39,152
6.6
22,780
3.4
27,902
4.7
100.0
8. DERIVATIVES AND RISK MANAGEMENT
The Company is exposed to certain risks relating to its ongoing business operations, which it attempts to manage by using derivative instruments. The primary risks managed by using derivative instruments are the fluctuations in global currencies that will ultimately be used by non-U.S. dollar functional currency subsidiaries to settle future payments of intercompany inventory transactions denominated in U.S. dollars. Specifically, the Company projects future intercompany purchases by its non-U.S. dollar functional currency subsidiaries generally over a period of up to 18 months. The Company enters into foreign currency forward contracts (“forward contracts”) generally for up to 65% of the forecasted purchases to manage fluctuations in global currencies that will ultimately be used to settle such U.S. dollar denominated inventory purchases. Forward contracts represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon settlement date. The majority of the Company’s forward contracts are designated as single cash flow hedges. Fluctuations in exchange rates will either increase or decrease the Company’s U.S. dollar equivalent cash flows from these intercompany inventory transactions, which will affect the Company’s U.S. dollar earnings. Gains or losses on the forward contracts are expected to offset these fluctuations to the extent the cash flows are hedged by the forward contracts. The Company also periodically enters into forward contracts to manage exchange rate risks associated with certain non-inventory intercompany transactions and to which the Company does not elect hedge treatment. All of the Company’s outstanding forward contracts were designated as hedging instruments as of March 30, 2013 and December 29, 2012.
The forward contracts that the Company purchased to hedge exchange rate risk associated with intercompany inventory transactions meet the criteria for hedge eligibility, which requires that they represent foreign-currency-denominated forecasted intra-entity transactions in which (i) the operating unit that has the foreign currency exposure is a party to the hedging instrument and (ii) the hedged transaction is denominated in a currency other than the hedging unit’s functional currency.
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At the inception of the hedge, the hedging relationship is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk. The Company assesses hedge effectiveness under the critical terms matched method at inception and at least quarterly throughout the life of the hedging relationship. If the critical terms (i.e., amounts, currencies and settlement dates) of the forward currency exchange contract match the terms of the forecasted transaction, the Company concludes that the hedge is effective.
The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments. Changes in the fair value of derivatives not designated as hedging instruments are recognized in earnings when they occur. For a derivative instrument that is designated and qualifies as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive (loss) income, net of taxes and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, the Company’s hedges resulted in no ineffectiveness in the condensed consolidated statements of comprehensive income, and there were no components excluded from the assessment of hedge effectiveness for the First Quarter or Prior Year Quarter.
All derivative instruments are recognized as either assets or liabilities at fair value in the condensed consolidated balance sheets. Forward contracts designated as cash flow hedges are recorded at fair value at each balance sheet date and the change in fair value is recorded to accumulated other comprehensive income (loss) within the equity section of the balance sheet until such forward contract’s gains (losses) become realized or the cash flow hedge relationship is terminated. If the cash flow hedge relationship is terminated, the derivative’s gains or losses that are deferred in accumulated other comprehensive income (loss) will be recognized in earnings when the hedged cash flows occur. However, for cash flow hedges that are terminated because the forecasted transaction is not expected to occur in the original specified time period, the derivative’s gains or losses are immediately recognized in earnings. There were no gains or losses reclassified into earnings as a result of the discontinuation of cash flow hedges in the First Quarter or Prior Year Quarter. Hedge accounting is discontinued if it is determined that the derivative is not highly effective. The Company records all cash flow hedge assets and liabilities on a gross basis as they do not meet the balance sheet netting criteria because the Company does not have master netting agreements established with the derivative counterparties that would allow for net settlement.
As of March 30, 2013, the Company had the following outstanding forward contracts that were entered into to hedge the future payments of intercompany inventory transactions (in thousands):
Functional Currency
Contract Currency
Type
Amount
Euro
172,450
U.S. Dollar
225,318
British Pound
17,650
27,688
Japanese Yen
2,083,700
24,924
Canadian Dollar
22,680
22,388
Mexican Peso
167,607
12,850
Australian Dollar
10,350
10,607
The effective portion of gains and losses on derivative instruments that was recognized in other comprehensive (loss) income, net of taxes during the First Quarter and the Prior Year Quarter is set forth below (in thousands):
Derivatives Designated as Cash Flow Hedges Under ASC 815
Foreign exchange forward contracts
Total gain (loss) recognized in other comprehensive income (loss)
The following table illustrates the effective portion of gains and losses on derivative instruments recorded in other comprehensive (loss) income, net of taxes during the term of the hedging relationship and reclassified into earnings during the First Quarter and Prior Year Quarter (in thousands):
15
Foreign Exchange Forward Contracts Under ASC 815
Condensed Consolidated Statements of Comprehensive Income Location
Cash flow hedging instruments
Total (loss) gain reclassified from other comprehensive (loss) income
The following table discloses the fair value amounts for the Company’s derivative instruments as separate asset and liability values, presents the fair value of derivative instruments on a gross basis, and identifies the line items in the condensed consolidated balance sheets in which the fair value amounts for these categories of derivative instruments are included (in thousands):
Asset Derivatives
Liability Derivatives
Condensed
Foreign Exchange Contracts Under
Consolidated Balance
Fair
Consolidated Balance Sheet
ASC 815
Sheet Location
Value
Location
7,614
2,336
Accrued expenses- other
1,706
4,560
Intangible and other assets- net
1,064
240
582
8,678
2,576
1,719
5,142
At the end of the First Quarter, the Company had foreign exchange forward contracts with maturities extending through September 2014. The estimated net amount of the existing gains or losses at March 30, 2013 that is expected to be reclassified into earnings within the next twelve months is a gain of $3.6 million. See “Note 1—Financial Statement Policies” for additional disclosures on foreign currency hedging instruments.
9. FAIR VALUE MEASUREMENTS
The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.
ASC 820, Fair Value Measurement and Disclosures (“ASC 820”), establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
· Level 1 — Quoted prices in active markets for identical assets or liabilities.
· Level 2 — Inputs, other than quoted prices in active markets, that are observable either directly or indirectly.
· Level 3 — Unobservable inputs based on the Company’s assumptions.
ASC 820 requires the use of observable market data if such data is available without undue cost and effort.
The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of March 30, 2013 (in thousands):
16
Fair Value at March 30, 2013
Level 1
Level 2
Level 3
Assets:
Securities available for sale:
Investments in publicly traded equity securities
Forward contracts
Deferred compensation plan assets:
Investment in publicly traded mutual funds
3,256
3,312
11,990
Liabilities:
7,532
9,251
The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of December 29, 2012 (in thousands):
Fair Value at December 29, 2012
3,188
3,315
5,891
The fair values of the Company’s securities available for sale and deferred compensation plan assets are based on quoted prices. The deferred compensation plan assets are recorded in intangible and other assets-net in the Company’s condensed consolidated balance sheets. The fair values of the Company’s forward contracts are based on published quotations of spot currency rates and forward points, which are converted into implied forward currency rates.
The Company has evaluated its short-term and long-term debt and believes, based on the interest rates, related terms and maturities, that the fair values of such instruments approximate their carrying amounts. As of March 30, 2013 and December 29, 2012, the carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximated their fair values due to the short-term maturities of these accounts.
The fair value of the contingent consideration liability related to Fossil Spain is determined using Level 3 inputs. See “Note 2 — Acquisitions and Goodwill” for additional disclosure about the acquisition. The contingent consideration is based on Fossil Spain’s earnings during the three year period from December 31, 2013 to December 31, 2015. The contingent consideration for calendar years 2013 and 2014 will be paid each year within thirty days of calculation of the amount. The contingent consideration for calendar year 2015 will be paid upon the execution of the purchase agreement in 2016. The fair value of the contingent consideration was determined using present value techniques with forecasted future cash flows for Fossil Spain as the significant unobservable input. Future revenue growth based on management’s projections for calendar years 2013, 2014, and 2015 ranges from 3% to 10%. Operating expenses are projected to be approximately 28% of revenues for calendar years 2013, 2014, and 2015. A discount rate of 19% was used to calculate the present value of the contingent consideration. An increase in future cash flows may result in a higher estimated fair value of the contingent consideration liability. Alternatively, a decrease in future cash flows may result in a lower estimated fair value of the contingent consideration liability. Future changes in the estimated fair value of the contingent consideration liability, if any, will be reflected in earnings.
10. CONTROLLING AND NONCONTROLLING INTEREST
The following tables summarize the changes in equity attributable to controlling and noncontrolling interest (in thousands):
17
Fossil, Inc.
Stockholders’
Noncontrolling
Equity
Interest
Currency translation adjustments
Unrealized loss on securities available for sale
Forward contracts hedging intercompany foreign currency payments - change in fair values
Common stock issued upon exercise of stock options and stock appreciation rights
Tax benefit derived from stock-based compensation
Stock-based compensation expense
Balance at December 31, 2011
1,105,929
10,917
1,116,846
Unrealized gain on securities available for sale
Balance at March 31, 2012
1,122,360
10,063
1,132,423
11. INTANGIBLE AND OTHER ASSETS
The following table summarizes intangible and other assets (in thousands):
18
Useful
Carrying
Accumulated
Lives
Amortization
Intangibles-subject to amortization:
Trademarks
10 yrs.
4,135
2,476
2,400
5-10 yrs.
42,501
11,113
32,144
9,980
3-20 yrs.
2,273
951
815
6 yrs.
1,881
314
1,895
237
7-20 yrs.
254
193
258
194
Total intangibles-subject to amortization
51,044
15,047
40,705
13,626
Intangibles-not subject to amortization:
Trade names
83,631
83,647
Other assets:
Key money deposits
35,170
14,178
35,655
14,060
Other deposits
17,508
17,591
Deferred compensation plan assets
Deferred tax asset-net
6,492
6,536
Restricted cash
681
991
Shop-in-shop
11,651
5,671
11,396
5,297
3,796
3,948
Total other assets
78,554
19,850
79,305
19,358
Total intangible and other assets
213,229
34,897
203,657
32,984
Total intangible and other assets-net
Key money is the amount of funds paid to a landlord or tenant to acquire the rights of tenancy under a commercial property lease for a certain property. Key money represents the “right to lease” with an automatic right of renewal. This right can be subsequently sold by the Company or can be recovered should the landlord refuse to allow the automatic right of renewal to be exercised. Key money is amortized over the initial lease term, which ranges from approximately four to 18 years.
Amortization expense for intangible assets was approximately $1.3 million and $0.2 million for the First Quarter and Prior Year Quarter, respectively. Estimated aggregate future amortization expense by fiscal year for intangible assets is as follows (in thousands):
Amortization Expense
2013 (remaining)
3,985
2014
5,065
2015
4,673
2016
4,535
2017
4,277
2018
4,858
12. COMMITMENTS AND CONTINGENCIES
Litigation. The Company is occasionally subject to litigation or other legal proceedings in the normal course of its business. The Company does not believe that the outcome of any currently pending legal matters, individually or collectively, will have a material effect on the business or financial condition of the Company.
13. DEBT
Long term U.S.-Based Activity. During the First Quarter, the Company had net borrowings of $75.0 million under its U.S. revolving line of credit (the “Revolver”), which was primarily used to repurchase shares of common stock under its repurchase programs. As of March 30, 2013, the Company had $140.0 million outstanding and available borrowings of approximately $209.1 million under the Revolver. The Company incurred approximately $0.7 million of interest expense related to the Revolver during the First Quarter and no interest expense during the Prior Year Quarter as a result of having no outstanding borrowings under the Revolver. The Company was in compliance with all covenants in the Revolver as of March 30, 2013.
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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 week period ended March 30, 2013 (the “First Quarter”) as compared to the thirteen week period ended March 31, 2012 (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 FOSSIL 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 129 retail stores located in premier retail sites and 95 outlet stores located in major outlet malls as of March 30, 2013. 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 130 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 188 retail stores and 65 outlet stores in select international markets as of March 30, 2013. 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 2013 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 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 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 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.
20
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 29, 2012.
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 29, 2012.
Recently Issued Accounting Standards
In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (“ASU 2013-05”). ASU 2013-05 addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The guidance outlines the events when cumulative translation adjustments should be released into net income and is intended by FASB to eliminate some disparity in current accounting practice. The guidance in ASU 2013-05 will become effective for us for annual and interim periods beginning after December 15, 2013. We will apply the guidance prospectively to any derecognition events that may occur after the effective date, and we do not expect the adoption of ASU 2013-05 to have a material impact on our condensed consolidated results of operations or financial position.
In February 2013, the FASB issued ASU 2013-04, Liabilities (Topic 405): Obligations Resulting From Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (“ASU 2013-04”). The update requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed as of the reporting date. The amount is equal to the sum of the obligation the entity agreed to pay among its co-obligors and any additional amount the entity expects to pay on behalf of its co-obligors. ASU 2013-04 will become effective for us for annual and interim periods beginning after December 15, 2013 and is required to be applied retrospectively to all prior periods presented for obligations that existed upon adoption of ASU 2013-04. We do not expect the adoption of ASU 2013-04 to have a material impact our condensed consolidated results of operations or financial position.
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”), to address certain comparability issues between financial statements prepared in accordance with GAAP and those prepared in accordance with International Financial Reporting Standards. In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01”), which clarifies which instruments and transactions are subject to the offsetting disclosure requirements established by ASU 2011-11. ASU 2011-11 will require an entity to provide enhanced disclosures about certain financial instruments and derivatives, as defined in ASU 2013-01, to enable users to understand the effects of offsetting in the financial statements as well as the effects of master netting arrangements on an entity’s financial condition. The amendments in ASU 2011-11 and ASU 2013-01 are effective for annual and interim reporting periods beginning on or after January 1, 2013, with respective disclosures required for all comparative periods presented. We do not expect the adoption of ASU 2011-11 and ASU 2013-01 to have a material impact on our condensed consolidated results of operations or financial position.
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Recently Adopted Accounting Standards
In July 2012, the FASB issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“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 is less than its carrying amount, it is 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 was effective for us beginning December 30, 2012 and did not have a material impact on our condensed consolidated results of operations or financial position.
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). FASB issued ASU 2013-02 to improve the transparency of changes in other comprehensive income (“OCI”) and items reclassified out of accumulated other comprehensive income (“AOCI”) in financial statements. ASU 2013-12 requires an entity to provide information about amounts reclassified out of AOCI by component. In addition, an entity must present either on the face of the income statement or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income. See “Note 6-Stockholders’ Equity and Benefit Plans” for additional disclosures about our OCI. The guidance in ASU 2013-02 became effective for us on December 30, 2012 and did not have a material impact on our condensed consolidated results of operations or 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
Change from
15.5
44.4
44.2
16.1
55.6
55.8
15.0
29.8
30.7
12.0
11.9
11.0
25.2
13.9
14.1
13.8
*
1.4
14.3
21.6
4.2
22.8
10.9
10.4
21.1
Net income attributable to noncontrolling interest
0.3
0.5
(38.8
10.6
9.9
24.2
* 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
Wholesale:
North America
255.2
225.0
37.5
38.2
Europe
173.9
152.9
25.6
25.9
Asia Pacific
86.8
76.7
12.7
13.0
Total wholesale
515.9
454.6
75.8
77.1
165.0
134.9
22.9
680.9
589.5
22
The following table illustrates 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 First Quarter Versus Prior Year Quarter
Attributable to Changes in the Following Factors
Exchange Rates
Organic Change
Total Change
0.1
4.0
13.4
11.2
2.3
13.7
(2.1
4.1
13.2
(0.4
2.4
20.3
22.3
(0.2
)%
5.5
10.2
The following net sales discussion excludes the impact on sales growth attributable to foreign currency exchange rate changes as noted in the above table.
Consolidated Net Sales. Net sales rose 15.7% as a result of double-digit sales growth across each of our wholesale and retail operations in comparison to the Prior Year Quarter. Our acquisition of Skagen Designs, Ltd. and certain of its international affiliates (“Skagen”) on April 2, 2012 contributed $29.1 million towards overall sales during the First Quarter. On an organic basis, excluding sales related to acquisitions, worldwide net sales increased 10.2% for the First Quarter. Global watch sales were the key driver, increasing 15.6%, or $65.4 million, while jewelry sales increased 5.4%, or $2.1 million. These sales gains were partially offset by sales decreases in eyewear of 35.7%, or $4.8 million, and leathers of 1.3%, or $1.3 million. The decrease in eyewear was primarily a result of our repositioning of the FOSSIL branded products in this category, while the decrease in leathers was the result of decreased sell through rates at retail.
North America Wholesale Net Sales. Net sales from the North America wholesale segment increased 13.3%, or $29.8 million, during the First Quarter in comparison to the Prior Year Quarter. North America sales were 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, leaving every month in this fiscal year misaligned. Accordingly, our fiscal calendar will not re-align with the NRF calendar until January 2014. Additionally, sales were favorably impacted by a timing shift of approximately $15 million from the second quarter of fiscal 2013 into the First Quarter. We believe this favorable shift was largely attributable to the early timing of Easter in the current fiscal year as compared to the prior fiscal year. North America sales growth was primarily driven by a 22.9%, or $37.0 million, increase in watch sales, including $9.9 million of sales related to SKAGEN branded products during the First Quarter. These sales gains were partially offset by decreases in our leathers and eyewear categories of 6.3%, or $2.9 million, and 35.1%, or $2.3 million, respectively. The decrease in leather product sales was primarily attributable to decreased sell through rates in our women’s handbags category. The First Quarter was also negatively impacted by the discontinuation of our footwear business. U.S. shipments increased 12.9%, or $25.8 million, while shipments from our Canadian and Mexican subsidiaries increased 16.5% and 35.3%, respectively, during the First Quarter as compared to the Prior Year Quarter.
Europe Wholesale Net Sales. Europe wholesale net sales rose 13.5%, or $20.5 million, including a $12.8 million contribution from sales of SKAGEN branded products during the First Quarter in comparison to the Prior Year Quarter. Growth in our watch category made the most significant contribution, increasing 22.1%, or $24.1 million. Sales to third party distributors favorably impacted the First Quarter, increasing 18.2%, or $5.7 million, as compared to the Prior Year Quarter as a result of increased sell-through rates. These sales gains were partially offset by decreases in the eyewear and leathers categories of 61.0%, or $2.7 million, and 18.6%, or $2.5 million, respectively. The decrease in eyewear was largely due to door reduction, while the decrease in leathers was primarily attributable to decreased sell-through rates at retail.
Asia Pacific Wholesale Net Sales. Asia Pacific wholesale net sales rose 15.3%, or $11.7 million, during the First Quarter in comparison to the Prior Year Quarter. The growth was primarily driven by our watch category and included $3.1 million of SKAGEN branded products. At the end of the First Quarter, we operated 281 concession locations in Asia with a net 11 new concessions opened during the First Quarter. For the First Quarter, concession sales increased by 26.1% with comp sales growing 4.0% in comparison to the Prior Year Quarter.
Direct to Consumer Net Sales. Direct to consumer net sales for the First Quarter increased by 22.7%, or $30.7 million, in comparison to the Prior Year Quarter, primarily the result of square footage growth of 24.2% and comparable store sales increases of 4.3%. The comparable store sales gain represents the 20th consecutive quarter of positive comparable store sales increases and comes on top of comparable store sales gains of 7.7% and 21.3% in the first quarter of fiscal 2012 and 2011, respectively.
23
Global outlet comparable store sales increased 2.1% for the First Quarter in comparison to the Prior Year Quarter.
The following table sets forth the number of stores by brand and concept as of March 30, 2013 and March 31, 2012:
Outside of North America
FOSSIL accessory stores
105
145
250
247
FOSSIL outlet stores
77
47
124
65
27
92
Watch Station International outlet stores
36
Outlet stores
99
61
160
75
FOSSIL clothing stores
31
33
29
Full-price Watch Station International
Other full-price multi-brand
Full-price multi-brand
SKAGEN branded
Total Stores
244
233
477
208
190
398
During the First Quarter, we opened 11 new stores and closed 7 stores. The 11 new stores opened included four accessory stores, three Watch Station International stores, one multi-brand store, two Fossil outlet stores, and one Watch Station International outlet store. For fiscal year 2013, we anticipate opening approximately 70-75 net new retail stores globally, with a focus on outlet and accessory stores.
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 of $378.5 million in the First Quarter increased 15.0% in comparison to $329.0 million in the Prior Year Quarter. The increase was a result of increased net sales partially offset by a 20 basis point reduction in gross profit margin to 55.6% compared to 55.8% in the Prior Year Quarter. Foreign currency exchange rate changes negatively impacted gross profit margin by approximately 20 basis points during the First Quarter. Additionally, gross profit margin was unfavorably impacted by a higher percentage of lower margin sales to third party distributors. Partially offsetting these negative influences on gross profit margin were improved margins in Company-owned full price retail stores and an increase in the sales mix of higher margin watch products and Direct to consumer sales in comparison to the Prior Year Quarter.
Operating Expenses. Total operating expenses increased by $38.0 million and, as a percentage of net sales, remained flat at 41.7% in the First Quarter as compared to the Prior Year Quarter. The translation of foreign-based expenses in the First Quarter decreased operating expenses by approximately $2.6 million as a result of the stronger U.S. dollar. Total operating expenses increased from the Prior Year Quarter due to the expansion of our retail store and concession base, infrastructure investments to support growth in the Asia Pacific region and global initiatives, as well as the impact of newly acquired businesses.
24
The following tables set forth operating expenses on a segment basis and the relative percentage of operating expenses to net sales for each segment for the periods indicated (in millions, except for percentage data):
Operating Expense
% of Net Sales
48.7
19.1
41.7
18.5
56.0
32.2
47.2
30.9
42.0
48.4
38.9
50.7
98.3
59.6
83.1
61.6
39.2
35.2
284.2
246.1
Operating Income. Operating income increased $11.5 million, or 13.8% in the First Quarter compared to the Prior Year Quarter. As a percentage of net sales, operating income decreased to 13.9% of net sales in the First Quarter compared to 14.1% of net sales in the Prior Year Quarter. During the First Quarter, operating income was favorably impacted by approximately $0.2 million as a result of the translation of foreign-based sales and expenses into U.S. dollars.
Other Income-Net. Other income-net increased favorably by $7.2 million in comparison to the Prior Year Quarter. This increase was primarily driven by (i) a $6.4 million non-cash, mark-to-market valuation gain related to our future acquisition of the remaining 50% of Fossil, S.L., our Spanish joint venture, owned by General De Relojeria, S.A. and (ii) increased net gains on foreign currency contracts and account balances as compared to the Prior Year Quarter.
Provision For Income Taxes. Our income tax expense for the First Quarter was $28.9 million, resulting in an effective income tax rate of 28.1%. The First Quarter income tax expense was favorably impacted by the recognition of previously unrecognized income tax benefits in connection with the settlement of prior year income tax audits. For the Prior Year Quarter, income tax expense was $23.5 million, resulting in an effective income tax rate of 27.8%. The Prior Year Quarter income tax expense was favorably impacted by various discrete items and management’s decision to indefinitely reinvest the undistributed earnings of certain foreign subsidiaries.
Net Income Attributable to Noncontrolling Interest. Net income attributable to noncontrolling interest, which represents the minority interest portion of subsidiaries in which we own less than 100%, decreased $1.1 million for the First Quarter as compared to the Prior Year Quarter. This decrease was primarily a result of our acquiring the remaining noncontrolling interests of our Mexico subsidiaries and decreased net income related to our less than 100% owned watch assembly facilities.
Net Income Attributable to Fossil, Inc. First Quarter net income attributable to Fossil, Inc. increased by 24.2% to $72.2 million, or $1.21 per diluted share, in comparison to $58.1 million, or $0.93 per diluted share, in the Prior Year Quarter. The First Quarter results included a $6.4 million non-cash, non-operating gain, which benefitted earnings by $0.11 per diluted share, related to our future acquisition of the remaining 50% of our Spanish joint venture. Additionally, net income attributable to Fossil, Inc. for the First Quarter included net foreign currency gains of $0.02 per diluted share, and a $0.05 per diluted share benefit as a result of a 4.3% lower outstanding share count due to common stock repurchases under our ongoing stock repurchase program.
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 the amount of any discretionary stock repurchases we make. Our cash and cash equivalents balance at the end of the First Quarter was $241.4 million, including $185.4 million held in banks outside the U.S., in comparison to $260.5 million at the end of the Prior Year Quarter and $177.2 million at the end of fiscal year 2012.
Net cash provided by operating activities and financing activities of $85.9 million and $20.3 million, respectively, was partially offset by net cash used by investing activities of $34.9 million. Excluding non-cash activities of $14.9 million, net cash provided by operating activities during the First Quarter consisted primarily of net income of $74.0 million, partially offset by uses of cash related to increases in working capital of $3.0 million. Net cash used in investing activities during the First Quarter was primarily driven by $19.5 million related to capital expenditures and $15.2 million used for business acquisitions, net of cash acquired. During the First Quarter, net cash provided by financing activities was principally comprised of $75.4 million of net debt borrowings, partially offset by $61.2 million of common stock acquisitions.
Net borrowings on notes payable primarily consisted of draws and repayments made under our revolving credit facility.
Accounts receivable increased by 22.2% to $272.9 million at the end of the First Quarter compared to $223.3 million at the end of the Prior Year Quarter, primarily as a result of increased wholesale sales and acquisitions. Excluding acquisitions, days sales outstanding for our wholesale segments for the First Quarter moderately improved.
Inventory at the end of the First Quarter was $520.3 million, representing an increase of 1.6% from the Prior Year Quarter inventory balance of $512.1 million. Our inventory growth was driven by investments in components to preserve production flow, the addition of Skagen, Fossil Spain, and Bentrani Watches, LLC, as well as new store growth.
In fiscal year 2010, our Board of Directors approved two common stock repurchase programs pursuant to which up to $30 million and $750 million, respectively, could be used to repurchase outstanding shares of our common stock. In December 2012, our Board of Directors approved an additional common stock repurchase program pursuant to which up to $1.0 billion could be used to repurchase outstanding shares of our common stock. All of these repurchase programs are to be conducted pursuant to Rule 10b-18 of the Securities Exchange Act of 1934. The $750 million repurchase program has a termination date of December 2013, and the $30 million repurchase program has no termination date. The $1.0 billion common stock repurchase program has a termination date of December 2016.
During the First Quarter, we repurchased 0.4 million shares under the $750 million repurchase program at a cost of $38.6 million, which completed the $750 million repurchase program. During the First Quarter, we also repurchased 0.2 million shares under the $1 billion repurchase program at a cost of $18.0 million. During the Prior Year Quarter, we repurchased approximately 0.6 million shares of common stock under the $750 million repurchase program at a cost of $59.3 million. We did not make any repurchases under the $30 million plan during the First Quarter or the Prior Year Quarter. We effectively retired 0.6 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 $6,000, additional paid-in capital by $2.0 million, retained earnings by $54.6 million and treasury stock by $56.5 million. We effectively retired 6.8 million shares of our common stock during the Prior Year Quarter that were repurchased under our repurchase programs during our 2012, 2011 and 2010 fiscal years. The effective retirement of common stock repurchased during the Prior Year Quarter decreased common stock by $68,000, additional paid-in capital by $28.5 million, retained earnings by $481.4 million and treasury stock by $510.0 million. At December 29, 2012 and March 30, 2013, all treasury stock had been effectively retired. As of March 30, 2013, we had $1.0 billion of repurchase authorizations remaining under the combined purchase plans.
At the end of the First Quarter, we had working capital of $833.3 million compared to working capital of $860.6 million at the end of the Prior Year Quarter. Additionally, at the end of the First Quarter, we had approximately $1.6 million of outstanding short-term borrowings and $151.1 million in long-term debt.
On December 17, 2010, we and certain of our subsidiaries entered into a three year Credit Agreement (the “Credit Agreement”) with (i) Wells Fargo Bank, National Association (“Wells Fargo”), as administrative agent, swingline lender and issuing lender, (ii) Wells Fargo Securities, LLC, as sole lead arranger and sole book manager and (iii) Bank of America, N.A., as lender. The Credit Agreement provides for revolving credit loans in the amount of $300 million (the “Revolver”), a swingline loan of $20 million, and letters of credit. On April 2, 2012, in connection with the Skagen acquisition, the Credit Agreement was amended to, among other things, (i) increase the aggregate commitment of the lenders under the Revolver from $300 million to $350 million, (ii) provide for an uncommitted $50 million incremental revolving credit commitment and (iii) extend the maturity date from December 17, 2013 to December 17, 2014. Amounts outstanding under the Revolver bear interest at our option of (i) the base rate (defined as the higher of (a) the prime rate publicly announced by Wells Fargo (3.25% at the end of the First Quarter), (b) the federal funds rate plus 1.50% and (c) the London Interbank Offer Rate (“LIBOR”) (0.22% at the end of the First Quarter) plus 1.50%) plus the base rate applicable margin (which varies based upon our consolidated leverage ratio (the “Ratio”) from 0.25% if the Ratio is less than 1.00 to 1.00, to 1.00% if the Ratio is greater than or equal to 2.00 to 1.00) or (ii) the LIBOR rate (defined as the quotient obtained by dividing (a) LIBOR by (b) 1.00 minus the Eurodollar reserve percentage) plus the LIBOR rate applicable margin (which varies based upon the Ratio from 1.25% if the Ratio is less than 1.00 to 1.00, to 2.00% if the Ratio is greater than or equal to 2.00 to 1.00). We had $0.9 million of outstanding standby letters of credit at March 30, 2013 that reduced amounts available under the Revolver. During the First Quarter, we borrowed $217.7 million under the Revolver at an average rate of 1.5% and repaid $142.7 million. These borrowings were mainly used to fund common stock acquisitions in the First Quarter. As of March 30, 2013, we had $140 million outstanding under the Revolver. At the end of the prior fiscal year, we had $65 million outstanding under the Revolver.
26
At the end of the First Quarter, excluding long-term capital lease obligations of $6.0 million, we had outstanding short-term and long-term borrowings of $0.1 million and $3.6 million, respectively, related to our wholly-owned subsidiary, Fossil Group Europe, Gmbh, in the form of a term note. This note requires Fossil Group Europe, Gmbh to submit an annual balance sheet and income statement and is secured by our building in Basel, Switzerland. This note has a variable interest rate (2.0% at the end of the First Quarter) and interest payments due quarterly. This note requires minimum principal payments of 100,000 Swiss Francs (approximately $105,000 at the end of the First Quarter) each year, has no stated maturity and has no penalties for early termination.
During fiscal 2012, we assumed a 500,000 Swiss Franc short-term note payable (the “STP Note”) with Eastime Limited, as lender. The STP Note has a fixed interest rate of 2% with interest due annually and expired on March 31, 2013. We expect to receive an extension of the maturity date of the STP Note. At March 30, 2013 Swiss Franc-based borrowings, in U.S. dollars, under the STP Note were approximately $0.5 million.
On October 31, 2012, Swiss Technology Components AG (“STC”), our wholly-owned subsidiary, entered into a 1.1 million Swiss Franc note payable (the “STC Note”) with New Civilization Limited, as lender. The STC Note has a fixed interest rate of 3% with interest due annually. The STC Note matures on October 31, 2013. STC is currently in discussions with the lender to extend the maturity date. During the First Quarter, STC borrowed an additional 0.4 million Swiss Francs under the STC Note, approximately $0.4 million as of March 30, 2013. At March 30, 2013, Swiss Franc-based borrowings, in U.S. dollars, under the STC Note were approximately $1.6 million.
At March 30, 2013, we were in compliance with all material debt covenants related to all of our credit agreements. For the remainder of fiscal year 2013, we expect total capital expenditures to be in a range of $95 million to $105 million. These capital expenditures will be primarily related to global retail store expansion and renovation and investment in technological infrastructure. We believe that cash flows from operations combined with existing cash on hand and amounts available under the Revolver will be sufficient to fund our working capital needs, common stock repurchases and planned capital expenditures for the next twelve months.
Contractual Obligations
There were no material changes to our contractual obligations set forth in our Annual Report on Form 10-K for the fiscal year ended December 29, 2012.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements at March 30, 2013.
Forward-Looking Statements
The statements contained and incorporated by reference in this Quarterly Report on Form 10-Q that are not historical facts, including, but not limited to, statements regarding our expected financial position, results of operations, business and financing plans found in this “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 3. Quantitative and Qualitative Disclosures About Market Risk,” constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a number of risks and uncertainties. The words “may,” “believes,” “expects,” “plans,” “intends,” “estimates,” “anticipates” and similar expressions identify forward-looking statements. The actual results of the future events described in such forward-looking statements could differ materially from those stated in such forward-looking statements. Among the factors that could cause actual results to differ materially are: the effect of worldwide economic conditions; significant changes in consumer spending patterns or preferences; interruptions or delays in the supply of key components; acts of war or acts of terrorism; changes in foreign currency valuations in relation to the U.S. dollar; lower levels of consumer spending resulting from a general economic downturn or generally reduced shopping activity caused by public safety or consumer confidence concerns; the performance of our products within the prevailing retail environment; customer acceptance of both new designs and newly-introduced product lines; financial difficulties encountered by customers; the effects of vigorous competition in the markets in which we operate; the integration of the organizations and operations of any acquired businesses into our existing organization and operations; the termination or non-renewal of material licenses, foreign operations and manufacturing; changes in the costs of materials, labor and advertising; government regulation; our ability to secure and protect trademarks and other intellectual property rights; and the outcome of current and possible future litigation.
In addition to the factors listed above, our actual results may differ materially due to the other risks and uncertainties discussed in this Quarterly Report on Form 10-Q and the risks and uncertainties set forth in our Annual Report on Form 10-K for the fiscal year ended December 29, 2012. Accordingly, readers of this Quarterly Report on Form 10-Q should consider these facts in evaluating the information and are cautioned not to place undue reliance on the forward-looking statements contained herein. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As a multinational enterprise, we are exposed to changes in foreign currency exchange rates. Our most significant foreign currency risks relate to the Euro, and to a lesser extent, the British Pound, Japanese Yen, Canadian Dollar, Mexican Peso and Australian Dollar as compared to the U.S. dollar. Due to our vertical nature whereby a significant portion of goods are sourced from our owned facilities, the foreign currency risks relate primarily to the necessary current settlement of intercompany inventory transactions. We employ a variety of operating practices to manage these market risks relative to foreign currency exchange rate changes and, where deemed appropriate, utilize forward contracts. These operating practices include, among others, our ability to convert foreign currency into U.S. dollars at spot rates and to maintain U.S. dollar pricing relative to sales of our products to certain distributors located outside the U.S. The use of foreign exchange forward contracts allows us to offset exposure to rate fluctuations because the gains or losses incurred on the derivative instruments will offset, in whole or in part, losses or gains on the underlying foreign currency exposure. We use derivative instruments only for risk management purposes and do not use them for speculation or for trading. There were no significant changes in how we managed foreign currency transactional exposure in the First Quarter and management does not anticipate any significant changes in such exposures or in the strategies we employ to manage such exposure in the near future.
At March 30, 2013, the following table reflects the outstanding foreign exchange contracts and their expiration dates (in millions).
Expiring
Through
September 2014
If we were to settle our Euro, British Pound, Japanese Yen, Australian Dollar, Mexican Peso and Canadian Dollar based contracts at March 30, 2013, the net result would have been a net gain of approximately $4.4 million, net of taxes. At the end of the First Quarter, a 10% unfavorable change in the U.S. dollar strengthening against foreign currencies to which we have balance sheet transactional exposures, would have decreased net pre-tax income by $4.5 million. The translation of the balance sheets of our foreign-based operations from their local currencies into U.S. dollars is also sensitive to changes in foreign currency exchange rates. At the end of the First Quarter, a 10% unfavorable change in the exchange rate of the U.S. dollar strengthening against the foreign currencies to which we have exposure would have reduced consolidated stockholders’ equity by approximately $65.7 million. In our view, these hypothetical losses resulting from these assumed changes in foreign currency exchange rates are not material to our consolidated financial position, results of operations or cash flows.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”), as defined by Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q. The Disclosure Controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Based upon this evaluation, our CEO and CFO have concluded that our Disclosure Controls were effective at the reasonable assurance level as of March 30, 2013.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the First Quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
28
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
There are no legal proceedings to which we are a party or to which our properties are subject, other than routine litigation incidental to our business, which is not material to our consolidated financial condition, results of operations or cash flows.
Item 1A. Risk Factors
There were no material changes to the risk factors set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2012.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table shows our common stock repurchases based on settlement date for the fiscal quarter ended March 30, 2013:
Total Number of Shares
Approximate Dollar Value of Shares
Total Number
Purchased as Part of
that May Yet Be
of Shares
Price Paid per
Publicly
Purchased
Period
Purchased (1)
Share
Announced Plans
Under the Plans (2)
December 30, 2012 - January 26, 2013
198,512
97.37
196,813
1,049,399,269
January 27, 2013 - February 23, 2013
103,800
105.16
1,038,483,870
February 24, 2013 - March 30, 2013
279,988
102.64
258,721
1,012,007,955
582,300
559,334
(1) During the First Quarter, 22,966 shares of repurchased common stock were acquired from grantees in connection with income tax withholding obligations arising from vesting of restricted stock grants. These shares were not part of our publicly announced program to repurchase shares of common stock.
(2) On August 10, 2010, we announced a common stock repurchase program pursuant to which up to $30 million could be used to repurchase outstanding shares of our common stock. The $30 million repurchase program has no termination date. On August 30, 2010, we announced a common stock repurchase program pursuant to which up to $750 million could be used to repurchase outstanding shares of our common stock. The $750 million repurchase program was completed during the First Quarter. On December 2012, we announced a common stock repurchase program pursuant to which up to $1 billion could be used to repurchase outstanding shares of our common stock. The $1 billion repurchase program has a termination date in December 2016. During the First Quarter, l77,000 shares were repurchased pursuant to the $1 billion plan.
Item 6. Exhibits
(a) Exhibits
Exhibit Number
Document Description
3.1
Third Amended and Restated Certificate of Incorporation of Fossil, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on May 25, 2010).
3.2
Third Amended and Restated Bylaws of Fossil, Inc. (incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K filed on May 25, 2010).
31.1(1)
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2(1)
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1(1)
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2(1)
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS(2)
XBRL Instance Document.
101.SCH(2)
XBRL Taxonomy Extension Schema Document.
101.DEF(2)
XBRL Taxonomy Extension Definition Link Document.
101.CAL(2)
XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB(2)
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE(2)
XBRL Taxonomy Extension Presentation Linkbase Document.
(1) Filed herewith.
(2) Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 9, 2013
/S/ DENNIS R. SECOR
Dennis R. Secor
Executive Vice President, Chief Financial Officer and Treasurer (Principal financial and accounting officer duly authorized to sign on behalf of the Registrant)
EXHIBIT INDEX
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
Certification of Chief Executive Officer Pursuant to Section 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer Pursuant to Section 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.