Fossil Group, Inc. - Quarter Report: 2012 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

 

For the transition period from                     to                     

 

Commission file number: 000-19848

 

 

FOSSIL, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

(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):

 

 

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 November 2, 2012: 60,021,257.

 

 

 

PART I—FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

FOSSIL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

UNAUDITED

IN THOUSANDS

 

		September 29, 2012			December 31, 2011
Assets
Current assets:
Cash and cash equivalents		$	142,837		$	287,498
Securities available for sale		181			155
Accounts receivable - net of allowances of $69,747 and $79,820, respectively		290,738			302,467
Inventories		589,045			488,983
Deferred income tax assets-net		47,510			45,803
Prepaid expenses and other current assets		104,964			110,496
Total current assets		1,175,275			1,235,402
Investments		8,068			7,520
Property, plant and equipment - net of accumulated depreciation of $250,180 and $217,245, respectively		318,172			282,050
Goodwill		182,681			44,054
Intangible and other assets-net		166,879			73,896
Total long-term assets		675,800			407,520
Total assets		$	1,851,075		$	1,642,922
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	144,591		$	157,883
Short-term debt		5,953			9,009
Accrued expenses:
Compensation		44,681			58,745
Royalties		30,985			48,807
Co-op advertising		13,388			21,287
Transaction taxes		19,407			23,086
Other		68,890			56,122
Income taxes payable		57,945			16,339
Total current liabilities		385,840			391,278
Long-term income taxes payable		6,933			17,194
Deferred income tax liabilities		89,099			86,328
Long-term debt		178,892			6,236
Other long-term liabilities		27,236			25,040
Total long-term liabilities		302,160			134,798
Commitments and contingencies (Note 11)
Stockholders’ equity:
Common stock, 60,331 and 68,370 shares issued at September 29, 2012 and December 31, 2011, respectively		603			684
Treasury stock, at cost, 6,215 shares at December 31, 2011		0			(450,700		)
Additional paid-in capital		139,907			149,243
Retained earnings		979,136			1,384,522
Accumulated other comprehensive income		27,769			22,180
Total Fossil, Inc. stockholders’ equity		1,147,415			1,105,929
Noncontrolling interest		15,660			10,917
Total stockholders’ equity		1,163,075			1,116,846
Total liabilities and stockholders’ equity		$	1,851,075		$	1,642,922

 

See notes to the condensed consolidated financial statements.

 

2

 

FOSSIL, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

UNAUDITED

IN THOUSANDS, EXCEPT PER SHARE DATA

 

		For the 13 Weeks Ended						For the 39 Weeks Ended
		September 29, 2012			October 1, 2011			September 29, 2012			October 1, 2011
Net sales		$	684,170		$	642,910		$	1,909,807		$	1,736,546
Cost of sales		302,646			283,381			842,942			763,229
Gross profit		381,524			359,529			1,066,865			973,317
Operating expenses:
Selling and distribution		193,276			172,208			570,979			495,198
General and administrative		75,161			68,512			211,841			180,492
Total operating expenses		268,437			240,720			782,820			675,690
Operating income		113,087			118,809			284,045			297,627
Interest expense		1,437			447			3,680			1,321
Other income (expense)-net		2,211			(6,551		)	6,185			(13,549		)
Income before income taxes		113,861			111,811			286,550			282,757
Provision for income taxes		33,984			39,307			85,213			98,156
Net income		79,877			72,504			201,337			184,601
Less: Net income attributable to noncontrolling interest		3,086			2,895			9,068			7,809
Net income attributable to Fossil, Inc.		$	76,791		$	69,609		$	192,269		$	176,792
Other comprehensive income (loss), net of taxes:
Currency translation adjustment		$	12,249		$	(26,112	)	$	6,639		$	3,795
Unrealized (loss) gain on securities available for sale		(4		)	(309		)	25			(556		)
Forward contracts hedging intercompany foreign currency payments-change in fair values		(1,983		)	11,985			(1,075		)	5,115
Total other comprehensive income (loss)		10,262			(14,436		)	5,589			8,354
Total comprehensive income		90,139			58,068			206,926			192,955
Less: Comprehensive income attributable to noncontrolling interest		3,086			2,895			9,068			7,809
Comprehensive income attributable to Fossil, Inc.		$	87,053		$	55,173		$	197,858		$	185,146
Earnings per share:
Basic		$	1.27		$	1.10		$	3.13		$	2.78
Diluted		$	1.26		$	1.09		$	3.11		$	2.75
Weighted average common shares outstanding:
Basic		60,573			63,176			61,342			63,542
Diluted		60,955			63,809			61,804			64,241

 

See notes to the condensed consolidated financial statements.

 

3

 

FOSSIL, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

IN THOUSANDS

 

		For the 39 Weeks Ended
		September 29, 2012			October 1, 2011
Operating Activities:
Net income		$	201,337		$	184,601
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		47,146			37,743
Stock-based compensation		12,858			10,524
Decrease in allowance for returns - net of inventory in transit		(2,929		)	(717		)
Loss on disposal of assets		1,473			1,093
Impairment loss		256			0
Equity in income of joint venture		(815		)	(54		)
Distribution from joint venture		0			2,226
(Decrease) increase in allowance for doubtful accounts		(3,047		)	1,173
Excess tax benefits from stock-based compensation		(11,223		)	(9,723		)
Deferred income taxes and other		4,836			14,808
Contingent consideration revaluation		(3,585		)	0
Changes in operating assets and liabilities:
Accounts receivable		41,043			(10,817		)
Inventories		(78,487		)	(143,535		)
Prepaid expenses and other current assets		(1,866		)	(11,449		)
Accounts payable		(28,586		)	9,465
Accrued expenses		(50,141		)	(12,333		)
Income taxes payable		40,231			9,724
Net cash provided by operating activities		168,501			82,729
Investing Activities:
Additions to property, plant and equipment		(59,710		)	(70,237		)
Increase in intangible and other assets		(4,980		)	(13,913		)
Purchase of securities available for sale		0			(222		)
Sales/maturities of securities available for sale		0			111
Proceeds from the sale of property, plant and equipment		21			21,319
Net change in restricted cash		6,903			(7,344		)
Business acquisitions-net of cash acquired		(229,151		)	0
Net cash used in investing activities		(286,917		)	(70,286		)
Financing Activities:
Acquisition of common stock		(205,631		)	(204,430		)
Distribution of noncontrolling interest earnings		(4,406		)	(3,772		)
Excess tax benefits from stock-based compensation		11,223			9,723
Borrowings on notes payable		399,198			12,881
Payments on notes payable		(235,688		)	(7,055		)
Common stock issued upon legal settlement		0			7,833
Proceeds from exercise of stock options		5,279			8,218
Net cash used in financing activities		(30,025		)	(176,602		)
Effect of exchange rate changes on cash and cash equivalents		3,780			2,520
Net decrease in cash and cash equivalents		(144,661		)	(161,639		)
Cash and cash equivalents:
Beginning of period		287,498			392,794
End of period		$	142,837		$	231,155

 

See notes to the condensed consolidated financial statements.

 

4

 

FOSSIL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED

 

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 September 29, 2012, and the results of operations for the 13 week periods ended September 29, 2012 (“Third Quarter”) and October 1, 2011 (“Prior Year Quarter”), respectively, and the 39 week periods ended September 29, 2012 (“Year To Date Period”) and October 1, 2011 (“Prior Year YTD Period”), 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 31, 2011. Operating results for the 13 and 39 week periods ended September 29, 2012 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 its most recent Annual Report on 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, shoes, 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 $0.5 million, net of taxes, as of September 29, 2012. Refer to Note 8—Derivatives and Risk Management for additional disclosures about the Company’s use of forward contracts. The tax benefit of changes in fair value of hedging activities for the Third Quarter and Year To Date Period was $2.8 million and $2.0 million, respectively. The tax expense of changes in fair value of hedging activities for the Prior Year Quarter and Prior Year YTD Period was $1.6 million and $1.4 million, respectively.

 

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.

 

Accounting Standard Codification (“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.

 

5

 

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of September 29, 2012 (in thousands):

 

		Fair Value at September 29, 2012
		Level 1			Level 2			Level 3			Total
Assets:
Securities available for sale:
Investments in publicly traded equity securities		$	181		$	0		$	0		$	181
Foreign exchange forward contracts		0			5,132			0			5,132
Deferred compensation plan assets:
Investment in publicly traded mutual funds		3,127			0			0			3,127
Total		$	3,308		$	5,132		$	0		$	8,440
Liabilities:
Contingent consideration		$	0		$	6,365		$	0		$	6,365
Foreign exchange forward contracts		0			4,340			0			4,340
Total		$	0		$	10,705		$	0		$	10,705

 

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 (in thousands):

 

		Fair Value at December 31, 2011
		Level 1			Level 2			Level 3			Total
Assets:
Securities available for sale:
Investments in publicly traded equity securities		$	155		$	0		$	0		$	155
Foreign exchange forward contracts		0			10,614			0			10,614
Deferred compensation plan assets:
Investment in publicly traded mutual funds		2,897			0			0			2,897
Total		$	3,052		$	10,614		$	0		$	13,666
Liabilities:
Foreign exchange forward contracts		$	0		$	3,586		$	0		$	3,586
Total		$	0		$	3,586		$	0		$	3,586

 

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 within intangible and other assets-net in the Company’s condensed consolidated balance sheets. The fair values of the Company’s foreign exchange 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 September 29, 2012 and December 31, 2011, 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.

 

6

 

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a nonrecurring basis as of September 29, 2012 (in thousands):

 

		For the 39 Weeks Ended			Fair Value Measurements Using									Total
		September 29, 2012			Level 1			Level 2			Level 3			Losses
Assets:
Specific Company-owned stores-net		$	0		$	0		$	0		$	0		$	(256	)

 

In accordance with the provisions of ASC 360, Property, Plant and Equipment, the Company recorded a write-down of $0.3 million related to the fair value of leasehold improvements and fixturing associated with certain Company-owned retail stores during the Year To Date Period. The fair values of assets related to the Company-owned retail stores were determined using Level 3 inputs. If undiscounted cash flows estimated to be generated through the operation of Company-owned retail stores are less than the carrying value of the underlying assets, impairment losses are recorded. Impairment expenses related to Company-owned retail stores are recorded in selling and distribution expense within the Direct to consumer segment.

 

The Company had no impairment losses for the Prior Year YTD Period.

 

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.

 

The following table reconciles the numerators and denominators used in the computations of both basic and diluted EPS (in thousands except per share data):

 

		For the 13 Weeks Ended						For the 39 Weeks Ended
		September 29, 2012			October 1, 2011			September 29, 2012			October 1, 2011
Numerator:
Net income attributable to Fossil, Inc.		$	76,791		$	69,609		$	192,269		$	176,792
Denominator:
Basic EPS computation:
Basic weighted average common shares outstanding		60,573			63,176			61,342			63,542
Basic EPS		$	1.27		$	1.10		$	3.13		$	2.78
Diluted EPS computation:
Basic weighted average common shares outstanding		60,573			63,176			61,342			63,542
Stock options, stock appreciation rights and restricted stock units		382			633			462			699
Diluted weighted average common shares outstanding		60,955			63,809			61,804			64,241
Diluted EPS		$	1.26		$	1.09		$	3.11		$	2.75

 

Approximately 370,000, 215,000, 40,000 and 40,000 shares issuable under stock-based awards were not included in the diluted EPS calculation at the end of the Third Quarter, Year To Date Period, Prior Year Quarter, and Prior Year YTD Period, respectively, because they were antidilutive.

 

Restricted Cash. As of September 29, 2012, the Company had short-term restricted cash balances of $0.2 million, primarily pledged as collateral to secure bank guarantees for the purpose of obtaining retail space.  As of December 31, 2011, the Company had restricted cash of  $5.9 million, primarily pledged as collateral to secure bank guarantees on behalf of the Company for payments related to prospective value-added tax liabilities. This 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. The Company also had long-term restricted cash balances of $0.9 million and $2.1 million as of September 29, 2012 and December 31, 2011, respectively, pledged as collateral to secure bank guarantees for the purpose of obtaining retail space. This restricted cash is reported in intangibles and other assets-net in the Company’s condensed consolidated balance sheets as a component of long-term assets.

 

7

 

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

 

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

 

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

 

In September 2011, FASB issued ASU 2011-08, which simplifies the assessment of goodwill for impairment by allowing companies the option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a company concludes from the qualitative assessment that impairment is more likely than not, the entity is required to perform the two-step quantitative impairment test. These changes became effective for the Company on January 1, 2012. The adoption of ASU 2011-08 did not have a material impact on the Company’s condensed consolidated results of operations and 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 marketed and distributed contemporary Danish design accessories including watches, clocks, jewelry and sunglasses globally. The primary purpose of the acquisition was to add an attractive brand to the Company’s portfolio that the Company can grow using 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. In addition, the sellers may receive up to 100,000 additional shares of the Company’s common stock if the Company’s net sales of SKAGEN® branded products exceed certain thresholds over a defined period of time (the “Earnout”).

 

As of September 29, 2012, the Company has recorded a $0.8 million tax-related indemnification asset, which is reflected in the Company’s condensed consolidated balance sheets in intangible and other assets-net. The purchase agreement imposes a liability to the seller for all taxes that are due with respect to tax returns for periods ending on or before the acquisitions date.  The Company also recorded liabilities of $0.6 million to long-term income taxes payable and $0.2 million to accrued expenses-other in the Company’s condensed consolidated balance sheets related to the indemnification asset.  The income tax liabilities were accrued in accordance with ASC 740, Income Taxes, and the non-income tax liabilities in accordance with ASC 450, Contingencies. The Company also recorded a contingent consideration liability in accrued expenses-other in the Company’s condensed consolidated balance sheets of approximately $10.0 million as of the acquisition date related to the Earnout. As of September 29, 2012, the contingent consideration liability was remeasured to $6.4 million, which resulted in an increase in operating expenses of $0.8 million during the Third Quarter and a decrease in operating expenses of $3.6 million during the Year To Date Period. The results of Skagen Designs’ operations have been included in the Company’s condensed consolidated financial statements since April 2, 2012.

 

8

 

Prior to closing the Skagen Designs acquisition, the Company incurred approximately $600,000 of acquisition-related expenses for legal, accounting and valuation services during the fiscal year ended December 31, 2011 and the 13 weeks ended March 31, 2012. The Company incurred additional acquisition and integration related costs of approximately $6.8 million since April 2, 2012, which includes $1.2 million during the Third Quarter. Acquisition and integration costs are reflected in general and administrative operating expenses on the condensed consolidated statements of comprehensive income.

 

The Company’s condensed consolidated statement of comprehensive income for the 13 and 39 weeks ended September 29, 2012 includes $25.2 million and $50.3 million of net sales and $1.8 million and $1.4 million of operating losses, respectively, related to the results of operations of Skagen Designs since April 2, 2012. Excluding nonrecurring acquisition and integration costs, Skagen Designs operations contributed $0.8 million and $2.4 million to operating income in the Third Quarter and Year To Date periods, respectively.

 

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 preliminary estimated fair value of the assets acquired and the liabilities assumed as of April 2, 2012, the effective date of the acquisition (in thousands):

 

Cash paid, net of cash acquired		$	229,012
Value of common stock issued		19,899
Contingent consideration		9,950
Total transaction consideration:		$	258,861
Accounts receivable - net of allowances		$	16,595
Inventories		22,638
Prepaid expenses and other current assets		3,306
Property, plant & equipment and other long-term assets		4,232
Goodwill		138,050
Trade name		64,700
Customer lists		24,400
Patents		1,500
Noncompete agreement		1,900
Other long-term assets		2,972
Current liabilities		(20,484		)
Long-term liabilities		(948		)
Total net assets acquired		$	258,861

 

The amounts shown above may change in the near term as management continues to assess the fair value of acquired assets and liabilities. A change in this valuation may also impact the income tax related accounts and goodwill. Additionally, the working capital adjustment included in the purchase price has not been finalized. The goodwill and trade name assets recognized from the acquisition have indefinite useful lives and will be tested annually for impairment. The amortization periods for the acquired customer lists, patents and noncompete agreements have amortization periods of 5-9 years, 3 years and 6 years, respectively.  Approximately $129.8 million of the goodwill recognized in the acquisition is expected to be deductible for tax purposes.

 

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The following unaudited pro forma financial 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 financial information for the 13 and 39 weeks ended September 29, 2012 were adjusted to exclude acquisition and integration costs and does not give effect to any potential cost savings or other operating efficiencies that could result from the acquisition. These acquisition and integration costs were included in the pro forma information for the 39 weeks ended October 1, 2011. The following table presents the unaudited pro forma financial information (in thousands, except per share data):

 

		For the 13 Weeks Ended						For the 39 Weeks Ended
		September 29, 2012			October 1, 2011			September 29, 2012			October 1, 2011
Net sales		$	684,170		$	674,936		$	1,940,251		$	1,816,680
Net income attributable to Fossil, Inc.		77,617			73,763			197,861			181,178
Earnings per share:
Basic		$	1.28		$	1.17		$	3.23		$	2.85
Diluted		$	1.27		$	1.16		$	3.20		$	2.82

 

Effective April 30, 2012, the Company acquired 51% percent of Swiss Technology Productions AG (“STP”) to support its Swiss-made watch production. The acquisition was completed for 255,000 Swiss francs, approximately $266,000. The Company recorded approximately $160,000 of goodwill related to the acquisition. The results of STP’s operations and related noncontrolling interest have been included in the Company’s condensed consolidated financial statements since the acquisition date.

 

On August 10, 2012, the Company’s joint venture company in Spain, Fossil, S.L. (“Fossil Spain”) entered into a Framework Agreement with several related and unrelated parties, including General De Relojeria, S.A., the Company’s joint venture partner, pursuant to which, among other things, Fossil Spain was granted the right to acquire the outstanding 50% of its shares owned by General De Relojeria, S.A. upon the expiration of the joint venture agreement on December 31, 2015.

 

The purchase price has a fixed and variable component.  The fixed price will be determined based on 50% of the net book value of Fossil Spain as of December 31, 2012 (the net book value was approximately 14.5 million Euros as of September 29, 2012).  The variable price will be determined based on Fossil Spain’s aggregated results of operations less dividends distributed by Fossil Spain to General De Relojeria for the calendar years 2013, 2014 and 2015, with a minimum variable price of 2.0 million Euros and a maximum variable price of 3.5 million Euros each respective year.

 

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			Direct to consumer			Total
Balance at December 31, 2011		$	23,605		$	17,891		$	2,558		$	0		$	44,054
Acquisitions		85,174			44,331			8,704			0			138,209
Foreign currency changes		156			208			54			0			418
Balance at September 29, 2012		$	108,935		$	62,430		$	11,316		$	0		$	182,681

 

3. INVENTORIES

 

Inventories consisted of the following (in thousands):

 

		September 29, 2012			December 31, 2011
Components and parts		$	39,322		$	37,482
Work-in-process		3,319			4,764
Finished goods		546,404			446,737
Inventories		$	589,045		$	488,983

 

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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 changes in the Company’s warranty liability for the periods indicated were as follows (in thousands):

 

		For the 39 Weeks Ended
		September 29, 2012			October 1, 2011
Beginning balance		$	10,996		$	8,534
Settlements in cash or kind		(4,591		)	(3,011		)
Warranties issued and adjustments (1)		6,561			5,061
Liabilities assumed in acquisition		595			0
Ending balance		$	13,561		$	10,584

 

(1)                  Changes in cost estimates related to pre-existing warranties are aggregated with accruals for newly issued warranties and foreign currency changes.

 

5.  INCOME TAXES

 

The Company’s income tax expense and related effective tax rate were as follows (in thousands, except percentage data):

 

		For the 13 Weeks Ended						For the 39 Weeks Ended
		September 29, 2012			October 1, 2011			September 29, 2012			October 1, 2011
Income tax expense		$	33,984		$	39,307		$	85,213		$	98,156
Income tax rate		29.8		%	35.2		%	29.7		%	34.7		%

 

The lower effective tax rate in the Third Quarter and Year To Date Period was attributable to a higher portion of foreign income taxed at lower overall foreign rates, a reduction in income tax rates in several countries and management’s decision to indefinitely reinvest the undistributed earnings of certain foreign subsidiaries.

 

As of September 29, 2012, the Company’s total amount of unrecognized tax benefits, excluding interest and penalties, was $19.8 million, of which $15.1 million would favorably impact the effective tax rate in future periods, if recognized. On October 2, 2012, the IRS Office of Appeals and the Company executed a Closing Agreement to settle various issues under protest after the close of the Internal Revenue Service’s income tax audit for the 2005-2006 tax years.  As a result of this settlement, the Company will reduce the amount of unrecognized tax benefits by approximately $6.0 million in the fourth quarter of fiscal 2012.  The Internal Revenue Service opened an audit of the 2007-2009 tax years in January 2012.  The Company is also subject to examinations in various state and foreign jurisdictions for the 2005-2011 tax years, none of which are individually significant. Audit outcomes and the 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 September 29, 2012, the Company had recorded unrecognized tax benefits of $13.9 million, 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 September 29, 2012 was $3.2 million and $0.3 million, respectively. For the Third Quarter, the Company accrued income tax-related interest expense of $0.2 million.

 

6. STOCKHOLDERS’ EQUITY AND BENEFIT PLANS

 

Common Stock Repurchase Programs. Purchases of the Company’s common stock are made from time to time, 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 and 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. These repurchase programs were conducted pursuant to Rule 10b-18 of the Exchange Act. During the period from the announcement of the Company’s $750 million buyback authorization in August 2010 until the end of the Third Quarter, the Company has repurchased approximately $646.4 million of its common stock, representing approximately 8.5 million shares.

 

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During the Year To Date Period, the Company effectively retired 8.5 million shares of common stock repurchased under its repurchase programs during fiscal years 2010, 2011 and 2012. The effective retirement of common stock repurchased decreased common stock by $85,000, additional paid-in capital by $49.3 million, retained earnings by $597.7 million and treasury stock by $647.0 million.

 

The following table reflects the Company’s common stock repurchase activity for the periods indicated (in millions):

 

							For the 13 Weeks Ended September 29, 2012					For the 39 Weeks Ended September 29, 2012
Fiscal Year Authorized		Dollar Value Authorized			Termination Date		Number of Shares Repurchased		Dollar Value Repurchased			Number of Shares Repurchased		Dollar Value Repurchased
2010		$	30.0		None		0.0		$	0.0		0.0		$	0.0
2010		$	750.0		December 2013		1.0		$	78.2		2.3		$	196.3

 

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 current stock-based compensation plans include: (i) stock options and restricted stock for its international employees, (ii) stock options and 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 Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

The following table summarizes stock options and stock appreciation rights activity during the Third Quarter:

 

Stock Options and Stock Appreciation Rights		Shares		Weighted- Average Exercise Price			Weighted- Average  Remaining Contractual Term (Years)		Aggregate Intrinsic Value
		IN THOUSANDS							IN THOUSANDS
Outstanding at June 30, 2012		1,201		$	61.81		6.3		$	34,152
Granted		3		67.10
Exercised		(54	)	23.92					3,599
Forfeited or expired		(35	)	116.63
Outstanding at September 29, 2012		1,115		61.92			6.5		37,158
Exercisable at September 29, 2012		466		34.00			4.8		23,844
Nonvested at September 29, 2012		649		81.95			7.7		13,314
Expected to vest		585		$	81.95		7.7		$	12,126

 

The aggregate intrinsic value in the table above is before income taxes and is based on (i) the exercise price for outstanding and exercisable options/rights at September 29, 2012 and (ii) the fair market value of the Company’s common stock on the exercise date for options/rights that were exercised during the Third 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 September 29, 2012:

 

Stock Options and Stock Appreciation Rights Outstanding									Stock Options and Stock Appreciation Rights Exercisable
							Weighted-
				Weighted-			Average				Weighted-
				Average			Remaining				Average
		Number of		Exercise			Contractual		Number of		Exercise
Range of Exercise Prices		Shares		Price			Term (Years)		Shares		Price
		IN THOUSANDS							IN THOUSANDS
$11.66 - $13.15		11		$	11.71		0.4		11		$	11.71
$13.15 - $26.29		295		18.39			4.2		207		20.36
$26.29 - $39.44		292		34.62			5.6		162		33.78
$39.44 - $52.58		32		43.12			5.2		32		43.12
$65.73 - $78.88		7		68.59			8.9		1		69.53
$78.88 - $92.02		202		81.23			8.0		46		81.23
$92.02 - $105.17		6		93.29			8.5		2		93.29
$118.31 - $131.46		270		128.02			9.0		5		128.29
Total		1,115		$	61.92		6.5		466		$	34.00

 

Restricted Stock and Restricted Stock Units. The following table summarizes restricted stock and restricted stock unit activity during the Third Quarter:

 

				Weighted-Average
Restricted Stock and Restricted Stock Units		Number of Shares		Grant-Date Fair Value
		IN THOUSANDS
Nonvested at June 30, 2012		275		$	68.19
Granted		4		67.10
Vested		(5	)	70.91
Forfeited		(1	)	49.91
Nonvested at September 29, 2012		273		68.24
Expected to vest		246		$	68.24

 

The total fair value of restricted stock and restricted stock units vested during the Third Quarter was approximately $0.4 million.

 

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 reportable 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.

 

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