Fossil Group, Inc. - Quarter Report: 2013 March (Form 10-Q)

 

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)

 

 

 

(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 May 3, 2013: 58,672,408.

 

 

 

PART I—FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

FOSSIL, INC.

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		$	1,856,569		$	1,841,989

 

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
		March 30, 2013			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		1,794			2,932
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:
Basic		59,393			61,859
Diluted		59,783			62,459

 

See notes to the condensed consolidated financial statements.

 

3

 

FOSSIL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

IN THOUSANDS

 

		For the 13 Weeks Ended
		March 30, 2013			March 31, 2012
Operating Activities:
Net income		$	73,980		$	61,072
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		0			(270		)
Gain on equity method investment		(6,410		)	0
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
Inventories		(11,507		)	(19,355		)
Prepaid expenses and other current assets		(14,721		)	(5,527		)
Accounts payable		(20,369		)	(45,310		)
Accrued expenses		(49,000		)	(60,930		)
Income taxes payable		(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		)	0
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		)
Excess tax benefits from stock-based compensation		4,082			9,901
Debt borrowings		218,098			3,899
Debt payments		(142,718		)	(4		)
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		177,236			287,498
End of period		$	241,396		$	260,478

 

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 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):

 

		For the 13 Weeks Ended
		March 30, 2013			March 31, 2012
Numerator:
Net income attributable to Fossil, Inc.		$	72,186		$	58,140
Denominator:
Basic EPS computation:
Basic weighted average common shares outstanding		59,393			61,859
Basic EPS		$	1.22		$	0.94
Diluted EPS computation:
Basic weighted average common shares outstanding		59,393			61,859
Stock options, stock appreciation rights and restricted stock units		390			600
Diluted weighted average common shares outstanding		59,783			62,459
Diluted EPS		$	1.21		$	0.93

 

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
Accounts receivable		$	16,595
Inventories		22,638
Prepaid expenses and other current assets		3,306
Property, plant and equipment		4,232
Goodwill		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		$	258,861

 

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):

 

		For the 13 Weeks Ended
		March 30, 2013			March 31, 2012
Net sales		$	680,899		$	619,977
Net income attributable to Fossil, Inc.		72,186			58,637
Earnings per share:
Basic		$	1.22		$	0.95
Diluted		$	1.21		$	0.94

 

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		$	184,793
Acquisitions		8,130			10,723			0			18,853
Foreign currency changes		102			(2,306		)	(86		)	(2,290		)
Balance at March 30, 2013		$	117,502		$	72,301		$	11,553		$	201,356

 

3. INVENTORIES

 

Inventories consisted of the following (in thousands):

 

		March 30, 2013			December 29, 2012
Components and parts		$	60,566		$	62,731
Work-in-process		6,757			8,071
Finished goods		452,983			435,512
Inventories		$	520,306		$	506,314

 

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

 

		For the 13 Weeks Ended
		March 30, 2013			March 31, 2012
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			0
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):

 

		For the 13 Weeks Ended
		March 30, 2013			March 31, 2012
Income tax expense		$	28,894		$	23,524
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			Number of Shares Repurchased		Dollar Value Repurchased
2012		$	1,000.0		December 2016		0.2		$	18.0		0.0		$	0.0
2010		$	30.0		None		0.0		$	0.0		0.0		$	0.0
2010		$	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							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			6.4		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		$	98.23		7.8		$	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.

 

11

 

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-
				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
$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		30		43.15
$65.73 - $78.88		7		68.59			8.4		3		69.53
$78.88 - $92.02		196		81.46			7.6		106		81.23
$92.02 - $105.17		8		99.37			9.3		1		93.29
$105.17 - $118.31		25		106.40			8.0		0		0.00
$118.31 - $131.46		253		128.02			8.5		82		127.93
Total		958		$	67.97		6.4		617		$	51.21

 

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		Number of Shares		Weighted-Average Grant-Date Fair Value
		IN THOUSANDS
Nonvested at December 29, 2012		277		$	68.69
Granted		104		106.22
Vested		(139	)	53.62
Forfeited		(7	)	72.73
Nonvested at March 30, 2013		235		94.09
Expected to vest		216		$	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):

 

		For the 13 Weeks Ended March 30, 2013
					Unrealized
		Currency			Gains (Losses) on			Gains
		Translation			Securities Available			(Losses) on
		Adjustments			for Sale			Forward Contracts			Total
Beginning balance		$	30,181		$	(475	)	$	(946	)	$	28,760
Other comprehensive (loss) income before reclassifications, net of tax expense of $3,474		(19,837		)	(71		)	3,345			(16,563		)
Amounts reclassed from accumulated other comprehensive income, net of tax expense of $87		0			0			(46		)	(46		)
Total other comprehensive (loss) income		(19,837		)	(71		)	3,391			(16,517		)
Ending balance		$	10,344		$	(546	)	$	2,445		$	12,243

 

12

 

		For the 13 Weeks Ended March 31, 2012
					Unrealized
		Currency			Gains (Losses) on			Gains
		Translation			Securities Available			(Losses) on
		Adjustments			for Sale			Forward Contracts			Total
Beginning balance		$	18,953		$	(446	)	$	3,673		$	22,180
Other comprehensive income (loss) before reclassifications, net of tax benefit of $1,081		10,071			50			(497		)	9,624
Amounts reclassed from accumulated other comprehensive income, net of tax expense of $444		0			0			852			852
Total other comprehensive income (loss)		10,071			50			(1,349		)	8,772
Ending balance		$	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

 

		For the 13 Weeks Ended March 30, 2013						For the 13 Weeks Ended March 31, 2012
		Net Sales			Operating Income			Net Sales			Operating Income
North America wholesale:
External customers		$	255,165		$	60,408		$	225,000		$	53,509
Intersegment		45,946						42,826
Europe wholesale:
External customers		173,906			38,547			152,950			31,098
Intersegment		40,688						34,561
Asia Pacific wholesale:
External customers		86,776			27,550			76,709			25,243
Intersegment		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		$	680,899		$	94,321		$	589,533		$	82,861

 

The following tables reflect net sales for each class of similar products in the periods presented (in thousands except percentage data):

 

		For the 13 Weeks Ended March 30, 2013					For the 13 Weeks Ended March 31, 2012
		Net Sales			Percentage of Total		Net Sales			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
Other		22,780			3.4		27,902			4.7
Total		$	680,899		100.0	%	$	589,533		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.

 

14

 

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):

 

 

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		For the 13 Weeks Ended March 30, 2013			For the 13 Weeks Ended March 31, 2012
Foreign exchange forward contracts		$	3,345		$	(497	)
Total gain (loss) recognized in other comprehensive income (loss)		$	3,345		$	(497	)

 

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