UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

 

FOSSIL, INC.

(Exact name of registrant as specified in its charter)

 

Indicate by check mark whether 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer  x

Accelerated filer  o

Non-accelerated filer  o

 

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 registrant’s common stock outstanding as of August 13, 2007: 68,140,234

PART I - FINANCIAL INFORMATION

Item 1.                       Financial Statements

FOSSIL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

UNAUDITED

AMOUNTS IN THOUSANDS

		July 7,  2007			January 6, 2007
ASSETS
Current assets:
Cash and cash equivalents		$	169,691		$	133,304
Securities available for sale		8,214			6,894
Accounts receivable – net of allowances of $35,796 and $38,258, respectively		151,314			155,236
Inventories – net		237,843			228,225
Deferred income tax assets		19,337			20,406
Prepaid expenses and other current assets		50,149			36,923
Total current assets		636,548			580,988
Investments		12,003			10,855
Property, plant and equipment – net of accumulated depreciation of $120,857 and $109,183, respectively		172,232			171,499
Goodwill		45,173			43,038
Intangible and other assets – net of accumulated amortization of $4,690 and $3,990, respectively		49,356			46,217
Total assets		$	915,312		$	852,597
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term debt		$	9,548		$	11,338
Accounts payable		58,200			53,306
Accrued expenses:
Accrued accounts payable		21,658			23,562
Compensation		34,758			28,896
Coop advertising		9,918			11,554
Other		43,710			41,653
Income taxes payable		26,844			53,071
Total current liabilities		204,636			223,380
Long-term income taxes payable		32,265			—
Deferred income tax liabilities		16,494			15,021
Other long-term liabilities		7,552			7,893
Total long-term liabilities		56,311			22,914
Minority interest in subsidiaries		4,449			4,102
Stockholders’ equity:
Common stock, 68,244 and 67,794 shares issued,  respectively		682			678
Additional paid-in capital		62,237			53,459
Retained earnings		562,936			529,376
Accumulated other comprehensive income		26,408			20,025
Treasury stock at cost, 120 and 69 shares, respectively		(2,347		)	(1,337		)
Total stockholders’ equity		649,916			602,201
Total liabilities and stockholders’ equity		$	915,312		$	852,597

 

See notes to condensed consolidated financial statements.

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FOSSIL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

UNAUDITED

AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA

		For the 13 Weeks Ended			For the 13 Weeks Ended			For the 26 Weeks Ended			For the 27 Weeks Ended
		July 7, 2007			July 8, 2006			July 7, 2007			July 8, 2006
Net sales		$	306,464		$	259,238		$	611,289		$	523,463
Cost of sales		155,934			132,204			304,640			263,416
Gross profit		150,530			127,034			306,649			260,047
Operating expenses:
Selling and distribution		88,089			79,675			174,456			164,655
General and administrative		39,325			31,163			76,523			62,205
Total operating expenses		127,414			110,838			250,979			226,860
Operating income		23,116			16,196			55,670			33,187
Interest expense		219			951			439			1,547
Other income (expense) – net		342			365			1,837			(538		)
Income before income taxes		23,239			15,610			57,068			31,102
Provision for income taxes		8,567			4,372			17,364			10,148
Net income		$	14,672		$	11,238		$	39,704		$	20,954
Other comprehensive income, net of taxes:
Currency translation adjustment		3,183			9,035			7,706			11,171
Unrealized loss on securities available for sale		(447		)	(371		)	(63		)	(361		)
Forward contracts hedging intercompany foreign currency payments – change in fair values		55			(1,369		)	(1,259		)	(2,152		)
Total comprehensive income		$	17,463		$	18,533		$	46,088		$	29,612
Earnings per share:
Basic		$	0.22		$	0.17		$	0.59		$	0.31
Diluted		$	0.21		$	0.16		$	0.57		$	0.31
Weighted average common shares outstanding:
Basic		67,814			66,884			67,695			67,122
Diluted		69,742			68,299			69,556			68,700

 

See notes to condensed consolidated financial statements.

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FOSSIL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

AMOUNTS IN THOUSANDS

		For the 26 Weeks Ended			For the 27 Weeks Ended
		July 7, 2007			July 8, 2006
Operating activities:
Net income		$	39,704		$	20,954
Noncash items affecting net income:
Minority interest in subsidiaries		2,413			1,982
Equity in earnings of joint venture		(719		)	(688		)
Depreciation and amortization		15,709			15,720
Stock-based compensation		2,184			1,821
Excess tax benefits from stock-based compensation		(1,266		)	(540		)
Loss on disposal of assets		207			189
Decrease in allowance for doubtful accounts		(622		)	(513		)
Increase in allowance for returns - net of related inventory		(977		)	(990		)
Deferred income taxes		1,362			(697		)
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable		7,007			15,396
Inventories		(11,103		)	(21,737		)
Prepaid expenses and other current assets		(13,227		)	(4,513		)
Accounts payable		1,161			(8,595		)
Accrued expenses		3,453			792
Income taxes payable		2,497			2,549
Net cash from operating activities		47,783			21,130
Investing activities:
Business acquisitions, net of cash acquired		(1,326		)	(7,227		)
Additions to property, plant and equipment		(11,597		)	(25,165		)
Purchase of securities available for sale		(1,339		)	(409		)
Increase in intangible and other assets		(3,756		)	(680		)
Net cash used in investing activities		(18,018		)	(33,481		)
Financing activities:
Proceeds from exercise of stock options		5,194			2,210
Acquisition and retirement of common stock		(287		)	(25,930		)
Excess tax benefits from stock-based compensation		1,266			540
Distribution of minority interest earnings		(2,065		)	(186		)
Net (payments on)/borrowings of short-term debt		(2,110		)	43,260
Net cash from financing activities		1,998			19,894
Effect of exchange rate changes on cash and cash equivalents		4,624			6,473
Net increase in cash and cash equivalents		36,387			14,016
Cash and cash equivalents:
Beginning of period		133,304			57,457
End of period		$	169,691		$	71,473

 

See notes to condensed consolidated financial statements.

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FOSSIL, INC. AND SUBSIDIARIES

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 July 7, 2007, and the results of operations for the thirteen-week periods ended July 7, 2007 (“Second Quarter”) and July 8, 2006, (“Prior Year Quarter”), respectively and the twenty-six week period ended July 7, 2007 (“Year To Date Period”) and the twenty-seven week period ended July 8, 2006 (“Prior Year YTD Period”), respectively. All adjustments are of a normal, recurring nature. The Company noted that fiscal 2007 is a 52-week year as compared to a 53-week year in fiscal 2006. For financial reporting purposes, this extra week was included in the first quarter of fiscal year 2006.

These interim financial statements should be read in conjunction with the audited 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 (the “Exchange Act”) for the year ended January 6, 2007. Operating results for the twenty-six week period ended July 7, 2007, are not necessarily indicative of the results to be achieved for the full year.

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and 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.

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, and apparel. In the watch and jewelry product category, 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, export and direct to the consumer at varying price points to service 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 forward contracts principally to hedge the future payment of intercompany inventory transactions with the U.S. company. At July 7, 2007, the Company’s foreign subsidiaries had forward contracts to sell (i) 64.9 million Euro for approximately $86.5 million, expiring through December 2008 and (ii) approximately 6.0 million British Pounds for $12.0 million, expiring through February 2008. If the Company’s foreign subsidiaries were to settle their Euro and British Pound based contracts at the reporting date, the net result would be a net loss of approximately $1.6 million, net of taxes, as of July 7, 2007. The net decrease in fair value for the Year To Date Period and the Prior Year YTD Period of approximately $1.3 million and $2.2 million, respectively, is included in other comprehensive income. The net decrease for the Year To Date Period consisted of net losses from these hedges of $1.4 million and approximately $200,000 of net losses reclassified into earnings.

Earnings Per Share. The following table reconciles the numerators and denominators used in the computations of both basic and diluted EPS:

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		For the 13 Weeks Ended July 7, 2007			For the 13 Weeks Ended July 8, 2006			For the 26 Weeks Ended July 7, 2007			For the 27 Weeks Ended July 8, 2006
		IN THOUSANDS, EXCEPT PER SHARE DATA
Numerator:
Net income		$	14,672		$	11,238		$	39,704		$	20,954
Denominator:
Basic EPS computation:
Weighted average common shares outstanding		67,814			66,884			67,695			67,122
Basic EPS		$	0.22		$	0.17		$	0.59		$	0.31
Diluted EPS computation:
Denominator:
Basic weighted average common shares outstanding		67,814			66,884			67,695			67,122
Dilutive effect of stock-based compensation		1,928			1,415			1,861			1,578
		69,742			68,299			69,556			68,700
Diluted EPS		$	0.21		$	0.16		$	0.57		$	0.31

 

Approximately 78,000, 2.0 million, 134,000 and 1.8 million weighted average shares issuable under stock-based awards were not included in the diluted earnings per share calculation at the end of the Second Quarter, Prior Year Quarter, Year To Date Period and Prior Year YTD Period, respectively, because they were antidilutive. These common share equivalents may be dilutive in future earnings per share calculations.

Goodwill. The changes in the carrying amount of goodwill, which is not subject to amortization, are as follows:

IN THOUSANDS		Domestic Wholesale			Europe  Wholesale			Other International Wholesale		Direct to Consumer			Total
Balance at January 6, 2007		$	21,799		$	17,518		3,721		$	—		$	43,038
Acquisitions		—			—			1,326		—			1,326
Currency		—			560			249		—			809
Balance at July 7, 2007		$	21,799		$	18,078		5,296		$	—		$	45,173

 

New Accounting Standards. In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). This Standard provides guidance for using fair value to measure assets and liabilities. Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS 157 is effective beginning in the Company’s fiscal year 2008. The Company is currently evaluating the effect of adopting SFAS 157, but does not expect it to have a material impact on its consolidated results of operations or financial condition.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (“SFAS 159”). The fair value option permits entities to choose to measure eligible financial instruments at fair value at specified election dates. The entity will report unrealized gains and losses on the items on which it has elected the fair value option in earnings. SFAS 159 is effective beginning in the Company’s fiscal year 2008. The Company is currently evaluating the effect of adopting SFAS 159, but does not expect it to have a material impact on its consolidated results of operations or financial condition.

There are no other recently issued accounting standards effective after July 7, 2007, that are expected to materially impact the Company.

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2.                                      INVENTORIES

Inventories - net consist of the following:

 

3.                                      INCOME TAXES

The provision for income taxes reflects the Company’s estimate of the effective tax rate expected to be applicable for the full fiscal year, adjusted for any discrete events, which are reported in the period that they occur.  This estimate is re-evaluated each quarter based upon the Company’s estimated tax expense for the full fiscal year.  The Company’s income tax expense for the Second Quarter and Prior Year Quarter was $8.6 million and $4.4 million, respectively, resulting in an effective income tax rate of 36.9% and 28.0%, respectively.  The lower effective rate for the Prior Year Quarter is the result of a release of certain income tax contingency reserves and the interest expense thereon.  Income tax expense was $17.4 million for the Year To Date Period, with an effective rate of 30.4%.  For the comparable Prior Year YTD Period, income tax expense was $10.1 million, resulting in an effective rate of 32.6%.  The lower effective tax rate for the Year to Date period is the result of the release of certain income tax contingency reserves related to our federal income tax return for 2003 that were effectively settled during the First Quarter when the Internal Revenue Service (“IRS”) completed the examination phase of its audit of our 2003 and 2004 federal income tax returns.

Effective January 7, 2007, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an Interpretation of FASB Statement No. 109 (“FIN 48”). Under FIN 48, the Company must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution.  This interpretation also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures. The cumulative effects of applying this interpretation have been recorded as a decrease of $6.1 million to retained earnings, an increase of $1.3 million to net deferred income tax liabilities, and an increase of $4.8 million in the liability for uncertain tax benefits as of January 7, 2007.

The Company has classified uncertain tax positions as long-term income taxes payable unless such amounts are expected to be paid in twelve months. Consistent with its past practice, the Company recognizes interest and/or penalties related to income tax overpayments and underpayments in income tax expense and income taxes payable. The total amount of accrued income tax-related interest and penalties included in the condensed consolidated balance sheet at adoption was $9.4 million (net).  For the six months ended July 7, 2007, the Company accrued interest expense of $1.1 million.

As of April 7, 2007 and January 7, 2007, the total amount of unrecognized tax benefits, excluding interest and penalties, was $44.3 million and $46.6 million, respectively, of which $29.7 million and $32.0 million would favorably impact the effective tax rate in future periods, if recognized.  As of January 7, 2007, the Company was subject to an IRS examination for the 2003 and 2004 tax years. The Company is also subject to examinations in various state and foreign jurisdictions for the 2001-2006 tax years, none of which are individually significant. During the first quarter, the examination phase of the IRS audit for tax years 2003 and 2004 was completed.  The IRS has proposed certain adjustments and the Company has filed a protest at this time.  This protest is under review by the IRS Office of Appeals and it is possible that it may be resolved within the next 12 months.  As of April 7, 2007, and January 7, 2007, the Company has recorded $14.2 million and $18.0 million, respectively of unrecognized tax benefits, excluding interest and

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penalties for positions that could be settled within the next twelve months. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.

4.             STOCK-BASED COMPENSATION PLANS

The Company accounts for stock-based compensation in accordance with the provisions of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS 123R”) using the Black-Scholes option pricing model to determine the fair value of stock options at the date of grant. The Company’s current stock-based compensation plans include: a) stock options and restricted stock for its international employees, b) stock options for its non-employee directors, and c) stock appreciation rights, restricted stock and restricted stock units for its U.S.-based employees.  Prior to 2006, the Company’s stock based-compensation plans included stock options for its non-employee directors and stock options and restricted stock for its employees, including its executive officers.

Long-Term Incentive Plan.  Designated employees of the Company, including officers, are eligible to receive a) stock options, b) stock appreciation rights, c) restricted or non-restricted stock awards, d) restricted stock units, e) cash awards or f) any combination of the foregoing.  As of July 7, 2007, approximately 15,000 shares issued to employees in prior years were forfeited and are held in the Company treasury to be issued as future awards are granted.  The current stock options, stock appreciation rights, restricted stock and restricted stock units outstanding include an original vesting term ranging from three to five years.  All stock options, stock appreciation rights, restricted stock and restricted stock units are accounted for at fair value at the date of grant.  All stock appreciation rights and restricted stock units are settled in shares of Company stock.

Restricted Stock Plan.  Shares awarded under the 2002 Restricted Stock Plan have been funded with shares contributed to the Company from a significant stockholder. As of July 7, 2007, approximately 105,000 shares issued to employees in prior years were forfeited and are held in the Company treasury to be issued as future awards are granted.  The current restricted shares outstanding include an original vesting term ranging from one to nine years. These shares are accounted for at fair value at the date of grant.

Non-employee Director Stock Option Plan.  During the first year individuals are elected as non-employee directors of the Company, they receive a grant of 5,000 non-qualified stock options. In addition, on the first day of each subsequent calendar year, each non-employee director automatically receives a grant of an additional 4,000 non-qualified stock options as long as the individual is serving as a non-employee director. Pursuant to this plan, 50% of the options granted will become exercisable on the first anniversary of the date of grant and in two additional installments of 25% on the second and third anniversaries. All stock options granted under this plan are accounted for at fair value at the date of grant.

The following table summarizes stock option and stock appreciation right activity during the Second Quarter:

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		Number of Shares		Weighted- Average Exercise Price			Weighted- Average Remaining Contractual Life (Yrs.)		Aggregate Intrinsic Value
		IN							IN
		THOUSANDS							THOUSANDS
Outstanding at April 7, 2007		4,665		$	14.53		5.2		$	67,794
Granted		268		31.19
Exercised		(63	)	16.75					805
Forfeited or expired		(27	)	17.77
Outstanding at July 7, 2007		4,843		15.41			5.3		74,615
Exercisable at July 7, 2007		3,989		13.87			4.7		55,312
Nonvested at July 7, 2007		854		22.60			8.2		19,303
Expected to vest		769		$	22.60		8.2		$	17,373

 

The aggregate intrinsic value in the table above is before income taxes and is based on the exercise price for outstanding and exercisable options and rights at July 7, 2007 and based on the fair market value on the exercise date for options and rights that have been exercised during the Second Quarter.

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 July 7, 2007 (number of shares in thousands):

 

The Company has elected to apply the long-form method to determine the hypothetical additional paid-in capital (“APIC”) pool provided by FASB Staff Position FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.  The Company had determined that a hypothetical pool of excess tax benefits existed in APIC as of January 1, 2006, the date of adoption of SFAS No. 123R, related to historical stock option exercises.  In future periods, excess tax benefits resulting from option and stock appreciation right exercises will be recognized as additions to APIC in the period the benefit is realized.  In the event of a shortfall (that is, the tax benefit realized is less than the amount previously recognized through periodic stock-based compensation expense recognition and related deferred tax accounting), the shortfall would be charged against APIC to the extent of previous excess

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benefits, if any, including the amounts included in the hypothetical APIC pool, and then to tax expense.

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

		Number of Shares		Weighted- Average Exercise Price
		IN
		THOUSANDS
Nonvested at April 7, 2007		463		$	20.24
Granted		57		31.14
Vested		(7	)	22.33
Forfeited		(27	)	15.96
Nonvested at July 7, 2007		486		21.69
Expected to vest		437		$	21.69

 

The total fair value of shares/units vested during the Second Quarter was $199,000.

5.             SEGMENT AND GEOGRAPHIC INFORMATION

The Company manages its business primarily on a geographic basis. The Company’s reportable operating segments are comprised of the United States Wholesale, Europe Wholesale, Other International Wholesale and Direct to Consumer. The United States Wholesale, Europe Wholesale, and Other International Wholesale reportable segments do not include activities related to the Direct to Consumer segment.   The Europe Wholesale segment primarily includes sales to wholesale or distributor customers based in European countries as well as the Middle East and Africa.  The Other International Wholesale segment primarily includes sales to wholesale or distributor customers based in Australia, Canada, China (including the Company’s assembly and procurement operations), Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Singapore, South America and Taiwan. The Direct to Consumer segment includes company-owned retail stores and sales generated from e-commerce activities.  Each reportable operating segment provides similar products and services.

The Company evaluates the performance of its operating 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.  Operating income for each segment includes the impact of intercompany profits associated with the sale of products by one segment to another.  Costs associated with various corporate expenses and amounts related to intercompany eliminations are not allocated to the various segments but are included in the United States wholesale segment. Intercompany sales of products between segments are referred to as intersegment items. Summary information by operating segment follows:

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		For the 13 Weeks Ended July 7, 2007						For the 13 Weeks Ended July 8, 2006
		Net Sales			Operating  Income (Loss)			Net Sales			Operating  Income (Loss)
		IN THOUSANDS
United States wholesale:
External customers		$	96,917		$	(14,335	)	$	96,111		$	(5,100	)
Intersegment		33,513			—			27,197			—
Direct to consumer		55,284			2,445			46,792			2,335
Europe – wholesale:
External customers		99,685			11,923			77,354			7,506
Intersegment		10,503			—			7,705			—
Other international – wholesale:
External customers		54,578			23,083			38,981			11,455
Intersegment		87,897			—			80,999			—
Intersegment items		(131,913		)	—			(115,901		)	—
Consolidated		$	306,464		$	23,116		$	259,238		$	16,196

 

		For the 26 Weeks Ended July 7, 2007						For the 27 Weeks Ended July 8, 2006
		Net Sales			Operating  Income (Loss)			Net Sales			Operating  Income (Loss)
		IN THOUSANDS
United States wholesale:
External customers		$	203,552		$	(17,706	)	$	202,630		$	(14,240	)
Intersegment		66,079			—			55,484			—
Direct to consumer		102,522			2,871			85,774			1,886
Europe – wholesale:
External customers		200,309			29,618			158,629			14,447
Intersegment		15,987			—			15,325			—
Other international – wholesale:
External customers		104,906			40,887			76,430			31,094
Intersegment		175,708			—			161,541			—
Intersegment items		(257,774		)	—			(232,350		)	—
Consolidated		$	611,289		$	55,670		$	523,463		$	33,187

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the financial condition and results of operations of Fossil, Inc. and its wholly and majority-owned subsidiaries for the thirteen and twenty-six week periods ended July 7, 2007 (the “Second Quarter” and “Year To Date Period,” respectively), as compared to the thirteen and twenty-seven week periods ended July 8, 2006 (the “Prior Year Quarter” and “Prior Year YTD Period,” respectively). Fiscal 2007 is a 52-week year as compared to a 53-week year for fiscal 2006. This extra week was included in the first quarter of fiscal year 2006.  This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and the related Notes attached hereto.

General

We are a global design, marketing and distribution company that specializes in consumer fashion accessories.  Our principal offerings include an extensive line of men’s and women’s fashion watches and jewelry and handbags, small leather goods, belts, sunglasses, and apparel. In the watch and jewelry product category, we have a diverse portfolio of globally recognized owned and licensed brand names under which our products are marketed. Our products are distributed globally through various distribution channels including wholesale, export and direct to the consumer at varying price points to service the needs of our customers, whether they are value conscious or luxury oriented. Based on our extensive range of accessory products, brands, distribution channels and price points, we are able to target style-conscious consumers across a wide age spectrum on a global basis.

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Domestically, we sell our products through a diversified distribution network that includes department stores, specialty retail locations, specialty watch and jewelry stores, owned retail and factory outlet stores, mass market stores, owned and affiliated internet sites and through our FOSSIL catalog.  Our wholesale customer base includes Neiman Marcus, Nordstrom, Macy’s, Dillard’s, JCPenney, Kohl’s, Sears, Wal-Mart and Target.  We also sell our products in the United States through a network of company-owned stores, which included 81 retail stores located in premier retail sites and 72 outlet stores located in major outlet malls as of July 7, 2007.  In addition, we offer an extensive collection of our FOSSIL brand products through our catalog and on our website, www.fossil.com, as well as proprietary and licensed watch and jewelry brands through other managed and affiliated websites.

Internationally, our products are sold to department stores, specialty retail stores and specialty watch and jewelry stores in over 90 countries worldwide through 21 company-owned foreign sales subsidiaries and through a network of approximately 56 independent distributors. Our products are distributed in Africa, Asia, Australia, Europe, Central and South America, Canada, the Caribbean, Mexico, and the Middle East. Our products are offered on airlines, cruise ships and in international company-owned retail stores, which included 45 accessory retail stores and 4 outlet stores in select international markets as of July 7, 2007. Additionally, our products are sold through independently-owned FOSSIL retail stores and kiosks in certain international markets.

Significant Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to product returns, bad debts, inventories, long-lived asset impairment, impairment of goodwill and income taxes. We base these estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe there have been no changes to the significant accounting policies disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K filed for the year ended January 6, 2007.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). This Standard provides guidance for using fair value to measure assets and liabilities. Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. SFAS 157 is effective beginning in our fiscal year 2008. We are currently evaluating the effect of adopting SFAS 157, but do not expect it to have a material impact on our consolidated results of operations or financial condition.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (“SFAS 159”). The fair value option permits entities to choose to measure eligible financial instruments at fair value at specified election dates. The entity will report unrealized gains and losses on the items on which it has elected the fair value option in earnings. SFAS 159 is effective beginning in our fiscal year 2008. We are currently evaluating the effect of adopting SFAS 159, but do not expect it to have a material impact on our consolidated results of operations or financial condition.

There are no other recently issued accounting standards effective after July 7, 2007, that are expected to materially impact the Company.

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Results of Operations

The following table sets forth, for the periods indicated, (i) the percentages of our net sales represented by certain line items from our condensed consolidated statements of income and comprehensive income and (ii) the percentage changes in these line items. Fiscal 2007 is a 52-week year as compared to a 53-week year in fiscal 2006. This extra week was included in our first quarter of fiscal year 2006.  We estimate the extra week increased net sales and operating expenses by approximately $16.0 million and $5.0 million, respectively, during the first quarter of fiscal 2006 and the prior year YTD period.

		Percentage of Net Sales
		For the 13 Weeks Ended July 7, 2007		For the 13 Weeks Ended July 8, 2006		Percentage Change
Net sales		100.0	%	100.0	%	18.2	%
Cost of sales		50.9		51.0		17.9
Gross profit		49.1		49.0		18.5
Selling and distribution expenses		28.7		30.7		10.6
General and administrative expenses		12.8		12.0		26.2
Operating income		7.6		6.3		42.7
Interest expense		(0.1	)	(0.4	)	(77.0	)
Other income - net		0.1		0.1		*
Income before income taxes		7.6		6.0		48.9
Income taxes		2.8		1.7		96.0
Net income		4.8	%	4.3	%	30.6	%

 

		Percentage of Net Sales
		For the 26 Weeks Ended July 7, 2007		For the 27 Weeks Ended July 8, 2006		Percentage Change
Net sales		100.0	%	100.0	%	16.8	%
Cost of sales		49.8		50.3		15.7
Gross profit		50.2		49.7		17.9
Selling and distribution expenses		28.6		31.5		6.0
General and administrative expenses		12.5		11.9		23.0
Operating income		9.1		6.3		67.7
Interest expense		(0.1	)	(0.3	)	(71.6	)
Other income (expense) - net		0.3		(0.1	)	*
Income before income taxes		9.3		5.9		83.5
Income taxes		2.8		1.9		71.1
Net income		6.5	%	4.0	%	89.5	%

 

* not meaningful

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Net Sales.  The following table sets forth certain components of our consolidated net sales and the percentage relationship of the components to consolidated net sales for the periods indicated (in millions, except percentage data):

 

		Amounts						% of Total
		For the 13 Weeks Ended July 7, 2007			For the 13 Weeks Ended July 8, 2006			For the 13 Weeks Ended July 7, 2007		For the 13 Weeks Ended July 8, 2006
International wholesale:
Europe		$	99.7		$	77.3		32.5	%	29.8	%
Other		54.6			39.0			17.8		15.1
Total international wholesale		154.3			116.3			50.3		44.9
United States wholesale:
Watch products		55.5			49.6			18.1		19.1
Other products		41.4			46.5			13.5		17.9
Total United States wholesale		96.9			96.1			31.6		37.0
Direct to consumer		55.3			46.8			18.1		18.1
Total net sales		$	306.5		$	259.2		100.0	%	100.0	%

 

		Amounts						% of Total
		For the 26 Weeks Ended July 7,  2007			For the 27 Weeks Ended July 8, 2006			For the 26 Weeks Ended July 7, 2007		For the 27 Weeks  Ended July 8, 2006
International wholesale:
Europe		$	200.3		$	158.7		32.8	%	30.3	%
Other		104.9			76.4			17.1		14.6
Total international wholesale		305.2			235.1			49.9		44.9
United States wholesale:
Watch products		102.0			98.2			16.7		18.8
Other products		101.6			104.4			16.6		19.9
Total United States wholesale		203.6			202.6			33.3		38.7
Direct to consumer		102.5			85.8			16.8		16.4
Total net sales		$	611.3		$	523.5		100.0	%	100.0	%

 

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The following tables are intended to illustrate by factor the total of the percentage change in sales by segment and on a consolidated basis:

		Analysis of Percentage Change in Sales Versus Prior Year Quarter Attributable to Changes in the Following Factors
		Exchange Rates		Acquisitions		Organic Growth		Total Change
Europe wholesale		8.1	%	0.0	%	20.8	%	28.9	%
Other international wholesale		0.5	%	1.8	%	37.7	%	40.0	%
United States wholesale		0.0	%	0.0	%	0.8	%	0.8	%
Direct to consumer		1.4	%	0.0	%	16.8	%	18.2	%
Total		2.8	%	0.3	%	15.1	%	18.2	%

 

		Analysis of Percentage Change in Sales Versus Prior Year YTD Attributable to Changes in the Following Factors
		Exchange Rates		Acquisitions		Organic Growth		Total Change
Europe wholesale		8.6	%	0.0	%	17.7	%	26.3	%
Other international wholesale		5.2	%	1.6	%	30.5	%	37.3	%
United States wholesale		0.0	%	0.0	%	0.5	%	0.5	%
Direct to consumer		1.1	%	0.0	%	18.4	%	19.5	%
Total		3.6	%	0.2	%	13.0	%	16.8	%

 

Europe Wholesale Net Sales (excluding the impact of sales growth attributable to foreign currency rate change as noted in the above table).  For the Second Quarter, European wholesale net sales increased as a result of sales volume growth in FOSSIL and licensed watch brands as well as from FOSSIL and EMPORIO ARMANI jewelry businesses.  Each of our major watch and jewelry businesses in Europe reported sales growth and all of our major subsidiaries in Europe achieved double-digit net sales increases during the Second Quarter.  Consumers responded favorably to our new watch and jewelry styles delivered into the market during the end of fiscal 2006 and early fiscal 2007.  Our branding efforts in Europe, including the expansion of our company-owned retail stores, are also benefiting our net sales growth in this segment.  Additionally, Germany, the location of our largest subsidiary in Europe, is experiencing a stronger economy in comparison to last year and reports are that consumer confidence in Germany is at the highest level in 27 years.

Other International Wholesale Net Sales (excluding the impact of sales growth attributable to foreign currency rate changes and acquisitions as noted in the above table). Our other international wholesale segment experienced strong double-digit growth across all of our major owned and licensed watch and jewelry brands during the Second Quarter.  Overall sales increases for the Second Quarter were positively impacted by a 68.7% increase in net sales from our Mexico subsidiary that we acquired in February 2006 and a 34.5% increase in net sales from our Asia Pacific subsidiaries in comparison to the Prior Year Quarter.  Our shop-in-shop concepts in the Asia Pacific region continue to build awareness, resulting in increased sales and market share within the department store environment.  Export sales from the U.S. grew 58.7% as a result of increased shipments to our distributors in South America and increases in our wholesale shipments to the Caribbean.  Although net sales from our Asia Pacific businesses represent only slightly more than 10% of the consolidated Company’s net sales, we believe this region will continue to provide a solid growth platform for our product portfolio.

We believe we maintain a competitive advantage as a result of our long-term relationships and strength of our business with retailers throughout the international marketplace. We believe the global recognition of our branded portfolio of watches and jewelry positions us as a significant resource to retailers throughout the international marketplace. Our strategy is not to force any one brand into a specific market, but rather allow the market to dictate which brands are important based upon consumer preference. We further believe our global distribution network and design and marketing capabilities will allow us to acquire additional brands that will position us for further penetration internationally as we continue to take shelf space from lesser known local and regional brands.

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United States Wholesale Net Sales.  Net sales from our U.S. watch business increased 11.9% primarily due to sales volume growth in our mass market and licensed watch businesses.  Our mass market business posted a 69% increase in sales during the Second Quarter reflecting a shift in Wal-Mart’s buying pattern, which moved certain deliveries from first quarter into the Second Quarter this year. Sales of licensed watches rose by 42% driven by sales volume growth from DKNY and EMPORIO ARMANI watches as a result of new and innovative styles performing well at retail.  Additionally, BURBERRY and MICHAEL KORS brand watch sales more than doubled during the Second Quarter.  U.S. sales of FOSSIL watches, excluding discontinued product sales from both the Second Quarter and the Prior Year Quarter, increased by 4.7%.  Second Quarter net sales from our U.S. accessories business declined 11.0% compared to the prior year quarter with sales volume growth from FOSSIL men’s leather goods and RELIC eyewear more than offset by sales volume declines in FOSSIL women’s leather products.  While our women’s handbag, small leather goods and belt businesses experienced sales volume declines, primarily due to our spring/summer styles not meeting consumer preferences in these categories, our men’s business grew 5.9% during the Second Quarter.  We believe we have identified and corrected the fashion miss in our women’s business and are working to have newer assortments into the stores for the holiday season.  Nevertheless, we are not expecting this category to demonstrate growth during the second half of fiscal 2007.  U.S. watch net sales for the Year To Date Period increased by $3.8 million, to $102.0 million, in comparison to $98.2 million in the Prior Year YTD Period, primarily due to sales volume growth from license watches.  U.S. accessory net sales for the Year To Date Period decreased by $2.8 million, to $101.6 million, in comparison to $104.4 million in the Prior Year YTD Period, primarily due to sales volume declines in FOSSIL women’s leather categories.

Direct to Consumer Net Sales (Excluding the impact on sales growth attributable to foreign currency rate changes as noted in the above table).  Net sales from our direct to consumer segment increased 18.2% during the Second Quarter as a result of a 12% increase in the average number of company-owned retail stores opened during the period and comparable store sales increases of 4.9%.  Second Quarter net sales from our e-commerce businesses increased by 23.3% in comparison to the Prior Year Quarter.  For the Year To Date Period, net sales from our direct to consumer segment increased 19.5% as a result of a 25.6% increase in the average number of stores opened and comparable store sales increases of 5.2%.  Net sales from our e-commerce businesses increased by 14.9% during the Year To Date Period.  We ended the Second Quarter with 202 stores, including 126 full price stores, 45 of which were outside the U.S., and 76 outlet locations, including four outside the U.S.  This compares to 181 stores at the end of the Prior Year Quarter that included 109 full-price stores, 36 outside the U.S. and 72 outlet locations, including one outside the U.S.  During the quarter we opened five new stores and closed two.

Gross Profit.  Second Quarter gross profit increased by $23.5 million to $150.5 million, compared to $127.0 million in the Prior Year Quarter.  Gross profit margin increased to 49.1% in the Second Quarter compared to 49.0% in the Prior Year Quarter.  A higher percentage of sales derived from our international wholesale business segments, as experienced during the Second Quarter, would have normally increased our reported gross profit margin. However, we were unable to reflect this positive mix shift in our reported gross profit margin due to weaker gross profit margins related to certain new watch styles sold during the Second Quarter.  In the development of these new watch styles, we experienced slightly higher manufacturing costs that we did not pass on to our customers.  We have implemented certain initiatives to address  this issue and are confident that our consolidated gross profit margin will show improvement, in comparison to the prior year periods and the Second Quarter, during the second half of fiscal year 2007.  Additionally, our Second Quarter gross profit margin reflects an approximate 30 basis point increase in comparison to the Prior Year Quarter as a result of the continued weakening of the U.S. dollar.  We also experienced a benefit in consolidated gross profit margin from increased outlet store margins as a result of reduced sales of deeply discounted watches sold through this channel during the Second Quarter in comparison to the Prior Year Quarter.  These increases in gross profit margin were partially offset by increased markdowns and lower margin off-price liquidation sales related to our U.S. accessory business and a higher sales mix of lower margin mass market sales.  For the Year To Date Period, gross profit margin increased by 50 basis points to 50.2% compared to 49.7% in the Prior Year YTD Period.  This increase was primarily related to factors similar to those experienced during the Second Quarter, and included a 40 basis point increase in gross profit margin related to a weaker U.S. dollar in the Year To Date Period in relation to the Prior Year YTD period.

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