-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IL4xq9XdTVxm1BHz3nni54VnnR2pWqK1aPKhkuXCzJxLCA8+ryExdJlqSfgId6Ku 28dckvXbxdCn3KHAenjwYw== 0000883569-98-000005.txt : 19980406 0000883569-98-000005.hdr.sgml : 19980406 ACCESSION NUMBER: 0000883569-98-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980103 FILED AS OF DATE: 19980403 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FOSSIL INC CENTRAL INDEX KEY: 0000883569 STANDARD INDUSTRIAL CLASSIFICATION: WATCHES, CLOCKS, CLOCKWORK OPERATED DEVICES/PARTS [3873] IRS NUMBER: 752018505 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-19848 FILM NUMBER: 98587426 BUSINESS ADDRESS: STREET 1: 2280 NORTH GREENVILLE AVE CITY: RICHARDSON STATE: TX ZIP: 75082 BUSINESS PHONE: 2142342525 MAIL ADDRESS: STREET 1: 2280 N GREENVILLE CITY: RICHARDSON STATE: TX ZIP: 75082 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ----- EXCHANGE ACT OF 1934 For the Fiscal Year Ended January 3, 1998 OR _____ 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 0-19848 FOSSIL, INC. (Exact name of registrant as specified in its charter) Delaware 75-2018505 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2280 N. Greenville Avenue Richardson, Texas 75082 (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (972) 234-2525 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value (Title of Class) ------------------------------ 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 --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ------ The aggregate market value of Common Stock held by nonaffiliates of the registrant, based on the sale trade price of the Common Stock as reported by the Nasdaq National Market on March 31, 1998, was $178,015,815. For purposes of this computation, all officers, directors and 10% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors or 10% beneficial owners are, in fact, affiliates of the registrant. As of March 31, 1998, 13,644,367 shares of Common Stock were outstanding (pre-split). DOCUMENTS INCORPORATED BY REFERENCE The Company's definitive proxy statement in connection with the Annual Meeting of Stockholders to be held May 27, 1998, to be filed with the Commission pursuant to Regulation 14A, and the Company's Annual Report to Stockholders are incorporated by reference into Part III of this report. PART I Item 1. Business General Fossil, Inc. (the "Company") is a Delaware corporation formed in December 1991 and is the successor to a Texas corporation formed in 1984. In 1993, the Company completed an initial public offering (the "Offering") of 2,760,000 shares of common stock, par value $.01 (the "Common Stock"). The Company's principal executive offices are located at 2280 N. Greenville Avenue, Richardson, Texas 75082, and its telephone number at such address is (972) 234-2525. The Company designs, develops, markets and distributes fashion watches and accessories, including sunglasses, small leather goods, belts and handbags, principally under the FOSSIL(R), RELIC(R) and FSL(TM) brand names. The Company designs, manufactures and markets a line of limited edition watches bearing the trademarks and logos of various entities, as well as contracts with retailers and other customers for the manufacture of watches for sale under private label. The Company conducts substantially all of its United States operations through Fossil Partners, L.P. ("Partners"), a Texas limited partnership formed in August 1994, of which the Company is the sole general partner. The sole limited partner of Partners is Fossil Trust, a Delaware business trust, an indirect wholly owned subsidiary of the Company, formed in August 1994. The Company's operations in the state of New York are conducted by Fossil New York, Inc., a Delaware corporation, a wholly owned subsidiary of the Company. The Company's outlet stores are leased and operated by Fossil Stores I, Inc., a Delaware corporation, a wholly owned subsidiary of the Company formed in November 1994. The Company's retail stores are leased and operated by Fossil Stores II, Inc., a Delaware corporation, a wholly owned subsidiary of Fossil Stores I, Inc., formed in November 1994. In addition, certain merchandising activities of the Company are conducted through Arrow Merchandising, Inc., a Texas corporation, a wholly owned subsidiary of the Company formed in August 1992. The Company's operations in Hong Kong relating to the procurement of watches from various manufacturing sources are conducted by Fossil (East) Limited ("Fossil East"), a wholly owned subsidiary of the Company organized under the laws of Hong Kong and acquired by the Company in 1992. Fossil Europe B.V. ("Fossil B.V.") a Netherlands holding company established in May 1993, is a wholly owned subsidiary of the Company. Fossil Europe GmbH ("Fossil GmbH") is a wholly owned German subsidiary of Fossil B.V., which markets and resells the Company's products throughout Europe. Fossil Italia, S.r.l. ("Fossil Italy"), a wholly owned Italian subsidiary of Fossil B.V., was formed in June 1994 and markets and sells the Company's products in Italy. Fossil France EURL, S.a.r.l. ("Fossil France") and Fossil U.K. Ltd. ("Fossil UK"), wholly owned subsidiaries of Fossil B.V., were formed in 1995 to market and sell the Company's products in France and the United Kingdom, respectively. In April 1996, the Company acquired an 81% interest in Fossil Japan, Inc. ("Fossil Japan") which acts as the distributor of the Company's products in Japan. In 1997, the Company discontinued sales in the U.K. through Fossil UK. Fossil Spain, S. A.("Fossil Spain"), a wholly owned subsidiary of Fossil B.V., was formed in 1996 and markets and sells the Company's products in Spain. 1 Forward-Looking Information The statements contained in this Annual Report on Form 10-K ("Annual Report") that are not historical facts, including, but not limited to, statements found in this Item 1. Business and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements and involve a number of risks and uncertainties. The actual results of the future events described in such forward-looking statements in the Annual Report could differ materially from those stated in such forward-looking statements. Among the factors that could cause actual results to differ materially are: general economic conditions, competition, government regulation and possible future litigation, as well as the risks and uncertainties discussed in this Annual Report, including, without limitation, the portions referenced above, and the risks and uncertainties set forth on the Company's Current Report on Form 8-K dated March 31, 1997. Industry Overview Watch Products The Company believes that the current market for watches in the United States can be divided into three segments. One segment of the market consists of fine watches characterized by high fashion and internationally known brand names, such as Concord, Piaget and Rolex. Watches offered in this segment are often manufactured in Switzerland and are sold by trade jewelers and in the fine jewelry departments of better department stores and other purveyors of luxury goods at retail prices ranging from $150 to $20,000. A second segment of the market consists of watches sold by mass marketers, which include certain watches sold under the Timex brand name as well as certain watches sold by Armitron under various brand names and labels. Retail prices in this segment range from $5 to $40. The third segment of the market consists of moderately priced watches characterized by contemporary fashion and well known brand names. Moderately priced watches are typically manufactured in Japan or Hong Kong and are sold by department stores and specialty stores at retail prices ranging from $40 to $150. The Company believes that this segment in turn can be divided into two discrete sectors that are competitive with each other only to a limited extent. One sector of the moderately priced market segment is targeted by companies that generally offer conservatively styled time pieces under well known brand names such as Seiko and Citizen. The second sector of this market segment is targeted by the Company and its principal competitors, including the companies that market watches under the Anne Klein II, Guess? and Swatch brand names, whose products attempt to reflect emerging fashion trends in accessories and apparel. Some of the watches in this sector are manufactured under license agreements with companies that market watches under various brand names, including Guess?, Kenneth Cole and Nautica. The Company believes that one reason for the growth of this sector has been that fashion-conscious consumers have increasingly come to regard branded fashion watches not only as time pieces but also as fashion accessories. This trend has resulted in consumers owning multiple watches that may differ significantly in terms of style, features and cost. Fashion Accessories The Company believes that the fashion accessories market in the United States includes products such as small leather goods, handbags, belts, eyewear, neckwear, underwear, lounge wear, costume jewelry, gloves, hats, hosiery and socks. These fashion accessory products are generally marketed through mass merchandisers, department stores and specialty shops. Fashion accessories for both men 2 and women are sold at low, moderate and higher price points. Lower price point items are typically retailed through mass merchandisers. Higher price point items are typically sold in moderate and better department stores and specialty shops and include products offered by Coach, Dooney & Burke, Ralph Lauren and Donna Karan. Moderately priced fashion accessories are typically marketed in department stores and are characterized by contemporary fashion and well known brand names. Fossil currently offers small leather goods, belts and eyewear for both men and women, men's underwear and lounge wear, as well as handbags, through department stores and specialty retailers in the moderate to upper-moderate price range. Companies such as Calvin Klein, Tommy Hilfiger, Swank, Guess?, Nine West, Kenneth Cole, and Liz Claiborne currently operate in this market. The Company believes that one reason for the growth in this line of business is that consumers are becoming more aware of accessories as fashion statements, and as a result, are purchasing brand name, quality items that complement other fashion items. The Company emphasizes its fashion accessories as a natural complement to the core watch business by offering consumers the same high quality and value that are associated with other FOSSIL brand products. The Company generally markets its fashion accessory lines through the same distribution channels as its watch business, using similar in-store presentations, graphics and packaging. Business Strategy The Company's business strategy is designed to achieve further growth in its watch and fashion accessories businesses and to capitalize on growing consumer awareness of the FOSSIL, RELIC and FSL brand names by expanding the scope of its product offerings to include additional categories of fashion accessories. The Company intends to seek further growth in its watch business by increasing consumer awareness of, and sales of the products marketed under, the FOSSIL, RELIC and FSL brand names, expanding the scope of its product offerings through the introduction or licensing of new categories of fashion accessories that would complement its existing products, and placing increased emphasis on growth in selected international markets. The Company also intends to seek further growth in its accessories business by broadening its domestic distribution channels and by introducing accessories in selected international markets. In order to expand the scope of its product offerings, the Company may in the future introduce additional categories of fashion accessories that would complement its existing products. The following are the principal elements of the Company's business strategy: Brand Development. The Company has established the FOSSIL and RELIC brand names and images to reflect a theme of fun, fashion and humor, and believes that both the FOSSIL and RELIC brand names have achieved growing acceptance among fashion-conscious consumers in their target markets. Product Value. The Company's products provide value to the consumer by offering high quality components and features at moderate prices. The Company's products offer a variety of distinctive details and treatments that provide value to the customer at suggested retail prices generally below competitive products of comparable quality. Fashion Orientation. The Company attempts to stay abreast of emerging lifestyle and fashion trends affecting accessories and apparel, and it responds to those trends by making adjustments in its product lines as frequently as five times each year. 3 Innovative Product Design. The Company differentiates its products from those of its competitors principally through innovations in fashion details, including variations in the treatment of watch dials, crystals, cases and straps for the Company's watches and innovative treatments and details in its other accessories. Expansion of International Business. The Company is seeking to achieve further growth in its international business through its international subsidiaries as well as by expanding the Company's network of distributors in selected international markets. Introduction of New Product Categories. The Company may leverage its design and marketing expertise to expand the scope of its product offerings through the introduction or licensing of new categories of fashion accessories that would complement its existing products. Active Management of Retail Sales. The Company manages the retail sales process by monitoring its customers' sales and inventories by product category and style and by assisting in the conception, development and implementation of their marketing programs. As a result, the Company believes it enjoys close relationships with its principal customers, often allowing it to influence the mix, quantity and timing of their purchasing decisions. Close Relationships with Manufacturing Sources. The Company has established and maintains close relationships with a number of watch manufacturers located in Hong Kong and Japan. The Company believes that these relationships allow it to quickly and efficiently introduce innovative product designs and alter production in response to the retail performance of its products. Coordinated Product Promotion. The Company coordinates product design, packaging and advertising functions in order to communicate in a cohesive manner to its target markets the themes and images that it associates with its products. Personnel Development. The Company actively seeks to recruit and train its design, advertising, sales, administrative and marketing personnel to assist it in achieving further growth in its existing businesses and in expanding the scope of its product offerings. Cost Advantages. Because the Company does not pay royalties on the watch, leather goods or sunglass products sold under the FOSSIL, RELIC and FSL brand names, and because of cost savings associated with the location of its headquarters and warehousing and distribution center in Richardson, Texas, the Company believes that it enjoys certain cost advantages that enhance its ability to provide better value yet achieve attractive profit margins. Centralized Distribution. Substantially all of the Company's products sold in the United States are distributed from its warehouse and distribution center located in Richardson, Texas. The Company's products sold in Europe generally are distributed from the Company's warehouse and distribution centers located in Germany and Italy, and in Japan from the Company's warehouse and distribution center in Tokyo. The Company believes that its distribution capabilities enable it to reduce inventory risk and increase its flexibility in meeting the delivery requirements of its customers. 4 Products Watch Products In 1986, the Company introduced FOSSIL watches, its flagship product. The Company commenced its FOSSIL watch strap program in 1989, introduced its RELIC watches in 1990 and introduced its FSL watches in 1995. Since 1986, the Company has also contracted with retailers and other customers for the manufacture of watches primarily for sale under private labels. Sales of the Company's watches for fiscal years 1997, 1996 and 1995 accounted for approximately 72.4%, 71.9% and 83.6% respectively, of the Company's gross sales. FOSSIL Watches. The Company's FOSSIL watches are targeted at middle and upper income consumers between the ages of 16 and 40 and are sold at retail prices generally ranging from $45 to $120, with an average price of approximately $73. The Company currently offers various categories of FOSSIL watches, including Blue Teq, Dress, DRT(TM), Fossil Steel, Fossil Blue(R), F2, Limited Edition, Skeleton, and Vintage watches. The Company believes that its strategy of offering various categories of FOSSIL watches enables it to market its watches to a wide range of consumers with differing tastes and lifestyles. New lines of FOSSIL watches are introduced each year in January, March, May, August and November. FOSSIL watches are sold through a diversified distribution system which includes major department stores, such as Federated/Macy's Department Stores, Dillard's, May Department Stores, Mercantile Stores, Dayton Hudson, Proffitts and Nordstroms, as well as specialty retail stores and independent distributors. RELIC Watches. RELIC watches incorporate a number of the features found in FOSSIL watches into a format suitable for lower priced fashion watches. RELIC watches are targeted at mid-level income consumers and are sold at retail prices generally ranging from $30 to $75, with an average price of approximately $55. The Company currently offers various categories of RELIC watches, including Dressy, Metal Sport, Moon, Novelty, Pendant, Pocket, RELIC Wet, Skeleton and Sport watches. New lines of RELIC watches are introduced each year in February, July and September. RELIC watches are sold principally through major retailers, such as Ames Department Stores, Bealls, JCPenney, Kohl's, Montgomery Ward, Sears, Service Merchandise, SRI and Uptons. FSL Watches. FSL watches are sold at retail prices generally ranging from $30 to $150, with an average price of approximately $60. The Company offers both analog and digital watches under the FSL brand which combine high quality engineering and fashion. New lines of FSL watches are introduced each year in January, May and August and are sold through better department stores, specialty gift and apparel stores and sports specialty stores. Emporio Armani Orologi. In 1997, the Company entered into a multi-year, worldwide license agreement with Giorgio Armani for the manufacture, distribution and sale of a line of Emporio Armani watches. These products are sold through better department stores, specialty retailers and jewelry stores at retail prices generally ranging from $125 to $500. Private Label and Premium Products. The Company designs, markets and arranges for the manufacture of watches on behalf of certain retailers, entertainment companies, theme restaurants and other corporate customers as private label products or as premium and incentive items for use in various corporate events. Under this arrangement, the Company performs design and product development functions as well as acts as a sourcing agent for its customers by contracting for the manufacture of 5 watches, managing the manufacturing process, inspecting the finished watches, purchasing the watches and arranging for their shipment to the United States. Certain of these services are provided for the Company through Fossil East. The Company has recently expanded the scope of its private label business to include other categories of accessories such as sunglasses, small leather goods, gifts and clocks. The Company's private label products are currently sold to certain retail chains and other customers. The Company's premium and incentive products are sold to many Fortune 500 companies. Participation in the private label and premium businesses provide the Company with certain advantages, including increased manufacturing volume (which may reduce the costs of manufacturing the Company's other watch products) and the strengthening of business relationships with its manufacturing sources. These lines provide income to the Company with reduced inventory risks and certain other carrying costs. Licensed Watches. The Company has entered into a number of licensing agreements for the sale of collectible watches under the Company's brands. Under these agreements, the Company designs, manufactures and markets the goods bearing the trademarks, trade names and logos of various entities through major department stores within the Company's channels of distribution. Sales of collectible watches in 1997 included the NFL, Star Wars, the Beatles, Felix the Cat, James Bond, Mickey & Co. and I Love Lucy. Fashion Accessories In order to leverage the Company's design and marketing expertise and its close relationships with its principal retail customers, the Company has developed a line of sunglasses, men's and women's small leather goods, men's and women's belts, and handbags under the FOSSIL brand and leather goods under the RELIC brand. The Company currently sells its sunglasses, small leather goods, belts and handbags through a number of its existing major department store and specialty retail store customers. These fashion accessories are typically sold in locations adjacent to watch departments, which may lead to purchases by persons who are familiar with the Company's FOSSIL watches. Sales of the Company's accessory lines for fiscal years 1997, 1996 and 1995 accounted for 26.4%, 26.5% and 15.2%, respectively of the Company's total sales. Sunglasses. In 1995, the Company introduced a line of sunglasses sold under the FOSSIL brand name. The FOSSIL Sunwear collection offers designs for both men and women. The sunglass line features optical quality lenses in both plastic and metal frames, with classic and fashion retro styling as found with other FOSSIL products. Suggested retail prices for the Company's sunglasses generally range from $28 to $75 with an average price of $40. Small Leather Goods and Belts. In 1992, the Company introduced a line of small leather goods and belts for ladies sold under the FOSSIL brand name. In July 1993, the Company introduced a line of small leather goods for men under the FOSSIL brand name and expanded the men's line to include belts in April 1994. These small leather goods are made of fine leathers and include items such as mini-bags, coin purses, key chains and wallets. Retail prices for the Company's small leather goods generally range from $15 to $70, with an average price of $40. Retail prices for the Company's men's and women's belts generally range from $20 to $45 with an average price of $30. Handbags. In 1996, the Company introduced a new line of FOSSIL handbags. The Company's handbags are made of a variety of fine leathers and other materials. Classic styles and a variety of creative designs. Retail prices generally range from $35 to $170 with an average price of $100. 6 Licensed Products In order to complement the Company's existing line of products and to increase consumer awareness of the FOSSIL brand, the Company has entered into various licensing agreements for other categories of fashion accessories and apparel. These license agreements provide for the payment of royalties based on a percentage of net sales and are subject to certain guaranteed minimum royalties. Men's Underwear and Lounge Wear. The Company entered into a multi-year license agreement for the manufacture, marketing and sale of men's underwear, sleepwear and lounge wear in the United States under the FOSSIL brand. This product line was introduced in December 1997 and is available at better department stores and specialty retailers in the United States. Apparel. The Company also entered into a multi-year license agreement for the manufacture, marketing and sale of various apparel items in Japan under the FOSSIL brand. These products are scheduled to be introduced in 1998 and include casual shirts, knit tops, pants, jackets and related separates for everyday wear. Future Products The Company entered into a multi-year license agreement for the manufacture, marketing and sale of outerwear in the United States under the FOSSIL brand. This line is currently scheduled to be introduced in 1999. In addition, the Company may expand its product offerings in the future to include other accessory or apparel lines that would complement its existing products. Design and Development The Company's products are created and developed by the in-house design staff for such products in cooperation with various outside sources, including its manufacturing sources and component suppliers. Product design ideas are drawn from various sources and are reviewed and modified by the design staff to ensure consistency with the Company's existing product offerings and the themes and images that it associates with its products. Senior management is actively involved in the design process. In order to respond effectively to changing consumer preferences, the Company attempts to stay abreast of emerging lifestyle and fashion trends affecting accessories and apparel. In addition, the Company attempts to take advantage of the constant flow of information from the Company's customers regarding the retail performance of its products. The design staff reviews weekly sales reports provided by a substantial number of the Company's customers containing information with respect to sales and inventories by product category and style. Once a trend in the retail performance of a product category or style has been identified, the design and marketing staffs review their product design decisions to ensure that key features of successful products are incorporated into future designs. Other factors having an influence on the design process include the availability of components, the capabilities of the factories that will manufacture the products and the anticipated retail prices of and profit margins for the products. The Company differentiates its products from those of its competitors principally by incorporating into its product designs innovations in fashion details, including variations in the treatment of dials, crystals, cases and straps for the Company's watches and details and treatments of its other 7 accessories. In certain instances, the Company believes that such innovations have allowed it to achieve significant improvements in consumer acceptance of its product offerings with only nominal increases in manufacturing costs. The Company believes that the substantial experience of its design staff will assist it in maintaining its current leadership position in watch design and in expanding the scope of its product offerings. Manufacturing The Company's products are manufactured to its specifications by independent contractors and by companies in which the Company holds a majority interest. Substantially all of the Company's watches are manufactured by approximately 19 factories located primarily in Hong Kong, and to a lesser extent in Japan and the United States Virgin Islands. Newtime, Ltd. ("Newtime"), a Hong Kong corporation, and Amazing Time, Ltd. ("Amazing Time"), a Hong Kong corporation are indirect wholly owned subsidiaries of the Company. In addition, the Company holds a majority interest in Pulse Time Center Company, Ltd. ("Pulse Time"), a Hong Kong corporation, and Trylink International Ltd. ("Trylink"), a Hong Kong corporation. During fiscal year 1997, approximately 19.5% of the Company's watches were manufactured by Pulse Time; 15.6% by Amazing Time; approximately 15.6% by Trylink and 25.3% by Newtime. In addition, one other factory accounted for more than 10% of the Company's watch supplies in 1997. The Company's sunglasses are manufactured by approximately 18 factories located in China, Hong Kong, Italy, Japan, Korea and Taiwan. The Company's leather products are manufactured by approximately 23 factories located in Hong Kong, Italy, Korea, the Philippines, Taiwan, Turkey and the United States. Except for its interest in Pulse Time, Amazing Time, Trylink and Newtime, the Company does not own or operate any manufacturing facilities. The Company does not have long-term contracts with any of its manufacturing sources. All transactions between the Company and its manufacturing sources are conducted on the basis of purchase orders. The principal components used in the manufacture of the Company's watches are cases, crystals, dials, movements and straps. These components are obtained by the Company's manufacturing sources from a large number of suppliers located principally in Hong Kong, Japan, China, Taiwan, Italy and Korea. The majority of the movements used in the manufacture of the Company's watches are supplied by two principal vendors. No other single component supplier accounted for more than 10% of component supplies in 1997. Although the Company does not normally engage in direct transactions with component suppliers, in some cases it actively reviews the performance of such suppliers and makes recommendations to its manufacturing sources regarding the sourcing of components. The Company does not believe that its business is materially dependent on any single component supplier. The Company believes that its policy of outsourcing products allows it to achieve increased production flexibility while avoiding significant capital expenditures, build-ups of work-in-process inventory and the costs of managing a substantial production work force. The Company believes that it has established and maintains close relationships with a number of watch manufacturers located in Hong Kong and Japan. In 1997, four separate watch manufacturers in which the Company holds a majority interest, each accounted for 10% or more of the Company's watch supplies. The loss of any one of these manufacturers could temporarily disrupt shipments of certain of the Company's watches. However, as a result of the number of suppliers from which the Company purchases its watches, the Company believes 8 that it could arrange for the shipment of goods from alternative sources within approximately 30 days on terms that are not materially different from those currently available to the Company. Accordingly, the Company does not believe that the loss of any single supplier, including Pulse Time, Amazing Time, Trylink or Newtime would have a material adverse effect on the Company's business. In general, however, the future success of the Company will depend upon its ability to maintain close relationships with its current suppliers and to develop long-term relationships with other suppliers that satisfy the Company's requirements for price and production flexibility. The Company's products are manufactured according to plans that reflect management's estimates of product performance based on recent sales results, current economic conditions and prior experience with manufacturing sources. The average lead time from the commitment to purchase products through the production and shipment thereof ranges from two to three months in the case of watches, from three to six months in the case of sunglasses and from three to four months in the case of leather goods. The Company believes that the close relationships that it has established and maintains with its principal manufacturing sources constitute a significant competitive advantage and allow it to quickly and efficiently introduce innovative product designs and alter production in response to the retail performance of its products. Fossil East, a subsidiary of the Company, acts as the Company's exclusive agent in Hong Kong. In such capacity, Fossil East is responsible for overseeing the production of samples of new products, placing orders with factories located in Hong Kong and China, monitoring manufacturing operations on a daily basis, inspecting finished goods and coordinating the shipment of finished goods. Fossil East also acts as the Company's payment agent in purchasing products from the Company's manufacturing sources. Quality Control The Company's quality control program attempts to ensure that its products meet the standards established by its design staff. Samples of products are inspected by the Company prior to the placement of orders with manufacturing sources to ensure compliance with its specifications. The operations of the Company's manufacturing sources located in Hong Kong are monitored on a periodic basis by Fossil East. Substantially all of the Company's watches and certain of its other accessories are inspected by personnel of Fossil East or by the manufacturer prior to shipment to the Company. In addition, the Company performs quality control checks on its products upon receipt at the Company's facility. Marketing and Promotion The Company's in-house advertising department oversees the conception, development and implementation of all aspects of the packaging, advertising, marketing and sales promotion of the Company's products. The advertising staff uses computer-aided design techniques to generate the images presented on product packaging and other advertising materials. The Company believes that the use of computers encourages greater creativity and reduces the time and cost required to incorporate new themes and ideas into effective product packaging and other advertising materials. Senior management is involved in monitoring the Company's advertising and promotional activities to ensure that themes and ideas are communicated in a cohesive manner to the Company's target audience. The Company's current advertising themes aim at evoking nostalgia for the simpler values and more optimistic outlook of the 1950s through the use of images of cars, trains, airliners and consumer 9 products that reflect the classic American tastes of the period. These images are carefully coordinated in order to convey the flair for fun, fashion and humor that the Company associates with its products. The Company participates in cooperative advertising programs with its major retail customers, whereby it shares the cost of certain of their advertising and promotional expenses. An important aspect of the marketing process involves the use of in-store visual support and other merchandising materials, including packages, signs, posters and fixtures. Through the use of these materials, the Company attempts to differentiate the space used to sell its products from other areas of its customers' stores. In addition, the Company frequently offers promotional gifts, such as T-shirts and caps, to consumers who purchase its products. The Company also provides its customers with a large number of preprinted, customized advertising inserts and from time to time stages promotional events designed to focus public attention on its products. In 1994, the Company introduced the Fossil Collectors Club. Club members receive a special limited edition watch, T-shirt and official Club membership card. Newsletters are produced quarterly to inform members of new product launches and to provide information to members about FOSSIL collectibles, trivia and upcoming store events. In 1995, the Fossil Collectors Club was successfully launched in certain international markets as well. The Company advertises, markets and promotes its products to potential consumers through a variety of media, including catalog inserts, billboards and print media. The Company has advertised from time to time with billboards and other outdoor advertisements including bus panels in major metropolitan areas. The Company also periodically advertises in national fashion magazines such as GQ and Glamour, as well as in trade publications such as Women's Wear Daily and Daily News Record. Sales and Customers The Company sells its products in approximately 15,000 retail locations in the United States through a diversified distribution network that includes department stores and other major retailers, as well as specialty retail stores. The Company also sells its product in retail stores operated by Fossil located at retail malls in the United States and sells certain of its products in Fossil outlet stores located at selected outlet centers throughout the United States. The Company also sells its products at retail locations in major airports in the United States, on cruise ships and in FOSSIL retail stores and kiosks in certain international markets. In addition, the Company from time to time sells its products to certain off-price retailers in order to manage current product offerings and inventory levels. The Company does not have long-term contracts with any of its retail customers. All transactions between the Company and its retail customers are conducted on the basis of purchase orders, which generally require payment of amounts due to the Company on a net 30-day basis. For fiscal years 1997, 1996 and 1995, domestic department stores accounted for 45.2%, 46.6% and 40.5% of the Company's net sales, respectively. In addition, in the same periods, the Company's ten largest customers represented approximately 45.0%, 47.0% and 46.0% of net sales, respectively. For fiscal year 1996, Dillard's Department Stores accounted for 10% of the Company's net sales. No other customer accounted for more than 10% of the Company's net sales in fiscal years 1997, 1996 and 1995. Certain of the Company's customers are under common ownership. Sales to the department store group under common ownership by Federated Department Stores accounted for approximately 10.8%, 11.1% and 11.8% of the Company's net sales in fiscal years 1997, 1996 and 1995, respectively. No other 10 customer, when considered as a group under common ownership, accounted for more than 10% of the Company's net sales in fiscal years 1997, 1996 and 1995. Sales by the Company to off-price retailers accounted for approximately 1.0%, 2.7% and 2.2% of its net sales during fiscal years 1997, 1996 and 1995, respectively. Off-price retailers include those customers to whom the Company makes periodic or occasional sales of products at reduced prices. A majority of the products sold to off-price retailers consist of watch styles that the Company has eliminated or proposes to eliminate from its current product lines. In 1995, the Company commenced operations of Fossil outlet stores at selected outlet centers throughout the United States. The Company operated 27 outlet stores at the end of fiscal year 1997. These stores, which operate under the FOSSIL name, carry some of the product that previously were sold by the Company to off-priced retailers. The Company's products in such stores are generally sold at discounts from 25% to 50% off the suggested retail price. In 1996, the Company commenced operations of full priced Fossil retail stores at some of the most prestigious retail malls in the United States. In 1997, the Company opened an additional three retail stores at the Galleria (Houston, Texas), The Mall of America (Minneapolis, Minnesota), and Tuttle Crossing (Columbus, Ohio). These stores, which operate under the FOSSIL name, carry a full assortment of FOSSIL merchandise which is generally sold at the suggested retail price. In November 1995, the Company began offering various products for sale to consumers through America Onlines's Market Place. The Company currently offers product through a "storefront" on America Online that is connected to the Company's website. These products include selected FOSSIL watches, sunglasses and leather goods, as well as NFL and NBA licensed watches. In November 1996, the Company established its own website at www.fossil.com. In addition to offering selected FOSSIL products, the Company also provides Company news and information, product annoucements and promotional contests on the website. The Company historically has relied on in-house sales personnel, instead of the independent sales representatives more typical in the industry. The Company utilizes independent sales representatives, however, to help develop the market for the FSL watch line into sports specialty stores and to expand the distribution of RELIC watches to selected retailers and to promote the sale of the Company's leather goods to certain specialty retailers. As of the end of fiscal year 1997, the Company had 72 in-house sales and customer service employees and 58 independent sales representatives. The Company's in-house sales personnel receive a salary and, in some cases, a commission based on a percentage of gross sales attributable to specified accounts. Independent sales representatives generally do not sell competing product lines and are under contracts with the Company that are generally terminable by either party upon 30 days' prior notice. These independent contractors are compensated on a commission basis. The Company's products are sold in over 70 countries through foreign subsidiaries in which Fossil has an interest and through a network of approximately 50 independent distributors operating in South and Central America, the Carribean, Canada, the Far East, Australia and the Middle East. Foreign distributors generally purchase products at uniform prices established by the Company for all international sales and resell them to department stores and specialty retail stores. The Company generally receives payment from its foreign distributors in United States currency. In May 1993, the Company formed Fossil B.V. which established Fossil GmbH to market and resell the Company's 11 products throughout Europe. Fossil GmbH resells the Company's products directly to department stores or other retailers, and in certain countries, Fossil GmbH also offers the Company's products through independent distributors. In 1994, Fossil B.V. established Fossil Italy to market and sell the Company's products in Italy. In 1995, Fossil B.V. established Fossil France and Fossil U.K. to market and sell the Company's products in France and England, respectively. During 1997, the Company appointed an independent distributor in the United Kingdom and discontiued operations through Fossil UK. In 1996, Fossil B.V. established Fossil Spain to market and sell the Company's products in Spain. In April 1996, the Company acquired an 81% interest in Fossil Japan which acts as the sole distributor of the Company's products in Japan. During the fiscal years 1997, 1996 and 1995, international and export sales accounted for 31%, 30% and 32% of net sales, respectively. During the past several years, the retail industry has undergone significant consolidation. As a result of these developments, department stores and other major retailers have generally become more dependent on the resources and market expertise of their suppliers. The Company believes that this dependence has created opportunities for suppliers that provide superior service to their retail customers and are able to manage the retail sales process effectively. In order to take advantage of the opportunities presented by this increasing dependence, the Company has developed an approach to managing the retail sales process that involves monitoring its customers' sales and inventories by product category and style and assisting in the conception, development and implementation of their marketing programs. For example, the Company reviews weekly selling reports prepared by certain of its principal customers and has established an active electronic data interchange program with certain of its customers. The Company also places significant emphasis on the establishment of cooperative advertising programs with its major retail customers. The Company believes that its management of the retail sales process has resulted in close relationships with its principal customers, often allowing it to influence the mix, quantity and timing of their purchasing decisions. The Company believes that its sales approach achieves high retail turnover in its products, which can result in attractive profit margins for its retail customers. The Company believes that the resulting profit margins for its retail customers encourage them to devote greater selling space to its products within their stores and enable the Company to work closely with buyers in determining the mix of products any store should carry. In addition, the Company believes that the buyers' familiarity with the Company's sales approach should facilitate the introduction of new products through its existing distribution network. The Company permits the return of damaged or defective products. In addition, although it has no obligation to do so, the Company accepts limited amounts of product returns from its customers in certain other instances. Accordingly, the Company provides allowances for the estimated amount of product returns. The allowances for product returns at for the fiscal years 1997, 1996 and 1995 were $10,576,000, $8,854,000 and $9,034,000, respectively. Since 1990, the Company has not experienced any returns in excess of the aggregate allowances therefor. Backlog For fiscal year 1997, the Company had unfilled customer orders of approximately $16,223,000 compared to $15,852,000 and $14,340,000 for fiscal years 1996 and 1995, respectively. It is the practice of a substantial number of the Company's customers not to confirm orders by delivering a formal purchase order until a relatively short time prior to the shipment of goods. As a result, the amounts shown above include confirmed orders and orders that the Company believes will be confirmed by 12 delivery of a formal purchase order. A majority of such amounts represent orders that have been confirmed. The remainder of such amounts represent orders that the Company believes, based on industry practice and prior experience, will be confirmed in the ordinary course of business. The Company's backlog at a particular time is affected by a number of factors, including seasonality and the scheduling of the manufacture and shipment of products. Accordingly, a comparison of backlog from period to period is not necessarily meaningful and may not be indicative of eventual actual shipments. In addition, the increased use and reliance on the electronic data interchange program in recent years has contributed to the decline in backlog in comparison to prior years. Distribution Upon completion of manufacturing, the Company's products are shipped to its warehousing and distribution centers in Richardson, Texas, Italy, Japan and Germany from which they are shipped to customers in their respective markets. In 1994, the Company consolidated its United States warehouse and distribution facilities into a single facility which enhances the Company's inventory management and distribution capabilities. In July 1997, the Company completed construction of an additional warehouse and distribution facility adjacent to its existing facility. On March 12, 1997, the Dallas/Fort Worth International Airport Board filed an application for authority to establish special purpose subzone status at the Company's warehouse/distribution facilities in Richardson, Texas. The establishment of the special purpose subzone was approved by the United States Department of Commerce Foreign Trade Zone Board on December 3, 1997. As a result of the establishment of the subzone, the Company enjoys certain economic and operational advantages: (i) the Company may not have to pay duty on imported merchandise until it leaves the subzone and enters the United States market, (ii) the Company may not pay any United States duty on merchandise if the imported merchandise is subsequently re-exported, and (iii) the Company may not pay local property tax on inventory located within the subzone. The Company maintains inventory control systems at its facilities which enable it to track each item of merchandise from receipt to ultimate sale. A significant number of products sold by the Company are pre-ticketed and bar coded prior to shipment to its retail customers. The Company believes that its distribution capabilities enable it to reduce inventory risk and increase its flexibility in responding to the delivery requirements of its customers. Warranty and Repair The Company's Fossil watch products are covered by a limited warranty against defects in materials or workmanship for a period of 11 years from the date of purchase. The Company's sunglass line is covered by a one year limited warranty against defects in materials or workmanship. Defective products returned by customers are processed at the Company's warehousing and distribution centers. In most cases, defective products under warranty are repaired by the Company's personnel. Products under warranty that cannot be repaired in a cost-effective manner are replaced by the Company at no cost to the customer. The Company also performs watch repair services on behalf of certain of its private label customers. 13 Governmental Regulations Imports and Import Restrictions. The vast majority of the Company's products are manufactured overseas in China, Hong Kong, Italy, Japan, Korea, the Philippines, Taiwan and Turkey. The Company's arrangements with its manufacturing sources are subject to the risks of doing business abroad. The Company's products imported to the United States are subject to United States customs duties and, in the ordinary course of its business, the Company may from time to time be subject to claims by the United States Customs Service for duties and other charges. The United States and the countries in which the Company's products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust prevailing quotas, duty or tariff levels, which could adversely affect the Company's operations and its ability to import products at current or increased levels. In general, the Company cannot predict the likelihood or frequency of any such events occurring or what effect such events could have on its financial condition and results of operations. The United States Trade Representative (the "USTR") has been directed to designate those countries that deny adequate and effective intellectual property rights or fair and equitable market access to United States firms that rely on intellectual property. From the countries designated, the USTR is to identify as "priority" foreign countries those countries where the lack of intellectual property rights protection is most egregious and has the greatest adverse impact on United States products. The USTR is directed to identify and investigate as priority foreign countries only those that have not entered into good faith negotiations or made significant progress in protecting intellectual property. Where such an investigation does not lead to a satisfactory resolution of such practices, through consultations or otherwise, the USTR is authorized to take retaliatory action, including the imposition of retaliatory tariffs and import restraints on goods from the priority foreign country. The Company cannot predict whether any of the countries in which its products are currently manufactured or any of the countries in which the Company may manufacture its products in the future will be subject to an investigation by the USTR. The Company cannot predict the likelihood, type or effect of any trade retaliation as a result of such investigations. Trade retaliation in the form of increased tariffs or quotas, or both, against products that are manufactured on behalf of the Company now or in the future could increase the cost or reduce the supply of such products available to the Company. There have been a number of ongoing trade disputes between the United States and China during which the United States has threatened to impose tariffs and duties on some products imported from China and to withdraw China's "most favored nation" status. There can be no assurance that legislation will not be introduced in Congress seeking to place restrictions on the renewal of China's most favored nation status or that China will continue to enjoy such status in the future. If goods manufactured in China enter the United States without the benefit of most favored nation treatment, such goods will be subject to significantly higher duty rates. Any such increased duties would increase the cost or reduce the supply of goods from China, although the Company believes that it could replace such goods with items manufactured in other countries at prices that would not materially affect its profit margins. Accordingly, the Company believes that the expiration of China's most favored nation status would not have a material adverse effect on the Company's financial condition or results of operations. 14 In addition to the foregoing factors, the Company's import operations may be adversely affected by political instability, foreign governmental regulation, fluctuations in exchange rates and changes in economic conditions in countries in which the Company's manufacturing sources are located, any of which could result in the disruption of trade from exporting countries. The potential effect of these factors on the Company may be heightened as a result of the fact that substantially all of the Company's products are manufactured in, or sourced from, Hong Kong, over which China resumed sovereignty in 1997. The Company cannot predict the effect, if any, this event will have on its operations in Hong Kong and there can be no assurances that Hong Kong will not experience political, economic or social disruption as a result of the resumption of Chinese sovereignty. General. The Company's sunglass products are subject to regulation by the United States Food and Drug Administration as medical devices. The Company does not believe that compliance with such regulations is material to its operations. In addition, the Company is subject to various state and federal regulations generally applicable to similar businesses. Trademarks The Company has registered the FOSSIL and RELIC trademarks for use on the Company's watches, leather goods and other fashion accessories, and has applied for registration of the FSL trademark for use on the Company's watches and other accessories in the United States. The Company has also registered or applied for the registration of certain other marks used by the Company in conjunction with the sale and marketing of its products and services. In addition, the Company has registered certain of its trademarks, including FOSSIL, RELIC and FSL, in certain foreign countries, including a number of countries located in Europe, the Far East, the Middle East, South America and Central America. The Company also has certain trade dress rights in, and has applied for registration of, the distinctive rectangular tins in which the Company packages the majority of its Fossil watch products. The Company regards its trademarks and trade dress as valuable assets and believes that they have significant value in the marketing of its products. The Company intends to protect its trademarks and trade dress rights vigorously against infringement. Competition There is intense competition in each of the businesses in which the Company competes. The Company's watch business competes with a number of established manufacturers, importers and distributors such as Guess? Anne Klein II and Swatch. In addition, the Company's leather goods and sunglass businesses compete with a large number of established companies that have significantly greater experience than the Company in designing, developing, marketing and distributing such products. In all its businesses, the Company competes with numerous manufacturers, importers and distributors who have significantly greater financial, distribution, advertising and marketing resources than the Company. The Company's competitors include distributors that import watches and accessories from abroad, domestic companies that have established foreign manufacturing relationships and companies that produce accessories domestically. The Company competes primarily on the basis of style, price, value, quality, brand name, advertising, marketing and distribution. In addition, the Company believes that its ability to identify and respond to changing fashion trends and consumer preferences, to maintain existing relationships and develop new relationships with manufacturing sources, to deliver quality merchandise in a timely manner and to manage the retail sales process are important factors in its ability to compete. 15 The Company considers that the risk of significant new competitors is mitigated to some extent by barriers to entry such as high startup costs and the development of long-term relationships with customers and manufacturing sources. During the past few years, it has been the Company's experience that better department stores and other major retailers have been increasingly unwilling to source products from suppliers who are not well capitalized or do not have a demonstrated ability to deliver quality merchandise in a timely manner. There can be no assurance, however, that significant new competitors will not emerge in the future. Employees As the end of fiscal year 1997, the Company (excluding the Company's foreign subsidiaries) had 472 full-time employees, including 65 in executive or managerial positions, and the balance in design, advertising, sales, quality control, distribution, clerical and other office positions. Also included in this amount are 62 full-time employees of Fossil Stores I, Inc. and 15 full-time employees of Fossil Stores II, Inc. As the end of fiscal year 1997, Fossil East had 55 full-time employees, including 12 in managerial positions and the balance in sampling, quality control, clerical and other office positions. As the end of fiscal year 1997, Fossil GmbH had 132 full time-employees, including 5 in managerial positions and the balance in sampling, quality control, clerical and other office positions. As the end of fiscal year 1997, Fossil Japan had 26 full time-employees, including 3 in managerial positions and the balance in sampling, quality control, clerical and other office positions. As the end of fiscal year 1997, Fossil Italy had 29 full-time employees, Fossil France had one full-time employee and Fossil Spain had seven full-time employees. The Company has not entered into any collective bargaining agreements with its employees. The Company believes that its relations with its employees are generally good. Item 2. Properties In July 1994, the Company completed construction of its new corporate headquarters located in a 150,000 square foot facility in Richardson, Texas. In July 1997, the Company completed construction of a new 138,000 square foot distribution center located on land immediately adjacent to its headquarters. These facilities contain the general office, warehousing and distribution functions of the Company and are located on approximately 20 acres of land. The Company owns both facilities and the land on which each is located. As the end of fiscal year 1997, the Company had entered into six lease agreements for retail space at prime locations in the United States for the sale of its full assortment of products. The leases, including renewal options, expire at various times from 2005 to 2010 and provide for minimum annual rentals above specified net sales amounts and for the payment of additional rent based on a percentage of sales ranging from 6% to 8%. The Company is also required to pay its pro rata share of the common area maintenance costs at each retail mall, including, real estate taxes, insurance, maintenance expenses and utilities. The Company also leases retail space at selected outlet centers throughout the United States for the sale of its products. As the end of fiscal year 1997, the Company had entered into 27 such leases. The leases, including renewal options, expire at various times from 2005 to 2010, and provide for minimum annual rentals and for the payment of additional rent based on a percentage of sales above 16 specified net sales amounts ranging from 4% to 6%. The Company is also required to pay its pro rata share of the common area maintenance costs at each outlet center, including, real estate taxes, insurance, maintenance expenses and utilities. The Company also leases showrooms in Atlanta, Chicago, Los Angeles and New York City, which are used to display the Company's products to its retail customers. Fossil East leases approximately 37,600 square feet of office, warehouse and assembly space in Hong Kong pursuant to a lease agreement that expires in December 1999. Fossil GmbH leases approximately 12,000 square feet of office and warehouse space in Erlstatt, Germany pursuant to a lease agreement that expires in 2002. Fossil Italy leases approximately 2,800 square feet of office space in Vicenza, Italy and an additional 3,100 square feet of warehouse and storage space. Fossil Japan also leases warehouse and office space in Tokyo, Japan. The Company believes that its existing facilities are well maintained, in good operating condition and adequate for its current needs. Item 3. Legal Proceedings There are no legal proceedings to which the Company is a party or to which its properties are subject, other than routine litigation incident to the Company's business which is not material to the Company's consolidated financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year 1997. 17 PART II Item 5.Market for the Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock is listed on the Nasdaq National Market System under the symbol "FOSL." Quotation of the Company's Common Stock began on the Nasdaq National Market on April 8, 1993. The following table sets forth the range of quarterly high and low sales prices per share of the Company's Common Stock on the Nasdaq National Market for the fiscal years ended January 3, 1998 and December 31, 1996 as adjusted to reflect a three for two stock split (the "3 for 2 Stock Dividend") of the Company's Common Stock effected as a fifty percent (50%) stock dividend declared on March 4, 1998, payable on April 8, 1998 to all stockholders of record on March 25, 1998. Such adjusted prices have been rounded to the nearest trading fraction on the Nasdaq National Market. High Low Fiscal year beginning January 1, 1997: First Quarter $ 9 3/4 $ 7 Second Quarter 11 7/8 8 1/4 Third Quarter 15 1/2 11 Fourth Quarter 17 7/8 11 Fiscal year beginning January 1, 1996: First Quarter $ 7 1/2 $ 4 1/2 Second Quarter 10 7/8 6 1/2 Third Quarter 9 3/4 4 7/8 Fourth Quarter 10 1/2 7 5/8 As of March, 31, 1998, the Company estimates that there were approximately 1,800 beneficial owners of the Company's Common Stock, represented by approximately 120 holders of record. Dividend Policy. The Company expects that it will retain all available earnings generated by its operations for the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. Any future determination as to dividend policy will be made in the discretion of the Board of Directors of the Company and will depend on a number of factors, including the future earnings, capital requirements, financial condition and future prospects of the Company and such other factors as the Board of Directors may deem relevant. The Company declared the 3 for 2 Stock Dividend on March 4, 1998, effected as a fifty percent (50%) stock dividend payable on April 8, 1998 to all stockholders of record on March 25, 1998. During fiscal year 1995, the Company made principal payments in the amount of $1,000,000 under promissory notes (the "Notes") in the principal amount of $10,910,000 issued prior to the date of the Offering to Messrs. Tom Kartsotis, Kosta Kartsotis and Alan D. Moore, a former director of the 18 Company. The Company used a portion of the proceeds of the Offering to repay $8,910,000 principal amount of the Notes. The Company did not make any other such payments or distributions in fiscal years 1997 and 1996. Recent Sales of Unregistered Securities. Effective as of February 1, 1997, Fossil B.V. entered into an agreement to purchase all of the issued and outstanding common stock of Fossil Italia from the minority stockholders in exchange for the issuance of 128,109 shares of Common Stock of the Company, without giving effect to the 3 for 2 Stock Dividend. Such securities were not registered under the Securities Act of 1933, as amended, in reliance on the exemption from registration provided under Section 4(2) thereof. Item 6. Selected Financial Data The information appearing under "Selected Consolidated Financial Highlights" in the Fossil, Inc. 1997 Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information appearing under "Management's Discussion" in the Fossil, Inc. 1997 Annual Report is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosure About Market Risk The information appearing under "Management's Discussion" in the Fossil, Inc. 1997 Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplemental Data The information appearing under "Financial Information" in the Fossil, Inc. 1997 Annual Report is incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures The Company has had no disagreements with its accountants to report under this item. 19 PART III Item 10. Directors and Executive Officers of the Registrant The information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 11. Executive Compensation The information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. Item 13. Certain Relationships and Related Transactions The information required in response to this Item is incorporated herein by reference to the Company's proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year covered by this report. 20 PART IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K (a) Documents filed as part of Report. 1. Financial Statements: The Financial Statements appearing under "Financial Information" in the Fossil, Inc. 1997 Annual Report are incorporated herein by reference. 2. Financial Statement Schedule: The following Financial Statement Schedule and related Auditor's Report are contained herein on pages S-1 and S-2 of this Report. Schedule II - Valuation and Qualifying Accounts 3. Exhibits: 3.1 Amended and Restated Certificate of Incorporation of Fossil, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 3.2 Amended and Restated Bylaws of Fossil, Inc.(incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 3.3 Certificate of Amendment of the Amended and Restated Certificate of Incorporation of Fossil, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.1 (2) Fossil, Inc. 1993 Nonemployee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.1 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.2 (2) Fossil, Inc. 1993 Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.2 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.3 (2) Fossil, Inc. 1993 Savings and Retirement Plan (incorporated herein by reference to Exhibit 10.3 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.4 (2) Description of Bonus Program (incorporated herein by reference to Exhibit 10.4 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 21 10.5 Non-Competition Agreement dated December 31, 1992 between Fossil, Inc. and Mr. Jal S. Shroff (incorporated herein by reference to Exhibit 10.12 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.6 Amended and Restated Buying Agent Agreement dated March 21, 1992 between Fossil, Inc. and Fossil East Ltd. (incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993). 10.7 Amended and Restated Loan Agreement dated August 31, 1994, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc. and Fossil Trust (without exhibits) (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.8 First Amendment to Amended and Restated Loan Agreement dated September 30, 1994, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust and Fossil New York, Inc. (without exhibits) (incorporated by reference to Exhibit 10.3 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.9 Second Amendment to Amended and Restated Loan Agreement dated February 13, 1995, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc.(without exhibits) (incorporated by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.10 Commercial/Real Estate Note dated as of August 31, 1994, in the principal amount of $5,000,000 executed by Fossil Partners, L.P. and payable to the order of First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.6 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.11 Subordination Agreement of Fossil Trust for the benefit of First Interstate Bank of Texas, N.A. dated as of August 31, 1994 (incorporated by reference to Exhibit 10.7 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.12 Indemnity Agreement dated as of August 31, 1994 from Fossil Partners, L.P. and Fossil, Inc. to First Interstate Bank of Texas, N.A.(incorporated by reference to Exhibit 10.8 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.13 Master Licensing Agreement dated as of August 30, 1994, by and between Fossil, Inc. and Fossil Partners, L.P. (incorporated by reference to Exhibit 10.12 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.14 Agreement of Limited Partnership of Fossil Partners, L.P. (incorporated by reference to Exhibit 10.13 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 22 10.15 Overhead Allocation Agreement by and between Fossil Partners, L.P. and Fossil New York, Inc. dated October 1, 1994 (incorporated by reference to Exhibit 10.33 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.16 Services and Operations Agreement by and between Fossil Partners, L.P. and Fossil New York,Inc. dated October 1, 1994 (incorporated by reference to Exhibit 10.34 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.17 Overhead Allocation Agreement by and between Fossil Partners, L.P. and Fossil Stores I, Inc. dated December 1, 1994 (incorporated by reference to Exhibit 10.35 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.18 Second Amended and Restated Loan Agreement entered into on May 2, 1995 by and between First Interstate Bank of Texas, N.A., Fossil Partners,L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc. (without exhibits) (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.19 Third Amended and Restated Master Revolving Credit Note dated April 30, 1995, in the stated principal amount of $25,000,000 executed by Fossil Partners, L.P. and payable to the order of First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.20 Stock Pledge Agreement entered into on May 2, 1995 by and between Fossil, Inc. and First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.3 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.21 Joint Development Agreement entered into on December 25, 1995 by and between Fossil, Inc., Seiko Instruments, Inc, and Time Tech, Inc. (incorporated by reference to Exhibit 10.43 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995). 10.22 First Amendment to Second Amended and Restated Loan Agreement by and between First Interstate Bank of Texas, N.A. and Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc. dated as of March 27, 1996 (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended March 31, 1996). 10.23 Second Amendment to Second Amended and Restated Loan Agreement by and between First Interstate Bank of Texas, N.A. and Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc. and Fossil Stores II, Inc. dated as of May 3, 1996 (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1996). 10.24 Stock Purchase Agreement by and between Franz Scheurl and Fossil, Inc. dated October 1, 1996. 10.25 (2) Letter Agreement dated October 4, 1995 between Fossil, Inc. and Mark D. Quick. 23 10.26 (1) Third Amendment to Second Amended and Restated Loan Agreement dated September 11, 1996, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits). 10.27 Stock Purchase Agreement dated February 1, 1997, by and between Bluewhale Holding S.a., and Fossil Europe B.V. (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the transition period from January 1, 1997 to April 5, 1997). 10.28 Fourth Amendment to Second Amended and Restated Loan Agreement dated April 2, 1997, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits)(incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the transition period from January 1, 1997 to April 5, 1997). 10.29 Fifth Amendment to Second Amended and Restated Loan Agreement dated June 1997, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits) (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended July 5, 1997). 13(1) Fossil, Inc. 1997 Annual Report to Stockholders. 21.1(1) Subsidiaries of Fossil, Inc. 23.1(1) Consent of Independent Auditors. 27(1) Financial Data Schedule. (1) Filed herewith. (2) Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K The Company did not file any report on Form 8-K during the last quarter of the period covered by this Report. 24 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Richardson, State of Texas, on April 1 , 1998. FOSSIL, INC. /s/ Tom Kartsotis ---------------------------------------------- Tom Kartsotis, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Capacity Date /s/ Tom Kartsotis - --------------------------- Chairman of the Board, April 1 , 1998 Tom Kartsotis Chief Executive Officer and Director (Principal Executive Officer) /s/ Kosta N. Kartsotis President and Chief Operating April 1 , 1998 - --------------------------- Officer and Director Kosta N. Kartsotis /s/ Randy S. Kercho Executive Vice President, April 1 , 1998 - --------------------------- Chief Financial Officer and Randy S. Kercho Treasurer (Principal Financial and Accounting Officer) /s/ Michael W. Barnes Executive Vice President April 1 , 1998 - --------------------------- and Director Michael W. Barnes /s/ Jal S. Shroff Director April 1 , 1998 - --------------------------- Jal S. Shroff /s/ Kenneth W. Anderson Director April 1 , 1998 - --------------------------- Kenneth W. Anderson /s/ Alan J. Gold Director April 1 , 1998 - --------------------------- Alan J. Gold /s/ Donald J. Stone Director April 1 , 1998 - --------------------------- Donald J. Stone 25 INDEPENDENT AUDITORS REPORT To the Board of Directors of Fossil, Inc.: We have audited the consolidated financial statements of Fossil, Inc. and subsidiaries as of January 3, 1998 and December 31, 1996 and for each of the three years in the period ended January 3, 1998 and have issued our report thereon dated February 19, 1998 (except for the first paragraph of Note 10 which is as of March 4, 1998), which report expressed an unqualified opinion; such consolidated financial statements and report are included in your 1997 Annual Report to Stockholders and are incorporated herein by reference. Our audit also included the consolidated financial statement schedule of Fossil, Inc. and subsidiaries listed in Item 14. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP Dallas, Texas February 19, 1998 S-1
SCHEDULE II FOSSIL, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS Fiscal Years 1995, 1996, and 1997 Additions Charged Balance at (Credited) to Deductions Actual Beginning of Costs and Returns or Balance at End of Classification Period Expenses Writeoffs Period - -------------- ------------ -------------- ------------------ ----------------- Fiscal Year 1995: Accounts receivable allowances: Sales returns 8,137,195 14,536,232 (13,639,303) 9,034,124 Bad debts 2,050,886 1,389,980 (584,800) 2,856,066 Cash discounts 85,232 115,507 (94,621) 106,118 Inventory in transit for estimated customer (4,277,578) (8,074,296) 7,524,874 (4,827,000) returns Fiscal Year 1996: Accounts receivable allowances: Sales returns 9,034,124 12,524,626 (12,704,297) 8,854,453 Bad debts 2,856,066 2,103,499 (667,419) 4,292,146 Cash discounts 106,118 218,500 (110,747) 213,871 Inventory in transit for estimated customer (4,827,000) (6,330,967) 6,694,021 (4,463,946) returns Fiscal Year 1997: Accounts receivable allowances: Sales returns 8,854,453 17,399,057 (15,677,328) 10,576,181 Bad debts 4,292,146 2,024,647 (1,616,962) 4,699,831 Cash discounts 213,871 204,448 (229,722) 188,597 Inventory in transit for estimated customer (4,463,946) (9,715,573) 8,484,687 (5,694,831) returns
S-2 EXHIBIT INDEX Exhibit Number Description 3.1 Amended and Restated Certificate of Incorporation of Fossil, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 3.2 Amended and Restated Bylaws of Fossil, Inc.(incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 3.3 Certificate of Amendment of the Amended and Restated Certificate of Incorporation of Fossil, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.1 (2) Fossil, Inc. 1993 Nonemployee Director Stock Option Plan (incorporated herein by reference to Exhibit 10.1 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.2 (2) Fossil, Inc. 1993 Long-Term Incentive Plan (incorporated herein by reference to Exhibit 10.2 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.3 (2) Fossil, Inc. 1993 Savings and Retirement Plan (incorporated herein by reference to Exhibit 10.3 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.4 (2) Description of Bonus Program (incorporated herein by reference to Exhibit 10.4 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.5 Non-Competition Agreement dated December 31, 1992 between Fossil, Inc. and Mr. Jal S. Shroff (incorporated herein by reference to Exhibit 10.12 of the Company's Registration Statement of Form S-1, registration no. 33-45357, filed with the Securities and Exchange Commission). 10.6 Amended and Restated Buying Agent Agreement dated March 21, 1992 between Fossil, Inc. and Fossil East Ltd. (incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993). 10.7 Amended and Restated Loan Agreement dated August 31, 1994, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc. and Fossil Trust (without exhibits) (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.8 First Amendment to Amended and Restated Loan Agreement dated September 30, 1994, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust and Fossil New York, Inc. (without exhibits) (incorporated by reference to Exhibit 10.3 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.9 Second Amendment to Amended and Restated Loan Agreement dated February 13, 1995, by and between First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc.(without exhibits) (incorporated by reference to Exhibit 10.21 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.10 Commercial/Real Estate Note dated as of August 31, 1994, in the principal amount of $5,000,000 executed by Fossil Partners, L.P. and payable to the order of First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.6 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.11 Subordination Agreement of Fossil Trust for the benefit of First Interstate Bank of Texas, N.A. dated as of August 31, 1994 (incorporated by reference to Exhibit 10.7 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.12 Indemnity Agreement dated as of August 31, 1994 from Fossil Partners, L.P. and Fossil, Inc. to First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.8 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.13 Master Licensing Agreement dated as of August 30, 1994, by and between Fossil, Inc. and Fossil Partners, L.P. (incorporated by reference to Exhibit 10.12 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.14 Agreement of Limited Partnership of Fossil Partners, L.P. (incorporated by reference to Exhibit 10.13 of the Company's Report on Form 10-Q for the quarterly period ended September 30, 1994). 10.15 Overhead Allocation Agreement by and between Fossil Partners, L.P. and Fossil New York, Inc. dated October 1, 1994 (incorporated by reference to Exhibit 10.33 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.16 Services and Operations Agreement by and between Fossil Partners, L.P. and Fossil New York,Inc. dated October 1, 1994 (incorporated by reference to Exhibit 10.34 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.17 Overhead Allocation Agreement by and between Fossil Partners, L.P. and Fossil Stores I, Inc. dated December 1, 1994 (incorporated by reference to Exhibit 10.35 of the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.18 Second Amended and Restated Loan Agreement entered into on May 2,1995 by and between First Interstate Bank of Texas,N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc. (without exhibits) (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.19 Third Amended and Restated Master Revolving Credit Note dated April 30, 1995, in the stated principal amount of $25,000,000 executed by Fossil Partners, L.P. and payable to the order of First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.20 Stock Pledge Agreement entered into on May 2, 1995 by and between Fossil, Inc. and First Interstate Bank of Texas, N.A. (incorporated by reference to Exhibit 10.3 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1995). 10.21 Joint Development Agreement entered into on December 25, 1995 by and between Fossil, Inc., Seiko Instruments, Inc, and Time Tech, Inc. (incorporated by reference to Exhibit 10.43 of the Company's Annual Report on Form 10-K for the year ended December 31, 1995). 10.22 First Amendment to Second Amended and Restated Loan Agreement by and between First Interstate Bank of Texas, N.A. and Fossil Partners, L.P., Fossil,Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc. and Fossil Stores I, Inc. dated as of March 27, 1996 (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the quarterly period ended March 31, 1996). 10.23 Second Amendment to Second Amended and Restated Loan Agreement by and between First Interstate Bank of Texas, N.A. and Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc. and Fossil Stores II, Inc. dated as of May 3, 1996 (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended June 30, 1996). 10.24 Stock Purchase Agreement by and between Franz Scheurl and Fossil, Inc. dated October 1, 1996. 10.25 (2) Letter Agreement dated October 4, 1995 between Fossil, Inc. and Mark D. Quick. 10.26 (1) Third Amendment to Second Amended and Restated Loan Agreement dated September 11, 1996, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil,Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits). 10.27 Stock Purchase Agreement dated February 1, 1997, by and between Bluewhale Holding S.a., and Fossil Europe B.V. (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the transition period from January 1, 1997 to April 5, 1997). 10.28 Fourth Amendment to Second Amended and Restated Loan Agreement dated April 2, 1997, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits) (incorporated by reference to Exhibit 10.2 of the Company's Report on Form 10-Q for the transition period from January 1, 1997 to April 5, 1997). 10.29 Fifth Amendment to Second Amended and Restated Loan Agreement dated June 1997, by and among Wells Fargo Bank (Texas), National Association, a national banking association formerly known as First Interstate Bank of Texas, N.A., Fossil Partners, L.P., Fossil, Inc., Fossil Intermediate, Inc., Fossil Trust, Fossil New York, Inc., Fossil Stores I, Inc., and Fossil Stores II, Inc. (without exhibits) (incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarterly period ended July 5, 1997). 13(1) Fossil, Inc. 1997 Annual Report to Stockholders. 21.1(1) Subsidiaries of Fossil, Inc. 23.1(1) Consent of Independent Auditors. 27(1) Financial Data Schedule. EX-10 2 EXHIBIT 10.26 Exhibit 10.26 THIRD AMENDMENT TO SECOND AMENDED AND RESTATED LOAN AGREEMENT ----------------------------------- THIS THIRD AMENDMENT TO SECOND AMENDED AND RESTATED LOAN AGREEMENT (this "Amendment") is made and entered into this 11th day of September, 1996, by and among WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION, a national banking association formerly known as First Interstate Bank of Texas, N.A. (the "Bank"), Fossil Partners, L.P. (the "Borrower"), Fossil, Inc. (the "Company"), Fossil Intermediate, Inc. ("Fossil Intermediate"), Fossil Trust ("Fossil Trust"), Fossil New York, Inc. ("Fossil New York"), Fossil Stores I, Inc. ("Fossil I") and Fossil Stores II, Inc. ("Fossil II"). RECITALS A. The Bank, the Borrower, the Company, Fossil Intermediate, Fossil Trust, Fossil New York and Fossil I are parties to that certain Second Amended and Restated Loan Agreement, dated effective April 30, 1995, as amended by (i) that certain First Amendment to Second Amended and Restated Loan Agreement, dated effective March 27, 1996, by and among the Bank, the Borrower, the Company, Fossil Intermediate, Fossil Trust, Fossil New York and Fossil I, and (ii) that certain Second Amendment to Second Amended and Restated Loan Agreement, dated effective May 3, 1996, by and among the Bank, the Borrower, the Company, Fossil Intermediate, Fossil Trust, Fossil New York, Fossil I and Fossil II (as amended, the "Loan Agreement"); B. The Bank and the Borrower desire to amend the Loan Agreement as hereinafter set forth. NOW, THEREFORE, in consideration of the premises herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties, intending to be legally bound, agree as follows: ARTICLE I Definitions ----------- 1.01 Capitalized terms used in this Amendment are defined in the Loan Agreement, as amended hereby, unless otherwise stated. ARTICLE II Amendments ---------- 2.01 Amendment to Section 1. Effective as of the date hereof, Section 1 of the Loan Agreement is hereby deleted in its entirety and the following substituted in lieu thereof: "1. The Line of Credit. Subject to, and upon the terms, conditions, covenants and agreements contained herein, the Bank agrees to loan the Borrower, at any time, and from time to time prior to the maturity of the Borrower's promissory note executed in conjunction with this Agreement such amounts as the Borrower may request up to, but not exceeding, an aggregate principal sum at any time outstanding equal to $30,000,000.00 (provided, however, that, notwithstanding the foregoing, during the period from September 1, 1996 through October 31, 1996, the Borrower may request an amount up to, but not exceeding, $37,000,000.00)(the 'Line of Credit'); within such limits and during such period, the Borrower may borrow, repay, and re-borrow hereunder. All loans under the Line of Credit shall be evidenced by the Borrower's Sixth Amended and Restated Master Revolving Credit Note (the 'Revolving Note'), substantially in form and substance satisfactory to the Bank, payable to the order of the Bank, and bearing interest upon the terms provided therein (but in no event to exceed the maximum non-usurious interest rate permitted by law). The principal of and interest on the Revolving Note shall be due and payable as set forth on the face of the Revolving Note. Notation by the Bank on its records shall constitute prima facie evidence of the amount and date of any payment or borrowing thereunder. (a) Renewals and Extensions. All renewals, extensions, modifications and rearrangements of the Revolving Note, if any, shall be deemed to be made pursuant to this Agreement, and accordingly, shall be subject to the terms and provisions hereof, and the Borrower shall be deemed to have ratified, as of such renewal, extension, modification or rearrangement date, all of the representations, covenants and agreements herein set forth. (b) Letters of Credit. Advances under the Line of Credit may also be made to fund Documentary or Stand-by Letters of Credit (as hereinafter defined) that are issued under the Revolving Note and are drawn upon, provided, the Bank may, in its own discretion, advance funds under the Line of Credit to fund such Documentary or Stand-by Letters of Credit (as hereinafter defined) when the Borrower does not reimburse the Bank for such funding. All such advances shall be added to the principal amount of the Revolving Note." 2.02 Amendment to Section 2. Effective as of the date hereof, Section 2 of the Loan Agreement is hereby deleted in its entirety and the following substituted in lieu thereof: "2. Documentary and Stand-by Letters of Credit. Subject to the conditions herein, the Bank shall (a) from time to time, at the request of the Borrower, issue documentary or stand-by letters of credit to Borrower's vendors for the acquisition of inventory for the Borrower (the 'Inventory Acquisition Letters of Credit') and (b) at the request of the Borrower, issue a stand-by letter of credit in an aggregate amount up to (Y)600,000,000.00 in favor of any Japanese domestic bank for the account of the Borrower (the 'JDB Letter of Credit')(the Inventory Acquisition Letters of Credit and the JDB Letter of Credit are hereinafter collectively referred to as the 'Documentary or Stand-by Letters of Credit'). The fees for such issuance shall be in accordance with the Bank's schedule of fees for issuance of letters of credit existing as of the time of issuance. Immediately upon issuance, such Documentary and Stand-by Letters of Credit shall be considered in computing the amount of funds available to the Borrower, as provided in Section 6 herein. The Bank shall not be obligated: (x)(i) during the period from September 1, 1996 through October 31, 1996, to issue Documentary or Stand-by Letters of Credit if the issuance of same would cause the Outstanding Revolving Credit (as hereinafter defined) to exceed the sum of (A) the Borrowing Base (as hereinafter defined) and (B) $7,000,000.00, and (ii) at any time after October 31, 1996, to issue Documentary or Stand-by Letters of Credit if the issuance of same would cause the Outstanding Revolving Credit to exceed the Borrowing Base; (y) to issue such Letters of Credit with an expiration date more than one hundred eighty (180) days after the maturity date of the Revolving Note; and (z) to extend the expiration date of such Letters of Credit to a date more than one hundred eighty (180) days after the maturity date of the Revolving Note." 2.03 Amendment to Section 6(a). Effective as of the date hereof, Section 6(a) of the Loan Agreement is hereby deleted in its entirety and the following substituted in lieu thereof: "(a) Revolving Note. The aggregate principal amount at any time outstanding under the Revolving Note for loans made in a currency other than in lawful money of Japan ('Yen'), plus one hundred twenty percent (120%) of the aggregate principal amount at any time outstanding under the Revolving Note for loans made in Yen (calculated by reference to the amount of United States of America dollars into which Bank determines it could, in accordance with its practice from time to time in the interbank foreign exchange market, convert such amount of Yen at its spot rate of exchange in effect at approximately 8:00 a.m. (Dallas, Texas time) on the day on which such loan is made), plus, one hundred twenty percent (120%) of the face amount of the JDB Letter of Credit (calculated by reference to the amount of United States of America dollars into which Bank determines it could, in accordance with its practice from time to time in the interbank foreign exchange market, convert such amount of Yen at its spot rate of exchange in effect at approximately 8:00 a.m. (Dallas, Texas time) on the date of determination), plus the face amount of all outstanding Documentary and Stand-by Letters of Credit (other than the JDB Letter of Credit) issued for the account of the Borrower, plus twenty percent (20%) of the aggregate amount of all foreign currency future contracts issued by the Bank for the account of the Borrower (said sum being herein referred to as the 'Outstanding Revolving Credit') shall not at any time exceed the lesser of (a) $30,000,000.00, or (b) the Borrowing Base (as hereinafter defined); provided, however, that, notwithstanding the foregoing, during the period from September 1, 1996 through October 31, 1996, the Outstanding Revolving Credit shall not at any time exceed the lesser of (a) $37,000,000.00, or (b) the sum of (i) the Borrowing Base and (ii) $7,000,000.00." 2.04 Amendment to Section 6(c). Effective as of the date hereof, Section 6(c) of the Loan Agreement is hereby deleted in its entirety and the following substituted in lieu thereof: "(c) Borrowing Base Compliance. In the event the Outstanding Revolving Credit at any time exceeds the Borrowing Base then, upon notice from the Bank, the Borrower shall immediately make such payments to the Bank necessary to reduce the Outstanding Revolving Credit to an amount such that the Outstanding Revolving Credit is less than or equal to the amount of the Borrowing Base; provided, however, that, notwithstanding the foregoing, during the period from September 1, 1996 through October 31, 1996, the term 'Borrowing Base' as used in this Section 6(c) shall be replaced by the phrase 'sum of (i) the Borrowing Base and (ii) $7,000,000.00.'" 2.05 Amendment to Section 16(a). Effective as of the date hereof, Section 16(a) of the Loan Agreement is hereby deleted in its entirety and the following substituted in lieu thereof: "(a) Debt. Create, incur, assume or suffer to exist any debt for borrowed money, whether by way of loan, or the issuance or sale of bonds, debentures, notes or securities, including deferred debt for the purchase price of assets, except (i) the loans described herein, (ii) revolving credit loans in an aggregate principal amount of up to (Y)600,000,000.00 from any Japanese domestic bank; provided, that the only security for such revolving credit loans shall be the JDB Letter of Credit, (iii) loans from one or more Guarantors to the Borrower or another Guarantor, so long as the indebtedness in respect of such loans is unsecured and fully subordinated to the indebtedness owing to the Bank pursuant to a written subordination agreement in form and substance satisfactory to the Bank, and (iv) current accounts payable and other current obligations (other than for borrowed money) arising out of transactions in the ordinary course of business." 2.06 Amendment to Section 19. Effective as of the date hereof, Section 19 of the Loan Agreement is hereby amended by deleting the reference therein to "First Interstate Bank of Texas, N.A." and substituting in lieu thereof "Wells Fargo Bank (Texas), National Association". ARTICLE III Conditions Precedent -------------------- 3.01 Conditions to Effectiveness. The effectiveness of this Amendment is subject to the satisfaction of the following conditions precedent, unless specifically waived in writing by the Bank: (a) The Bank shall have received the following documents, each in form and substance satisfactory to the Bank and its counsel: (i) This Amendment, duly executed by the Borrower, the Company, Fossil Intermediate, Fossil Trust, Fossil New York, Fossil I and Fossil II; (ii) A Revolving Note in the form of Exhibit A to this Amendment, duly executed by Borrower; and (iii) A company general certificate (hereinafter referred to as the "Company General Certificate")for the Company, certified by its Secretary or Assistant Secretary, acknowledging (A) that its Board of Directors has met and has adopted, approved, consented to and ratified resolutions which authorize the execution, delivery and performance of this Amendment, the Revolving Note and all other Loan Documents to which it is or is to be a party, and (B) the names of the officers authorized to sign this Amendment, the Revolving Note and each of the other Loan Documents to which it is or is to be a party (including the certificates contemplated herein) together with specimen signatures of such officers. The Company General Certificate shall conform to the Company General Certificate which is attached hereto as Exhibit B and incorporated herein for all purposes; (b) There shall have been no material adverse change in the financial condition of the Borrower or any Guarantor; (c) There shall be no material adverse litigation, either pending or threatened, against the Borrower or any Guarantor that could reasonably be expected to have a material adverse effect on the Borrower or such Guarantor; (d) The representations and warranties contained herein and in the Loan Agreement and the other Loan Documents, as each is amended hereby, shall be true and correct as of the date hereof, as if made on the date hereof; (e) No default or Event of Default shall have occurred and be continuing, unless such default or Event of Default has been specifically waived in writing by the Bank; (f) All corporate proceedings taken in connection with the transactions contemplated by this Amendment and all documents, instruments and other legal matters incident thereto shall be satisfactory to the Bank and its legal counsel; and (g) The Bank shall have received from the Borrower a closing fee in the amount of Five Thousand and No/100 Dollars ($5,000.00)(the "Closing Fee"), payable on the date hereof. The Closing Fee shall reimburse the Bank for its costs and expenses incurred in connection with the negotiation, execution and delivery of this Amendment, including the Bank's attorney's fees. ARTICLE IV Limited Waiver and Consent -------------------------- 4.01 By execution of this Agreement and upon satisfaction of the conditions precedent set forth in Article III of this Amendment, the Bank hereby (a) consents to the Borrower guaranteeing certain loans made by one or more financial institutions to the Borrower's officers and employees (provided, that the aggregate principal amount of such loans shall not exceed $50,000.00)(the "Officer Guarantees"), and (b) waives any default or Event of Default arising under the Loan Agreement solely by reason of the Borrower's violation of Section 16(b) of the Loan Agreement resulting from the Borrower entering into the Officer Guarantees. Except as specifically provided in this Article IV, nothing contained herein shall be construed as a waiver by the Bank of any covenant or provision of the Loan Agreement, the other Loan Documents, this Amendment, or of any other contract or instrument between the Borrower or the Guarantors and the Bank, and the failure of the Bank at any time or times hereafter to require strict performance by the Borrower or any Guarantor of any provision thereof shall not waive, affect or diminish any right of the Bank to thereafter demand strict compliance therewith. The Bank hereby reserves all rights granted under the Loan Agreement, the other Loan Documents, this Amendment and any other contract or instrument between the Borrower, the Guarantors and the Bank. ARTICLE V Ratifications, Representations and Warranties --------------------------------------------- 5.01 Ratifications. The terms and provisions set forth in this Amendment shall modify and supersede all inconsistent terms and provisions set forth in the Loan Agreement and the other Loan Documents, and, except as expressly modified and superseded by this Amendment, the terms and provisions of the Loan Agreement and the other Loan Documents are ratified and confirmed and shall continue in full force and effect. The parties hereto agree that the Loan Agreement and the other Loan Documents, as amended hereby, shall continue to be legal, valid, binding and enforceable in accordance with their respective terms. 5.02 Representations and Warranties. The Borrower, the Company, Fossil Intermediate, Fossil Trust, Fossil New York, Fossil I and Fossil II hereby represent and warrant to the Bank that (a) the execution, delivery and performance of this Amendment and any and all other Loan Documents executed and/or delivered in connection herewith have been duly authorized by all requisite corporate, partnership or trust proceedings, as appropriate, and will not contravene, or constitute a default under, any provision of applicable law or regulation or of the Agreement of Limited Partnership, Articles of Incorporation, By-Laws or Trust Agreement, as applicable, of the Borrower or any Guarantor, or of any mortgage, indenture, contract, agreement or other instrument, or any judgment, order or decree, binding upon the Borrower or any Guarantor; (b) the representations and warranties contained in the Loan Agreement, as amended hereby, and the other Loan Documents are true and correct on and as of the date hereof and on and as of the date of execution hereof as though made on and as of each such date; (c) no default or Event of Default under the Loan Agreement, as amended hereby, has occurred and is continuing, unless such default or Event of Default has been specifically waived in writing by the Bank; and (d) the Borrower and the Guarantors are in full compliance with all covenants and agreements contained in the Loan Agreement and the other Loan Documents, as amended hereby. ARTICLE VI Miscellaneous Provisions ------------------------ 6.01 Survival of Representations and Warranties. All representations and warranties made in the Loan Agreement or any other Loan Documents, including, without limitation, any document furnished in connection with this Amendment, shall survive the execution and delivery of this Amendment and the other Loan Documents, and no investigation by the Bank or any closing shall affect the representations and warranties or the right of the Bank to rely upon them. 6.02 Reference to Loan Agreement. Each of the Loan Agreement and the other Loan Documents, and any and all other agreements, documents or instruments now or hereafter executed and delivered pursuant to the terms hereof or pursuant to the terms of the Loan Agreement, as amended hereby, are hereby amended so that any reference in the Loan Agreement and such other Loan Documents to the Loan Agreement shall mean a reference to the Loan Agreement, as amended hereby. 6.03 Expenses of the Bank. As provided in the Loan Agreement, the Borrower agrees to pay on demand all reasonable costs and expenses incurred by the Bank in connection with the preparation, negotiation, and execution of this Amendment and the other Loan Documents executed pursuant hereto and any and all amendments, modifications, and supplements thereto, including, without limitation, the costs and fees of the Bank's legal counsel, and all costs and expenses incurred by the Bank in connection with the enforcement or preservation of any rights under the Loan Agreement, as amended hereby, or any other Loan Documents, including, without, limitation, the costs and fees of the Bank's legal counsel. 6.04 Severability. Any provision of this Amendment held by a court of competent jurisdiction to be invalid or unenforceable shall not impair or invalidate the remainder of this Amendment and the effect thereof shall be confined to the provision so held to be invalid or unenforceable. 6.05 Successors and Assigns. This Amendment is binding upon and shall inure to the benefit of the Borrower, the Guarantors and the Bank and their respective successors and assigns. 6.06 Counterparts. This Amendment may be executed in one or more counterparts, each of which when so executed shall be deemed to be an original, but all of which when taken together shall constitute one and the same instrument. 6.07 Effect of Waiver. No consent or waiver, express or implied, by the Bank to or for any breach of or deviation from any covenant or condition by the Borrower or any Guarantor shall be deemed a consent to or waiver of any other breach of the same or any other covenant, condition or duty. 6.08 Headings. The headings, captions, and arrangements used in this Amendment are for convenience only and shall not affect the interpretation of this Amendment. 6.09 Applicable Law. THIS AMENDMENT AND ALL OTHER AGREEMENTS EXECUTED PURSUANT HERETO SHALL BE DEEMED TO HAVE BEEN MADE AND TO BE PERFORMABLE IN AND SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE lAWS OF THE STATE OF TEXAS. 6.10 Final Agreement. THE LOAN AGREEMENT AND THE OTHER LOAN DOCUMENTS, EACH AS AMENDED HEREBY, REPRESENT THE ENTIRE EXPRESSION OF THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF ON THE DATE THIS AMENDMENT IS EXECUTED. THE LOAN AGREEMENT AND THE OTHER LOAN DOCUMENTS, AS AMENDED HEREBY, MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. NO MODIFICATION, RESCISSION, WAIVER, RELEASE OR AMENDMENT OF ANY PROVISION OF THIS AMENDMENT SHALL BE MADE, EXCEPT BY A WRITTEN AGREEMENT SIGNED BY THE BORROWER, THE GUARANTORS AND THE BANK. 6.11 Release. THE BORROWER HEREBY ACKNOWLEDGES THAT IT HAS NO DEFENSE, COUNTERCLAIM, OFFSET, CROSS-COMPLAINT, CLAIM OR DEMAND OF ANY KIND OR NATURE WHATSOEVER THAT CAN BE ASSERTED TO REDUCE OR ELIMINATE ALL OR ANY PART OF ITS LIABILITY TO REPAY THE "INDEBTEDNESS" OR TO SEEK AFFIRMATIVE RELIEF OR DAMAGES OF ANY KIND OR NATURE FROM THE BANK. THE BORROWER AND THE GUARANTORS HEREBY VOLUNTARILY AND KNOWINGLY RELEASE AND FOREVER DISCHARGE THE BANK, ITS PREDECESSORS, OFFICERS, DIRECTORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, FROM ALL POSSIBLE CLAIMS, DEMANDS, ACTIONS, CAUSES OF ACTION, DAMAGES, COSTS, EXPENSES, AND LIABILITIES WHATSOEVER, KNOWN OR UNKNOWN, ANTICIPATED OR UNANTICIPATED, SUSPECTED OR UNSUSPECTED, FIXED, CONTINGENT, OR CONDITIONAL, AT LAW OR IN EQUITY, ORIGINATING IN WHOLE OR IN PART ON OR BEFORE THE DATE THIS AMENDMENT IS EXECUTED, WHICH THE BORROWER OR THE GUARANTORS MAY NOW OR HEREAFTER HAVE AGAINST THE BANK, ITS PREDECESSORS, OFFICERS, DIRECTORS, AGENTS, EMPLOYEES, SUCCESSORS AND ASSIGNS, IF ANY, AND IRRESPECTIVE OF WHETHER ANY SUCH CLAIMS ARISE OUT OF CONTRACT, TORT, VIOLATION OF LAW OR REGULATIONS, OR OTHERWISE, AND ARISING FROM ANY LOANS OR EXTENSIONS OF CREDIT FROM THE BANK TO THE BORROWER UNDER THE LOAN AGREEMENT OR THE OTHER LOAN DOCUMENTS, INCLUDING, WITHOUT LIMITATION, ANY CONTRACTING FOR, CHARGING, TAKING, RESERVING, COLLECTING OR RECEIVING INTEREST IN EXCESS OF THE HIGHEST LAWFUL RATE APPLICABLE, THE EXERCISE OF ANY RIGHTS AND REMEDIES UNDER THE LOAN AGREEMENT OR OTHER LOAN DOCUMENTS, AND NEGOTIATION FOR AND EXECUTION OF THIS AMENDMENT. 6.12 Agreement for Binding Arbitration. Each party to this Amendment hereby acknowledges that it has agreed to be bound by the terms and provisions of the Bank's current Arbitration Program, which is incorporated by reference herein and is acknowledged as received by the parties pursuant to which any and all disputes shall be resolved by mandatory binding arbitration upon the request of any party. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, this Amendment has been executed and is effective as of the date first above-written. "BANK" WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION, By:___________________________________________ Jeffrey S.A. Cook Vice President "BORROWER" FOSSIL PARTNERS, L.P. By: Fossil, Inc., its general partner By:__________________________________________ Randy S. Kercho, Executive Vice President and Chief Financial Officer "GUARANTORS" FOSSIL, INC. By:___________________________________________ Randy S. Kercho, Executive Vice President and Chief Financial Officer FOSSIL INTERMEDIATE, INC. By:___________________________________________ Kosta N. Kartsotis, President FOSSIL TRUST By:___________________________________________ Randy S. Kercho, Trustee FOSSIL NEW YORK, INC. By:___________________________________________ Kosta N. Kartsotis, Chief Executive Officer FOSSIL STORES I, INC. By:___________________________________________ Randy S. Kercho, Treasurer FOSSIL STORES II, INC. By:___________________________________________ Randy S. Kercho, Treasurer Exhibits: A - Form of Revolving Note B - Form of Company General Certificate EXHIBIT A ---------- FORM OF REVOLVING NOTE (See Attached) EXHIBIT B --------- FORM OF COMPANY GENERAL CERTIFICATE (See Attached) EX-13 3 EXHIBIT 13 1997 FOSSIL ANNUAL REPORT Company Profile ........................................................... 2 Financial Highlights ...................................................... 3 Letter to Stockholders .................................................... 4 Company Overview .......................................................... 6 Management Discussion ..................................................... 10 Financial Information ..................................................... 23 Corporate Information ..................................................... 40 1 COMPANY PROFILE FOSSIL is a design and marketing company that specializes in consumer products predicated on fashion and value. The Company's flagship product, FOSSIL brand watches, is sold in department stores and other upscale retailers in over seventy countries around the world. Complementary lines of accessories such as leather goods and sunglasses also capitalize on the increasing awareness of the FOSSIL brand. The wholesome brand image of 1950s Americana is targeted to today's value-driven, back-to-basics consumer. Designs for the distinctive tin packaging, advertising materials, and point-of-purchase displays are conceived in an in-house creative services department. Products are planned and developed using a series of design, manufacturing and marketing systems which are flexible and efficient. The Company's strategy is to capture an increasing market share of a growing number of markets by providing customers with high quality, value-driven products which are marketed in a unique manner. The Company also develops products under the RELIC and FSL brand names as well as creates private label products for some of the most distinguished companies in the world. [Graphic presentation of Net Sales, Operating Income, Net Income and Stockholders' equity for fiscal years 1997, 1996, 1995, 1994 and 1993.] 2
SELECTED CONSOLIDATED FINANCIAL HIGHLIGHTS (In thousands, except per share amounts) 1997 1996 1995 1994 1993 Net sales $244,798 $205,899 $181,114 $161,883 $105,089 Gross profit 117,528 98,038 82,900 71,880 45,343 Operating income 34,610 24,373 20,463 26,217 16,576 Income before taxes 32,151 23,040 20,142 24,923 16,718 Net income (1) 18,942 13,591 12,057 15,345 11,485 Basic earnings per share (1)(2) 0.94 0.69 0.61 0.78 0.61 Diluted earnings per share (1)(2) $ 0.91 0.68 0.60 0.77 0.60 Weighted average common and common equivalent shares outstanding: Basic (1)(2) 20,136 19,783 19,761 19,720 18,765 Diluted (1)(2) 20,833 20,068 19,940 19,956 18,993 Working capital $ 70,603 $ 59,861 $ 49,251 $ 41,434 $ 27,692 Total assets 139,570 118,978 96,994 80,420 46,539 Long-term debt -- 4,350 4,811 4,750 1,000 Stockholders' equity 95,263 74,568 61,269 48,906 33,025 (1) 1993 amounts and prior are pro forma (2) All weighted average share and per share data and 1997 actual share data has been adjusted to reflect a three-for-two stock split effected in the form of a stock dividend payable on April 8, 1998.
STOCK INFORMATION FOSSIL'S common stock prices are published daily in The Wall Street Journal and other publications under the Nasdaq National Market Listing. The stock is traded under the ticker symbol "FOSL." The following are the high and low sale prices of the Company's stock per the Nasdaq National Market. All per share data has been adjusted to reflect a three-for-two stock split effected in the form of a stock dividend payable on April 8, 1998 to all stockholders of record on March 25, 1998. Stock prices have been adjusted to the nearest traded amount.
1997 1996 High Low High Low First quarter $ 9 3/4 $ 7 $ 7 1/2 $4 1/2 Second quarter 11 7/8 8 1/4 10 7/8 6 1/2 Third quarter 15 1/2 11 9 3/4 4 7/8 Fourth quarter 17 5/8 11 10 1/2 7 5/8
3 LETTER TO STOCKHOLDERS To our stockholders: We are pleased with our progress in 1997. o FOSSIL recaptured its position as the leading supplier of fashion watches to department stores in the United States. o Other FOSSIL branded accessories continued to show dramatic growth domestically. o Our retail stores continued to enhance our brand and served as a showcase for our diverse products. Our outlet stores allowed us to cleanse our inventory in a profitable manner. o Our international subsidiaries each made significant strides in terms of improving our presence in important foreign markets as well as improving profitability. o Our non-FOSSIL watch businesses continued to grow in size and profitability and expanded into new segments of the industry. o Our product development teams and manufacturing operations in the Far East continued to exceed our expectations in terms of expanding our creative and manufacturing capabilities in a profitable manner. 4 All in all, 1997 was our best year ever. While we believe we are positioned for continued success in 1998, we are approaching our immediate future with cautious aggression. "After victory, tighten your chinstrap" is an old Japanese adage which appropriately describes the current mind set at Fossil. We are focused on improving our creative capabilities, our cost efficiencies and our competitive position within all markets in which we compete. The opportunities presented through the evolution of FOSSIL as a lifestyle brand are tremendous. Our brand is diverse in that it appeals to both male and female consumers and can apply to a number of product categories that are only limited by one's imagination. Also, the FOSSIL brand easily crosses international borders. This is evidenced by the fact that almost one third of our revenues in 1997 came from international sources. We are continually evaluating new opportunities to expand our product offerings and our global retail presence via licensing relationships and other partnerships with world class companies. Product development teams continue to aggressively develop exciting new watch products and programs which enable us to seek bigger percentages of business within the watch assortments of existing customers. At the same time, we are systematically developing our distribution capabilities in order to enter new distribution channels, worldwide. We believe that over the next several years we can achieve significant growth by competing in new layers of our existing businesses with relatively little increase in our present infrastructure. We are proud of our financial performance in 1997 and we are excited about the diversity and growth potential in untapped segments of our business. The power of the FOSSIL brand is rapidly opening doors to new opportunities and we are navigating those opportunities with the long term as our focus. We believe the FOSSIL brand will rapidly become prominent within a multitude of product categories in a number of markets. Our five year anniversary as a publicly traded company is upon us. We have weathered numerous storms and, through it all, believe that we have continually learned how to be a better public company. We will do our best to continue the learning process. We appreciate everyone who continues to play a hand in our growth... especially our dedicated employees, customers, suppliers and, most importantly, our consumers. Sincerely, /s/ Tom Kartsotis - --------------------- Tom Kartsotis Chairman of the Board /s/ Kosta Kartsotis - --------------------- Kosta Kartsotis President 5 COMPANY OVERVIEW The Company's primary objective is to create value by building the FOSSIL brand name. A strong brand identity encourages retailers to increase the visibility of the FOSSIL brand within their assortments and thus increase sales. A strong brand also provides opportunities to expand into new product categories. The FOSSIL brand continued to be one of the leading fashion watch brands in 1997, while continuing to gain momentum in sales on non-watch products and increasing its brand presence globally. Watches: The FOSSIL line continued its leadership position in department stores with the highly successful second quarter launch of FOSSIL Steel, featuring solid stainless steel bracelets and casebacks for both men and women. FOSSIL BLUE, a line of water resistant sport watches introduced in 1996, has become the dominant product category in the Fossil line. Contributing to the dominance of Fossil Blue was the introduction of Blue Teq, a group of chronograph look watches in late 1997. 6 Leathers: The leather division continued to exhibit strong sales and earnings growth. Handbags, introduced in 1996, continued to increase market share and enhance the visibility and sales of the Company's other leather categories, including men's and women's small leather goods and belts. During 1998, a line of FOSSIL nylon handbags will be introduced in addition to a group of bags with a sport feel and look under the Company's FSL brand. Strong growth should continue in the leather product category during 1998 as key basic collections continue to increase in sales and new lines of more classic, less ornamented styles provide a fresh and exciting product assortment. Sunglasses: The sunglass market presented a challenge for the Company in 1997, as a number of competitors entered the market pushing supply above apparent consumer demand. While the majority of sunglass companies, including FOSSIL, recorded fewer sales in this category during 1997, the Company was able to maintain a strong presence in its department store distribution channel as well as optical stores such as LensCrafters. The eyewear division ended 1997 on a strong note as a new collection of more popularly priced sunglasses tested successfully and continued the rollout of products into an increasing number of Sunglass Hut locations. FOSSIL sunwear complements the quality and value of the FOSSIL brand perfectly by providing 100% UV protection, optical quality materials and the unique tin box with its assortment. International: Aside from the Company's expanding presence in Europe and the Far East through Company owned sales and distribution locations, an increasing number of distributors joined the Company in 1997. New distributors covering Canada, the United Kingdom, Venezuela, Columbia/Ecuador, Lebanon and New Zealand were added throughout the year. In addition to selling the Company's products to retailers, our distributors often open FOSSIL stores or kiosks within their assigned territories to enhance the brand's image. Currently there are over 40 FOSSIL stores or kiosks outside the U.S. owned and operated by our distributors. RELIC: RELIC continued its strong presence in national and regional chain department stores and specialty stores during 1997. This past year saw the RELIC brand expand into two new categories of watches that paralleled the success 7 of FOSSIL BLUE and Adjust-o-matic categories. The RELIC WET category of performance sport watches features stainless steel bracelets and are water resistant to 165 ft. The new Adjust-a- link watches for women, which enable the retail store to quickly shorten the length of a bracelet without tools, have been an instant success. The RELIC brand continued to expand its brand statement with the successful introduction of small leather goods. This RELIC brand expansion should continue in 1998. Emporio Armani: In 1997, the Company entered into a worldwide, multi-year licensing agreement with Giorgio Armani for Emporio Armani Orologi, a new line of watches. 8 This collection was launched in October in Milan. The Armani line features distinctive interpretations of retro and modern design. Throughout the collection, the Emporio Armani name and Eagle logo are used as a background element on the dials, etched into the casings, or incorporated more subtly into the band design. These watches are being sold in Emporio Armani Boutiques, better department stores, specialty stores, and select jewelry stores worldwide. Licensing: The Company continues to broaden the product reach of the brand through strategic licensing agreements. In 1997, Itochu Fashion Systems initiated development of a full casual apparel line for the Japanese market. These products will be tested in select Japanese department stores beginning in the spring of 1998. Domestically, FOSSIL brand men's underwear was introduced in the fourth quarter of 1997. The Company has also signed an agreement for outerwear with London Fog, the world leader in this category. These products are scheduled to launch in the fall of 1999. The Company will continue to pursue licensed opportunities as growing brand awareness allows the Company to attract strong market leaders in targeted product categories. Private Label: In addition to building its own brand, the Company also designs and manufactures private label products for some of the most prestigious companies in the world including national retailers, entertainment companies and theme restaurants. The Company continues to expand its core private label business as well as integrate other product categories such as leather goods and eyewear. The Company's premium/incentive division featured substantial gains in 1997 utilizing its sourcing, design and development systems to translate many corporate themes, events or promotions into a comprehensive custom program. FOSSIL General Stores: The Company was operating six mall-based FOSSIL stores at the end of 1997 having added three new locations during the year. New stores were opened in Houston, Texas (the Galleria), Minneapolis, Minnesota (The Mall of America) and Columbus, Ohio (Tuttle Crossing). These stores continue to provide an excellent as well as profitable format to display the Company's increasing product assortments and convey the FOSSIL brand image. The Company also operates twenty-seven outlet stores, coast to coast, allowing the Company to properly control the liquidation of discontinued styles while maintaining the integrity of the FOSSIL brand image. 9 MANAGEMENT DISCUSSION AND ANALYSIS Since the Company's origination in 1984, sales growth has been principally attributable to increased sales of FOSSIL brand watches both domestically and in a growing number of international markets. Adding to the Company's sales growth has been the addition of FOSSIL brand leather goods and sunglasses, the diversification into FOSSIL outlet and retail stores and the introduction of accessories and watches under other owned brands (RELIC and FSL). Increased sales volume has also been generated through leveraging the Company's infrastructure of sourcing, design and developmental systems for the production of its products for premium and corporate gift programs as well as under the names of internationally recognized designers, specialty retailers, entertainment companies and theme restaurants. The Company's products are marketed internationally mainly though major department stores and specialty retailers. The Company maintains sales and distribution offices in the United States, Germany, Italy, Japan, Spain and Hong Kong. In addition to sales through the Company's offices, the Company also currently distributes its products to over 60 additional countries through licensed distributors. 1997 HIGHLIGHTS o Sales volume of FOSSIL Blue, a line of mainly metal-bracelet, water resistant sport watches first introduced in mid-1996, accounted for nearly half of the Company's FOSSIL brand watch business domestically. 10 o A line of stainless steel watches, FOSSIL Steel, and chronograph look watches, BLUE TEQ, were introduced under the FOSSIL brand in mid- and late-1997, respectively. Both of these introductions were well received by the consumer and positively impacted sales volumes. o The newly designed line of FOSSIL handbags, first shipped in mid-1996, continued to be a success in the retail marketplace. Aside from increased sales volumes, their success at retail also has raised the awareness and credibility of the Company's other leather products, positively impacting sales volumes as well. o Sunglass sales were negatively impacted as a multitude of competitors entered the marketplace driving supply above apparent consumer demand. The Company quickly reacted to the market conditions, by producing a new sunglass line with a wider breadth of price points and design. o The Company opened three additional FOSSIL retail stores in high traffic, international destination type malls bringing the total number of mall-based retail stores to six at the end of the year. o Several multi-year licensing agreements were awarded to companies for the use of the FOSSIL brand name on their products. These included FOSSIL brand underwear and lounge wear for the domestic market introduced in late 1997, FOSSIL brand apparel in Japan to be introduced during 1998 and FOSSIL brand outerwear to be introduced domestically during 1999. o The Company entered into a worldwide, multi-year licensing agreement with Giorgio Armani for the rights to design, produce and market a line of Emporio Armani watches. Distribution began in September 1997. o The Company acquired the remaining 40% of the capital stock of its distribution company covering Italy and the remaining 35% of the capital stock of one of the Company's four main watch assembly factories. 11 [Graphic depiction of Fossil sunglasses] 12 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated: (i) the percentages of the Company's net sales represented by certain line items from the Company's consolidated statements of income and (ii) the percentage changes in these line items between the years indicated.
percentage percentage change change from year from year Fiscal year ended 1997 1996 1996 1995 1995 Net sales 100.0% 18.9% 100.0% 13.7% 100.0% Cost of sales (52.0) 18.0 (52.4) 9.8 (54.2) ----------------------------------------------- Gross profit 48.0 19.9 47.6 18.3 45.8 Operating expenses (33.9) 12.6 (35.8) 18.0 (34.5) ----------------------------------------------- Operating income 14.1 42.0 11.8 19.1 11.3 Interest expense (0.4) (20.7) (0.6) 7.9 (0.6) Other income (expense) (0.6) (1077.6) -- (116.0) 0.4 ----------------------------------------------- Income before income taxes 13.1 39.5 11.2 14.4 11.1 ----------------------------------------------- Income taxes: Federal, State, Foreign (5.4) 39.8 (4.6) 16.9 (4.4) ----------------------------------------------- Net income 7.7% 39.4% 6.6% 12.7% 6.7%
The following table sets forth certain components of the Company's consolidated net sales and the percentage relationship of the components to consolidated net sales for the years indicated (in millions, except percentage data):
Fiscal year ended 1997 1996 1995 1997 1996 1995 International: Europe $ 45.2 $ 45.9 $ 40.0 18.4% 22.3% 22.1% Other 30.8 15.2 18.7 12.6 7.4 10.3 ----------------------------------------------------- Total International 76.0 61.1 58.7 31.0 29.7 32.4 ----------------------------------------------------- Domestic: Watch products 101.2 86.4 89.4 41.3 41.9 49.4 Other products 47.6 44.5 25.7 19.5 21.6 14.2 ----------------------------------------------------- Total 148.8 130.9 115.1 60.8 63.5 63.6 Stores 20.0 13.9 7.3 8.2 6.8 4.0 ----------------------------------------------------- Total Domestic 168.8 144.8 122.4 69.0 70.3 67.6 ----------------------------------------------------- Total Net Sales $ 244.8 $ 205.9 $ 181.1 100.0% 100.0% 100.0% -----------------------------------------------------
13 Net Sales. Worldwide sales volume of FOSSIL branded watches showed strong gains in the later half of 1996 and throughout 1997 due primarily to the increase of metal bracelet watches in the Company's sales mix and the popularity of two FOSSIL watch lines, FOSSIL Blue and FOSSIL Steel. Metal bracelet watches have increased significantly as a percentage of the Company's watch mix in response to a dramatic shift in consumer preference away from leather strap watches during 1995. Sales of non-branded watches used for premium incentives and watches sold under certain licensing agreements also positively impacted net sales during 1997. Leather and sunglass product sales, that comprise the majority of the domestic: Other Products sales line in the above table, both contributed significantly to overall sales increases in 1996. While the Company continued to increase its market share in leather goods during 1997, sunglass sales declined. Sales increases in the sunglass line improved dramatically, however, in the fourth quarter of 1997, increasing approximately 20% over the prior year same period. The Company entered into owned retail operations in early 1995. At the end of 1997, the Company had 27 outlet store locations and 6 mall-based locations throughout the U.S. Growth in the number of store locations, as well as increases in same store sales, have added to sales growth in 1996 and 1997. Management anticipates that sales volumes will continue to increase in 1998 at approximately the 1997 rate with the exception of the second quarter which will likely fall below the average 1997 growth rate. During the second quarter of 1997, the Company had a one-time international-based sale amounting to approximately $6 million of non-branded watches used as a premium incentive. Sales increases during 1998 will likely stem from continued sales momentum across the Company's product lines and geographic regions. 14 Gross Profit. Gross profit margins increased over the past two years from 45.8% in 1995, to 47.6% in 1996, to 48.0% in 1997. The increases in gross profit margin are primarily attributable to an increase in the amount of the Company's watch products supplied by its majority-owned assembly facilities and increases in sales through the Company-owned retail locations. Additionally, during 1996 and 1997, the Company's purchase cost of certain watch components decreased due to the strength of the U.S. dollar over the Japanese Yen. Management believes that the Company's gross profit margins in 1998 will approximate 1997 levels. Operating Expenses. Total selling, general and administrative expenses as a percentage of net sales were 33.9% in 1997 compared to 35.8% in 1996 and 34.5% in 1995. The aggregate increases in operating expenses were due primarily to costs necessary to support increased sales volumes and operating costs of both new ventures and from the Company's increasing outlet and retail store locations. Operating expense ratios were positively impacted in 1997 by leveraging expenses against higher sales volumes and as a result of the reduction in operating expenses incurred in France and the United Kingdom, where the Company has curtailed its owned operations in favor of sales through independent distributors. Management believes the operating expense ratio for 1998 will marginally improve as a result of leveraging fixed costs on higher sales volumes and layering on sales of certain licensed brand name watches with only minimal infrastructure increases. Other Income (Expense). Other income (expense) typically reflects the minority interests in the profit (loss) of the Company's majority-owned operations. Other income (expense) has moved from an income item in 1995 to an expense item in 1997. The fluctuation in this income statement line item has generally been impacted by unusual charges. Other income in 1995 was positively impacted by the income recognition of approximately $1.6 million, recorded from non-recurring consulting services performed and from insurance proceeds related to a fire at one of the Company's operations. During 1996, income derived from refunds from certain prior year duty payments in addition to interest income substantially offset minority interest expense. In 1997, the net expense was primarily a result of legal settlements of approximately $700,000 as well as increased foreign currency losses due primarily to the strength of the U.S. dollar. Provision for Income Taxes. In 1997 and 1996, the Company's effective tax rate was approximately 41.0% compared to 40.1% in 1995. The 1996 increase resulted primarily from losses incurred in countries where the Company had commenced operations in 1996 and late 1995. The Company will not recognize any tax benefits in these countries until realization is assured. Effective tax rates have also risen as the Company accrued taxes at U.S. tax rates in certain lower tax jurisdictions in anticipation of possible repatriation of earnings. Management believes that the effective tax rate during 1998 will approximate 1997 levels. 15 EFFECTS OF INFLATION Management does not believe that inflation has had a material impact on results of operations for the periods presented. Substantial increases in costs, however, could have an impact on the Company and the industry. Management believes that, to the extent inflation affects its costs in the future, the Company could generally offset inflation by increasing prices if competitive conditions permit. YEAR 2000 COMPLIANCE Computer programs that were written using two digits rather than four digits to define the applicable year may recognize a date using "00" as the year 1900 rather than the year 2000. This result is commonly referred to as the "Year 2000" problem. The Year 2000 problem could result in information system failures or miscalculations. Beginning in 1997, the Company initiated a program to evaluate whether internally developed and/or purchased computer programs that utilize embedded date codes could experience 16 operational problems when the year 2000 is reached. The scope of this effort addressed internal computer systems and supplier capabilities. The Company is completing an extensive review of its businesses to determine whether or not purchased and internally developed computer programs are Year 2000 compliant, as well as the remedial action and related costs associated with any required modifications or replacements. A significant amount of information has been collected and analyzed as part of this review; however, the process will not be completed until the end of fiscal year 1998. The Company plans to complete all remediation efforts for its critical systems prior to the year 2000. Based upon its evaluation to date, management currently believes that, while the Company will incur internal and external costs to address the Year 2000 problem, such costs will not have a material impact on the operations, cash flows or financial condition of the Company in future years. LIQUIDITY AND CAPITAL RESOURCES The Company's general business operations historically have not required significant capital expenditures. The Company built out 29 store locations during 1996 and 1995, totaling $3.9 million in leasehold improvement expenditures. During 1997, four additional store locations were added in addition to the construction of a 138,000 sq. ft. warehouse and distribution facility. The construction costs of the new facility were approximately $4.4 million. Long-term financing of $5.0 million was obtained in 1994 to cover building projects of which $4.4 million was outstanding at year-end. During January 1998, the Company paid this long-term credit facility in full with available cash. Short-term credit facilities totaling approximately $43.0 million are available to the Company for general working capital needs of which $3.5 million was outstanding at the end of 1997. Management believes the Company's financial position remains extremely strong. Working capital of $70.6 million and net cash balances (defined as cash and cash equivalents less current notes payable) of $13.2 million existed at the end of fiscal 1997 compared to working capital of $59.9 million and net cash balances of $1.5 million as of 17 December 31, 1996. Management believes that cash flow from operations and existing credit facilities will be sufficient to satisfy its working capital expenditure requirements for at least twelve months. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board issued four new standards during 1997 that require additional financial reporting disclosures. See Note 1 to the Consolidated 18 Financial Statements of the Company for a discussion of the new standards. The Company does not expect the adoption of these standards to have a material impact on its financial condition or results of operations. FORWARD LOOKING STATEMENTS Included within management's discussion of the Company's operating results and this annual report, forward- looking statements were made regarding expectations for 1998. The actual results may differ materially from those expressed by these forward-looking statements. Significant factors that could cause the Company's 1998 operating results to differ materially from management's current expectations include, among other items, significant changes in consumer spending patterns or preferences, competition in the Company's product areas, international in comparison to domestic sales mix, changes in foreign currency valuations in relation to the United States Dollar, principally the German Mark, Italian Lira and Japanese Yen, an inability of management to control operating expenses in relation to net sales without damaging the long-term direction of the Company and the risks and uncertainties set forth in the Company's report on Form 8-K dated March 31, 1997. SELECTED QUARTERLY FINANCIAL DATA The table on page 19 sets forth selected quarterly financial information. The information is derived from unaudited consolidated financial statements of the Company and includes, in the opinion of management, all normal and recurring adjustments that management considers necessary for a fair statement of results for such periods. The operating results for any quarter are not necessarily indicative of results for any future period. 19
Fiscal Year 1997 (dollars in thousands, 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr except per share amount) Net sales $47,449 $56,932 $61,013 $79,404 Gross profit 23,195 26,305 29,690 38,338 Operating expenses 17,735 19,527 19,875 25,781 Operating income 5,460 6,778 9,815 12,557 Income before income taxes 5,041 6,137 9,303 11,670 Provision for income taxes 2,067 2,503 3,793 4,846 Net income 2,974 3,634 5,510 6,824 Basic earnings per share 0.15 0.18 0.27 0.34 Diluted earnings per share 0.15 0.18 0.26 0.32 Gross profit as a percentage of net sales 48.9% 46.2% 48.7% 48.3% Operating expenses as a percentage of net sales 37.4% 34.3% 32.6% 32.5% Operating income as a percentage of net sales 11.5% 11.9% 16.1% 15.8% Fiscal Year 1996 (dollars in thousands, 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr except per share amount) Net sales $42,909 $45,238 $52,821 $64,931 Gross profit 19,036 22,463 25,756 30,783 Operating expenses 14,787 17,862 18,478 22,538 Operating income 4,249 4,601 7,278 8,245 Income before income taxes 3,902 4,464 6,491 8,183 Provision for income taxes 1,562 1,880 2,661 3,346 Net income 2,340 2,584 3,830 4,837 Basic earnings per share 0.12 0.13 0.19 0.24 Diluted earnings per share 0.12 0.13 0.19 0.24 Gross profit as a percentage of net sales 44.4% 49.7% 48.8% 47.4% Operating expenses as a percentage of net sales 34.5% 39.5% 35.0% 34.7% Operating income as a percentage of net sales 9.9% 10.2% 13.8% 12.7%
While the majority of the Company's products are not seasonal in nature, a significant portion of the Company's net sales and operating income are generally derived in the second half of the year. The Company's fourth quarter, which includes the Christmas season, typically generates 20 in excess of 30% of the Company's annual operating income, while the first quarter generally accounts for less than 20% of the annual operating income. The amount of net sales and operating income generated during the first quarter is affected by the levels of inventory held by retailers at the end of Christmas season, as well as general economic conditions and other factors beyond the Company's control. In general, high levels of inventory at the end of the Christmas season may have an adverse effect on net sales and operating income in the first quarter as a result of lower levels of restocking orders placed by retailers. Management currently believes that the Company's inventory levels at its major customers as of the end of 1997 were not substantially above or below targeted levels and therefore should not significantly impact retailers restocking orders in the first quarter of 1998. As the Company increases the amount of owned outlet and retail stores, it would generally amplify the Company's seasonality by decreasing the Company's operating income in the first quarter and increasing the operating income in the fourth quarter. The results of operations for a particular quarter may also vary due to a number of factors, including retail, economic and monetary conditions, timing of orders or holidays and the mix of the products sold by the Company. During the 1997 second quarter gross profit margins decreased principally as a result of the low gross profit margin realized on the significant sale of the non-branded premium watches. 21 FINANCIAL INFORMATON 22 INDEPENDENT AUDITORS' REPORT To the Directors and Stockholders of Fossil, Inc.: We have audited the accompanying consolidated balance sheets of Fossil, Inc. and subsidiaries as of January 3, 1998 and December 31, 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended January 3, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Fossil, Inc. and subsidiaries at January 3, 1998 and December 31, 1996, and the results of their operations and their cash flows for each of the three years in the period ended January 3, 1998, in conformity with generally accepted accounting principles. Deloitte & Touche LLP Dallas, Texas February 19, 1998 (except for the first paragraph of Note 10 which is as of March 4, 1998) REPORT OF MANAGEMENT The accompanying consolidated financial statements and other information contained in this Annual Report have been prepared by management. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based upon our best estimates and judgements. To help assure that financial information is reliable and that assets are safeguarded, management maintains a system of internal controls and procedures which it believes is effective in accomplishing these objectives. These controls and procedures are designed to provide reasonable assurance, at appropriate costs, that transactions are executed and recorded in accordance with management's authorization. The consolidated financial statements and related notes thereto have been audited by Deloitte & Touche LLP, independent auditors. The accompanying auditors' report expresses an independent professional opinion on the fairness of presentation of management's financial statements. The Audit Committee of the Board of Directors is composed of the Company's outside directors, and is responsible for selecting the independent auditing firm to be retained for the coming year. The Audit Committee meets periodically with the independent auditors, as well as with management, to review internal accounting controls and financial reporting matters. The independent auditors also meet privately on occasion with the Audit Committee, to discuss the scope and results of their audits and any recommendations regarding the system of internal accounting controls. /s/ Tom Kartsotis /s/ Randy S. Kercho - --------------------------- -------------------------- Tom Kartsotis Randy S. Kercho Chairman of the Board and Executive Vice President Chief Executive Officer and Chief Financial Officer 23 CONSOLIDATED BALANCE SHEETS
FISCAL YEAR END 1997 1996 Assets Current assets: Cash and cash equivalents $ 21,103,581 $ 11,981,246 Accounts receivable-net 34,237,526 30,252,964 Inventories 51,382,160 49,782,555 Deferred income tax benefits 4,503,749 3,666,344 Prepaid expenses and other current assets 2,432,282 1,942,791 ------------------------------ Total current assets 113,659,298 97,625,900 Property, plant and equipment - net 21,073,333 16,718,976 Intangible and other assets 4,837,259 4,633,193 ------------------------------ $ 139,569,890 $ 118,978,069 ------------------------------ Liabilities and Stockholders' Equity Current liabilities: Notes payable: Banks $ 7,862,145 $ 9,505,400 Affiliates -- 1,000,744 Accounts payable 9,609,805 7,476,324 Accrued expenses: Co-op advertising 8,700,696 7,857,196 Compensation 2,665,485 2,154,996 Other 8,714,067 7,931,693 Income taxes payable 5,504,304 1,838,656 ------------------------------ Total current liabilities 43,056,502 37,765,009 ------------------------------ Long-term debt -- 4,350,000 Commitments (Note 9) Minority interest in subsidiaries 1,250,405 2,295,026 Stockholders' equity: Common stock, shares issued and outstanding -20,308,503 and 13,242,994, respectively 203,085 132,430 Additional paid-in capital 26,021,255 22,766,468 Retained earnings 71,257,176 52,315,069 Cumulative translation adjustment (2,218,533) (645,933) ------------------------------ Total stockholders' equity 95,262,983 74,568,034 ------------------------------ $139,569,890 $ 118,978,069 ------------------------------ See notes to consolidated financial statements.
24
CONSOLIDATED STATEMENTS OF INCOME FISCAL YEAR 1997 1996 1995 Net sales $ 244,797,532 $ 205,899,262 $ 181,114,447 Cost of sales 127,269,749 107,861,291 98,214,748 ----------------------------------------------- Gross profit 117,527,783 98,037,971 82,899,699 Operating expenses: Selling and distribution 58,065,138 50,638,117 42,581,303 General and administrative 24,852,550 23,026,895 19,854,943 ----------------------------------------------- Total operating expenses 82,917,688 73,665,012 62,436,246 ----------------------------------------------- Operating income 34,610,095 24,372,959 20,463,453 Interest expense (956,182) (1,205,233) (1,116,883) Other income (expense) - net (1,502,806) (127,619) 795,894 ----------------------------------------------- Income before income taxes 32,151,107 23,040,107 20,142,464 Provision for income taxes 13,209,000 9,449,000 8,085,000 ----------------------------------------------- Net income $ 18,942,107 $ 13,591,107 $ 12,057,464 ----------------------------------------------- Basic earnings per share $ 0.94 $ 0.69 $ 0.61 ----------------------------------------------- Diluted earnings per share $ 0.91 $ 0.68 $ 0.60 ----------------------------------------------- Weighted average common and common equivalent shares outstanding: Basic 20,135,540 19,783,172 19,760,693 Diluted 20,833,431 20,067,653 19,939,560 See notes to consolidated financial statements.
25
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY common stock additional cumulative total paid-in retained translation stockholder's shares par value capital earnings adjustment equity Balance, Fiscal Year End 1994 13,162,924 $ 131,629 $ 22,022,755 $ 26,666,498 $ 84,863 $ 48,905,745 Common Stock issued upon exercise of stock options 19,409 194 196,937 -- -- 197,131 Net Income -- -- -- 12,057,464 -- 12,057,464 Foreign currency translation adjustment -- -- -- -- 109,118 109,118 ----------------------------------------------------------------------------------------- Balance, Fiscal Year End 1995 13,182,333 131,823 22,219,692 38,723,962 193,981 61,269,458 Common stock issued upon exercise of stock options 10,661 107 106,651 -- -- 106,758 Common stock issued for purchase of certain minority interests 50,000 500 440,125 -- -- 440,625 Net income -- -- -- 13,591,107 -- 13,591,107 Foreign currency translation adjustment -- -- -- -- (839,914) (839,914) ----------------------------------------------------------------------------------------- Balance, Fiscal Year End 1996 13,242,994 132,430 22,766,468 52,315,069 (645,933) 74,568,034 Common stock issued upon exercise of stock options 167,899 1,679 1,622,711 -- -- 1,624,390 Tax benefit derived from exercise of stock options -- -- 464,000 -- -- 464,000 Common stock issued for purchase of certain minority interests 128,109 1,281 1,235,771 -- -- 1,237,052 Three-for-two stock split 6,769,501 67,695 (67,695) -- -- -- Net income -- -- -- 18,942,107 -- 18,942,107 Foreign currency translation adjustment -- -- -- -- (1,572,600) (1,572,600) ----------------------------------------------------------------------------------------- Balance, Fiscal Year End 1997 $ 20,308,503 $ 203,085 $ 26,021,255 $ 71,257,176 $ (2,218,533) $ 95,262,983 ----------------------------------------------------------------------------------------- See notes to consolidated financial statements.
26
CONSOLIDATED STATEMENTS OF CASH FLOWS Fiscal Year 1997 1996 1995 ---- ---- ---- Operating Activities: Net income $ 18,942,107 $ 13,591,107 $ 12,057,464 Noncash items affecting net income: Minority interest in subsidiaries 343,879 362,084 685,055 Depreciation and amortization 3,047,329 3,125,598 2,481,649 Increase in allowance for doubtful accounts 407,686 1,424,243 911,298 Increase in allowance for returns - net of related inventory in transit 784,300 183,382 347,508 Deferred income tax benefits (837,405) (375,925) (504,236) Cash from (used for) changes in assets and liabilities: Accounts receivable (6,113,976) (5,384,069) 1,526,055 Inventories (662,178) (6,353,919) (9,611,015) Prepaid expenses and other current assets (489,491) 82,839 (655,458) Accounts payable 1,392,915 1,574,382 1,267,585 Accrued expenses 2,136,362 3,989,332 2,314,422 Income taxes payable 4,129,648 (992,803) 806,227 -------------------------------------------- Net cash from operations 23,081,177 11,226,251 11,626,554 Investing Activities: Net assets acquired in business combination/consolidation, net of cash received (384,614) (634,734) -- Additions to property, plant and equipment (7,363,440) (4,260,546) (6,177,791) Increase (decrease) in intangible and other assets 272,002 (391,669) (1,179,619) -------------------------------------------- Net cash used in investing activities (7,476,052) (5,286,949) (7,357,410) Financing Activities: Issuance of common stock 1,624,390 547,383 197,131 Distribution of Minority interest earnings (498,784) (83,774) (368,714) Issuance of notes payable - affiliates -- -- 1,128,574 Repayment of notes payable - affiliates (1,000,744) (127,830) (1,000,000) Repayments in notes payable - banks (5,993,255) (62,396) (659,240) -------------------------------------------- Net cash (used in) from financing activities (5,868,393) 273,383 (702,249) Effect of exchange rate changes and cash equivalents (614,397) (211,974) 96,818 -------------------------------------------- Net increase in cash and cash equivalents 9,122,335 6,000,711 3,663,713 Cash and cash equivalents: Beginning of year 11,981,246 5,980,535 2,316,822 -------------------------------------------- End of year $ 21,103,581 $ 11,981,246 $ 5,980,535 -------------------------------------------- See notes to consolidated financial statement
27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES Consolidated Financial Statements include the accounts of Fossil, Inc., a Delaware corporation, and its subsidiaries (the "Company"). Significant intercompany balances and transactions are eliminated in consolidation. The organizational structure of the Company's U.S.-based operations was changed in August 1994 by transferring substantially all of its assets and liabilities, except those connected with investments in subsidiaries, trademarks, or similar intangible assets, to Fossil Partners, L.P., a Texas limited partnership. Fossil, Inc. is the sole managing general partner of Fossil Partners, L.P. The Company is primarily engaged in the design, development and distribution of fashion watches and other accessories, principally under the "fossil", "fsl", and "relic" brand names. The Company's products are sold primarily through department stores and other major retailers, both domestically and internationally. The preparation of financial statements in conformity with generally accepted accounting principles requires management 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. Actual results could differ from those estimates. Beginning January 1, 1997, the Company changed its fiscal year to reflect the retail-based calendar (containing 4-4-5 week calendar quarters). Due to this change, the First Quarter contained an additional one-half week for the transition period. This change had an immaterial impact on comparability to the prior fiscal year. Cash Equivalents are considered all highly liquid investments with original maturities of three months or less. Accounts Receivable are stated net of allowances of $10,576,181 and $8,854,453 for estimated customer returns and $4,699,831 and $4,292,145 for doubtful accounts at the close of fiscal year 1997 and 1996, respectively. Inventories are stated at the lower of average cost, including any applicable duty and freight charges, or market. Property, Plant and Equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided using the straight-line method over the estimated useful lives of the assets of three to ten years for equipment and thirty years for buildings. Leasehold improvements are amortized over the shorter of the lease term or the asset's useful life. Intangible and Other Assets include the cost in excess of tangible assets acquired, noncompete agreements and trademarks, which are amortized using the straight-line method over the estimated useful lives of generally twenty, three and five years, respectively. Cumulative Translation Adjustment in stockholders' equity reflects the unrealized adjustments resulting from translating the financial statements of foreign subsidiaries. The functional currency of the Company's foreign subsidiaries is the local currency of the country. Accordingly, assets and liabilities of the foreign subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at the average rates prevailing during the year. Changes in exchange rates which affect cash flows and the related receivables or payables are recognized as transaction gains and losses in the determination of net income. The Company incurred net foreign currency losses of approximately $733,000, $308,000 and $151,000 for fiscal years 1997, 1996 and 1995, respectively, which have been included in other income (expense). Forward Contracts are entered into by the Company principally to hedge the payment of intercompany inventory transactions with its non-U.S. subsidiaries. Currency exchange gains or losses resulting from the translation of the related accounts, along with the offsetting gains or losses from the hedge, are deferred until the inventory is sold or the forward contract is completed. At January 3, 1998, the Company had hedge contracts to sell 22,900,000 German Marks for approximately $13.2 million, expiring through November 1998 and 221,100,000 Japanese Yen for approximately $1.8 million, expiring through May 1998. Revenues are recognized as sales when merchandise is shipped. Company permits the return of damaged or defective products and accepts limited amounts of product returns in certain other instances. Accordingly, the Company provides allowances for the estimated amounts of these returns at the time of revenue recognition. 28 Advertising costs for in-store and media advertising as well as co-op advertising and promotional allowances are expensed as incurred. Advertising expenses for fiscal years 1997, 1996 and 1995 were approximately $14,255,000, $14,919,000 and $14,254,000, respectively. New Accounting Standards. The FASB issued in February 1997 Statement of Financial Accounting Standards ("SFAS") No. 129 "Disclosure of Information About Capital Structure" which establishes standards for disclosing information about an entity's capital structure, and is effective for financial statements for periods ending after December 15, 1997. In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued which establishes standards for reporting and display of comprehensive income and its components in the financial statements. SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which was also issued in June 1997, establishes standards for the way public companies disclose information. These pronouncements will require such disclosures in financial statements for periods beginning after December 15, 1997. Earnings Per Share is based on the weighted average number of common and common equivalent shares outstanding during each period. During 1997, the Company adopted SFAS No. 128, "Earnings per Share". As a result of the adoption of SFAS No. 128, all earnings per share ("EPS") amounts have to be restated to the basic and diluted presentations required by this pronouncement. Deferred Income Taxes are provided for under the asset and liability method for temporary differences in the recognition of certain revenues and expenses for tax and financial reporting purposes. Fair Value of Financial Instruments are estimated to approximate the related book values, unless otherwise indicated, based on market information available to the Company. 2. ACQUISITIONS Effective April 1997, Fossil (East) Limited acquired the remaining 35% of capital stock of Amazing Time, Ltd. from its minority stockholder in exchange for approximately $380,000 in cash. The acquisition of this Hong Kong-based watch assembly factory has been accounted for as a purchase and, in connection therewith the Company recorded goodwill of approximately $210,000. Effective April 1996, the Company invested approximately $700,000 in cash for an 81% interest in Kabushiki Kaisha Fossil Japan, a Japanese corporation ("Fossil Japan"). Fossil Japan is the sole distributor of Fossil products within Japan and was previously 100% owned by a foreign-based entity. The acquisition has been accounted for as a purchase, and in connection therewith, the Company recorded goodwill of approximately $300,000. In May 1993, the Company formed Fossil Europe b.v., a Netherlands holding company ("Fossil b.v."). The Company contributed $1.43 million to the joint venture for 70% of Fossil b.v.'s outstanding common stock. In July 1995, the Company acquired an additional 18% of Fossil b.v.'s outstanding common stock from its minority stockholders for approximately $1.68 million, of which approximately $1.32 million was recorded as goodwill. Effective October 1, 1996, the Company acquired the remaining 12% of Fossil b.v.'s outstanding common stock from its minority stockholders for $1.0 million in cash, 50,000 shares of the Company's $0.01 par value common stock ("Common Stock") and the issuance of options to acquire 20,000 shares of Common Stock, of which approximately $1.0 million was recorded as goodwill. Fossil b.v.'s initial purpose was to form and purchase through Fossil Europe GmbH ("Fossil GmbH") certain inventory and fixed assets from the Company's prior distributor in Germany. During 1994, Fossil b.v. formed an Italian subsidiary, Fossil Italia, S.r.l., ("Fossil Italy") and invested approximately $7,500 for a 60% equity interest in the Italian subsidiary. Effective February 1997, Fossil B.V. acquired the remaining 40% of Fossil Italy's outstanding common stock from it's minority stockholders for 128,109 of the Company's Common Stock, of which approximately $300,000 was recorded as goodwill. Fossil b.v. also formed a wholly owned subsidiary in Spain, during 1996. Each of these subsidiaries is generally responsible for sales and operations within their respective countries with the exception of Fossil GmbH, which acts as the Company's main marketing and distribution point in Europe The balance sheets and results of operations of these subsidiaries and affiliates are included in the accompanying consolidated financial statements since the dates of their formation or acquisition. 29 3. INVENTORIES Inventories consist of the following: FISCAL YEAR END 1997 1996 Components and parts $ 2,751,719 $ 2,294,750 Work-in-process 2,064,623 657,125 Finished merchandise on hand 35,707,813 38,404,535 Merchandise at Company's stores 5,484,479 3,962,199 Merchandise in-transit from customer returns 5,373,526 4,463,946 -------------------------- $ 51,382,160 $449,782,555 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following: FISCAL YEAR END 1997 1996 Land $ 2,535,361 $ 2,535,361 Building 9,209,315 4,982,164 Furniture and fixtures 6,720,046 5,960,469 Equipment 4,905,291 4,446,863 Computer software 1,382,537 1,203,440 Leasehold improvements 6,790,409 5,260,858 --------------------------- 31,542,959 24,389,155 Less accumulated depreciation and amortization 10,469,626 7,670,179 --------------------------- $21,073,333 $16,718,976 5. INTANGIBLE AND OTHER ASSETS Intangibles and other assets consist of the following: FISCAL YEAR END 1997 1996 Costs in excess of tangible net assets acquired $4,545,098 $4,031,643 Noncompete agreement 475,000 475,000 Trademarks 547,573 528,132 Deposits 430,503 453,213 Other 203,174 253,411 ----------------------- 6,201,348 5,741,399 Less accumulated amortization 1,364,089 1,108,206 ----------------------- $4,837,259 $4,633,193 30 6. DEBT Bank: U.S.-based. In August 1994, the Company signed a $5.0 million financing agreement with its primary bank ("Long-term revolver") to partially finance the Company's facilities construction costs and for other general corporate purposes. The financing agreement was for a ten-year revolving term loan with quarterly payments equal to 1% of the stated principal amount of the facility. The interest rate was the lender's prime rate (8.50% at January 3, 1998) and was payable quarterly with an unused fee of 0.5% per annum. The financing agreement additionally allowed for interest to be calculated at the London Interbank Offered Rate ("LIBOR") (5.82 % at January 3, 1998), plus 1.25%. The amount outstanding under this facility was $4.35 million and $4.55 million at the end of fiscal year 1997 and 1996, respectively. The Company paid the Long-term revolver in full in January 1998 from available cash on hand, therefore the funds outstanding under the facility were classified as short-term debt as of January 3, 1998. In May 1997, the Company extended the maturity date of its short-term revolving credit facility with its primary bank ("U.S. short-term revolver"). In June 1997, the Company renewed the U.S. short-term revolver and amended it to increase the funds available under the facility to $40 million, an increase of $10 million over the previous facility size, not subject to any borrowing base calculation. The facility was also amended to eliminate Japanese Yen currency borrowings and replace them with a stand-by letter of credit for 540 million Yen (approximately $4.1 million) as collateral for Company borrowings from any Japan-based bank. All borrowings under the U.S. short-term revolver accrues interest at the bank's prime rate less 0.5% or LIBOR plus 1.25% and is collateralized by substantially all the Company's assets and requires the maintenance of specific levels of net worth, quarterly income, working capital and financial ratios. There were no borrowings under the U.S. short-term revolver as of fiscal year end 1997. Borrowings under the U.S. short-term revolver were $6,500,000 and $3,000,000 as of fiscal year-end 1996 and 1995, respectively. Interest expense under these credit facilities was $835,275, $1,077,713 and $855,631 for fiscal years 1997, 1996 and 1995, respectively. At fiscal year-end 1997, 1996 and 1995, the Company had outstanding letters of credit of approximately $1,225,250, $2,695,000 and $592,000, respectively, to vendors for the purchase of merchandise. Banks: Foreign-based. During 1995, Pulse Time purchased its office facilities in Hong Kong and signed a financing agreement with its primary Hong Kong-based bank for approximately $350,000 ("Term Loan") to partially finance the approximate $650,000 cost of the facility. The financing agreement was for a seven-year term loan with monthly payments of approximately 1.2% of the stated principal amount plus interest, calculated at bank prime rate in the United States plus 1.5%. The entire note balance was paid in full in 1996. Fossil GmbH has short-term credit facilities with two Germany-based banks with combined borrowing capacity of 5,000,000 deutsche marks (approximately $2.8 million as of fiscal year-end 1997). No borrowings were outstanding under the combined credit facilities at the end of fiscal 1997 or 1996, with outstanding borrowings, in U.S. dollars, of $2.8 million at December 31, 1995. Outstanding borrowings under the facilities bore interest at approximately 6% and are collateralized by substantially all of Fossil GmbH's assets. During August 1997, Fossil Japan restructured its short-term credit facility with a Japan-based bank allowing borrowings of up to 540 million Yen. All outstanding borrowings under the facility bore interest at the Euroyen rate (1.03% at January 3, 1998) plus 1.8%. In connection with the financing agreement, Fossil Japan agreed to pay an origination fee equal to 0.12% of the amount available under the facility and an unused fee of 0.5% per annum. The facility is collateralized by a standby letter of credit issued by the Company's primary U.S. bank. Japan-based borrowings, in U.S. dollars, under the facilities were approximately $3.5 million and $2.8 million as of fiscal year-end 1997 and 1996, respectively. Interest expense under these credit facilities was $21,188 and $27,427 for fiscal years 1997 and 1996, respectively. Affiliates. In connection with the Company's initial public offering in April 1993, the Company issued notes payable to stockholders of $10,910,000. The remaining $1,000,000 due under these notes and $20,000 in interest was paid to stockholders during 1995. Prior to Fossil Italy being a wholly owned subsidiary of the Company, the minority stockholders of Fossil Italy were required to provide a portion of any short-term financing necessary for that entity. The minority stockholders were required to provide short-term financing of approximately $1.1 million. 31 7. OTHER INCOME (EXPENSE) - NET Other income (expense) - net consists of the following: FISCAL YEAR 1997 1996 1995 Consulting fees $ - $ - $ 1,000,000 Insurance proceeds above book value, - 101,814 579,673 Minority income (expense) (561,929) (840,084) (685,055) Legal settlements (661,365) 50,000 (251,000) Duty drawback, - 321,836 - Interest income 335,528 235,098 91,896 Currency loss (732,614) (308,249) (151,087) Royalty income 106,100 - - Other income (expense) 11,474 311,966 211,467 ------------------------------------------ $(1,502,806) $ (127,619) $ 795,894 8. INCOME TAXES Deferred income tax benefits reflect the net tax effects of deductible temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant items comprising the Company's net deferred tax benefits, consist of the following: FISCAL YEAR 1997 1996 Deferred tax assets: Bad debt allowance $ 1,514,158 $ 1,146,268 Returns allowance 3,359,383 2,835,344 263(A) capitalization of inventory 418,355 555,135 Miscellaneous tax asset items 1,033,373 655,514 Deferred tax liabilities: In-transit returns inventory (1,821,520) (1,525,917) -------------------------- Net current deferred tax benefits $ 4,503,749 $ 3,666,344 Management believes that no valuation allowance against net deferred tax benefits is necessary. The resulting provision for income taxes consists of the following: FISCAL YEAR 1997 1996 1995 Current expense: United States $ 9,026,405 $ 6,776,925 $ 5,932,384 Foreign 5,020,000 3,048,000 2,656,852 Deferred benefit - United States (837,405) (375,925) (504,236) -------------------------------------------- Provision for income taxes $ 13,209,000 $ 9,449,000 $ 8,085,000 32 A reconciliation of income tax computed at the U.S. Federal statutory income tax rate of 35% to the provision for income taxes is as follows: FISCAL YEAR 1997 1996 1995 Tax at statutory rate $11,252,887 $ 8,064,037 $ 7,049,862 State, net of federal tax benefit 378,005 194,312 288,073 Other 1,578,108 1,190,651 747,065 --------------------------------------- Provision for income taxes $13,209,000 $ 9,449,000 $ 8,085,000 Deferred U.S. federal income taxes are not provided on certain undistributed earnings of foreign subsidiaries as management plans to continue reinvesting these earnings outside the United States. Determination of such tax amounts is not practical because potential offset by U.S. foreign tax credits would be available under various assumptions involving the tax calculation. 9. COMMITMENTS License Agreements. The Company has various license agreements to market watches bearing certain trademarks owned by various entities. In accordance with these agreements, the Company incurred royalty expense of $1,374,190, $1,703,245 and $1,299,976 in fiscal years 1997, 1996, and 1995, respectively. These amounts are included in the Company's cost of sales and selling expenses. The Company has several agreements in effect at the end of fiscal year 1997 which expire on various dates from March 1998 and require the Company to pay royalties ranging from 5% to 15.5% of defined net sales. Future minimum royalty commitments under such license agreements at the close of fiscal year 1997 are as follows: ROYALTIES ---------- 1998 $1,400,000 1999 2,014,000 2000 -- 2001 10,000 ---------- $3,424,000 Leases. The Company leases its retail and outlet store facilities as well as certain of its office facilities and equipment under non-cancelable operating leases. Most of the retail store leases provide for contingent rental based on operating results and require the payment of taxes, insurance and other costs applicable to the property. Generally, these leases include renewal options for various periods at stipulated rates. Rent expense under these agreements was $4,387,821, $3,698,981 and $2,288,677 for fiscal years 1997, 1996 and 1995, respectively. Future minimum rental commitments under such leases at the close of fiscal year 1997, are as follows: 33 LEASES ----------- 1998 $ 3,892,412 1999 3,822,805 2000 2,904,990 2001 2,210,417 2002 1,752,918 Thereafter 3,399,624 ----------- $17,983,166 10. STOCKHOLDERS EQUITY AND BENEFIT PLANS On March 4, 1998, the Board of Directors declared a three-for-two stock split of the Company's $0.01-par-value common stock ("Common Stock") to be effected in the form of a stock dividend payable on April 8,1998 to stockholders of record on March 25,1998. Retroactive effect has been given to the stock split in stockholders' equity accounts as of fiscal year end 1997, and in all share and per share data in the accompanying financial statements. The Company has 50,000,000 shares of authorized Common Stock, with 20,308,503 and 13,242,994 shares issued and outstanding at the close of fiscal year end, 1997 and 1996, respectively. The Company has 1,000,000 shares of authorized $0.01-par-value preferred stock with none issued or outstanding. The following table reconciles the numerators and denominators used in the computations of both basic and diluted EPS: Fiscal Year End 1997 1996 1995 Basic EPS computation: Numerator: Net income $18,942,107 $13,591,107 $12,057,464 Denominator: Weighted average common shares outstanding 13,423,693 13,188,781 13,173,795 Three-for-two stock split paid April 1998 6,711,847 6,594,391 6,586,89 --------------------------------------- 20,135,540 19,783,172 19,760,693 Basic EPS $ 0.94 $ 0.69 $ 0.61 Diluted EPS computation: Numerator: Net income $18,942,107 $13,591,107 $12,057,464 Denominator: Weighted average common shares outstanding 13,423,693 13,188,781 13,173,795 Stock option conversion 465,261 189,654 119,245 Three-for-two stock split paid April 1998 6,944,477 6,689,218 6,646,520 ---------------------------------------- 20,833,431 20,067,653 19,939,560 Diluted EPS $ 0.91 $ 0.68 $ 0.60 34 Savings Plan. The Company has a savings plan in the form of a defined contribution plan (the "401(k) plan") established in July 1992 for substantially all full-time employees of the Company. Employees are eligible to participate in the 401(k) plan after one year of service. The Company matches 50% of employee contributions up to 3% of their compensation and 25% of the employee contributions between 3% and 6% of their compensation. The Company also has the right to make certain additional matching contributions not to exceed 15% of employee compensation. The Company's Common Stock is one of several investment alternatives available under the 401(k) plan. Matching contributions made by the Company to the 401(k) plan totaled $156,575, $129,035 and $97,808, for fiscal years 1997, 1996 and 1995, respectively. Long-Term Incentive Plan. An aggregate of 1,725,000 shares of Common Stock were reserved for issuance pursuant to the 1993 Fossil Long-Term Incentive Plan ("Incentive Plan"), adopted April 1993. An additional 900,000 shares were reserved in 1995 for issuance under the Incentive Plan. Designated employees of the Company, including officers and directors, are eligible to receive (i) stock options, (ii) stock appreciation rights, (iii) restricted or nonrestricted stock awards, (iv) cash awards or (v) any combination of the foregoing. The Incentive Plan is administered by the Compensation Committee of the Company's Board of Directors (the "Compensation Committee"). Each option issued under the Incentive Plan terminates at the time designated by the Compensation Committee, not to exceed ten years. The current options outstanding predominately vest over a three-year period and were priced at not less than estimated fair market value of the Company's Common Stock at the date of grant. Effective January 10, 1996, the Company offered the participants under the Incentive Plan the opportunity to exchange any outstanding stock option grants with an exercise price of $10.33 or above for a pro-rata number of options at a $6.67 exercise price. The pro-rata number of options offered in exchange was equivalent to the total number of options outstanding for each grant exchanged multiplied by the percentage figure calculated by dividing $6.67 by the optionees's previous exercise price. A total of 366,487 options with exercise prices ranging from $10.33 to $19.00 were canceled in exchange for 196,191 options with an exercise price of $6.67. The weighted average fair value of the stock options granted during fiscal years 1997, 1996 and 1995 were $5.36, $3.29, and $5.04, respectively. Nonemployee Director Stock Option Plan. An aggregate of 150,000 shares of Common Stock were reserved for issuance pursuant to this nonqualified stock option plan, adopted April 1993. During the first year an individual is elected as a nonemployee director of the Company, they receive a grant of 7,500 nonqualified stock options. In addition, on the first day of each subsequent calendar year, each nonemployee director will automatically receive a grant of an additional 4,500 nonqualified stock options, so long as the person is serving as a nonemployee 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. The exercise prices of options granted under this plan were not less than the fair market value of the Common Stock at the date of grant. The weighted average fair value of the stock options granted during fiscal years 1997, 1996 and 1995 were $7.95, $3.45 and $5.79, respectively. The fair value of options granted under the Company's stock option plans during fiscal years 1997, 1996 and 1995 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: no dividend yield, expected volatility of approximately 65%, risk free interest rate of 5.5 to 6.11%, and expected life of 5 to 5.5 years. The following tables summarize the Company's stock option activity: 35
INCENTIVE PLAN weighted weighted average average exercise exercise exercise price price price available per share per share outstanding per share exercise for grant Balance Fiscal, 1994 $5.00 - $19.00 $ 9.770 685,650 $5.473 103,387 983,213 Shares designated for grant through the Incentive Plan - - - - - 900,000 Granted $5.92 - $17.00 $ 8.367 489,300 - - (489,300) Exercised $5.00 - $13.00 $ 6.771 (29,113) - - - Canceled $5.00 - $17.83 $ 7.363 (50,925) - - 50,925 Exercisable - - - - 250,094 - ------------------------------------------------------------------------------- Balance Fiscal, 1995 $5.00 - $19.00 $ 9.262 1,094,912 $9.475 353,481 1,444,838 Granted $4.417 - $10.583 $ 5.323 828,291 - - (828,291) Exercised $5.00 - $ 9.083 $ 6.676 (15,992) - - - Canceled $4.417 - $19.00 $11.594 (450,311) - - 450,311 Exercisable - - - - 264,900 - ------------------------------------------------------------------------------- Balance Fiscal, 1996 $4.417 - $17.167 $ 6.521 1,456,900 $6.953 618,381 1,066,858 Granted $8.334 - $16.792 $ 8.651 506,588 - - (506,588) Exercised $4.417 - $11.917 $ 6.344 (243,971) - - - Canceled $4.417 - $14.75 $ 7.842 (54,758) - - 54,758 Exercisable $4.417 - $19.00 - - - 257,799 - ------------------------------------------------------------------------------- Balance Fiscal, 1997 $4.417 - $19.00 $ 7.173 1,664,759 $6.975 876,180 615,028
36
NONEMPLOYEE DIRECTOR PLAN weighted weighted average average exercise exercise exercise price price price available per share per share outstanding per share exercise for grant Balance Fiscal, 1994 $5.00 - $12.667 $ 7.875 36,000 $ 5.000 11,250 114,000 Granted $8.083 - $11.417 $ 9.703 21,000 - - (21,000) Exercisable $5.00 - $12.667 - - - 12,375 - --------------------------------------------------------------------------- Balance Fiscal, 1995 $5.00 - $12.667 $ 8.548 57,000 $ 7.191 23,625 93,000 Granted $5.583 $ 5.583 18,000 - - (18,000) Exercisable $5.00 - $12.667 - - - 19,500 - --------------------------------------------------------------------------- Balance Fiscal, 1996 $5.00 - $12.667 $ 7.837 75,000 $ 7.94 43,125 75,000 Granted $9.00 - $16.667 $ 12.833 27,000 - - 27,000) Exercised $5.583 - $11.417 $ 9.750 (7,875) - - - Canceled $5.583 - $11.417 $ 8.235 (4,125) - - 4,125 Exercisable $5.00 - $12.667 - - - 23,250 - --------------------------------------------------------------------------- Balance Fiscal, 1997 $5.00 - $16.667 $ 9.10 90,000 $ 7.81 66,375 52,125
Additional weighted average information for options outstanding and exercisable as for fiscal year end 1997:
options outstanding options excercisable ------------------- -------------------- weighted weighted weighted average average average exercise remaining exercise range or exercise number of price contractual number of price per prices shares per share life shares share Long-Term Incentive Plan: $ 4.4177 - $8.66 1,290,138 $ 6.511 8.2 years 567,112 $ 5.801 $ 8.67 - $19.00 374,621 $ 9.452 7.4 years 309,068 $ 9.130 Nonemployee Director Plan: 5.00 - $8.66 36,000 $ 5.219 6.3 years 32,625 $ 5.180 $ 8.67 - $16.667 54,000 $11.771 8.0 years 33,750 $10.367
The Company applies Accounting Principles Board Opinion No.25 and related Interpretations in accounting for its stock option plans. Accordingly, no compensation cost (generally measured as the excess, if any, of the quoted market price of the Common Stock at the date of the grant over the amount an employee must pay to acquire the Common Stock) has been recognized for the Company's stock option plans. SFAS No. 123, "Accounting for Stock-Based Compensation," issued by the Financial Accounting Standards Board in 1995, prescribed a method to record compensation cost for stock-based employee compensation plans at fair value. Pro forma disclosures as if the Company had adopted the cost recognition requirements under sfas 123 in fiscal years 1997 and 1996 are presented below. Because the sfas 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that expected in future years. 37 FISCAL YEAR 1997 1996 Net income: As reported $18,942,107 $13,591,107 Pro forma $17,177,727 $12,254,598 Basic earnings per share: As reported $0.91 $0.69 Pro Forma $0.85 $0.62 11. SUPPLEMENTAL CASH FLOW INFORMATION The following is provided as supplemental information to the consolidated statements of cash flows: FISCAL YEAR 1997 1996 1995 Cash paid during the year for: Interest $ 923,635 $ 1,117,107 $ 1,073,248 Income taxes $10,641,735 $11,614,532 $ 7,424,463 Acquisition of minority interest in subsid- iary in exchange for common stock $ 1,235,771 - - Reduction in income tax payable resulting from exercise of stock options $ 464,000 - - 12. SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION Customers of the Company consist principally of major department stores and specialty retailers located throughout the United States. The most significant customers, individually or considered as a group under common ownership, which accounted for over 10% of net sales for the periods presented, were as follows: FISCAL YEAR 1997 1996 1995 Customer A 11% 11% 12% Customer B 9% 10% - 38 The Company operates in a single industry, as a designer, developer, marketer and distributor of fashion watches and other accessories. Information about the Company's operations in the United States and international markets in fiscal years 1997, 1996 and 1995 is presented below. Intercompany sales of products between geographic areas are referred to as intergeographic items. These intercompany sales primarily consist of product sales from the Far East into the U.S. and European operations which are priced at cost plus a 5%-8% trade agent commission.
FISCAL YEAR END 1997 Net Sales Operating Income Assets United States $189,590,607 $20,402,118 $ 95,757,491 Europe 46,032,760 2,552,650 24,743,975 Far East 89,214,060 12,369,973 14,333,258 Japan 9,613,533 (714,646) 4,735,166 Intergeographic items (89,653,428) - - -------------------------------------------------- Consolidated $244,797,532 $34,610,095 $139,569,890 FISCAL YEAR END 1996 Net Sales Operating Income Assets United States $158,159,270 $17,741,711 $ 78,302,341 Europe 45,926,815 1,781,220 27,842,878 Far East 66,270,186 5,008,243 8,335,684 Japan 6,266,671 (158,215) 4,497,166 Intergeographic items (70,723,680) - - -------------------------------------------------- Consolidated $205,899,262 $24,372,959 $118,978,069 FISCAL YEAR END 1995 Net Sales Operating Income Assets United States $134,747,319 $14,293,470 $ 64,772,200 Europe 40,053,692 4,468,898 24,795,443 Far East 69,430,240 1,701,085 7,425,884 Intergeographic items (63,116,804) - - -------------------------------------------------- Consolidated $181,114,447 $20,463,453 $ 96,993,527
39 CORPORATE INFORMATION EXECUTIVE OFFICERS AND DIRECTORS Tom Kartsotis Randy S. Kercho Kenneth W. Anderson Chairman of the Board and Executive Vice President Director Chief Executive Officer and Chief Financial Officer Kosta N. Kartsotis Mark D. Quick Alan J. Gold President, Executive Vice President Director Chief Operating Officer and Director Michael W. Barnes T.R.Tunnell Donald J. Stone Executive Vice President Senior Vice President, Director Development Chief Legal Officer and Secretary Richard H. Gundy Jal S. Shroff Executive Vice President Managing Director- Fossil East and Director CORPORATE INFORMATION Transfer Agent and Registrar ChaseMellon Shareholder Independent Auditors Corporate Counsel Services LLC Deloitte & Touche LLP Jenkens & Gilchrist Overpeck Centre 2200 Ross Avenue 1445 Ross Avenue 85 Challenger Road Dallas, TX 75201 Dallas, TX 75202 Ridgefield Park, NJ 07760 INTERNET WEB SITE The Company maintains a web site at the worldwide internet address of www.fossil.com. Certain product, event, press release and collector club information concerning the Company is available at the site. STOCKHOLDER INFORMATION Annual Meeting The Annual Meeting of Stockholders will be held on Wednesday, May 27, 1998, at 4:00 pm at the Company's headquarters, 2280 N. Greenville Ave., Richardson, Texas. COMPANY INFORMATION A copy of the Company's Annual Report on Form 10-k and the Annual Report to Stockholders, as filed with the Securities and Exchange Commission, in addition to other Company information, is available to stockholders without charge upon written request to FOSSIL, Investor Relations, 2280 N. Greenville Ave., Richardson, Texas 75082-4412. 40 EX-21 4 EXHIBIT 21.1
Subsidiaries of Fossil, Inc. as of January 3, 1998 Place Percent Name of Subsidiary of Incorporation Parent Company Ownership - -------------------------------------------------------------------------------------------------------------- Fossil Intermediate, Inc. Delaware Fossil, Inc. 100 Fossil Stores I, Inc. Delaware Fossil, Inc. 100 Fossil New York, Inc. Delaware Fossil, Inc. 100 Arrow Merchandising, Inc. Texas Fossil, Inc. 100 Fossil East Limited Hong Kong Fossil, Inc. 100 Fossil Europe B.V. The Netherlands Fossil, Inc. 100 Fossil Japan, K.K. Japan Fossil, Inc. 81 Fossil Trust Delaware Fossil Intermediate, Inc. 100 Fossil Stores II, Inc. Delaware Fossil Stores I, Inc. 100 Newtime, Ltd. Hong Kong Fossil East, Ltd. 100 Pulse Time Center Company, Ltd. Hong Kong Fossil East, Ltd. 60 Amazing Time, Ltd. Hong Kong Fossil East, Ltd. 100 Fossil Trading, Ltd. Hong Kong Fossil East, Ltd. 100 Trylink International, Ltd. Hong Kong Fossil East, Ltd. 51 Fossil Europe GmbH Germany Fossil Europe B.V. 100 Fossil Italia, S.r.l. Italy Fossil Europe B.V. 100 Fossil France Eurl, S.a.r.l. France Fossil Europe B.V. 100 Fossil (U.K.) Ltd. England Fossil Europe B.V. 100 Fossil Spain, S.A. Spain Fossil Europe B.V. 100
EX-23 5 EXHIBIT 23.1 Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-65980 and Post-Effective Amendment No. 1 to Registration Statement No. 33-77526 on Form S-8 of our reports dated February 19, 1998 (except for the first paragraph of Note 10 which is as of March 4, 1998), appearing in and incorporated by reference in the Annual Report on Form 10-K of Fossil, Inc. for the fiscal year ended January 3, 1998. Deloitte & Touche LLP Dallas, Texas April 2, 1998 EX-27 6 FDS --
5 Part II Item 8 Financial Statements of Fossil, Inc. and Subsidiaries as of and for the Fifty-Two and One-Half Weeks Ended January 3, 1998 Filed on Form 10-K. 0000883569 Fossil, Inc. 1 U.S. Dollars 12-MOS JAN-03-1998 JAN-01-1997 JAN-03-1998 1 21,103,581 0 38,937,357 4,699,831 51,382,160 113,659,298 31,542,959 10,469,626 139,569,890 43,056,502 0 0 0 203,085 95,059,898 139,569,890 244,797,532 244,797,532 127,269,749 210,187,437 0 407,686 956,182 32,151,107 13,209,000 0 0 0 0 18,942,107 0.94 0.91
-----END PRIVACY-ENHANCED MESSAGE-----