Jewelers in America often complain about low margins on fine watch sales. “We can’t make any money,” they lament. “The watch manufacturers are making all the money,” they assert. Unfortunately, based on Movado’s most recent financial results, this major producer, distributor and marketer of watches is not making much money, either.

 

For its most recent fiscal quarter ended April 2008, its revenues were flat and pretax profits were down 41 percent. Net after-tax profits dropped by 50 percent. It lost a lot of money in the U.S. market.

The table below summarizes the company’s most recent financial results.

 

 

Movado Hasn’t Made Money in the U.S. Recently

Why can’t Movado make money on its U.S. watch operations? Why are overall corporate profits down? What is going on?

 

Movado Group’s sales are split roughly 60 percent in the U.S. and 40 percent in overseas markets. However, almost all of its operating profits come from overseas markets. For the year ended 2008, the following graph illustrates the source of Movado’s revenues by geographic location and channel:

 

Movado Sales by Geography Source: Company Reports

 

The table below summarizes revenues and operating profits by geographic and operating segment for the full fiscal year ended January 2008. As the table clearly illustrates, Movado lost just over $20 million on wholesale U.S. revenues of nearly $233 million. It posted a paltry operating profit of 2 percent from its 60+ retail stores, all of which are located in the U.S. Without the large profits from its overseas operations, Movado would be a highly unprofitable company.

 

In the prior year – fiscal 12-month period ended January 2007 – Movado eked out a modest $2 million operating profit on revenues of $277 million in its U.S. wholesale business. Even in the prior year – FYE January 2006 – operating profits from the U.S. wholesale business were about $4 million on $241 million in revenues.

 

Clearly, the U.S. wholesale market is a drag on Movado’s financials. This helps explain why Movado is closing roughly 35 percent of its wholesale doors in the U.S. this year. These highly unprofitable wholesale accounts generated only 2 percent of corporate revenues last year.

 

Movado’s Brands
The following table summarizes the market positioning of Movado’s brands.

 

 

Tax Rates May Dictate Where Profits Are Generated

Is there a reason why Movado’s profits are so strong overseas and lacking in the U.S.? In part, it may be due to taxation of profits in a particular geopolitical region. A “normal” U.S. tax rate would be about 36-39 percent, depending on a number of factors; overseas tax rates are often far lower, especially if a company agrees to provide jobs and build facilities. Thus, it is to Movado’s advantage to keep profits out of the U.S.

 

However, because every government wants their legitimate (or more) share of taxes, tax department bureaucrats keep a close eye on “transfer pricing” and other accounting calculations to determine where a company’s profits are actually being generated. Movado paid taxes at the high U.S. level only once in the past five fiscal years, as the table below illustrates. For the most recent fiscal year, there was a tax credit.

 

 

First Quarter Financials Weak Due to U.S. Market

During the first fiscal quarter ended April 2008, Movado began the job of house-cleaning its wholesale accounts. By the end of the second quarter, all of the accounts which will be closed will have been notified, and we expect all of those doors to be out of Movado merchandise prior to the 2008 holiday selling season.

 

Movado’s retail division is also under stress. While it posted a very small operating profit last year, its overall profitability has been disappointing. As a result, the company is searching for a new president, and has begun remerchandising those stores.

 

First quarter’s financials were affected significantly by the challenges in the U.S. market – Movado’s unprofitable wholesale business, its lackluster retail business, and a slowdown in the retail environment. The only thing that saved the company was its business in international markets.

 

The following table summarizes operating results by geographic area and operating segment for Movado’s first fiscal quarter ended April 2008.

 

 

The loss in Movado’s retail division jumped by nearly 50 percent from $2.0 million last year to just under $3.0 million this year. The loss in its U.S. wholesale operations rose from $6.3 million last year to $6.5 million this year. Overseas operating profits were about flat, year-to-year.

 

The following is a summary of first quarter financial highlights for Movado Group.

 

• Movado’s licensed watch business was up 44 percent; all licensed brands posted a sales increase in the first fiscal quarter, primarily due to increased sales in overseas markets. These brands include Coach, Tommy Hilfiger, Hugo Boss, Juicy Couture and Lacoste.
• Demand was strong in South American markets for licensed brands.
• In Europe, demand was also strong for licensed brands, with France, Germany and the U.K. among the strongest markets.
• In Asia, Movado posted significant growth. It is now selling direct, after exiting its use of a distributor in that market.
• In the U.S., total sales – retail and wholesale – were down 12.5 percent. Retail sales were down 8.7 percent while wholesale sales were down 14.0 percent.
• The luxury watch division – Concord and Ebel – posted a 13 percent sales decline. Concord continues to rebuild the brand. Capacity constraints on mechanical watch movements hurt the company’s ability to supply high-end product.
• The accessible luxury category – Movado and ESQ – were hurt the most by the slowdown in the U.S. market; its sales were down nearly 17 percent in the first quarter. Roughly 80 percent of the sales of these two brands take place in the U.S.
• In the U.S., wholesale sales were hurt as Movado curbed shipments to some of its distributors who were experiencing credit issues. We applaud Movado’s aggressive stance: credit problems will likely continue to worsen in the U.S., even after demand recovers in the retail market.
• Demand in Latin America, the Caribbean, and Canada is very strong for Movado’s watches.
• The Movado Boutiques continue to be a strain on the company. We look for major merchandise shifts, with a focus on Movado branded watches – particularly the newest styles – as well as a changing jewelry assortment, with a focus on Movado diamonds.
• In international markets, management highlighted both China and the Middle East as posting strong gains in the quarter ended April.
• In the U.S., Movado noted that watch sales through department stores were holding up better than watch sales through independent jewelers.

Unusual Financial Comparisons

From a financial viewpoint, there were some unusual comparisons in the first quarter.

 

• Revenues were as follows:
• GAAP Revenues were flat (Generally Accepted Accounting Principles). GAAP revenues were those reported by Movado in its press release and in its SEC filings.
• If liquidation revenues were eliminated last year, sales would have been up 1.3 percent this year. Last year, Movado was in the midst of a major inventory liquidation program.
• If revenues had been compared on a constant currency basis, total corporate revenues would have been reported down 5.2 percent this year, rather than flat (GAAP). Since 40 percent of Movado’s revenues come from geopolitical regions outside of the U.S., the weakness of the U.S. dollar this year had a positive “reported” impact on overseas sales denominated in local currency.
• If liquidation sales are eliminated from first quarter 2007 results, and currency swings are eliminated from first quarter 2008 results, Movado’s first quarter sales would have been down 4.0 percent in the period.
• Because liquidation sales are a “fact of life,” and because currency swings tend to mask true operating performance, we think the most accurate comparison is that sales for Movado’s first quarter were down 5.2 percent. While we, as a journalist, might be accused of reporting the bad news, we, as an analyst, believe that this is the most accurate comparison.

• The reported gross margin for Movado was 64.2 percent versus 60.8 percent last year.
• If the impact of the liquidation merchandise is removed from last year’s results, Movado’s gross margin would have been 62.9 percent last year, rather than the reported 60.8 percent.
• A swing in Movado’s sales mix hurt this year’s gross margin. Sales of Movado branded product were down; this merchandise carries an above-average margin. In contrast, sales of licensed watches were up; this merchandise carries a lower-than-average margin. Thus, this year’s reported 64.2 percent gross margin really understates what is going on with Movado’s overall margins. However, there is an offset – currency swings helped boost reported margins.

Outlook: No Overall Revenue Growth

For the full year, Movado is predicting that revenues will be flattish year-over-year in the $560 million range. We believe that this means that U.S. revenues will likely be down while sales in international markets will be up. However, Movado management said that it is seeing some sales softness in Spain, and that it believes demand in the U.K. is at risk.