Fossil Group Inc. (FOSL) expects to stay in compliance with its debt agreements through the end of the year, but the watch and accessory retailer faces challenges ahead.

The company, which released its quarterly earnings statement on Aug. 10, said that it has improved its cash position to $319.9 million from $231.8 million at the end of last quarter, and thus its net debt, even though its debt load overall increased slightly to $646.3 million from $636.3 million at the end of 2016.

The situation should allow the company to stay in compliance with the amended terms of its credit agreement, it said, which in March extend the maturity date until 2019 and altered the leverage ratio requirements. The new requirements will mean that Fossil needs to finish the third quarter with debt in the range of $575 million to $650 million, which CFO Dennis Secor said on the company's investor call is "roughly where we ended in the second quarter."

However, the amended agreement does require Fossil to pay off its $185 million term loan in October or face a higher interest rate. Analyst Anna Andreeva of Oppenheimer said the company may not have sufficient cash on hand to make that payment.

In that scenario, the margin increases to 2.75% a year for base rate loans and 3.75% a year for LIBOR rate loans. If the company doesn't repay the term loan by the following March another point will be added to each of those rates. And beginning in April 2018, interest payments will be due monthly.

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Fossil's balance sheet is stable for now, Andreeva said, even though its debt is on the high end of what it can sustain under its loan agreements. However, Fossil faces many of the troubles that other traditional retailers are struggling with, in addition to technological advancements that affect traditional watch sales.

A Fossil watch.
A Fossil watch.

In the second quarter of 2017, Fossil's watch sales fell 9.3%, to $469.4 million, compared to the first half of last year. Fossil's wearables segment, which includes its smart watches, grew to 9% of the business.

"In the second quarter, the strength of our wearables product, particularly in key brands, once again demonstrated that wearables have the ability to help mitigate the ongoing softness in the traditional watch category and ultimately, we believe, turn current headwinds into tailwinds," Chief Executive Kosta N. Kartsotis said in an earnings statement.

With $94 million wearable sales, Andreeva said that has another $250 million in sales to go in this segment to reach the low end of its annual range. Additionally, Fossil said it plans to roll out 300 new products this year in its wearable segment, which would double its total number. With that, "cannibalization of the portfolio is inevitable," Andreeva said.

Like so many other retailers, Fossil is shuttering stores in response to consumers' continuing move to online purchasing, closing 50 stores this year in addition to 50 that were closed last year. 

Kartsotis said that the company is "looking to see what the optimum number of stores is both in the outlet channel and the regular price and how the footprint looks based on the new reality, which is e-commerce growing very quickly."

Overall, net sales for the second quarter of 2017 were $596.8 million, a 13% decrease from $685.4 million during the same period in 2016. Watch sales made up 78.6% of it. Net losses were $344.7 million, or $7.11 a share. Of that, $6.50 was an impairment charge related to the company's market capitalization. During the same period of 2016, Fossil logged $6 million in profits.

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