1. FINANCIAL STATEMENT POLICIES

Basis of Presentation. The condensed consolidated financial statements include the accounts of Fossil, Inc., a Delaware corporation, and its wholly and majority-owned subsidiaries (the “Company”). The condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to present a fair statement of the Company’s financial position as of June 30, 2012, and the results of operations for the thirteen week periods ended June 30, 2012 (“Second Quarter”) and July 2, 2011 (“Prior Year Quarter”), respectively, and the twenty-six week periods ended June 30, 2012 (“Year To Date Period”) and July 2, 2011 (“Prior Year YTD Period”), respectively. All adjustments are of a normal, recurring nature.

These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Annual Report on Form 10-K filed by the Company pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for the fiscal year ended December 31, 2011. Operating results for the thirteen and twenty-six week periods ended June 30, 2012 are not necessarily indicative of the results to be achieved for the full fiscal year.

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates. The Company has not made any changes in its significant accounting policies from those disclosed in its most recent Annual Report on Form 10-K.

Business. The Company is a global design, marketing and distribution company that specializes in consumer fashion accessories. Its principal offerings include an extensive line of men’s and women’s fashion watches and jewelry, handbags, small leather goods, belts, sunglasses, shoes, soft accessories and clothing. In the watch and jewelry product categories, the Company has a diverse portfolio of globally recognized owned and licensed brand names under which its products are marketed. The Company’s products are distributed globally through various distribution channels, including wholesale in countries where it has a physical presence, direct to the consumer through its retail stores and commercial websites and through third-party distributors in countries where the Company does not maintain a physical presence. The Company’s products are offered at varying price points to meet the needs of its customers, whether they are value-conscious or luxury oriented. Based on its extensive range of accessory products, brands, distribution channels and price points, the Company is able to target style-conscious consumers across a wide age spectrum on a global basis.

Foreign Currency Hedging Instruments. The Company’s foreign subsidiaries periodically enter into foreign exchange forward contracts to hedge the future payment of intercompany inventory transactions denominated in U.S. dollars. If the Company’s foreign subsidiaries were to settle their contracts designated as cash flow hedges that were denominated in Euros, British Pounds, Mexican Pesos, Australian Dollars, Canadian Dollars and Japanese Yen, the net result would have been a gain of approximately $5.9 million, net of taxes, as of June 30, 2012. Refer to Note 8—Derivatives and Risk Management for additional disclosures about the Company’s use of forward contracts. The tax expense of changes in fair value of hedging activities for the Second Quarter and Year To Date Period was $2.3 million and $0.8 million, respectively. The tax benefit of changes in fair value of hedging activities for the Prior Year Quarter and Prior Year YTD Period was $0.6 million and $0.2 million, respectively.

Fair Value Measurements. The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.

Accounting Standard Codification (“ASC”) 820, Fair Value Measurement and Disclosures (“ASC 820”), establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

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Level 1 — Quoted prices in active markets for identical assets or liabilities.

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Level 2 — Inputs, other than quoted prices in active markets, that are observable either directly or indirectly.

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Level 3 — Unobservable inputs based on the Company’s assumptions.

ASC 820 requires the use of observable market data if such data is available without undue cost and effort.

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of June 30, 2012 (in thousands):


	Fair Value at June 30, 2012
	Level 1		Level 2		Level 3		Total
Assets:
Securities available for sale:
Investments in publicly traded equity securities	$	185	$	0	$	0	$	185
Foreign exchange forward contracts		0		10,361		0		10,361
Deferred compensation plan assets:
Investment in publicly traded mutual funds		3,031		0		0		3,031

Total	$	3,216	$	10,361	$	0	$	13,577

Liabilities:
Contingent Consideration	$	0	$	5,568	$	0	$	5,568
Foreign exchange forward contracts		0		1,364		0		1,364

Total	$	0	$	6,932	$	0	$	6,932

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of December 31, 2011 (in thousands):


	Fair Value at December 31, 2011
	Level 1		Level 2		Level 3		Total
Assets:
Securities available for sale:
Investments in publicly traded equity securities	$	155	$	0	$	0	$	155
Foreign exchange forward contracts		0		10,614		0		10,614
Deferred compensation plan assets:
Investment in publicly traded mutual funds		2,897		0		0		2,897

Total	$	3,052	$	10,614	$	0	$	13,666

Liabilities:
Foreign exchange forward contracts	$	0	$	3,586	$	0	$	3,586

Total	$	0	$	3,586	$	0	$	3,586

The fair values of the Company’s securities available for sale and deferred compensation plan assets are based on quoted prices. The deferred compensation plan assets are recorded within intangible and other assets-net in the Company’s condensed consolidated balance sheets. The foreign exchange forward contracts are entered into by the Company’s foreign subsidiaries to hedge the future payment of intercompany inventory transactions denominated in U.S. dollars. The fair values of the Company’s foreign exchange forward contracts are based on published quotations of spot currency rates and forward points, which are converted into implied forward currency rates.

The Company has evaluated its short-term and long-term debt and believes, based on the interest rates, related terms and maturities, that the fair values of such instruments approximate their carrying amounts. As of June 30, 2012 and December 31, 2011, the carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximated their fair values due to the short-term maturities of these accounts.

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2012 (in thousands):


			Fair Value Measurements Using
	For the 26 Weeks Ended June 30, 2012		Level 1		Level 2		Level 3		Total Losses
Assets:
Specific Company—owned stores—net	$	0	$	0	$	0	$	0	$	(256	)

In accordance with the provisions of ASC 360, Property, Plant and Equipment, the Company recorded a write-down of $0.3 million related to the fair value of leasehold improvements and fixturing associated with certain Company-owned retail stores during the Year To Date Period. The fair values of assets related to the Company-owned retail stores were determined using Level 3 inputs. If undiscounted cash flows estimated to be generated through the operation of Company-owned retail stores are less than the carrying value of the underlying assets, impairment losses are recorded. Impairment expenses related to Company-owned retail stores is recorded in selling and distribution expense within the Direct to consumer segment.

The Company had no impairment losses for the Prior Year YTD Period.

Earnings Per Share (“EPS”). Basic EPS is based on the weighted average number of common shares outstanding during each period. Diluted EPS adjusts basic EPS for the effects of dilutive common stock equivalents outstanding during each period using the treasury stock method.

The following table reconciles the numerators and denominators used in the computations of both basic and diluted EPS (in thousands except per share data):


	For the 13 Weeks Ended				For the 26 Weeks Ended
	June 30, 2012		July 2, 2011		June 30, 2012		July 2, 2011
Numerator:
Net income attributable to Fossil, Inc.	$	57,338	$	51,361	$	115,478	$	107,182

Denominator:
Basic EPS computation:
Basic weighted average common shares outstanding		61,669		63,411		61,741		63,743

Basic EPS	$	0.93	$	0.81	$	1.87	$	1.68

Diluted EPS computation:
Basic weighted average common shares outstanding		61,669		63,411		61,741		63,743
Stock options, stock appreciation rights and restricted stock units		423		713		509		734

Diluted weighted average common shares outstanding		62,092		64,124		62,250		64,477

Diluted EPS	$	0.92	$	0.80	$	1.86	$	1.66

Approximately 248,000, 248,000, and 2,000 shares issuable under stock-based awards were not included in the diluted EPS calculation at the end of the Second Quarter, Year To Date Period, and Prior Year YTD Period, respectively, because they were antidilutive. At the end of the Prior Year Quarter, all shares issuable under stock-based awards were included in the diluted EPS calculation.

Restricted Cash. As of June 30, 2012 and December 31, 2011, the Company had restricted cash of $6.0 million and $5.9 million, respectively, primarily pledged as collateral to secure bank guarantees on behalf of the Company for payments related to prospective value-added tax liabilities. This restricted cash is reported in prepaid expenses and other current assets in the Company’s condensed consolidated balance sheets as a component of current assets. The Company also had restricted cash of $1.4 million and $2.1 million as of June 30, 2012 and December 31, 2011, respectively, pledged as collateral to secure bank guarantees for the purpose of obtaining retail space. This restricted cash is reported in intangibles and other assets-net in the Company’s condensed consolidated balance sheets as a component of long-term assets.

Recently Adopted Accounting Standards. In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Fair Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). FASB intends the new guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. The amended guidance changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 assets and liabilities, for which the Company will be required to disclose quantitative information about the unobservable inputs used in the fair value measurements. These changes became effective for the Company on January 1, 2012. The adoption of ASU 2011-04 did not have a material impact on the Company’s condensed consolidated results of operations and financial position.

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 eliminates the option to report other comprehensive income and its components in the consolidated statement of shareholder’s equity and comprehensive income and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. The amendments in the update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This amendment also required an entity to present on the face of the financial statements adjustments for items that are reclassified from accumulated other comprehensive income to net income. However, in December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05 (“ASU 2011-12”). ASU 2011-12 defers the specific requirement to present items that are reclassified from accumulated other comprehensive income to net income separately with their respective components of net income and other comprehensive income while FASB further deliberates this aspect of the proposal. ASU 2011-05, as amended by ASU 2011-12, became effective for the Company on January 1, 2012. The adoption of ASU 2011-05 did not have a material impact on the Company’s condensed consolidated results of operations and financial position.

In September 2011, FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment (“ASU 2011-08”). ASU 2011-08 simplifies the assessment of goodwill for impairment by allowing companies the option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If a company concludes from the qualitative assessment that impairment is more likely than not, the entity is required to perform the two-step quantitative impairment test. These changes became effective for the Company on January 1, 2012. The adoption of ASU 2011-08 did not have a material impact on the Company’s condensed consolidated results of operations and financial position.