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Executives

Kosta Kartsotis – Chief Executive Officer

Mike Barnes – Chief Operating Officer

Mike Kovar – Chief Financial Officer

Analysts

Neely Tamminga – Piper Jaffray

Barbara Wyckoff – Buckingham Research Group

[Eric Tracy – BB&T Capital Markets]

Anna Andreeva – J.P. Morgan

Ronald Bookbinder – Global Hunter Securities

Fossil Inc. (FOSL) Q3 2008 Earnings Call November 11, 2008 9:00 AM ET

Operator

Welcome to the Fossil 2008 third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Alison Malkin of ICR.

Alison Malkin

Before we begin you should be aware that during this conference call, certain discussions will contain forward-looking information. Actual results could differ materially from those that will be projected during these discussions. Fossil's policy on forward-looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is readily available in our Form 10-K and 10-Q reports filed with the SEC.

In addition, Fossil undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. If any non-GAAP financial measure is used on this call, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the non-GAAP financial measure to GAAP will be provided as supplemental financial information to this release under the earnings release section on the investor relations heading on Fossil's web site.

Please note that this call is being broadcast live on Fossil's web site. It will be available for replay on the web site under the investor relations heading after the conclusion of the call. And now, I would like to turn the call over to Fossil's CEO, Kosta Kartsotis.

Kosta Kartsotis

Good morning everyone. Thanks for joining us. Also here today are Mike Barnes, our President and COO and our CFO, Mike Kovar. We will give you some detailed information regarding the earnings announcement and then I'll open up the call for questions.

Today we reported strong Q3 numbers in spite of the difficult environment, showing the resilience and strength of the business model. During the quarter, we grew sales 14.3% to $409.8 million. We increased both our gross profit and operating margin by over 200 basis points and reported net income of $36.5 million generating a 25.6% increase in earnings per share.

We experienced broad based growth all across the company with particular emphasis in our key growth initiatives; namely growing the market share of the Fossil brand globally, increasing our international presence and expanding our direct to consumer channels. Our strategy going forward will be to continue to play to our strengths, maximize our core businesses and to be very aggressive in increasing the efficiency of the company during these tough times.

[break in audio] include a 15.4% constant dollar increase in Fossil brand sales worldwide. This increase included solid contributions from our wholesale domestic segment where our business is more developed and double digit growth in our international wholesale and direct to consumer segments. Worldwide, sales of Fossil watches also increased 16.3% on a constant dollar basis.

The strengthening of the Fossil brand has been our biggest initiative the past few years and we are very pleased with the progress. Innovations in design, a more focused point of view, and great affordable products put us in a position for substantial long-term growth.

Considering the fact that this strong performance with a regular price and a mostly sale environment and that Fossil is and always has been a strong value proposition, we feel the brand is well positioned to do well in a rough environment.

Making the case vehicle for the brand image is our direct to consumer business. Retail delivered a solid performance with total sales rising 22.4% during the quarter driven by door expansion and a comp sales increase of 2.7% for the quarter. As it relates to new store openings, our international stores are showing the strongest performance. They are smaller, have higher sales per foot, require less build out costs and have higher gross profits because the prices are slightly higher.

We are putting stores in some of the best street locations around the world and doing very well both in Europe and Asia and communicating the Fossil brand to a much larger audience. The International opportunity is very significant and as a result, we expect two-thirds of the 80 plus stores opening this year will be outside of the U.S.

Moreover, in 2009, we plan to shift the vast majority of accessory store openings to Europe and Asia where we are experiencing a better performance and increasing brand recognition.

We're also seeing tremendous progress in the e-commerce business with a 33% increase for the third quarter. We had a 7.8% increase in web sales in the United States and had strong results from our Germany site that opened in September of last year. Recently, we have opened new e-commerce sites in the U.K., Singapore and Australia.

These web sites coupled with our catalog are great advertising for the brand. Increasingly, consumers are shopping on line before they go into a store and that fact is a big part of our strategy.

On the international front, wholesale shipments rose 12.1% on a constant dollar basis, with Europe up 8.2% and other international markets up 20.1%. We have some of the best brands in the world, great product innovation and a fast turning operating model. Also, our accessory business continues to gain momentum outside the United States. The opening of our retail stores overseas is introducing more customers to our non-watch offerings and this is providing us additional wholesale opportunity.

We also achieved strong results in jewelry which recorded a 31% constant dollar increase in sales for the quarter. This was fueled by the Fossil brand and the introduction of DKNY jewelry into 1,300 doors during the quarter. We are rapidly developing a sizable business in jewelry and we expect it to remain one of our fastest growing categories. The product is unique, well priced and plays to the trends in jewelry which is getting increasingly globally branded.

We also continue to work on new initiatives. We will be shipping men's shoes in the spring of '09 followed by women's shoes in the fall. We also will be making our first shipment of Michelle handbags in the spring of '09.

This brings us to the current environment. Without a doubt the world has changed since our last quarter ended. Worldwide economies have weakened. The financial markets are uncertain. Global stock markets are down and the U.S. dollar has significantly appreciated. All of this has created a climate where visibility is lessened.

What we do know is that our business model is stronger than ever. We are distributing globally branded, high margin accessories with relatively high inventory turns and short lead times. We have great brands and the best design and execution infrastructure. The Fossil brand is in great shape. We have a great staff of seasoned, focused employees all around the world striving for operational excellence.

Our balance sheet and cash flows remain strong and we are expecting to end the year with substantial cash. We entered the current quarter with $125 million after spending $110 million on stock repurchases in the last year. Our total debt at quarter end stood at a modest $9.1 million.

Our inventories are also current and in good shape. Additionally, our stores have the capacity to move large amounts of inventory if needed at advantageous prices. Keep in mind that we have improved the margin in the outlets by 600 basis points and that the outlet organization makes a high single operating profit even after corporate expenses. This is a great advantage in today's market place.

The environment is rough and may get rougher. In response, we will be very aggressive in the way we manage our business, reducing costs and inventories to align with our current sales expectations while directing resources to those businesses that are achieving strong returns and immediate ROI.

We have already begun to delay and cut expenditures and initiatives until we get more visibility. There will be great challenges and great opportunities for us during this time period. We feel we are position to weather the storm and only get stronger.

Now I'll turn it over to Mike Barnes.

Mike Barnes

I'll start with a review of our domestic business where we saw sales rise 7.7% for the quarter with watches up 6.7% and non-watch categories up 8.6%. Domestic wholesale watch growth was primarily driven by our licensed and Michelle watch brands. This was partially offset by a 12% decline in Relic watches due to a timing shift which we expect to make up during the fourth quarter. Fossil domestic watch shipments were essentially flat during the quarter representing an improved performance on a sequential quarter basis.

Growth in our licensed watch category was led by sales volume growth from Michael Kors and Emporio Armani watches as we continue to gain market share and add door growth within these businesses. Speaking of the Emporior Armani brand, I'd like to announce that we continue to strengthen this partnership and we've just signed a five-year extension for the brand through the year 2013.

Overall domestic wholesale business remains challenging we do believe we can continue to achieve positive growth within our domestic watch business during Q4 based in part on the strength of the brand portfolio we bring to the market place. We also believe that there is [inaudible] by capturing the sales we lost last year due to shortages we had on key watch styles stemming from facotry delays in the fourth quarter.

Our proprietary luxury watch brand Michelle, experienced a solid increase in wholesale shipments for the quarter. Michelle remains the best selling watch in the fashion luxury tier of distribution. Although the recent comp performance in luxury department stores overall were challenged in business during Q4, we feel we have great products and a proven execution strategy to meet this challenge.

Also, as Kosta mentioned, we remain on track to test Michelle handbags in spring of 2009 which we expect will continue to build market share for the brand.

Our domestic accessory business experienced an 8.8% increase in wholesale shipments during the third quarter driven by growth in the Relic and Fossil women's lines. Furthermore, the success and continued roll out of the Fossil accessory jewelry line, the Fossil 54 handbag line and the Fossil cold weather accessories contributted nicely to the sales growth.

Relic handbags and small leather goods had a great quarter with wholesale shipments increasing 20% and retail selling remained strong. Our Fossil women's business was up 6.6% for the quarter with solid growth in small leather and belt categories. Additionally, our Fossil handbag line added positive comps of 3.4% for the quarter.

These increased were partially offset by a decline in shipments in men's leathers as we were comping a private label business during Q3 last year that did not repeat. We're excited about the progress we've made in our domestic Fossil jewelry business since its launch during Q3 of last year. We've almost doubled the doors we're shipping to since last year and we we've seen very good sales performance.

Now on to the international wholesale business segment where we saw solid performance for the quarter. As I provide you with some financial comparisons, to keep things simple, and on an apples to apples basis, all of my references to sales and percentage comparisons will be based upon constant dollars.

International net sales increased by 12.1%. In Europe, wholesale shipments rose by 8.2% a nice improvement from the 3% growth we delivered in Q2. We posted a 17% increase in wholesale shipments of Fossil watches and posted solid growth for Emporior Armani and Adidas. The Michael Kors line that launched early last year is rapidly expanding into new doors as evidenced by a 67% increase in wholesale shipments over last year.

In Europe, total jewelry sales rose 17.5% on the strength of Fossil jewelry and the addition of DKNY jewelry. We're also experiencing a solid contribution from the newly designed Diesel jewelry line. These increases were partially offset by some weakness in our Emporio Armani jewelry offerings.

In leather goods, our expansion in Europe continued favorably and we're excited about the long-term potential to expand this category throughout Europe.

Looking to the fourth quarter, we expect to deliver positive wholesale comps driven by the continued roll out of DKNY jewelry and continued growth in our core watch and jewelry lines. We also expect additional sales growth from other product groups such as small leather goods as we continue to expand our wholesale offerings into additional non-watch and jewelry categories.

In our other international segment, wholesale shipments rose by 20.1%. This strong performance continues to show the benefit of our globally diversified business model. Fossil watch sales rose 28.9% while licensed watch sales rose 12.5% in the quarter. In addition to solid performances from our more mature subsidiaries, we're also experiencing strong contributions from our newer businesses in China, India and Korea. We continue to expand our concessions in the Asia Pacific region which are building awareness for our brand and allowing us to gain market share in the department store environment.

For our direct to consumer segment we had a terrific quarter as well with sales rising 22.4% or 22% on a constant dollar basis. This was primarily the result of a 29% increase of retail store growth and comp store increases of 2.7%, and a solid performance from our e-commerce business as Kosta mentioned earlier.

That 2.7% came on top of a 5.9% comp increase we announced last year in Q3. Our growth engine in this segment which is the Fossil accessory store concept delivered global comp increases of 2.8% in 84 comp stores that were opened during the quarter.

We experienced solid growth in the U.S. accessory stores with comps rising 5.8% and our Europe stores were up 1%. If you recall, our Q4 comps were down last year by 3.4% which means that we're up against an easier comparison in Q4.

Although many retailers reported rather dismal comp sales for October to begin Q4, we saw comp sales more in line with our positive Q3 comps. Our U.S. accessory stores finished up with a relatively strong 4.8% comp performance for the month.

Our outlet stores which we utilize to clear discontinued products reported comp increases of 6.8% in Q3. These stores allow us to maintain brand integrity and better control of our discontinued styles while offering consumers a shopping alternative to higher priced channels.

Globally, we ended the quarter with 288 stores. This includes 156 full price accessory stores, half of which were outside of the U.S. and 81 outlet locations including eight outside the U.S.

Additionally, we ended the quarter with 33 apparel stores, 18 multi brand stores. This compares to 225 stores at the end of the prior year quarter including 97 full price accessory stores with 48 outside the U.S. and 79 outlet stores including five outside the U.S., 33 apparel stores and 16 multi brand stores.

During the fourth quarter we expect to open 37 new doors, bringing total net door count to 325 at year-end. As previously stated, we'll concentrate on full price accessory concept with more stores being opened internationally than domestically.

Looking forward, while we have stated that we're well positioned to open 80 to 85 doors per year, and we're currently satisfied with the performance, our expectations for 2009 are more in line with 40 to 50 doors based on the current environment. We will however, remain opportunistic as we see the opportunities materialize and we will remain flexible to get more aggressive with openings based on those potential opportunities.

At this time, I will turn the call over to Mike Kovar to discuss our financial results.

Mike Kovar

First I'd like to summarize our third quarter results from this morning's press release. Net sales increased 14.3% to $409.8 million compared to $358.6 million last year. Gross profit grew 19.9% to $224.2 million or 54.7% of net sales compared to $187 million or 52.1% of net sales last year.

Operating income increased 31.5% to $63.7 million or 15.6% of net sales compared to $48.5 million or 13.5% of net sales last year. Net income rose 19.8% to $36.5 million compared to $30.5 million and diluted earnings per share increased 25.6% to $0.54 on 68 million shares outstanding compared to $0.43 per diluted share on 70.3 million shares last year.

The sales mix for the third quarter was as follows; 16.3% from domestic wholesale watch sales, 14.5% from other domestic wholesale businesses, 18.5% from world wide direct to consumer businesses, 33.1% from European wholesale sales and 17.6% from wholesale sales in other international locations.

The 14.3% sales growth for the quarter consisted of the following increases by category and geographic regions. Domestic watch sales increased 6.7% to $68.6 million compared to $62.6 million in the prior year quarter. Other domestic sales which include our leather, sunglass and jewelry businesses increased 8.8% to $59.6 million compared to $54.8 million in the prior year quarter.

Sales generated from European based wholesale operations increased 12.4% to $135.5 million compared to $120.6 million in the prior year quarter. Other international sales which consist of export sales to distributors and sales from our Canada, Mexico and Asia Pacific wholesale operations increased 22.9% to $72 million compared to $58.6 million in the prior year quarter.

And finally, sales from our world wide direct to consumer businesses grew 22.4% to $75.9 million compared to $62 million in the prior year quarter, the result of 29% growth and the average number of doors open during the third quarter, constant dollar comp store sales increases of 2.7% and the 33.1% increase in e-commerce sales.

The gross profit margin increased by 260 basis points to 54.7% in the third quarter compared to 52.1% in the prior year quarter. This increase is primarily the result of an increase in the sales mix of higher margin, direct to consumer and international wholesale segment sales.

The increase in our direct to consumer segment includes a 600 basis point increase in outlet store gross profit margins, an increase in the mix of full price of accessory stores opened as compared to the prior year quarter and a 33.1% increase in e-commerce sales.

Additionally, our ongoing initiatives to reduce product costs and decrease the proportion of lower margin product within out assortments contributed to the overall increase in gross profit margin.

Gross profit margin was benefited by approximately 60 basis points as a result of the weaker average U.S. dollar for the quarter. Partially offsetting these increases was an increase in the sales mix of lower margin shipments to third party distributors. Given the recent strengthening of the U.S. dollar in comparison with most of the other global markets, major currencies we operate in, we do expect to see some reduction in our fiscal 2008 fourth quarter gross profit margin in comparison to our third quarter gross profit margin, excluding the impact of sales mix.

In comparison to the prior year quarter, total operating expenses increased by $21.9 million to $160.4 million. Operating expenses included $2.8 million related to the translation of foreign-based expenses as a result of the weaker average U.S. dollar during the quarter.

As a percentage of net sales, operating expenses increased 50 basis points in the third quarter to 39.1% compared to $38.6 % in the prior year quarter. Operating expenses in the prior year quarter also included approximately $3 million related to expenses associated with our equity grant review.

Excluding the impact of currency translation and expenses associated with our prior U.S. grant review, the increase in operating expenses was principally driven by expenses associated with retail store growth in our direct to consumer segment and increases to support higher levels of sales.

As a percentage of net sales, direct to consumer operating expense increased during the third quarter compared to the prior year quarter resulting in approximately $5.1 million in additional operating expenses including approximately $1.1 million related to provision made for store impairment.

Operating income increased by 31.5% for the third quarter to 15.6% of net sales compared to 13.5% of net sales in the prior year quarter as a result of increased gross profit margin, partially offset by decreased operating expense leverage. Operating income was favorably impacted by approximately $3.4 million as a result of the translation of foreign-based sales and expenses into U.S. dollars.

Other income and expense increased unfavorably by $5.4 million during the third quarter. This increase was primarily driven by increased foreign currency transaction losses and to a lesser extent, an increase in minority interest expense.

As the U.S. dollar significantly strengthened during September we recognized currency losses related to our international subsidiary foreign currency payable balances denominated in U.S. dollars. Although we do hedge a portion of our currency risk by utilizing contracts for certain subsidiaries with U.S. dollar denominated payables, we have generally limited that exposure to the Euro and British Pound.

We have not historically entered into contracts for our smaller international subsidiaries due to the unpredictable nature of these subsidiaries cash flow. As a result, the strengthening of the U.S. dollar from the end of the second quarter of fiscal 2008 resulted in significant mark to market losses being recorded in many of our non-Euro and British Pound based subsidiaries.

As the U.S. dollar has continued to strengthen since the end of the third quarter, we expect to record additional mark to market losses in the fourth quarter.

Income tax expense of $23.2 million for the third quarter resulted in an effective tax rate of 38.8%, basically unchanged from the prior year effective tax rate of 38.7%, and we are estimating our tax rate for the fourth quarter to be approximately 37% excluding any discrete items.

Third quarter net income increased by 19.8% to $36.5 million or $0.54 per diluted share compared to $30.5 million or $0.43 per diluted share in the prior year quarter. Diluted earnings per share for the third quarter was not impacted by foreign currency gains or losses as foreign currency translation gains included an operating income offset by foreign currency mark to market losses included in other income and expense.

Diluted earnings per share in the prior year included option review costs equating to approximately $0.03 per diluted share.

Now turning to the balance sheet, we ended the third quarter with cash and cash equivalents and securities available for sale totaling $125.2 million compared with $193.4 million at the end of the prior year quarter and had $9.1 million of total debt.

From November last year until the end of the third quarter, we have repurchased approximately 3.4 million shares of our common stock for $110.8 million. At the end of Q3, we had approximately 600,000 shares remaining under the current 2 million-share buy back plan and expect to complete this buy back by December.

Accounts receivable increased by 12.7% to $229.3 million compared to $203.4 million at the end of the third quarter last year. Day sales outstanding for the third quarter was 51 days in comparison with 52 days in the prior year quarter.

Inventory at quarter end was $331.6 million representing an increase of 24.6% from the prior year quarter of $266.2 million and included a $12 million increase in inventory and approximately $4.1 million of inventory related to an additional net 63 retail stores being opened since the end of the prior year quarter.

As we mentioned during our August call, we were expecting inventory increases in excess of sales as we were anniversaring production delays on key styles during this time frame last year which caused our inventories to be unseasonably low. In fact, during the third quarter last year, inventory decreased by 1.4% while net sales increased by 19.6%. On a two-year basis, inventory balances have increased 22.9% while net sales have increased 36.7%.

Capital additions for the first nine months of the year totaled approximately $40.5 million. We are expecting 2008 capital expenditures of approximately $60 million to $70 million which is a reduction from the $75 million to $80 million we mentioned in the August call. Given the environment, we have chosen to defer certain projects with longer-term paybacks.

Depreciation and amortization expense for the first nine months of 2008 was $27.8 million and we are estimating full year 2008 depreciation and amortization expense of approximately $40 million, with the increase over 2007 levels, primarily related to our direct to consumer businesses.

As it relates to guidance for the fourth quarter, we are currently estimating reported fourth quarter net sales increases of 5% to 6% with constant dollar sales growth in the 10% to 12% range. On a constant dollar basis, we have reduced our previous fourth quarter estimates provided during our second quarter call in August from a range of $0.94 to $0.97 per diluted share to $0.91 per diluted share to reflect the more difficult environment. Our current guidance for the fourth quarter of $0.70 per diluted share includes currency losses of $0.21 in comparison to that previous guidance.

We would also like to remind you that as we continue to grow our retail store base, sales from our direct to consumer segment increases a percentage of our total sales mix, historically benefiting our profitability in the fourth quarter generally at the expense of the first and second quarter due to seasonality, it is more difficult to leverage retail expenses against retail sales.

In summary, we delivered a solid performance in Q3 and while we recognize the environment is clearly changed, we believe the strength of our brands, the compelling value of our products and our diversified business model positions us for market share gains during this holiday period.

While we remain cautious, we remain focused on maximizing our profitability and will reduce costs while continuing to capitalize on the growth we see for our business long term. With that, I'd like to turn the call back over to the operator to begin the question and answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instruction) Your first call comes from Neely Tamminga – Piper Jaffray.

Neely Tamminga – Piper Jaffray

Can you talk a little bigger picture here? You talk about some of these projects which is obviously very understandable considering the overall environment, but I'm just wondering how that move might influence your five year plan, and maybe if you could just remind us, implied in the guidance for this year X currency, where are you going to size up on that broader five year plan in terms of goals achieved.

Michael Barnes

Basically we still believe in our five-year plan. Obviously we're going to make adjustments along the way. Five years is a pretty long time frame and we're all obviously very hopeful that the economic situation that everybody is in today will improve at some point. We still believe in our five-year plan. We think its executable. The timing may shift a little bit here, a little bit there.

There's a lot of projects in the works. Some of them, some very important ones as a matter of fact will continue to go forward because they're integral to our five year plan of increasing our business, growing our international businesses, growing our retail businesses. So we do have a lot of very important projects that will go forward. Other ones that can be put on hold for the time being, will be.

Think of this as making it unable to meet our five-year objectives, I think that at this point in time, we feel pretty good about where we're going. We're just going to take it one-step at a time and do the most important projects first whereas in a different environment, we might have been able to do more things in parallel and move the needle a little bit quicker.

Kosta Kartsotis

When we laid out the five-year plan back in September of last year during the analyst meeting, we did indicate that that plan was based upon a much lower Euro to U.S. dollar comparison. In fact, I think we called out at that five-year plan was based on a 1.25 rate. So at this point in time the five-year plan extrapolated over the next five years for currency purposes hasn't really been impacted.

Neely Tamminga – Piper Jaffray

You have a wide range of consensus estimates on a shrinking group of analysts. I'm just wondering if directionally you could speak to some of the streets' numbers in the first half of next year, beyond the commentary you put in the press release about the overall retail mix shift in Q1, Q2 next year relative to Q3, Q4. It would seem to me that considering that mix shift as well as the implication of a strengthening dollar would actually assume that your guidance for the first half would come in lower than the streets collective $0.64. Is that a fair general directional assumption?

Michael Barnes

We generally do not provide any guidance for 2009 until we get to our fourth quarter call in February and we're going to maintain that position. I would agree that yes, there is some pressure on the first half of next year's earnings based upon the fact that we will continue to mix heavier to retail stores and the currency will be a head wind.

Neely Tamminga – Piper Jaffray

If I'm hearing all the commentary correctly about comps and the strength of the underlying business which is commendable, I'm assuming then that your wholesale accounts really haven't shifted much of the order flow outside of the Relic commentary that you made in terms of holiday quarters and maybe early spring quarters? Are you getting any sense that guys are just pulling back on orders overall?

Michael Barnes

I think our orders have continued to come in on a reasonable basis and you're correct that Relic, we did see a shift there, and we expect that that third quarter shift to made up in the fourth quarter. As far as the rest of our businesses based on the growth numbers that we put out there, we feel pretty good about where we're at, and we'll just have to see things unfold for the back half of the quarter. Obviously that's a big part of our business plan.

Neely Tamminga – Piper Jaffray

This is a question for Kosta, not to call our your age, but you've been around retail for awhile, and I'm just wondering from your perspective as we go through tough times and economies macro wise, do you find that watches as an accessory is a not a resilient category per se but on a price point basis to play a brand. It seems to me that it would be a relatively inexpensive type gift. Can you give us any sort of broader, bigger picture perspective on your watch category business specifically as it relates to just macro trends?

Kosta Kartsotis

It's very interesting, but if you look back at the company when we were mostly watches, it was a very difficult environment. We have always been a very strong value play, very strong design play and a very strong quick to react play. We do a lot of test and reorder instead of producing huge quantities and pushing them to market.

With this environment, I've never seen anything like this. I don't think anybody has. We don't really know what's going to happen. We see a lot of real exciting things happening in our business but yet the environment tells us that we've got to be very fast, cautious, aggressive on efficiency and make our business model operate the way it was built to do which is products turning through very quickly at high gross profit, very fast supply chain, be very quick to market, be very aggressive on the innovation and design side.

If you look at our quarter we had an increase in Fossil watches globally of 16%. We have seen as you can tell from the comps from last month, the more luxury the store, the worst the comps were . It's obvious the customer is reacting to value. And we have had a program in place all year that in every single brand we have, every category, every store, every country, everywhere we do business, we do price point analysis and we've been focusing on the opening price in every category in every brand.

For example, if you go into a Macy's store right now, you'll see the opening price of Fossil is $75.00. You'll see it featured in the price point sign. We didn't do that last year, and we haven't done it for a couple of year, because price hasn't been as much of an issue.

If you also look at even Armani, Armani is a great luxury brand and what we've done is, we have a group of watches at $175, so we've got more designs at $175 and if you go in the store, you'll see that point of sale, they're all put together and they're focused, and there's sign that says $175. We think that we're going to capture some of those customers that are moving down the cycle.

We do know the better watch business has not been good. So if people move towards value, we think in every brand and every category we have, we are a strong player. At the end of the day, you look at the watches we're making, all stainless steel, very high quality, very low return rate. We have a very strong, strong, value connotation. We can be very aggressive in the market place against our competitors especially with the scale we have in our operating model.

We think we're in a very good position to weather this storm and get even stronger and that's our mission.

Operator

Your next question comes from Barbara Wyckoff – Buckingham Research Group

Barbara Wyckoff – Buckingham Research Group

You talked about 17% operating margins on your strategic plan. Has this outlook changed? I would guess not from what you said before, but how should we be thinking about the projected spread between the margins between international, owned retail, domestic? Should we use the historical or does it change with the international owned retail growing?

Could you talk about specific win the margin maniac program that's helped margins so far and how much impact does that have going forward? Do you see any opportunity for new licenses or acquisitions given that the dislocation in retail? Could you update us on how many doors Fossil jewelry is in domestically and then what is the timing and initial distribution of the Relic jewelry.

Could you update us on the Watch Station watch world initiative?

Michael Barnes

17% was the goal for operating margin in the five year plan that we rolled out last year and as I mentioned earlier on the call, even though we're pulling back on certain initiatives and we're looking at a slightly reduced store growth count for next year, we think that we obviously have some bit of time to make up for that over the next five years.

At the same time, we don't expect currency to be a head wind in the five-year plan because we did utilize a much lower rate than the prevailing rate at the time we rolled out that plan.

As it relates to the operating margin mix, what we would intend to see is as we go forward, you know the five year plan we rolled out really had no SG&A leverage built into it. The growth in the operating margin was basically coming from the expansion of the gross margins of a heavier sales mix of retail and international wholesale, and we expect that to be the case as we move forward as well.

One thing that we do expect on an operating margin basis is to see the overall operating margin contribution from our retail organization to continue to strengthen as we go forward. We obviously have added a lot of infrastructure to that group over the last year, year and a half to affect a larger construction team, field sales team, to manage many more stores around the world, and as we continue to grow doors we'll obviously start leveraging some of those expenses.

On the license question you have for new licenses, I think our operating plan is the same as we talked about recently is that we plan to take our businesses and grow them. Kosta mentioned we've had great success in continuing to grow the Fossil brand and reposition the Fossil brand, and it is very well positioned as are our other brands even in this economic time we're in. We feel like we're better positioned than most of our competition. We still have some of the best brand names and partners out there and our biggest goal is to take those brands and continue to drive those sales.

Having said that because of the situation out there in the economy, we are still going to be extremely opportunistic. If the right opportunity comes along for a new license or even an acquisition, we're open for business here. We have a strong company, strong balance sheet, and we're better positioned than most people out there to take advantage of any opportunity that comes along. So we're keeping our eyes wide open for that.

On the Watch Station, I'll address that as well. We bought the Watch Station name and we are beginning to put together plans on how we're going to grow that business. Currently, right now our direct to consumer growth plan is in our Fossil accessory stores. It will continue to be so for the near to medium term, but we're looking at Watch Station and we do have a few multi brand stores in the United States.

There's some in Asia. There's some in Europe and we're looking at how we can consolidate our multi brand environment under this Watch Station umbrella both for stores and also for our web site. We think there's a huge opportunity there. We think there's a lot of value to the name and that will be something that we're be doing in the future. We're working on a plan for that right now.

Kosta Kartsotis

On the margin maniacs, we've improved our margins quite a bit. An interesting thing that we're seeing now if you can imagine is that the situation in Hong Kong with labor increases and shortages of factories is that has alleviated quite a bit and we've had a number of factories coming to us and saying that they can get lower prices, and some of the suppliers to them can get lower prices.

There's also some reductions in the cost of raw materials. So we do think we have some advantages there, especially in a difficult environment. The manufacturers over there tend to gravitate towards our balance sheet and our ability to pay. The environment is rough now for them in terms of them getting paid by smaller companies, so we think we have some room there.

We are also studying very closely, we potentially do have the opportunity to continue especially in Europe maybe to move some prices up, probably not on the opening price but the average would go up a little bit. It continues to be a less competitive environment and our own stores I think we have the opportunity to raise prices a little bit over there. So we're studying that very closely. We're going to be careful not to raise prices in a value environment, but we do think on the average we can move up.

As far as the jewelry goes, the jewelry business continues to grow at a very fast clip. We had a great Q4 in DKNY, and 1,300 doors it's going to be great in Europe. Fossil jewelry in Europe is still very, very, strong. Our jewelry business in the United States is in about 1,000 doors, doing well. We're getting better locations and we're performing well and we're getting better at it so we've very excited about that.

And Relic jewelry will be launching to about 800 doors in the spring so we're interested in that as well.

Operator

Your next question comes from Eric Tracy – BB&T Capital Markets

Eric Tracy – BB&T Capital Markets

Can you just talk a little bit about the outlook for Q4 international X currency? I think you said this is [inaudible] expected to continue to be positive. Can you talk about just given the underlying fundamentals deteriorating there? What gives you confidence in that? Is it an incremental in DKNY, just incremental door growth are getting deeper or more channels?

Michael Barnes

In Q4, we do expect to continue to see positive comp numbers there. Having said that, we realize that there is more in Europe right now, and we don't expect probably to post the $8.2% comp number that we saw in Q3. We would expect something a little bit less than that, probably low to mid single digit comp numbers on an organic basis in Europe.

For Asia, it remains very strong for us. We're still underdeveloped and even in somewhat of a declining economy, when you're underdeveloped, you can continue to grow your business, add new doors etc. And we continue to see that growth in the strong double-digit fashion for us. We expect for the United States to remain in the area where it has been over the past quarter. Overall we expect to see pretty good comps numbers in Q4 on an organic basis.

Eric Tracy – BB&T Capital Markets

Is it possible to get the contribution from the DKNY jewelry, because we've got 1,300 doors, the contribution in Q3?

Michael Barnes

The DKNY jewelry for the third quarter contributed about $3.3 million of sales.

Eric Tracy – BB&T Capital Markets

You talked about the trade down taking a certain benefit of Fossil domestically, I think you mentioned the margins trends at the higher end, you're seeing a lot pressure. On the impact on Michelle, are you feeling like it's higher in retail, is it sort of chasing a stronger sale period business or just overall business is under pressure?

Michael Barnes

We've actually seen Michelle hold up pretty well in the environment relative to that business level. We do have opportunities in Michelle as well. We do have some products there that are less expensive without diamonds, etc. That may or not become a bigger part of the business but in any case, it's held up pretty strongly.

Eric Tracy – BB&T Capital Markets

On a bigger picture, as part of this five-year plan talking about the brand repositioning a little bit, focusing on demographics and realizing that some of these moves may be masked by the environment, maybe just talk a little bit about how you feel about the brand positioning for

Fossil?

Michael Barnes

The brand repositioning has been obviously very good for us and if you go to our web site which has been recently changed, you'll see a lot of the branding there. Also on our web site you'll see our most recent catalogue. We just launched this last week. We have, as we mentioned before, we have related web stores and catalogues.

If you look at the products and the catalog on the web site, you can see a lot more detail. It's more aspirational in nature but still very affordable and we have a great group of watches for $75 and everything's priced pretty well. So the whole idea is to make it more aspirational but still affordable for a typical audience out there or the typical shopper in the mall.

We think long term this is going to play very well globally as we're seeing. What's really interesting to us is that we've opened stores in a number of new markets this year, in Milan and Spain and Scandinavia and Japan, and China, and there's no place in the world that this doesn't work.

We're very encouraged by that because we have the infrastructure over there to do it and these stores have the opportunity to give us great sales increases but also communicate the brand which has given us more wholesale opportunities. And it's basically an advertising vehicle that makes money. So we think long term, the positioning of it, and the products we make and the types of products we make and our creativity and our innovation is going to play well globally.

Operator

Your next question comes from Anna Andreeva – J.P. Morgan.

Anna Andreeva – J.P. Morgan

Going back to the guidance, I was wondering if you mentioned October comps, very impressive in this environment. Could you talk about the trends in the business globally quarter to date versus your 105 to 12% organic sales growth guidance? Your guidance still implies significant growth compared to what we've been hearing from other manufacturers and retailers. Are you tracking that number so far, or does the guidance assume acceleration of the business into the holiday?

Michael Barnes

As far as the trend quarter to date, we wanted to give you a little bit of color on how our own comps and our own stores had gone, but generally speaking, our give our guidance for Q4 we don't talk month to month about what the actual results are, so it would be hard for us to get into granularity with that issue.

Our expectations are as we laid it out, a little bit weaker in Europe, and the 8.2% that we saw in the third quarter in the U.S. is pretty much in line with where it's been, and we continue to expect to see strong double-digit comp numbers out of Asia going forward. But to get any more granular than that is not something we usually do.

Kosta Kartsotis

I would also add from a mixed perspective, the direct to consumer segment will play a much larger part in the fourth quarter due to the fact that we'll have all 83 doors that we opened, or most of the 83 doors that we opened doing business in that quarter, so you'll see a significant increase in the overall mix component as it reflects the direct to consumer segment.

Anna Andreeva – J.P. Morgan

As you approach the holiday, would you categorize your expectation for things to get better or roughly the same, just looking at the business overall.

Kosta Kartsotis

Our guidance has always given the prevailing environment, and that's what we would say at this point in time as well.

Anna Andreeva – J.P. Morgan

Looking into '09, you mentioned cutting the square footage growth. Could you talk about what else you're doing kind of playing defense, more specifically about expense opportunities in '09 to protect margins?

Michael Barnes

We're looking at every single expense very closely. Our company is very strong. We've held up very well in this environment, but we do not have our heads stuck in the sand. We realize it's tough out there. We look at it as a big opportunity for us, because I think with the strength that we have, we will gain market share out of this environment and we may be able to find new businesses that become more attractive to us as we get in this environment, and see the opportunities that develop.

We're going to be aggressive and we're going to be opportunistic, but at the same time, we are watching every expense. We're looking very closely at everything that we're doing as a company. We are looking at all of our capital investments and we are putting them in line as to what we want to move forward with and what we don't.

Even as it regards opening new stores, as I said, for 2009, we're probably looking at more like 40 to 50 stores but if the opportunities present themselves out there, if we find the right real estate, if the prices on the real estate get better, we find great locations, we're well positioned to increase that number if the opportunity is there.

We're just trying to take a cautious, optimistic, opportunistic attitude about this and we're looking at everything very, very closely, and expenses is something that we're going to watch and we're going to be looking at how we can consolidate and save money, obviously just like everyone else.

Kosta Kartsotis

What we're trying to do is basically get the company as lean and efficient as it possibly can be on all issues, on inventory. For example, we slowed down hiring except for critical positions like store managers, and we have attrition. What we've done is move people around and not back fill them. We're going to do more of that.

For example, we've been investing for a time in the shoe business. We hired some very seasoned professionals and they're doing a great job. Basically what we've done in terms of moving forward in the sales force etc., is we basically moved some people around and we're going to staff that internally without that back fill.

So we're doing a lot of that. It's kind of energized the company. People are saying, I can do more, I can do more, and they want to be part of the team, and it's basically very energizing culture here and I think everybody's focused on doing more with less, and we're going to come out of this stronger.

Anna Andreeva – J.P. Morgan

This 40 to 50 stores next year, what is the breakdown internationally versus domestically and initial thoughts on CapEx for '09?

Michael Barnes

The breakdown for the 40 to 50 stores is going to be primarily international. It's going to be a higher number opened internationally than the U.S. I would guess at least two thirds international.

Kosta Kartsotis

As it relates to CapEx expectations, we'll deliver that along with the rest of our 2009 expectations during our February call.

Anna Andreeva – J.P. Morgan

Can you talk just a little bit more about Europe between some of your more mature markets versus new markets? I was curious on Germany and U.K. where you have a big exposure.

Michael Barnes

Obviously Germany and the U.K. are the more developed markets for us as a company in Europe and we have seen some slowing growth in those regions. That's one big reason why we feel like the comp number for Q4 is going to come down below the 8.2 number that we reported for Q3. There are still very strong markets. We're staying in full communication with our customers there and we're continuing to do business as usual, but it's just going to be a slower environment.

We do have some opportunities in some of the less mature markets to continue to push for growth and a lot of our third party distribution markets are continuing to move forward, and we've had good meetings with our distributors. Some of our more underdeveloped owned markets, Scandinavia, etc., I think there's opportunity for us there.

We're just going to use this environment as a way to go out and get market share. We are still in a position and our goal is to go out and continue to open shop and shops, continue to open concessions on a global basis, and really just take as much market share as we can and stay lean, and when we come out of the economic situation, when the world comes out of it, we're going to be well positioned to fully explode.

Operator

Your next question comes from Ronald Bookbinder – Global Hunter Securities.

Ronald Bookbinder – Global Hunter Securities

The gross margin, I think you mentioned in the text that you expect Q4 gross margin to be below Q3. With the shift to more retail, is that just from the currency?

Michael Barnes

I think my comment also included excluding the impact of mix. There could be some offset obviously from the constant dollar impact of margins with the U.S.D being where it was today based upon the average rate for the third quarter. We expect some of that loss to be recovered based upon a much higher mix of our direct to consumer businesses in the fourth quarter.

Ronald Bookbinder – Global Hunter Securities

These 40 to 50 store openings for 2009, how many of those leases are signed, and do you expect the openings to be more pushed toward the first half of the year?

Kosta Kartsotis

We signed or are committed to about 20 stores globally and most of those open, if you look toward the second and third quarter, so some of those are already signed. New locations are maybe opening in malls, etc. in the third quarter that we signed this year.

Ronald Bookbinder – Global Hunter Securities

What is the flow of the openings for 2009? They would mainly come in the second and third quarter?

Kosta Kartsotis

Right.

Ronald Bookbinder – Global Hunter Securities

Inventory, where do you expect to end the year on inventory?

Michael Barnes

I expect inventory growth year over year is in low to mid teens area. We're going to have a little pressure on inventory at year-end due to the fact that the Chinese New Year is moving up by two weeks this year, so we're going to have to take some earlier deliveries obviously with the factories over there closing that much earlier in the year.

Kosta Kartsotis

On thing I would mention is that our modus operandi during this time is to be as responsive and as quick as possible on every issue. To just give you an example, if the environment does get more difficult, our stores, we've improved the operations so much to the point they're doing extremely well. They have the capacity to move much larger amounts of merchandise at advantageous prices. It really wouldn't affect the margin that much so we're watching it very closely.

If the environment changes, basically a safety valve that we can adjust if we need to, but right now, we've been very pleased with the currency of the inventory and how it's flowing from Hong Kong.

Ronald Bookbinder – Global Hunter Securities

On the CapEx for 2009, without giving direct guidance, we should expect a decline with a reduction in the store revenues, correct?

Michael Barnes

As it relates to stores, yes, we would expect to see a decline. As we mentioned earlier, we'll have a full reporting of our CapEx plans in 2009 in the February call, but as we mentioned on the call, we're looking at moving back certain initiatives that maybe had been planned for 2009, move them back without impacting the current business.

Ronald Bookbinder – Global Hunter Securities

On these currency losses that subsidiaries due to mark to market, can you pay off those payables quicker? Can you get those payables in local currency? Is there a way that you could mitigate that impact?

Michael Barnes

There is a way to mitigate that impact and part of that is obviously our hedging program and utilizing contracts, but the book board contracts you've got to have some sense of the validity of the cash flows of the underlying subsidiary. What we are looking at as it relates to some of the smaller subsidiaries is potentially local borrowing lines or potentially including them in a cash pool that we have in Europe so they could borrow from other subsidiaries that have excess cash.

To your point of being able to pay down those balances much quicker and not leave significant U.S. dollar denominated A/P balances on the balance sheet for any longer than you need to.

Ronald Bookbinder – Global Hunter Securities

Could you give us a review of the expanded offerings for 2009, like the Michelle handbags or the Relic jewelry or the continued roll out of shoes? What are the larger announcements of expansion for 2009?

Kosta Kartsotis

We do have DKNY which is staring in the third quarter and will be a plus in the spring. As you see it's a pretty sizable number. Men's shoes starts in the spring. In shoes, it's a relatively small role out, it's not a significant number. We also have a small roll out of Michelle handbags that will be going in the first quarter, and Relic jewelry, 800 doors will go out in the spring as well.

Operator

We have no more questions. I would now like to turn the conference back over to management for any closing statements.

Michael Barnes

Should you want to replay this conference call, it has been recorded and will be available from 10:00 am central time today until 12 midnight central time tomorrow by calling 303-590-3000 or 1-800-405-2236 entering reservation number 11119864 followed by the pound sign.

The conference call is also available on Street Events and may be accessed through Street Events web site at www.streetevents.com or directly through our web site at fossil.com by clicking on investor relations on our home page and then on web cast.

Should you have any questions that did not get addressed today, please give Mike Barnes or myself a call. Thank again for joining us today. Our next scheduled conference call will be in February for the release of our 2008 fourth quarter and full year operating results.

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Source: Fossil Inc. Q3 2008 Earnings Call Transcript
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