Fossil's CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: Fossil, Inc. (FOSL)

Fossil, Inc. (NASDAQ:FOSL)

Q2 2012 Earnings Call

August 9, 2011 9:00 am ET


Allison Malkin - ICR

Kosta Kartsotis - CEO

Mike Kovar - CFO

Mark Quick - Vice Chairman

Jennifer Pritchard - President of Retail


Amanda Sigouin - Jefferies & Co

Neely Tamminga - Piper Jaffray

Omar Saad - ISI Group

Barbara Wyckoff - CLSA

Kelly Hauser - BB&T Capital Markets


Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Fossil Incorporated Q2 Earnings Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Tuesday, August 9, 2011.

I would now like to turn the conference over to Allison Malkin of ICR. Please go ahead.

Allison Malkin

Thank you. Good morning everyone.

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 on our Form 10-K and Form 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 direct comparable GAAP financial measure and a reconciliation of the non-GAAP financial measure to GAAP will be provided as supplemental financial information through this release under the Earnings Release section under the Investor Relations heading on Fossil's website.

Please note that you may listen to a live webcast or a replay of this call by visiting Fossil's website and then clicking on Investor Relations at the bottom of the Home page and then on Webcast.

Now, I would like to turn the call over to Fossil's CEO, Kosta Kartsotis. Kosta?

Kosta Karsotis

Thanks, Allison. Good morning everyone, and welcome to our call covering Fossil's second quarter results. Joining us today are Mike Kovar, our CFO; Mark Quick, our Vice Chairman; and Jennifer Pritchard, our President of Retail. Mike will provide a detailed review of our financial results later in the call while Mark and Jennifer will be available for questions at the conclusion of the prepared remarks.

We were pleased to announce earlier this morning the double digit sales increases across all of our geographies and categories as well as through our own retail stores allowed us to achieve a second quarter sales record. As a result, our $0.80 per share earnings for the quarter significantly both surpassed our previous earnings guidance. The second quarter sales increase of 35% represented the fifth consecutive quarter of at least 25% top line growth.

The Fossil brand is continuing to show strong growth and we are in what we believe to be the early stage of the strong watch trend, which is driving watch sales increases on a global basis through our wholesale, retail and ecommerce distribution channels. Our intense focus on design, innovation and brand development, combined with the ongoing success of our global expansion continues to provide us with a powerful formula for growth.

During the quarter, watches again lead our performance rising 32% in constant currency. Our emphasis on newness, new materials, new ideas and unique designs are allowing us to capitalize on the increasing importance of the category around the world. During Q2, Fossil watch sales grew by 13% while other noteworthy increases included Marc by Marc Jacobs which rose a 156%, Armani Exchange 136% and Michael Kors 91%. All our watch brands experienced double-digit growth.

On an aggregate dollar volume increase, Michael Kors and Fossil were the two largest contributors. The Michael Kors watch brand continues to surpass our expectations. The brand is maintaining a strong momentum in North America, is just beginning to expand into Europe, and is still small but showing huge potential in Asia. By the end of the year, we expect Michael Kors to reach an annual sales volume level of approximately $300 million, representing a more than $100 million increase over the prior year.

While Armani exchange and Marc by Marc are still in their early stages of their growth, we are experiencing similar trends in these two brands that we saw in the Kors business early in its stages.

These new and developing watch brands, in addition to our core brands, and coupled with the strength of our design, product development, and supply chain teams, and anchored by our global distribution platform serve as the foundation for our continued profitable market share growth.

In addition to solid increases in our watch business, sales of Fossil accessories grew 22% resulting in an overall Fossil branded sales increase of 17% during the second quarter. Sales in the accessories category will lead by a 44% increase in women’s bags; a portion of the growth is due to an increase in our [Averagina] retails and primarily a result of introducing a growing selection of higher quality details and fabrications. We believe the handbag category will continue to benefit greatly from increase in the awareness of Fossil as a lifestyle brand.

Our overall leather category also continues to make significant headway in Europe and Asia, increasing 64% and 39% respectively during the second quarter and providing a glimpse of the growth opportunity in that category.

The other significant contributed to sales growth in the second quarter was our direct-to-consumer business, consisting of our own retail stores and ecommerce sites. Our own stores delivered another outstanding performance; with a global comp store sales growth of 22%, on top of 15% increase in the second quarter of last year. It represents the 13th consecutive quarter of comp increases, and the 7th consecutive quarter of double-digit comp increases.

The emphasis we have placed upon engaging our customers within our redesigned store environment and the focus on improving our selling metrics is increasing store productivity and paying strong dividends in terms of ROI. Our accessory store concept comps grew over 16%, increasing net sales per square feet to $742 a foot compared to $685 last year. Our outlet store comps were even higher at 30% plus as we continue to raise our Averagina retail in the outlets through a reduction in promotional activity.

From a geographic perspective, North America led our comp performance with 25% increase, followed by Asia with 19% gain, and Europe, which rose 12%.

In terms of our store expansion, through the first half of fiscal 2011, we have opened 15 new stores and closed 11. For 2011, we now expect to open approximately 58 to 62 new stores and close 20 existing locations. This compares to our previous expectation of opening 80 to 85 stores and closing 26 to 28.

The reduction in openings is primarily due to us getting a late start and not having enough deals in the pipeline to open that number of stores. We have since added additional real estate resources around the world, and it is our intent to accelerate our store expansion in 2012. We currently have substantially more commitments in hand at this point for 2012 locations than we did for 2011 locations a year ago.

Our global ecommerce sales rose 20% during the quarter with our two principal sites in the US and Germany increasing 14% and 41% respectively. Currently, we have four e-commerce capable sites in five countries and are on track to launch additional Fossil branded sites in Japan, Korea, France, Italy, and Austria by the end of the year. In addition, we will be launching our first Watch Station website in United States in September. The objective here is to raise the awareness of the innovation in our various watch brands and support the Watch Station stores.

Our largest opportunity, however, remains our continued expansion into the Asia-Pacific region. We are intently focused on the expansion of our two core businesses in Asia, and continue to expect the region to represent an increasing percentage of our global sales. We increased our overall sales in Asia by 35% during the second quarter, principally through watch sales in Korea, Japan, and Australia, as well as through 39% growth in our non-watch categories, although is off a smaller base.

We are putting a lot of energy into optimizing our business in the Asia region, including expanding our concession and retail store footprint, investing our back office infrastructure in Hong Kong, as well as acquiring additional management team members to facilitate the growth. Additionally, we are expanding our resources in digital presentation, real estate, and construction, environmental design, inventory planning and training, all to facilitate our long-term strategies. The growing recognition of the Fossil brands and our globally recognized portfolio of license brands is opening a number of doors for us as we expand into the region.

In summary, while there are many positive developments and milestones achieved during the second quarter, we also began to see the impact of higher production cost into our overall gross profit margins, and we certainly to not overlook the recent negative economic events taking place. Even though we continue to experience very favorable trends across our brands in geographies, we would not expect to be immune to consumer spending cutbacks. Having said that, we remain optimistic and confident about our growth potential over the next several years. We believe very strongly in the resilience and the growth opportunities that our business model provides us.

The demand for Fossil and our multi-brand watch portfolio remains very strong and the investments we are making in talent and infrastructure position us to capitalize on the significant growth opportunities we see in Asia and other parts of the world.

Now, I will turn the call over to Mike for more color.

Mike Kovar

Thanks Kosta. Good morning everyone. I will start off by summarizing our second quarter 2011 versus 2010 results from this morning's press release. Net sales increased by 34.9% to $556.7 million, compared to $412.6 million. Gross profit rose 31.7% to $312 million or 56% in net sales, compared to $236.9 million or 57.4% of net sales last year.

Operating income increased by 34.1% to $86.3 million or 15.5% of net sales, compared to $64.3 million or 15.6% of net sales. Other income and expense decreased unfavorably by $4.2 million. Income taxes increased to $27.7 million resulting in an effective tax rate of 33.9%, compared to $8 million resulting in an effective tax rate of 12.3% last year.

Net income attributable to Fossil Inc. decreased by 5.7% to $51.4 million, compared to $54.5 million and diluted earnings per share remain constant at $0.80 a share on 64.1 million shares, compared to 68.3 million shares last year.

The sales mix breakdown for the second quarter with comparable prior year levels was as follows: 38.3% from North America wholesale activities versus 37.8%; 25.4% from Europe wholesale activity versus 26.1%; 12.2% from Asia-Pac wholesale versus 11.2%; and 24.1% from our worldwide direct-to-consumer businesses versus 24.9%.

In connection with our wholesale operations, sales from North America wholesale businesses, which include our operating activities in the US, Canada and Mexico, as well as sales to third-party distributors in South America increased by $57 million or 36.7% to $213 million. Excluding approximately $1 million from favorable currency comparisons to Q2 last year, North America wholesale sales increased by 36%.

Sales from our Europe wholesale operations increased by $34 million or 31.7% to $142 million. Excluding currency that favorably impacted sales by $16 million, Europe wholesale sales grew by 16.8%. As a result of some late inventory deliveries, we experienced a shift in shipments out of June and into July, which negatively impacted the reported European growth in Q2. In fact, our constant dollar shipments in Europe were up by over 35% in July.

Sales from our Asia-Pac wholesale operations increased by $21 million or 46.3% to $68 million, and excluding currency that favorably impacted sales by $5 million, Asia-Pac wholesale sales grew by 35.3%. However, when excluding Japan that was obviously impacted by the tragic events of Q1, and our decision to discontinue certain non-branded, non-license businesses, Asia-Pac's constant dollar sales increased 48% during the quarter.

Highlighting some notable increases from a major product category perspective, total watch sales increased $111.8 million or 38.8%, 32.1% ex-currency to $400 million. Drilling down into this number, you will find that our proprietary brand watch sales increased by $24.3 million or 20%, 14.6% ex-currency to $146 million, and our licensed watch sales increased by $88.4 million or 58.3%, 50% ex-currency to $240 million.

On the non-watch side of our business, leather product sales increased $24 million or 34.8%, 30.4% ex-currency to $92 million, and jewelry sales increased $6 million to 19.5%, 8.7% ex-currency to $38 million.

Moving on the direct-to-consumer segment, sales from direct-to-consumer businesses increased by $31 million, or 30.5% to $134 million, and excluding currency that favorably impacted sales by $5 million, DTC sales increased by 25.7%. As Kosta mentioned, constant dollar comps in our retail stores maintained a strong double-digit performance coming in at 22% in Q2.

Globally, we ended Q2 with 367 stores and occupied 642,000 square feet, compared to 619,000 square feet at the end of the prior year quarter. This included 235 full price accessory stores, 132 of which were outside of North America; 95 outlet locations, including 22 outside North America; 27 clothing stores, including 3 outside of North America; and 10 full price multi-brand stores including 9 outside of North America.

This compares to 354 stores at the end of the second quarter last year, which included 222 full price accessory stores with 120 located outside of North America; 88 outlet locations including 17 outside North America; 31 clothing stores including 2 outside of North America; and 13 full price multi-brand stores including 12 outside of North America.

Gross profit of $312 million in the second quarter represented 31.7% increase from $236.9 million in Q2 last year. The increase was a result of increased net sales partially offset by a reduction in gross profit margin. Gross profit margin decreased to 140 basis points to 56% in Q2, compared to 57.4% last year, inclusive of 150 basis point favorable impact standing from a weaker U.S dollar.

The decrease in gross profit margin was primarily driven by production cost increases and to a lesser extent a larger percentage of lower margin product sales in the sales mix. Lower margin US wholesales sales and sales to third party distributors and off price retailers increased as a percentage of the sales mix, negatively impact in gross profit margin.

This year we have experienced a 32% increase in labor rates in our China based watch factories, which includes appreciation in the RMB. In fact, both labor and material costs are running higher than our previous expectations for 2011.

We made a strategic decision not to raise prices on core watch styles despite expected increases. Our plans would engineer higher prices on newness in order to mitigate the impact of increased costs on core. Although we have done that to some extent, it was not enough to compensate for the overall impact that increased cost that we are having on our core styles.

Given the more rapid increase in pricing than we originally expected, we are reviewing opportunities to revisit our pricing strategies. Nevertheless, we will experience year-over-year as well as sequential margin deterioration in Q3. We currently estimate Q3 gross margins just above 55%. However, we expect Q4 margins to be more inline with last year, but lower than we guided to in May. The impact of newness and higher mix of direct-to-consumer and higher margin Asia Pac wholesale sales are expected to partially offset our ongoing labor and material cost increases.

As a percentage of sales operating expenses decreased to 40.5% in the second quarter, compared to 41.8% in Q2 last year. Even with the increased expenses associated with our longer term strategic initiatives, our better than expected top line growth allowed us to generate some nice SG&A leverage during the quarter.

Total operating expenses increased by $53 million from the prior year quarter primarily the result of increased cost associated with sales growth and $12.4 million of unfavorable impact from the translation of foreign based expenses due to a weaker US dollar. On a constant dollar basis, Q2 operating expenses in our wholesale segments and corporate cost area increased by $17.6 million and $10.7 million respectively.

Expense growth in the wholesale segment was a result of increased infrastructure spending in the Asia-Pacific region and increased payroll cost and marketing expenses in North America and Europe. Expense growth in the corporate cost area was primarily associated with increased payroll cost including stock compensation and higher levels of professional fees.

In our direct-to-consumer segment operating expenses increased by $12.4 million, compared to Q2 last year primarily due to store growth, cost associated with the launch of our CRM initiative, expansion of catalog mailings, and increased web based marketing and infrastructure expenditures.

Regarding our planned strategic investments for this year, through the first half of fiscal 2011 we have spend approximately $10 million with 70% of this spend in the Asia-Pacific region. For the second half of 2011, we are projecting another $24 million in strategic spend including 75% of this year marked for Asia. The remainder of the $24 million relates to the completion of our CRM initiative and cost associated with the move an increased occupancy cost of our new headquarters in Richardson, Texas.

As a percentage of net sales Q2 operating income remain relatively unchanged from 15.5% of sales, compared to 15.6% of net sales in Q2 last year. Q2 operating income was positively impacted by approximately $10.8 million as a result of the translation of foreign based sales and expenses into US dollars when compared to last year. We estimate our operating profit margin for the full-year in the 18% range.

Just a reminder. Currency rate changes as well as deviations from our current expectations in sales mix over the balance of the year could influence both gross margins and operating margins performance.

Other income and expense decreased unfavorably by $4.2 million during the second quarter. This decrease was primarily driven by unfavorable foreign currency changes resulting from mark-to-market, hedging, and other transactional activities. At prevailing foreign currency exchange rates, we estimate that outstanding forward contracts with scheduled settlement dates in the second half of fiscal year 2011 will result in hedge losses of approximately $5.1 million and $6.3 million in the third and fourth quarters respectively.

Income tax expense for the second quarter was $27.7 million resulting in an effective tax rate of 33.9%, compared to an effective rate of 12.3% last year. As you recall, included in the 12.3% effective tax rate in the prior year quarter, we had 21.8% rate reduction from our structural tax rate related to the recognition of previously unrecognized tax benefits as a result of certain audit settlements. We estimate our effective tax rate for the third and fourth quarters will approximately 35%, excluding any discrete events.

Net income attributable to non-controlling interest, which represents the minority interest portion of subsidiaries in which we own less than 100%, increased by about $600,000 during the second quarter. This was primarily a result of increased net income related to our less than 100% owned watch assembly facilities.

Second quarter net income attributable to Fossil Inc. decreased by 5.7% to $51.4 million or $0.80 per diluted share, inclusive for a favorable $0.07 per diluted share increase related to foreign currency. This $0.07 foreign currency gain represents gains of $0.11 included in operating income from favorable currency translation rates, partially offset by losses of $0.04 from mark-to-market activity included in other income and expense. As a reminder, last year's earnings of $0.80 per diluted share, included a $0.22 benefit as a result of a reduction in certain income tax liabilities identified earlier.

Now turning to the balance sheet, we ended Q2 with cash, cash equivalents, and securities available for sale of $332.2 million, compared to $443 million at the end of the prior fiscal year's second quarter. Since the end of the prior year second quarter, we have invested approximately $343 million to repurchase 5.2 million shares of our common stock.

Inventory at the end of the second quarter was $450 million, an increase of 51.50% from last years Q2 balance of $298 million. Higher inventory levels resulted from continued smoothing of factory production throughout the year, which results in higher inventory levels in the first half of the year, due to sales being seasonally higher in the second half of the year. Although, we expect inventory increases to slow over the balance of the year, and expect our fiscal year-end inventory growth to be in line with sales growth.

Accounts receivable increased by 38.8% to $226 million, compared to $163 million at the end of the prior year quarter. This increase was primarily due to an increase in wholesale sales in comparison to last year's Q2. Our day sales outstanding for the wholesale segment increased 1 day to 47 in comparison to 46 days in the prior quarter.

During the first half of fiscal 2011, we had capital expenditures of approximately $44 million, and are expecting fiscal year 2011 capital expenditures of approximately $125 million. The bulk of this CapEx spend is related to new store openings and concessions build outs, as well as leasehold improvements related to our new corporate office that we will be moving into later this month.

Depreciation and amortization expense for the first half of the year totaled $21 million and we estimate full 2011 depreciation and amortization of approximately $47 million.

As it relates to guidance for 2011, for the third and fourth quarters we expect reported net sales to increase in the range of 22% to 24% with constant dollar net sales increasing in the range of 18% to 20%. Third quarter 2011 diluted earnings per share are expected to be in the range of $1 to $1.03 while fourth quarter diluted earnings per share expected to be in the range of $1.78 to $1.82. This guidance results in estimated fiscal year 2011 diluted earnings per share of $4.44 to $4.50 compared to last year's actual diluted earnings per share of $3.77. Our forward guidance is always based upon the current prevailing rate of the US dollar in comparison to other foreign currencies for countries in which we operate.

Now, I would like to turn the call over to the operator to begin the Q&A portion. Operator?

Question-and-Answer Session


(Operator Instructions). And our first question comes from the line of Randy Konik with Jefferies & Company. Please go ahead.

Amanda Sigouin - Jefferies & Co

Hi, good morning. This is Amanda Sigouin on for Randy.

Kosta Karsotis

Hi Amanda.

Amanda Sigouin - Jefferies & Co

First, just wanted to make sure I understand the margin picture for the second half of the year. What is the expected gross margin impact from the higher sourcing costs in the third quarter, and why does it seem to be coming on stronger than originally expected?

Kosta Karsotis

As you look into the second quarter the impact of higher than expected production costs resulted in about 180 basis points of deterioration in our gross margin. We expect that to continue into Q3 and somewhat into Q4 although we've got a better opportunity in terms of mitigating that in Q4 in terms of a much higher expected mix in sales for our higher margin Asia-Pacific wholesale activities in direct-to-consumer segment activities.

We are primarily finding that labor rates are increasing at a slightly faster rate than we expected early on. There has also been some appreciation in the RMB that’s impacting us in terms of those labor rates. And we are finding cost increases in certain materials that we weren’t expecting as well. In fact, our movement costs are up about 9% from where we were last year and that wasn’t expected. We did expect obviously to have some challenges with production given the events that occurred within the factories in Japan in the first quarter and we’ve been able to see that ramp up in terms of production to meet our needs for assembly, but we weren’t expecting a 9% increase in movement costs.

Amanda Sigouin - Jefferies & Co

Okay, thank you. And then on the strategic investments, I think you said $24 million is still going to be spent in the balance of the year. Could you give us the breakout between 3Q and 4Q?

Kosta Karsotis

Yes, you’ll see probably that $24 million, around $10 million of that being spent in Q3 and the remainder in Q4. Q3 will be a little bit heavier in terms of completion of our move into our new facility, as well as the completion of our CRM initiative, whereas Q4 will be more impacted by our continuing investments in the Asia region.


Thank you. And our next question comes from the line of Neely Tamminga, with Piper Jaffray. Please go ahead.

Neely Tamminga - Piper Jaffray

Mike, I just have a couple of your questions for you. Dissecting a little bit more on Q2, it was about 180 basis points was high to the production cost increases. Am I right in thinking then that lower merchandizing mix closer to about 110, 100ish sort of basis points impact? And how much of that is tied to the delayed shipments for European wholesale in terms of distorting the percentage of sales mix?

Mike Kovar

If you look at what happened in terms of sales mix, quarter-over-quarter, we gave up about 30 basis points of margin in terms of lower contributions in terms of our direct-to-consumer businesses, which is kind of interesting, given we had 22% comps in our retail stores that we actually lost mix because the rest of the company was growing faster. So, combined on a sales mix basis, we saw about 30% unfavorable or 30 basis points of unfavorable mix towards the overall gross margin performance.

In terms of Europe, we are talking in terms of probably instead of coming in a 16% had those shipments in our warehouse is more timely, Europe would have been probably slightly over 20% for the third quarter and obviously a little bit less than the 35% increase we saw in July of this year.

Neely Tamminga - Piper Jaffray

Okay. So overall, just to be very clear you are not looking for – you have not experienced or you’re looking for some sort of increase in marked down rate or obsolescence tied to kind of the inventory and all the different moving parts. Is that correct?

Mike Kovar

That’s correct.

Neely Tamminga - Piper Jaffray

Okay. Just want to make sure that that’s amply clear. And then going back to the guidance, labor obviously is the big aha moment I think over the last quarter relative to where you guys were a quarter ago from now, and how much also of the slowdown store openings might be contributing to the guidance kind of coming in a little bit? Or is that not as much of factor?

Mike Kovar

No, that’s not really an issue really in terms of our total picture. We actually this year will do more on retail sales than we planned even though we’ll have fewer openings just bring good increase in our productivity.

Neely Tamminga - Piper Jaffray

Okay, okay, that’s great. And then one last question on the cash, obviously, there has been some interesting events that have occurred in the market over the last two week or two. And your stock is obviously going to take it on the chin today. Just wondering how you guys might view some strategic redeployment of cash, as you continue to throw if off at a great rate?

Kosta Karsotis

Since we announced the buyback back in September last year, Neely, as you recall, we have been pretty active, every quarter buying back shares. We just completed our last buyback under a 10b5-1 plan last week and we’ll continue to look at the opportunities as we move forward.


Thank you. And our next question comes from the line of (inaudible) with JPMorgan. Please go ahead.

Unidentified Analyst

Hi, thanks guys for taking my question. I guess a couple of questions. First question, I would ask you is, in Europe it sounds like due to the inventory issues, the top line so you picked up in July. Can you comment about any other regions whether it be wholesales or DTC? What are you seeing quarter-to-date?

Kosta Karsotis

I would say what’s implied in our guidance is 20% to 24% increase in sales for the third and the fourth quarter. I would say we’re coming up against the impact of some pretty large numbers that we threw out last year, sales increasing in excess of 30% last year. On a segment basis, we would expect to see the growth in the US wholesale market to drop somewhat in terms of where we’ve been operating over the last five quarters as we start anniversary, some of the significant increases we saw from Kors and some of the other brands here. While picking up some of that activity in terms of Kors and growing the Europe region with that brand, as well as some of the other growth brands, I would say the mixed changes you will see is slight reduction in the overall US wholesale piece favoring higher growth levels in terms of our international wholesale including Europe and Asia.

Unidentified Analyst

Okay, and then in terms of the investments you guys are making, a lot of that going over in Asia and China specifically. What kind of -- I mean from and -- in terms of the concessions or wholesales sales, what kind of a ramp up are you kind of looking at 2012 and then maybe even a year or two out from there?

Mike Kovar

Well, what we’re doing in Asia, as we mentioned last time, is mostly concession based, so as we put more infrastructure over there in every category from sale associated to management, the inventory flow planning, visual presentation et cetera, it gives us the ability to open more of the concessions. So we do expect pretty dramatic growth over there, in the next couple of years we are seeing some of our initiatives in China really starting to show some good proved labor there, good inventory turns, starting to be a buzz about the brands over there. So we’re starting to see some signs that we are on kind of a fast growth track the next couple of years. And we are accelerating all the efforts we have in all categories. We just hired a couple of management members over there, that have a lot of experience in the region.

So also looking at the types of sell-throughs in the products, and what other customers in the region are telling us, and the previous position towards the increasing numbers of consumers' interest in watches and jewelry, we think we are in a very good position, and we’re really moving very quickly, I think, to capture that business in the future.

Unidentified Analyst

Okay. And then lastly, with the DTC and some of the store openings that being pushed out, you gave us what you think for 2011, but since you are pushing some of those previous openings in the '12, what should we be thinking about for 2012 in terms of new store openings?

Mike Kovar

But we will probably detail that out for you in the later call. We don’t really have it all finalized, except to say that we have significantly number significantly more stores in the pipeline this year than last. We hired a couple of new real estate people one based in Hong Kong and some other assets in the Unites States, as well as in Europe. And we think seeing some pretty advantages deals and obviously our performances is opening our eyes to some even more important locations. For example, if you get a chance to go by and see our new Times Square store, we just double the size of it; it's showing incredible performances. It’s really a great flagship location and the results are very, very strong. So we’re kind of looking around the world at more flagship type locations, and I think and real estate community’s eyes we’re becoming a more important tenant in getting better looks and better locations. That obviously is very good for the brand globally. So, we think we’re in a very strong position in terms of moving forward with DTC.


And our next question comes from the line of Omar Saad with ISI Group. Please go ahead.

Omar Saad - ISI Group

Just a couple of clarification questions, and I have one business question. Mike, on the guidance, SG&A, if I think about the kind for you are looking for similar top-line growth rates in 3Q and 4Q, I guess maybe a little bit of more gross margin pressure in 3Q than 4Q, really is significant amount lot of SG&A falling in the third quarter and a lot of that’s driven by that quarter. I just want to make sure I am interpreting that correctly?

Mike Kovar

Yeah, lot of that is driven by the investment spend we’re talking about. And in terms of the quote activity of the quarters, if you look at the implied guidance that we gave the expectations for Q4 revenues are to be somewhere in excess of $200 million and greater than Q3 revenues. So, there is a larger opportunity to leverage some of those increased strategic spends in the fourth quarter than they are on third quarter.

Omar Saad - ISI Group

Perfect, got you. And then on the business side, Kosta, can you talk about you had some really nice watch numbers and thanks for laying it out kind of by brand and some of the brands are seeing tremendous growth. The Fossil brand in watches continues to grow nicely as well, but obviously not -- it’s a little bit further penetrated than some of the other brands to be licensed. Can you talk about your opportunities in Fossil as a lifestyle brand and how you are thinking about that as you think about how to spread your CapEx and investment spend around versus the opportunity to really leverage your scale in the watch business across your existing brand including Fossil and then maybe other brands in the future as you invest to build out the supply chain? Thanks.

Kosta Kartsotis

Well looking a way we look at company we have two core businesses and I think over the last 12, 18 months I think it’s kind of crystallized into what we think is a much larger opportunity than we thought than it has. On a Fossil side, if you think of Fossil as head to lifestyle brand and accessories base lifestyle brand, it’s running about half the size of the company; very strong comp growth. We’re seeing increasing awareness of Fossil around the world and just a sense of kind of presenting this American image in Asia and Europe, we think is a very strong long-term proposition. And when we communicate that through our stores driven catalog the customer really gets it. So, you could say over the last couple of years has taken control of the brand presented the way we want to our store driven catalog is really accelerated people’s affinity for the brand and accelerated the awareness of it.

I think simultaneous to that we’ve also got much better I think at showing our categories of product with clarity and telling stories and been clear in what our offerings are and that has resonated very strongly with consumers also. So, if you look at the comp increases we had I think in the last couple of years in our stores of increase something like 42% sales and even year before that was strong, we still think we have increasing productivity we can get out of our stores. So we are thinking that Fossil can be much larger than we thought even a couple of years ago.

The watch brand continues to be very strong it will be probably at most to $100 million as we’re probably are on track to do that and we’re now in a position, because of our voice to our store driven catalog we’re able to say what we think is important to our own trends and set on direction. So, I think that’s a huge thing for us.

On the other core business on the multi-brand watch business, the cost of machine it’s a huge amount of resources we have for design and innovation big R&D team great sourcing in China and a lot of people around the world working on putting new ideas in there and some great brands that resonate very strongly all over the world and both of those businesses have, you know, since they’re both are pretty much accessory based 70% of our business is watches, we have a huge amount of advantage in the global marketplace in terms of the risk profile of the company. We have somewhere around ecosystem, we have a huge amount of planning resource around the world appropriately flow of products to those stores and watches is a great category operating and is not as not a weather related component to it there are sizes in it tends, styles tend to stay around for a longer period of time lead times are shorter so in good times then bad I think we have shown and we can be very resilient and operate at a very high profit level and we’re focused the whole company is putting a lot of energy and we’re relentless on building the platform for a much larger infrastructure to grow much larger business around both those two ideas so we think we’re in a very strong position.

Omar Saad - ISI Group

Okay thanks. And then if you could just address the supply chain some of the stuff that’s going on there it caught you little bit by surprise you have to really work with your partners to invest to grow that supply chain to kind of keep cost under control are those really external issues around wages that it may or might overtime force you to move out of China into some other region, some other region to keep the product cost under control thanks?

Kosta Kartsotis

Now that’s a good question we actually we saw prices increasing faster than we expected and we have seen labor increases over the last couple of years, but an increase in the last six months higher than what we expected we also, as Mike mentioned, we got here with the situation in Japan caused our movement prices to go up 9% that’s a big part of our margin drop. We do think that will moderate back overtime the factories in Japan are really ramping up back up to speed and there is even discussion about building additional facilities, so we think overtime that will moderate a bit so on the cost side, we do think that we are going to see some things in the future that would moderate back on the long-term sourcing there is a couple of things we have an initiative in building now our supply chain initiative to use in technology and some other demand planning techniques that can help us quite a bit, and we also interestingly now have gotten the situation where in the factories in China we are starting to do more automation now they started this probably five years ago and we think there is increase in amounts of that, that can be done that really would enable us to make more watches with fewer people, so we are really interested in that I think that’s a great opportunity for us also so all in all we think we’re in a pretty good position.


Thank you. (Operator instructions) And our next question comes from the line of Barbara Wyckoff with CLSA. Please go ahead.

Barbara Wyckoff - CLSA

Hi, a couple of questions. So is the domestic business has been very strong, how does this compare your lot of it is in department stores, how does this compare in the department stores to, the store trends and into watch departments trends number one and then could you remind us the breakdown between the department stores versus specialty and do you see any new channels of distribution and then I have a follow-up?

Kosta Kartsotis

I’m just saying, Barbara, over the last couple of years, we actually have probably globally fewer points of sale than we’ve ever had in, in fact lot of cases we’re closing some doors around the world, small or less productive not as important doors and what we’re finding as, we can do a lot more business in our existing doors, specially the largest ones so we’re spending a lot of time focusing on the top 20% of our doors, because they probably do a significant part of our business. We have seen, this watch trend continuous and we’re seeing very, very strong sell-throughs around the world, including United States, even though its grown dramatically over the last couple of years. So that, all the signs in this, the metrics we read a very healthy and we were seeing very strong response to new items, the new categories, and new things, that we put out there and specially when we do it with clarity, I think this is an example where scale matters when we can put an idea in the marketplace and tell people it’s important we see a jump and sell-throughs on it. So I think if you just look at the health and the turn of the inventory globally on this category, we’re very, very pleased and we think there is a huge amount of additional sales opportunities out there in some of the lesser developed parts of the world that we can fill into.

Mark Kovar

Barbara, this is Mark, also in the answer to your specific question about performance relative to domestic department stores. Watch department generally in our brands specifically within domestic department stores are significantly outperforming the overall comps for seeing in those outlets.

Barbara Wyckoff - CLSA

Okay, great. That’s perfect. Can you just comment on the AUR this year versus last year say, maybe year-to-date?

Mike Kovar

I would say, the average in retails are, I’m just on top of my head, just probably 10% higher than a year ago, we’ve seen that across the board lot of that due, in Fossil for example, we put additional details materials and let me guess for example, we have a lot more hardware, finer materials et cetera, so we been able to really, I think as part of the Fossil brand transition to a more aspirational brand we’ve lowered, we’ve taken out some of the lower price items that in effect have raised our average in retail and the customer I think is responding very strongly to it.

Barbara Wyckoff - CLSA

Okay. And then just a couple of more questions. Speaking on domestic a little bit and you didn’t talk about Relics and then just moving onto Asia Pacific, can you talk about how many concessions you have now in China, Korea, and then maybe separate out Hong Kong out of the China and then how do you think how many do you think you will have by the end of the year and since you would give us just a ballpark by the end of 2012 for say China, Korea, Hong Kong?

Mike Kovar

See Barbara, I think the question on concessions. We have currently in our growth markets, which would be Japan, Korea, and China around 300 concessions. We expect to grow that over the balance of this year and a lot of the investments and we talked about in terms of Asia Pacific is four building concessions in those markets and even looking at broadening our representation of our multi-brand and the Fossil business through concessions and markets like Hong Kong as well. Not going to call out a specific number we’re targeting, I will just say that a large amount of the initiative and increase in the expense in Asia is going toward growing our market share for our representative brands. In terms of Relic brand, the Relic brand had a great performance through the second quarter and the year-to-date period, as well I think what we’re seeing there is that category in those department stores the depending closer the world is starting to catch up to the overall trend in watches, they are a little bit late come into the party in terms of some of the newness that we were driving in our more fashion brands Fossil and others, but we’ve had a solid performance on Relic during the first half of this year.

Kosta Kartsotis

Part of our excitement about growth in Asia is that as we’ve said before is largely the concession based, which gives us the ability to capture the full retail of it and the margins were much higher. And we can also control the entire distribution of our sale we have our own sales associates and our own assortments that it’s much clear and are more efficient business in terms of inventory usage as well as in higher margin and a higher profitability.

Barbara Wyckoff - CLSA

So of the business in Asia Pacific how much is now wholesale or just say year-to-date there has been wholesale versus your own concessions, that is the concessions going to the direct to consumer?

Mike Kovar

Concessions are still reported in our wholesale segment for reporting purposes and that business is still an insignificant piece of the total wholesale activities going on in Asia today, but we expect that to grow quite significantly over the next several years.

Barbara Wyckoff - CLSA

Okay, and so how many stores I mean how many concessions conceivably could you open in the next two years?

Kosta Kartsotis

Over the next two years literally hundreds. So you know as we’ve described before the whole strategy for Asia is that in the major departments stores throughout the region, Japan, Korea, and China, et cetera, we are going to have in those stores, we will have a Fossil accessory store concession inside that store, and also a multi-brand watch concession in that store. So, in different parts of the area like in Korea, the growth we’ve had there is pretty dramatic, it’s because the watch concessions are – had been going in place and they are generating obviously huge returns and they’re growing very, very quickly.

We still have not started any significant growth in the Fossil side there , so Korea’s got a good head start in watches, but not so much in – in the accessory side. In Japan, where we’ve opened, we have a wholesale business we sold to for a number of years, we are in a process now of opening more of those watch concessions and those Fossil concessions, in addition to putting some Fossil flagship stores in the market to kind of communicate the brand.

In China, we have concessions in the market and the numbers of concessions are growing very quickly. Some of that is done through third-party partners et cetera. The difference I think in China is that it’s a very fragmented market in terms of the department store groups. It’s not a big chain that as you can go to immediately, so it’s going to take a little bit longer time, but the ideas in all those groups to have a Fossil concession and a multi-brand watch concession. So the answer to your question is, hundreds in the next couple of years and potentially thousands in the next five to six years.

So, as in our entire organization over there, we kind of get a restructure going, we are hiring a lot of additional people in every category from the management all the way down to visual presentation and the sales associates, just building a much larger infrastructure to handle this, but in effect it’s going to be a direct to consumer business.

And on that regard, we’re internally talking about, we are going to have to figure out how to communicate more how do we count the number of locations we have globally, how much have more extra stores and concessions, that’s something that we are going to figure out over the next several months and how to clearly communicate, exactly what that means, you can see it clear.


Thank you. And then final question comes from the line of Scott Krasik with BB&T Capital Markets. Please go ahead.

Kelly Hauser - BB&T Capital Markets

Actually, Kelly Hauser for Scott. I just had a couple of questions. Of go back to your facing strategies, you said this quarter that you weren’t able to offset some of the higher costs that you saw coming out of China. I just was wondering what is your strategy with facing going forward, coming into your larger selling season? Do you expect to see three places more or are you given the higher costs that you are seeing out of China? Do you think that it’s still be a bigger increase going forward?

Kosta Kartsotis

Well, as Mike said in his remarks, we are working on increasing prices in a lot of different categories and different geographies. Some of that is actually going to start right away and we do think we have some places, locations etc., where that can happen right away and then some of it will happen through the balance of the year and then there will be a bigger initiative next year. But we do think that just based on the rate of sales that we see and the health of the business in general globally. We do think there is opportunities for us to increase our prices and therefore our margins.

Kelly Hauser - BB&T Capital Markets

Okay. so, I guess if in terms of gross margins going into the back half of year, do you see you are expecting a larger benefit from the higher pricing relative to Q2?

Kosta Kartsotis

I’m not sure it will be significant enough, but for Q3 and Q4, but we’re moving in that direction.

Kelly Hauser - BB&T Capital Markets

Okay, my next question is in terms of your leather business they’re really accelerating this quarter. Looking at the back half of a year, how do you see that thing on your gross margin? Do you feel it’s going to continue on this front, it will accelerate or was Q2 just marginally a onetime thing?

Kosta Kartsotis

The one thing I would ask you to do is if you go and look at our website and our catalog section, of our website as well or go and look in our stores, you will see the clarity of offering. The kind of iconic looks we are doing on handbags right now. Something we have been working on for a while is really resonating with customers and I think we’re becoming somewhat of the because of the increase in awareness of the Fossil brand, the more aspirational nature of Fossil handbags are becoming more of the handbags to wear kind of thing, which and as you know is a very emotional and vital purchase for consumers. I think just the increase in awareness and the affinity for the brand gives us a big huge long-term opportunity in handbags. Also if you look at our accessory store, in fact that the whole strategy was not to be a watch store, but to communicate clearly that we’re kind of an accessory based lifestyle brand and obviously handbags is the biggest part of that. So it is part of the long-term strategy to communicate our ability and our handbags business well. And I think we are really just starting to get into it right now.

Kelly Hauser - BB&T Capital Markets

My last question is in terms of your repurchase program. I don’t know if I just missed this but could you kind of quantify how much and how many shares you bought back in the quarter?

Mike Kovar

We don’t have that information in the quarter what we said is we purchased $5.2 million shares since we commenced the program back in September. Just estimating, I would say our purchases within the last 90-day period under the 10B-5 plan was probably somewhere in the 300,000 plus range.


Thank you. I’m showing no further questions at this time and I’ll turn the call back over to Mike Kovar for any closing remarks you may have

Mike Kovar

Thanks. Should you want to replay this conference call, it has been recorded and will be available from 10:00 a.m. Central Time today until 12:00 midnight Central Time tomorrow by calling 303-590-3030 or 1-800-406-7325 and entering passcode 4456794. Again, those numbers are 303-590-3030 or 1-800-406-7325, passcode 4456794.

The conference call has also been recorded by Street Events and may be accessed through Street Events' website at or directly through our website at by clicking on Investor Relations on our home page and then on Webcasts.

Finally, should you have any questions that did not get addressed in today’s call, please give me a call. Thanks again for joining us today. Our next scheduled conference call will be in November for the release of our 2011 third quarter operating results.


Thank you. Ladies and gentlemen, that does conclude our conference call for today. We like to thank you all for your participation and you may now disconnect.

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