Fossil's CEO Discusses Q4 2011 Earning Results - Earnings Call Transcript

| About: Fossil, Inc. (FOSL)

Fossil, Inc. (NASDAQ:FOSL)

Q4 2011 Earnings Call

February 14, 2012 09:00 am ET


Allison Malkin - ICR

Kosta Kartsotis - Chairman & CEO

Mike Kovar - EVP, CFO & Treasurer


Randy Konik - Jefferies & Company

Ike Boruchow - JPMorgan

Neely Tamminga - Piper Jaffray

Omar Saad - ISI Group

Oliver Chen - Citibank

Barbara Wyckoff - CLSA

Rick Patel - Bank of America

Ana Andreeva - FBR

John Kernan - Cowen & Company

Jane Thorn Leeson - KeyBanc Capital Markets


Good day ladies and gentlemen, thank you for standing by. Welcome to the Fossil, Inc. fourth quarter and fiscal year 2011 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 recorded today Tuesday February 14, 2012.

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 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 except as required by law.

If any non-GAAP financial measure is used on this call, a presentation of the most directly comparable GAAP financial measure and reconciliation of this non-GAAP financial measure to GAAP will be provided as supplemental financial information to 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 About Us at the bottom of the home page and then on Investor Relations and select webcast.

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

Kosta Kartsotis

Thanks, Allison. Good morning everyone and welcome joining us today to discuss our fourth quarter and full-year results from Mike Kovar, our CFO; Mark Quick, our Vice Chairman, Jennifer Pritchard our President of Retail. At the conclusion of these remarks, we’ll open the call up for your questions.

The fourth quarter concluded a very successful year for the company. We experienced double-digit sales gains across all of our business segments and all our principle brands and product categories. We believe these results demonstrate the ongoing success of our two core businesses, the overall Fossil brand and our multi-brand watch business.

Our direct to consumer channel had a great holiday quarter, sales growing 23%. We continue to experience strong comp store sales while growing the global store base to just under 400 locations by yearend. In fact Q4 represented our third consecutive holiday quarter of double-digit comp store sales growth.

Our ongoing innovation to design an imagery coupled with our owned distribution models allows us the opportunity to present powerful and consistent branding, compelling product offerings and superior financial results while gaining market share on a global basis. In particular, 2011 included several significant milestones. Total sales topped $2.5 billion increasing by over $500 million during the year. The sales of Fossil branded products surpassed $1 billion coming in just shy of $1.2 billion for the year. Our multi-brand watch business grew to over $1.8 billion with both Michael Kors and the Armani brands exceeding $300 million and we made significant inroads into establishing a much larger infrastructure in Asia that will serve as our base for growth in that region.

The Fossil brand continued to make significant progress during the year increasing 19% in constant currency, lead by a 20% increase in watches and a 31% increase in leather sales. As we present the image of American vintage with more authenticity and clarity, the brand continues to grow in important around the world. With increasing focus on fewer, better told stories and platforms have given us the ability to give a richer brand experience at the point of sale.

We believe we are in the early stages of this process and that there is a significant global opportunity in front of us as the Fossil brand becomes even clear and more aspirational. The brand is strong in both men’s and women’s side of the business and works all over the world. As we expand around the globe, our positioning as an accessories-based lifestyle brand gives us huge advantages as these categories carry higher margins, have shorter lead times and have less Obsolescence along the categories. It is a much simpler business to operator especially on a global scale.

Our comp store sales had another strong showing and we were up 14% for the quarter with North America up 16%, Europe up 8% and Asia up 21%. It was our ninth consecutive quarter of double-digit growth which shows the ongoing improvement in the overall brand and customer experience in our stores. For the year, global comps rose 17% on top of a 19% increase last year with a similar performance regionally to that of Q4.

We have made solid progress in improving the productivity of the store base over the last four years, evidenced by the expansion of our four-wall operating margin. With our stores performing well across all regions and with our metrics improving, we believe we’re still in the early innings of a rather large, multi-year retail growth opportunity.

In 2012, we will continue to focus on increasing on the productivity of our existing stores while we also accelerate our store openings. We currently expect to open 70 to 75 new stores with equal distribution between United States and international markets, while closing approximately 18 doors.

We will focus on opening accessory stores, wallet stores and watch station stores. Our global real-estate team is well ahead of where they were at this time a year ago. As of today, we have commitments to 49 locations for 2012, including 21 signed leases. Turning to our multi-brand watch business, sales were up 20% in the fourth quarter and 27% for the year. This impressive growth follows 40% increases in both the fourth quarter and full year last year.

Our brand team, our creative teams and our sourcing and sales organizations continue to do an excellent job, innovating within familiar styles and telling more compelling product stories and delivering a better, more branded customer experience.

During the fourth quarter, some notable callouts include Michael Kors with sales up 56%, marked by Marc Jacobs doubling over the prior year and our money exchange increasing 48% while Diesel and Burberry were both up 30% or more.

As mentioned earlier, Michael Kors sales surpassed $300 million this year in watches. We also launched the Kors jewelry line in the fall in limited doors and the sales exceeded our expectations with sales exceeding $6 million.

Most of the Kors business is still in the United States, we believe we have a significant opportunity to grow this business to a much larger number as the Kors brand is further introduced globally. We are also experiencing tremendous growth in up and coming brands like Mark by Marc and Armani Exchange both demonstrating sizeable sales growth in this past year and we believe all of these brands have significant long-term opportunity in Asia where we saw our sales last year increase by 28%.

This growth was led by Korea which grew at 74% and China growing 71%. Japan also did very well considering the tsunami and had a growth of 9% for the year. The rapidly growing consumer market in Asia is particularly predisposed towards watches, jewelry and leather goods and has an affinity for the global brands that we produce. It clearly is a game-changing opportunity for the company. We have made considerable progress this past year in attracting talent and growing concessions and building our infrastructure to capitalize on what we expect to a much larger long-term opportunity.

Turning to Europe. Sales rose 18% in the quarter and 22% for the year led by Germany which remains our most highly-penetrated European country. We also saw double-digit growth in France, Italy, the UK and Netherlands. Each of these countries represents a sizable opportunity for continued expansion over the next several years. For 2012, we continue to focus on investing in the Fossil brand in key markets like France, Italy and the UK as we expand our footprint through market share gains and product expansions as well as through internet and retail store buildouts.

Before I turn the call over to Mike, let us share with you our thoughts on the acquisition of Skagen and what we think this means for the company. We signed this deal back in January and expect it to close around the end of March. Skagen is a fast growing and profitable watch brand that has a global footprint and is successful in North America, Europe and Asia and also operates 13 retail locations around the world.

The company has demonstrated a strong track record of growth with 2011 sales of about $120 million and operating margins similar to ours.

Skagen is a design-driven brand with a unique point of view, based on Danish design. It is contemporary in look and different than any other products that we currently make. Our objective is to turbo-charge this Skagen watch business while supporting it and expanding its distribution. And just like the Fossil brand’s mission is to curate and communicate American vintage inspired merchandise, our long-term plan with Skagen is to curate and communicate its unique Danish design heritage and to tell its story more broadly as an accessories-based lifestyle brand and an untold number of other benefits.

They have great people in management, that will now be joined with ours to manage the company together. We would also gain some needed additional sourcing as their factory bases is different from ours and also gives us more critical mass in the global watch business and gives us an additional owned brand that we can focus resources on in an effort to make it a much larger business with additional categories as well as additional stores and websites.

All of these initiatives will further leverage our existing and growing global infrastructure and give the company a larger long-term opportunity.

In closing we would like to thank our Fossil team members and partners around the world for another terrific performance in 2011. The numbers for last year are due to their collective spirit and the ongoing pursuit of excellence. Mike?

Mike Kovar

Thanks, Kosta. I will start off this morning by briefly touching on our fourth quarter 2011 versus 2010 results from this morning’s press release. Net sales increased 18.5% to $831 million compared to $701 million. Gross profit increased 16.4% to $466 million or 56.1% of net sales compared to $400 million or 57.1% of net sales.

Operating income increased 16.6% to $174 million or 21% of net sales compared to $150 million or 21.3% of net sales. Net income increased 22% to $118 million compared to $97 million and diluted earnings per share increased 28.1% to $1.87 on 63.2 million share outstanding compared to a $1.46 on 66.3 million shares.

The $831 million of net sales was at the lower end of our previous guidance but still represented doubled-digit sales growth across all of our operating segments and major businesses in comparison to Q4 last year. The impact of weaker Euro during the latter part of the quarter and slightly weaker sales growth and certain non-strategic Asia based markets were primary factors.

In comparison to Q4 last year we experienced 80 basis points shift in sale mix from our wholesale business to our direct consumer businesses. And on regional basis each of our wholesale businesses experienced a slightly decline in comparison to the prior year quarter mix.

In connection with our wholesales operations, sales for our North America wholesale businesses, which include our operating activities in the US, Canada and Mexico, as well as sales to third party distributors, primarily located in South America grew by $45 million or 17.3% to $307 million. Excluding approximately 1.7 million from unfavorable currency comparisons to Q4 last year, North American wholesale sales increased by 18%.

Sales from our Europe wholesales operations increased by $33 million or 17.5% to $224 million and excluding currency that unfavorably impacted sales by $1.7 million, Europe grew by 18.5%.

And sales from Asia wholesale operations increased by $12 million or 15.7% to 86 million. Excluding currency that favorably impacted sales by $1.4 million, Asia wholesales sales grew by 13.8%.

Sales from our direct-to-consumer businesses increased by $39 million or 22.6% to $214 million. Year-over-year currency fluctuation had no significant impact on reported sales on this segment. Constant dollar comps on our retail stores maintained their strong double-digit performance, coming in at 14.4% in Q4, on top of a 20.3% increase in the prior year quarter. This represents the fifteenth consecutive quarter of positive comps and as Kosta mentioned, the ninth consecutive quarter of double-digit positive comps.

Globally, we ended the year with 398 stores and occupied 715,000 square feet compared to 644,000 square feet at the end of 2010, an increase of about 11%. This included 245 full price accessory stores, 142 of which were outside of North America; 104 outlet locations including 29 outside of North America; 36 closing stores with four outside of North America, and 13 full price multi-brand stores including 11 outside of North America.

This compares to 364 stores at the end of 2010 including 230 full price accessory stores, 127 located outside of North America; 93 outlets, including 22 outside of North America; 31 clothing stores with three outside of North America; and 10 full price multi-brand stores with 9 of those outside of North America. For the year we opened 51 stores and closed 17.

From a watch and non-watch category perspective, total watch sales increased by $103 million to 20.4% to $607 million with the Fossil brand sales increasing $33 million or 19.3% to $201 million and licensed watch sales increasing by $82.3 million or 30.8% to $350 million.

While on the non-watch side of our business, leather product sales increased $26 million or 23.4% to $137 million and jewelry sales increased $4.5 million or 7.5% to $63 million.

Q4 growth profit margin declined 100 basis points to 56.1% compared to 57.1% in the prior year quarter. This decline was principally driven by an increase in the cost of factory labor in certain watch components, as well as lower gross margin on sales to the off-price channel.

The lower off-price channel margin were primarily a result of sales of discontinued inventory in the foot wear, relic watch and the mass market businesses at levels below costs.

Year-over-year currency rate changes benefited overall gross margin by approximately 80 basis points in comparison to the prior year.

For fiscal 2012, we expect full year gross margins slightly below the 56.1% level achieved in 2011. At prevailing FX rates, currency will negatively impact gross margins throughout the year, with the more severe impact on Q1, Q2 and Q3.

Also, in comparison to the prior year, Q1 and Q2 margins will be impacted by input cost increases as we don’t anniversary most of the production cost increases we absorbed last year until the second half of 2011.

However, select price increases expected to take in March, a reduction of sales through the off-price channel, and an expected higher mix of sales from our Asia Wholesale and direct-to-consumer segments throughout the year will partially offset the impact of currency and higher input costs.

Operating expenses as a percentage of net sales decreased to 35.1% in Q4 compared to 35.7% in the prior year quarter. We generated nice leverage in the quarter against the backdrop of continued investments in Asia and increased cost related to our new headquarters. Total operating expenses in our wholesale segment increased by $70.5 million of which approximately $10 million were related to the Asia region.

On a combined basis our North America and Europe wholesale businesses were able to generate approximately 200 basis points of SG&A leverage in Q4.

Expense increases of $17.4 million in the director-to-consumer segment were primarily attributable to store growth, increased web-based market expenditures and ongoing cost associated with our new CRM initiative.

Corporate segment expenses increased $6.1 million, which were primarily attributable to increased payroll costs, including stock compensation and higher operating cost associated with our new corporate headquarters.

For fiscal year 2012 we are expecting slightly deleverage in operating expenses. The deleverage will be more impactful in the first half of the year, as we would not anniversary the bulk of Asia investments and expenses associated with our new headquarters until the second half of the year.

As a percentage of net sales Q4 operating income decreased slightly to 21% of net sales compared to 21.3% in the prior year quarter, primarily the result of a decrease in gross profit margin, partially offset by 60 basis points of SG&A leverage. During the fourth quarter, operating income was positively impacted by approximately $7million as a result of currency translation.

Other income and expense net decreased unfavorably by $10.6 million for the fourth quarter. This decrease was primarily driven by unfavorable foreign currency charges resulting from mark-to-market, hedging and other transactional activities during Q4 compared to currency gains in the prior year quarter. Currency losses were slightly higher than we expected as a result of the significant appreciation of the US dollar against the Euro and certain other currencies from the end of Q3 to Q4.

The company’s income tax expense for the fourth quarter was $46 million resulting in an effective income tax rate of 27.3%. Fourth quarter income tax expense was positively impacted from certain tax provision offsets carrying a higher effective tax rate. For fiscal year 2012, we estimate our effective tax rate will be at or slightly below the 2011 fiscal year rate excluding any discrete events.

Fourth quarter net income attributable to Fossil, Inc. increased by 22% to $117.9 million or $1.87 per diluted share compared to $96.7 million or $1.46 per diluted share in the prior year quarter. Q4 was negatively impacted by net unfavorable currency losses of $0.03 per diluted share.

Now turning to our balance sheet. We ended the year with cash, cash equivalents and securities available for sale totaling $288 million compared to $402 million at the end of fiscal 2010 and we had approximately $15 million of debt. Since the inception of our $750 million buyback authorization in August of 2010, we have purchased 487 million of common stock representing approximately 6.6 million shares. And under our latest 10b5 plan that we completed last week, we purchased 863,000 shares at a cost of $75 million. During fiscal year 2011, we purchased 3.1 million shares at a cost of $271 million.

Year-end inventory was $489 million representing an increase of 31.5% from the prior year end balance of $372 million. The percentage increase exceeded our Q4 sales growth primarily due to an acceleration of factory watch shipments near at the end of the year that effectively represented a five day reduction in lead times. Additionally, given the events that unfolded in Japan in early 2011 and the concentration of our movement supplying that country, we have also increased the level of inventory related to key watch component parts including those with longer lead times.

Accounts receivable increased by 14.9% to $303 million at year end compared to $263 million at the end of fiscal 2010, primarily due to the increase in wholesale shipments during Q4. Our DSO for the fourth quarter was 43 days in comparison of 44 days last year.

During 2011, we had capital expenditures of just over $130 million and are expecting 2012 capital expenditures of approximately $120 million. Depreciation and amortization expense for the year totaled $45 million and we estimate full year 2012 depreciation and amortization of approximately $60 million.

As it relates to our guidance for 2012; the following guidance as well as the prior forward looking information as to gross margins and operating expense expectation excludes the impact of Skagen.

For the first quarter and full year 2012, we expect reported net sales to increase around 15% with constant dollar net sales increasing at a slightly higher rate. First quarter 2012 diluted earnings per share are expected to be in the range of $0.90 to $0.92. For the full year, we expect diluted earnings per share in the range of $5.47 to $5.50.

We expect 2012 operating margin to fall approximately 70 to 80 basis points below the 18.4% level we’ve achieved in 2011. However, we do anticipate EPS growth to outpace the operating income growth as currency hedges in place will partially offset expected currency translation losses moving through operating income. Additionally, we expect the lower share count in fiscal 2012, a result of our continuing share repurchase program and a sustainably lower effective tax rate also benefit EPS growth.

Our forward guidance is based upon the current prevailing rate of the US dollar compared to other foreign currencies for countries in which we operate. As it relate to Skagen, although we have clear regulatory hurdles in Germany and the US, we are still waiting on clearance from UK which we expect in late March and because we haven’t closed the transaction at this time , our 2012 forward-looking projections exclude any Skagen activity. However, we felt it might be beneficial to provide you with Skagen’s 2011 sales and operating margin.

In that regard, Skagen’s net sales for 2011 were approximately $120 million with an operating margin slightly north of 17%. While we believe they are both from short-term and long-term synergies available to us, we also recognize that there will be certain one-time charge related to the transaction and the ultimate integration of the business.

And now I’ll turn the call over to the operator to begin the Q&A portion of the call.

Question-and-Answer Session


(Operator Instructions) The first question is from the line of Randy Konik with Jefferies & Co. Please go ahead.

Randy Konik - Jefferies & Company

My first question would be for Mike, Mike you know the SG&A leverage you got in the quarter, is that something that we can expect to continue in 2012 despite the lower operating margin guidance; so is the operating margin guidance more of a gross margin compression?

And then just related around the operating margins being guided down for 2012, is that something where we would see it down in the first half, but up in the second half. Can you just give us a little more color there? Thanks.

Mike Kovar

As we’ve always said, it’s easier for us to leverage operating expenses in the fourth quarter just due to the seasonality of sales in that period. We generate a lot of operating margin improvement based upon our direct consumer business having an overweight in that quarter. So I think we even gave some guidance back in November, we laid out in Q4 that we expect to see some potential leverage in Q4 just based upon the seasonal sales weighting.

You’re exactly right. As we move forward into 2012, the reduction in operating margin will be a combination of both gross margin declines as well as deleverage on the SG&A side, with most of that SG&A deleverage occurring in the first half of the year, as we don’t start anniversarying a lot of the Asia investments and the cost associated with our new corporate office until the second half of the year.

Randy Konik - Jefferies & Company

And then my last question would be, can you just give us a little color on what happened like -- the Asia numbers came in a little below our expectations, just can you just kind of talk about the Asia numbers for the quarter and then how do you see them unfolding going into 2012? Thanks.

Kosta Kartsotis

We made a lot of progress in Asia last year just building out infrastructure, getting a lot of new management members and other people in place and as you know, we have some expats over there from different parts of the world to beef up the organization and get some [planning] going on. We also were up against some new concessions in Korea, so we’re up against some pretty big numbers. So although the sales growth, I think was 28%, I think we made a lot of progress in putting things in place to turbo charge that even faster going forward.

Mike Kovar

Randy, as we mentioned on previous calls, there were also some non-strategic business that we were exiting throughout the year. We had a local jewelry business that we acquired in connection with the India distribution, we opened up about three or four years ago. And then there were some non-branded watch businesses we were attributing that we have also pulled back on.


The next question is from the line of Ike Boruchow with JPMorgan. Please go ahead.

Ike Boruchow - JPMorgan

A question for you, I guess I’ll focus on the US wholesale business; it’s been a great grower for the last several years. I guess close to how do kind of see this business kind of leveling out; is this more of a GDP grower; how is the channel today within the department stores? And then I guess a similar question for Europe; is there more room for distribution and productivity within that region within that wholesale business?

Kosta Kartsotis

Well, as you know the US watch business has been very strong last couple of years and as that has occurred, the stores have added more space and more sales people and continues to be strong grower. And what we see, it should outgrow GDP by some margin over the next couple of years as based the overall interest in watches and all the dynamics going on.

In addition of that, we do have some very rapidly growing business, as Fossil continue to grow in the US and the watch business and also Kors had again a very rapid growth, and AX had a fast growth mark-by-mark; Diesel is trying to grow really quickly in the US as well. We also have as you saw, we’re starting to get because of the position of Fossil and the more aspiration nature of it; we are starting to see handbags grow very quickly which is a big benefit to us especially in the United States.

We also are as you know we’re going to be adding additional stores in that space, stores provisional grow we are expecting comp store increases and of course also in the United States I think Skagen is going to give us some position and opportunity to grow our US business as well. So we think we can continue to gain market share and a faster growing business, both in watch and the handbag side. As far as Europe goes, the environment over there has been somewhat rocky for the last couple of years and we continue to do well, gaining market share. We have a lot of opportunities just in the metrics, you know as you know Germany is our largest business for Fossil.

If we could get UK, Italy and France up to that level, a significant opportunity. We made progress on that with regard to last year, we put a number of stores in France and Paris, in these that did very well. In fact we are seeing the stores over there, they are selling more handbags per store than anywhere else in the world. So we have a very good position in the market. We also opened a couple of flagship stores in Italy, both in Florence and Rome that are doing very well communicating with the brand very strongly and our business in the UK, the number of stores we've built there over the last several years have really increased in profitability and the brand is showing some real strength there as well. So we are, obviously our biggest opportunity long term is in Asia, but we think we have opportunity in both Europe and the US.

Ike Boruchow - JPMorgan

And then Mike one quick follow-up. The tax rate that you mentioned I guess you guys ended around 32 for this year and you are guiding us something similar for next year, just to make sure where are you clearly, is it a sustainable tax rate going forward for the company or is this kind of a one-time a year.

Mike Kovar

Yeah, we do believe it’s sustainable, Ike, I mean part of it is that we are increasing a lot of our taxable income in markets outside the United States as most of you guys know. We have better tax rates than the US has. So that's something that we continue to see as we move forward, sustainable rate, that 32% or below as we move into 2012.


Thank you. The next question is from the line of Neely Tamminga with Piper Jaffray. Please go ahead.

Neely Tamminga - Piper Jaffray

So just a quick clarification on the guidance for next year, the revenue stock. Mike, would you be able to give us just a little bit of guidance of Q1 by maybe Asia versus North America you know in terms of the 15% growth. And then I just have a follow-up question for Kosta.

Mike Kovar

Sure, I think if we look at it by region, Neely what we are looking at is the US and Europe kind of growing in that you know low-double digit area in terms of both wholesale and retail activity. Whereas with Asia, we see that to be you know 25% or more as we now have a lot more infrastructure in place to effect rolling out more concessions and obviously driving metrics through our existing locations to improve performance in those doors as well. And then on the retail side you know we are looking at 20% plus type of growth, Kosta alluded to the square footage growth we are expecting in 2012, adding another 70 to 75 doors and closing around 18 doors. We’ll have square footage growth at about 14% increase and we are expecting to continue obviously the momentum we have with our store comps. Store comps are in the high single digit range for the full year.

Neely Tamminga - Piper Jaffray

Right, that’s really helpful. And just a follow up question for Kosta. You touched on the jewelry opportunity and it’s something that we’ve covered the stock for a long time and continue to see an opportunity for guys. How do you view kind of the next five years or closer to three years even for the licenses, is it going to be Fossil, where is going to be the primary growth story in your businesses?

Kosta Kartsotis

You are talking about jewelry right.

Neely Tamminga - Piper Jaffray

Yes, sir.

Kosta Kartsotis

Okay. so you know if you look at what’s happened in the last several years, you know Fossil last year did not grow as fast as in jewelry as we like it too and we have a whole initiative in place right now to total (inaudible) and you’ll see a total revamp of the line and clear to tell the story, I think it is going to be a big boost to our sales globally.

In addition to that we are going to have, the quarter’s rollout will be going on during this year and our expectations are that it’s going to be pretty good. We also, as you know, have some rather small businesses in jewelry which is and (inaudible) for example, we think has a much bigger opportunity. We tune it more towards Asia and we are working on that. We have a small business in Europe with DKNY which is not growing at a very fast rate.

And then the Diesel jewelry has shown some sparks. Probably the biggest growers over the next couple of years is going to, we think we can put a lot more increases on Fossil and develop it to a much higher level by adding more category-type classifications through the charms, bracelets et cetera and that’s in our stores, we also think that the Skagen jewelry business is an opportunity.

They do have a very small business in jewelry that is pretty successful and we think that the opportunity is that we can grow that pretty quickly. As you know Fossil jewelry in Europe is a $110 million, $120 million because branded jewelry in Europe has a very strong positioning. Skagen brand is actually, sell very well especially in that Northern Europe area and then the UK where the branded jewelry is important.

So we think one of the low-hanging fruit improvement in the Skagen branding idea is to put jewelry over there quickly. So one of the things that we are doing, one of the first things we will do with the Skagen once it is closed is get our global operation really to support and to quickly grow that jewelry business. So we think it’s going to be a big opportunity. So we expect that we are going to grow jewelry over the next several years at a pretty rapid rate.


Thank you. The next question is from the line of Omar Saad with ISI Group. Please go ahead.

Omar Saad - ISI Group

Wanted to see if I can get you guys to talk a little bit about the multi-brand kind of watch business. You know, traditionally in the US, it’s been a wholesale channel distribution largely and I think internationally, that’s largely been true as well. Can you kind of give us an update in terms of the dynamics and that department stores channel in the US, where you stand from that standpoint and is there an opportunity if the watch category really can be a much bigger category and how do you develop the channel and how is that different in Europe and Asia and lastly, how does that plan to your plans for 2012 in terms of your CapEx and investment to develop the watch channel if you will, as a multi-brand watch channel. Thanks.

Kosta Kartsotis

Well in the last year with 23 stores and Watch Station stores and our plan is that within 2012, with 49. So, we’re going to build a number of those around the world. So, if you look at United States, for example, Watch Station is mostly an out-of-store strategy. We have a number of those in the US that are doing extremely well and we want to expand that, just really, partly to help us with liquidation efforts as the company gets to a larger scale.

We also will continue to develop our department store business by adding additional categories in this space. For example, next year, about a year from now, we will ship the Karl Lagerfeld line into that distribution. So we think that’s going to be a very strong brand for us. So and the stores, as you know, continue to add space and sales people.

A lot of the stores have really intensified their efforts in watches and we think that’s ongoing in the United States. So that’s pretty much there. We are opening a few flagship Watch Station locations really for communication of the brands and the stories we’re telling and really to elevate the awareness of that as well, as we opened the Watch Station website last year that we will get lot more active this year in the United States.

In Europe, largely what we have is we sell mostly the small watch and jewelry stores. There is a pretty good network over there. Our Watch Station efforts over there also on the outlet store side as well as flagships. We opened a store in London last year that is doing very well. In the Stratford Centre near where the Olympics is going to be and we are planning on looking at other potential flagship locations in Europe.

We also of course as you know have the House of Fraser concession there, we own the watch business in that market. The biggest initiatives for ongoing growth are in Asia. So largely what we are playing into is that category that is, the customers are somewhat very predisposed towards buying and there is largely not a big distribution channel. We’ve talked about this kind of wide space, that’s going on especially in Asia where there is a huge demand for Swiss watches and a lot of scarcity.

If you look at the Hong Kong market alone last year was actually 20% of the Swiss watches went to Hong Kong, I think 24%. It was twice the size of US market. The growth of watches in that market is really incredible and the awareness of it and it seems to be the number one category in people’s minds and probably jewelry and handbags are right behind it. So this is kind of lifestyle branded watch business that we are in. You know it’s not really what we used to be and which was the fashion watch business, it’s not assortment driven and novelty driven, it’s iconic lifestyle branded. It’s really almost a brand new category, not only in Asia, but in the Europe and US as well we’ve seen big growth in higher average you know retails and more developed, more designed product and more details et cetera. It’s really a new customer and a new business, but I think we have a distribution channel in Europe and Asia that can handle that.

In Asia largely, it’s a brand new business which is why we are so interested in developing the concessions that we are developing and also adding to it the Watch Station stores that would be freestanding in global markets over there. We think it’s a pretty significant opportunity.

Mike Kovar

Omar, I will add to that on the long-term investments. In the US wholesale market we have obviously a strong relationship with a lot of the majors here and our ability to continue to grow our presentation of existing portfolios and add additional brands to that is basically something that didn't command a lot of investment. It’s basically a pipeline of orders that we fulfill.

And even on the Watch Station side as Kosta mentioned, most of that growth will be in the [office] store environment and the success we've had with Watch Station stores has been wildly successful. Our ROI on that activity is one of the best in the company. So where we are really focusing a lot of the investment, and this was the theme in 2011 as well, is to build out that concession basis stores throughout Asia, have the appropriate level of back office in terms of field sales management, inventory planning, environmental design, the fixtures and build all these concessions out and that's where most of the investment is going to come from as we move forward.


Thank you. The next question is from the line of Oliver Chen from Citibank. Please go ahead.

Oliver Chen - Citibank

Related to the concession and points of concession, what can we think about in terms of how many points of concession you may be able to ramp up to in ’12 from your 213 now? And secondly regarding M&A and Skagen could you refresh us for modeling purposes where the proceeds are, where you are getting the source of cash for that deal and secondly related to M&A are there any, if you have an appetite for licensed or niche brands going forward?

Kosta Kartsotis

As far as the number of concessions in Asia potentially there are hundreds, literally hundreds of department stores there and there is more being built all the time especially in China. We have not identified the finite universe or ones that we will go into but it’s a much larger than where we are right now.

And consider the fact that in each of those departments stores that are viable with the long-term plan have two concessions; one is the multi-brand concession or somewhat of Watch Station concession and the others have a multi-category Fossils store inside that store. So that the infrastructures that we’re building now that’s the ability to open, build and effectively run profitability those businesses.

In terms of other watch brands as you know, we think the Skagen brand has got a huge long-term potential for us. It’s a big project, something we invest in and really make large. And the size of the company now is such that, you know, new licenses don’t move the needle and we also don’t want to end up with somewhere down a road with a large number of licenses that are hard to manage. So we really have been focused in the last several years on making our existing business is much larger.

And starting with Fossil and then making Armani much larger than a huge focus. We think our Armani could potentially double or triple over the next several years just based on the huge potential for example in Asia and I would say that’s true for all the brands. Our Kors continues to develop in the world with the branding; that business will continue to grow and Burberry got a huge long-term potential as well as Diesel Marc by Marc and the rest of the brands.

So we think, we have a great portfolio brands that all of them can give much larger. And we are focused on that. We think Karl Lagerfeld has the unique positioning that is a great opportunity for us and a long-term global opportunity and we continue to look out to see what other brands potentially could make a difference in the watch business and we’d continue to talk to them and we will continue to look, but we are really focused mostly on the larger businesses that we have and make a niche one in the market.

Mike Kovar

Oliver on the Skagen purchase price side, the purchase will effectively include three separate legal entities; one in the US, one in Europe and one in Asia. So some of those funds will come from the excess cash we have internationally as well as in the US and if need be in the US, obviously we have the backdrop of a $300 million line in credit that we can tap into.

Oliver Chen - Citibank

Thank you. And a final follow up related to fourth quarter gross margins in terms of the pressure from the increase in some operators, retailers and the third party distributors, could you just give us the strategic understanding of what happened there?

Mark Quick

Right. I think what we had was we had three businesses that if we look at were we wanted to move excess inventories by the end of the year and have the opportunity to do that just based upon the seasonality of the quarter with these off-price guides and as we mentioned on the call, that was basically our footwear mass market and Relic watch businesses. So, about $2.5 million of that product, one out the door at below cost and obviously cleaned our inventory position up in those categories as we move forward.

On the third party distributor activity, again we have a lot of opportunity in our third party distribution network to continue to grow sales. We have seen a significant amount of interest in watches in South America. We have got two distributors that we work with in that part of the country and they are seeing phenomenal results in terms of our brands in their environments.

Additionally, even with what’s going on in Europe and some of the Southern European countries being affected by the sovereign debt issues. Even though we have distributors in markets like Turkey and Greece, our third party distribution business in Europe was up over 25% in the quarter again. So I think that just identifies that there was a much larger opportunity in terms of Eastern Europe and Middle East, South Africa where we have sizeable growth, as these markets kind of catch up to the trends going on in watches.


Thank you. The next question is from the line of Barbara Wyckoff with CLSA. Please go ahead.

Barbara Wyckoff - CLSA

I have a couple of question. First, I guess, from Mark Quick. Can you talk about the performance of the Fossil, your owned and licensed brands and key department stores relative to the competition and then I have a follow up question for Kosta.

Mark Quick

Barbara, the performance in all of our major domestic department stores has been exceptionally strong. As Kosta mentioned earlier, the lead brands, Michael Kors, number one, some of the smaller brands putting on big, big increases. AX, Marc By Marc, Diesel, which is already a big sized brand, is just on fire right now.

So, the total portfolio is throwing of strong double-digit increases of retail. In fact, our retail increases are slightly higher than the wholesale shipments going out the door, which is very encouraging for us to be in that kind of a balance situation. As we go into the first quarter with them, we have not seen a significant change in how that business is actually continuing to flow, in terms of brands that are increasing and the relative performance to the total portfolio of Fossil continues to be that healthier component to it. And as you know, when you walk this case line in any of our major stores, whether it be Nordstrom or Macy’s, you see a very, very dominant presence of the Fossil brands which is reflective of how important we’ve become to them and our relative gains in market share.

Barbara Wyckoff - CLSA

So could you talk about of Asia little more what is the biggest country, is it Korea or followed by Japan and China and how do you see that growth potential by country and could you talk about any obstacles outside if I can see the diverse store base in China to accelerating growth in China?

Kosta Kartsotis

The three markets that we are focused are Japan, Korea and China. So as you know in Korea last several years we were converted from a distributor situation, we were selling to a distributor of our own concessions. So there is about 70 big huge department stores in Korea. Confessions that go in there have kind of a pretty identified group of stores that are relatively easy to get to and they are doing extremely well and we have an opportunity to grow inside of those doors.

We also are looking at a similar situation in Japan where we have number of concessions there that are doing well. We think they can expand. Again each of these department stores in those two markets, the idea is to have multi-brand watch concession and a Fossil store inside of those. We are working on that. We also have just recently and we have opened a number of stores in Japan that present a brand really well and it well help us get those Fossil concessions open and we just hope our Fossil store in Seoul in Korea will do the same.

So the idea is to take our experience in Korea and those confessions are extremely profitable and growing very quickly, to take our experience in Korea and expand that to China. And China is more difficult just because it’s not scalable. There is not a department store group that owns very many stores, a lot of them are individual stores owned by local government etcetera.

So its just a more fragmented market, it just takes more people, time, there is more processes involved to really get those installed and up and running and that’s the process we are working on now.

But we do expect that overtime, we will be able to have operation in China that is significant and we’ll have an experience similar to what is going on in Korea. We have enough sell-through information from existing concession there to know there are these multi-brand watch things that is going to work very well once we all get it in place.


The next question is from the line Rick Patel with Bank of America. Please go ahead.

Rick Patel - Bank of America

Can you give us an update on the rollout of Michael Kors across each geographical segment; you know perhaps just talk about which inning you’re in right now and where you expect to end the year?

Kosta Kartsotis

Well, the business is, most of it is in the US; it’s been very explosive and ongoing. I mean it is incredible to watch the depth and the customers continuing to respond to it and enter into a collectible situation, customers owning farewell etcetera. So in United States that continues and we do have, we have seen over the last couple of years sparks of sell-throughs and around the world that show very strong; UK has been one of our fastest turning brands in the House of Fraser for example. Korea has been very strong, and that we’ve seen huge response and huge growth throughout Europe last year as well as in several markets in Asia.

And as you know the watch business inside of their boutiques is a relatively large part of their store, so as they continue to build out stores around the world, two things happen, one is we get sales from their boutiques and we also penetrate those markets with brand experience and knowledge that enable to put a larger wholesales business in there. So just looking on at the response in sell-through we see in emerging markets for the brand and their penetration in the world of stores, we think there is a huge long-term growth track for Michael Kors.

Rick Patel - Bank of America

And then just a question on Skagen, you know you talked about margins north of 17% there. You know once you start integrating that business, can you talk about how you see those margins changing, you know perhaps just highlight the synergies that you see across these businesses and the potential upside we can see from that?

Mike Kovar

Yeah, I think long-term what we see is you know Skagen comes on board and has an opportunity to leverage a lot of the infrastructure we’ve build around the world in terms of distribution, brand management, etcetera. The principles will stay very involved with the brand, but obviously we’ll be able to give them the opportunity to leverage a lot of our design, product development you know all the other stuff that goes with building out a global aspirational brand.

We have a little history here, I think if you look at you know the last acquisition we made in the branded space was Michele and we paid about two-times sales for that business back in 2004. And in that business has clearly been very successful for us and right now on about $80 million business has thrown off close to 40% operating margins.

So I think the ability to take these brands, not only leverage our distribution footprint, but you know provide a much larger back office for them to expand in terms of reach expand in terms of category will be something that will generate some you know pretty normalized leverage as we move forward.


The next question is from the line of Ana Andreeva with FBR. Please go ahead.

Ana Andreeva - FBR

I had question on inventories; it came in a little higher than what we were thinking and you know given the sales growth that you guys are guiding to, how should we think about inventories as we go through the year, should we expect that number to begin to moderate?

Kosta Kartsotis

The good news on the entry level is, a lot of increase in percentage was caused by us, getting faster at lead times. I think we have a factory, respond very well during the fourth quarter. Part of it is just due to more regular flow of movements and that expedited lead times. I think we had actually during the fourth quarter, our lead times were five days shorter than it were a year ago. In addition to that, we do have additional work in process. We are keeping on hand the largest supply movement because we feel it’s prudent just based on what happened last year.

So the combination of two things, if you take those two things out, we do have a more normalized inventory relative to sales growth. But the good news in all this is that we have a number of initiatives in place to get our lead times faster. As you know during the last couple of years, the huge amount of quantities that we require at factories has put us in a position where lead times have gotten longer and we have a lot of issues in place to actually reverse that and get quicker.

And this was the first step and I think it’s very good news in the future because we do think we can grow the company and the sales over a long period of time with the slower growth in inventory and turn faster which would make the company grow even faster and more profitable.

Mike Kovar

And to that point, we have gone back and reassigned weeks of supply targets for quarter endings that reflect this five day improvement which is almost a week that we believe is sustainable. You will begin to see the impact fully by the end of the third quarter. So that’s one we really think, the full impact on this shorter lead time will hit us.

Ana Andreeva - FBR

So ending 1Q inventories you would still be it sounds like a little higher than the sales growth that you guys guided to? But as we move through the year, that should moderate?

Kosta Kartsotis

Right. I would say and I think I missed, by the end of second quarter is when we will see a pretty dramatic impact of that.

Ana Andreeva - FBR

And Mike, you broke out the sales to the authorized channel in the fourth quarter, you know that was very helpful. Could you maybe give us the full impact for 2011 both sales if you have and margins just as we think about the gross margins for the year?

Mike Kovar

I think if you look at for the full year, authorized channel sales were probably up about, 15%, 20% more than they were last year, and margin rates were holding very steady through Q3 and if you exclude the activity around the footwear, Relic and mass market watch businesses that we decided to move through the fourth quarter, those margins were at levels of last year as well.

So you know, until, as we continue to grow our outlet base, we still have a lot of pressure in terms of discontinued product as our watch business is growing dramatically over the last two years. You know, over the last two years, we added over a $1 billion in sales. And we haven’t added the outlet capacity to keep up with just how we flow inventory through our own stores and through the wholesales channel, and take back, you know, product as we’re introducing new units etcetera.

So we do believe the authorized channel serves the purpose for us and it obviously allows, you know, those guys that have a flow of product as well and they participate in what’s going on in this category, but I think long-term the opportunity is reduce our exposure of that as we increase the exposure to our, not only Fossil outlet stores, but our Watch Station outlet stores.

Ana Andreeva - FBR

And Kosta, the final one to you just, as you think about 2012, I mean you guys have done a great job, flowing units; what are seeing out there just from the style perspective; I know the cycle began couple of years ago with Ceramics, then Rose Gold was the big story as we went through holiday, how do you see involving that into next year?

Kosta Kartsotis

Well, I think our issue really as we mentioned earlier is just to tell fewer stories and tell them much better. And if you look at our Fossil catalogue for example, you can see it online by the way, I think in there you’ll see there is a lot fewer ideas being presented and they are all being presented much better. I think we have something like 30% fewer SKUs in the catalogue within the year and sales have been very, very strong.

So I think in all of our brands and Fossil included, just continuing to innovate within the familiar telling local stories, presenting new ideas and innovation within the something that the customer is familiar with, I think is our strategy and it’s really resonated in a very strong way and we’ll continue that process. We have seen over the last couple of years, when we represented a new idea of material innovation with authority and tell that story well that the customer will respond and that’s really our initiative.


Our next question is from the line of John Kernan with Cowen & Company. Please go ahead.

John Kernan - Cowen & Company

I just wanted to talk about the comp, obviously another great performance on top of a very difficult comparison. What was the driver of the same store sales, was it traffic, was it ticket, just some colors on that?

Kosta Kartsotis

Well, overall traffic was static or slightly down, so we got higher conversion rates, higher average unit in retails. You know big driver in our stores globally continues to be handbags and we’ve talked about this before, as the brand becomes a clear vintage inspired story and we present our ideas with more clarity and focus. The brand gets stronger more aspirational, and we are developing more stronger, more emotional attachment to the customers and the handbag both emotional and viral of all the categories and also at a big place in our stores. We actually had and we are continuing to see that, we are seeing very strong sell-through globally as we said. We saw very strong sales in France. We are also getting strong sales on a per-store basis in Asia as well.

So our handbag business I think for the quarter was up 25% in our stores and it’s looking like its just going to continue to grow much larger. I would urge you to go into our stores to look at our online and see the offerings that we have. It’s much clear, we have much fewer groups presenting our ideas and I think the customer is really resonating to that clarity and simplicity in a strong way and we think we have a lot more opportunity going forward.

Our store basically if you look at it is, the largest presentation that you see when you walk by the store is handbag and it looks like a leather store and those categories are oversized inside the store, which means they can do a lot more volume inside the store, which leads us to believe that we can increase our comp store sales and our productivity over the next several years as the brand gets harder, gets more emotional attachment at the point of sale with the customer. So we think we are in a very good place.

John Kernan - Cowen & Company

Okay, great. And then kind of keeping on that thought what’s the driver for price increases this year and as you start to lap product margins now, nearly 200 basis points in Q2 of this year, what's the ultimate margin recovery potential on that product margin line? Thanks.

Mike Kovar

John, as we talked about in the prepared remarks, we see a little bit of pressure on gross margin as we move forward just based upon the fact we've got some currency comparisons that run favorable, we won't start anniversarying a lot of the production cost increases until we get into the second half of the year. However we have instituted price increases on units and select Kors styles, we think that could benefit us in terms of gross margin by about 60 basis points over the full year. That will not start until the March timeframe for the most part. So we’ll continue to look at our opportunity in terms of reengineering the margin to gain as much benefit as we can within the gross margins .But also we’re going to look closely at how consumer are been impacted as we continue to raise prices.


Thank you. The next question is from the line of Jane Thorn Leeson with KeyBanc Capital Markets. Please go ahead.

Jane Thorn Leeson - KeyBanc Capital Markets

Hi, thank you for taking my question. Just got a couple of more question. How much progress on the infrastructure and the sales management team you have made to-date for Asia?

Kosta Kartsotis

But we have hired a number of people throughout the region from larger global companies than we are. So the lot of expertise in doing this, a lot of knowledge of the markets specific from China. In addition to that we’ve sent a number of ex-pats to that region, some planning people from the US, from our store people from both UK and Hong Kong. And they have been there over a year now, and they’ve trained a lot of people in the markets. So I would say we’re making significant progress and some of our teams have just been through over the last couple of weeks and the spirit and enthusiasm and the capability is dramatically increasingly month-third-party-month. So we think we are in a very, very good position. But its ongoing, we still have a number of positions to fill, lot of initiatives going on right now throughout the region, adding additional people to open and manage this concessions. Especially in China it’s a very large and difficult place to operate but we are making lot of progress and we’re looking towards growing over the long period of time over the next several years.

Jane Thorn Leeson - KeyBanc Capital Markets

And what percentage of your current business is actually in China?

Kosta Kartsotis

Last year, we had something like 13% of the full company….

Mike Kovar

Yeah, China represents, still represents less than 1% of total sales. We do feel we have a huge opportunity there. But as Kosta mentioned, it’s a very fragmented place in terms of distribution and that’s part of obviously building the necessary infrastructure in Tier 1, Tier 2 and Tier 3 cities to affect distribution. We clearly feel like we have some leading brands there like Armani and Burberry that can be impact-able early on and kind of set the stage for us to gain access to those markets.

Jane Thorn Leeson - KeyBanc Capital Markets

And then just on the European consumer, what was your experience in UK first in terms of the austerity measures; I mean if you saw a material impact back then and what you expect in Europe?

Kosta Kartsotis

Most of our Europe business is in Northern Europe and we are not impacted a lot by what’s going on in Southern Europe. We have distributors operating in the region, (inaudible) a very small part of the company’s business and we actually have seen our European distributor business grow at very quick rate over the last couple of years.

So we are not being impacted directly by Southern Europe and we just feel like we’re in a position where even though the European economy has not been greater over last couple of years, we’re just in a position, so we have a lot of momentum, we have a lot of great initiatives in place. We are going to continue to gain market share, our stores have done very well as we go from there. We have a lot of opportunity both on the branded watch side and on the Fossil side, and we just continue to move forward and do the best we can in the market.

Jane Thorn Leeson - KeyBanc Capital Markets

And just a last question, can you implicate any more discontinued inventory to incur any more discontinued inventory in 2012?

Kosta Kartsotis

You know, as far as discontinued inventory, we did, as we said, we sold from the third parties during the fourth quarter and we feel that our inventory is very clean at this point. We are this year opening, as part of our store opening calendar that we got in place, we will open almost half the fourth local in United States with the outlet stores. So it’s going to be an increasing number.

You know, the Watch Station outlets have been extremely productive in getting rid of discontinued inventories. So we’re going to open a number of those and those are highly productive, you know the sales per foot in those operations are very, very high. Can’t just look at the store count, you got to look at the sales productivity that will come out of it.

So, we feel like we’re in a very good place with the currency inventory we have now and our ability to liquidate it going forward, we think we’re in a very good situation, especially when you consider that it looks like our lead times are getting faster, which should throw off less discontinued products relative to the sales over the couple of few years.


Thank you. That concludes the question-and-answer session. I’ll turn it back over to management for any closing remarks.

Mike Kovar

Thank you. Should you want to replay this conference call, it has been recorded and will be available from 10:00 am Central Time today until 12:00 am Midnight Central Time tomorrow by calling 303-590-3030 or 1-800-406-7325. Enter passcode 4509170 followed by the pound sign. Again, those numbers are 303-590-3030 or 1-800-406-7325; passcode 4509170.

The conference call has also been recorded by StreetEvents and may be accessed through StreetEvents’ website at or directly through our website at by clicking on About Us on our home page and then on webcast.

Finally, should you have any questions that did not get addressed today, please give me a call. Thanks again for joining us today. Our next scheduled conference call will be in May for the release of our 2012 First Quarter operating results.


Ladies and gentlemen, that does conclude the conference call. You may now disconnect. Thank you for your participation.

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