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Fossil, Inc. (NASDAQ:FOSL)

Q2 2012 Earnings Call

August 7, 2012 9:00 AM ET

Executives

Allison Malkin – IR

Kosta Kartsotis – Chairman and CEO

Mike Kovar – EVP, CFO and Treasurer

Jennifer Pritchard – President, Retail

Analysts

Barbara Wyckoff – CLSA

Oliver Chen – Citi

Shreya Jawalkar – Jefferies

Ike Boruchow – JP Morgan

David Wu – Telsey Advisory Group

Neely Tamminga – Piper Jaffray

Rick Patel – Bank of America Merrill Lynch

Omar Saad – ISI Group

Anna Andreeva – FBR Capital Markets

Liz Dunn – Macquarie

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Fossil, Incorporated Second Quarter Fiscal 2012 Earnings Conference Call. Prior today’s recorded presentation, all participant will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator Instructions)

I will now hand the conference over to Ms. Allison Malkin of ICR. Please go ahead ma’am.

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 statement, 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 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 webcast under the connections heading.

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

Kosta Kartsotis

Thanks, Allison. Good morning, everyone. Joining us today in our Dallas office to discuss our first quarter are Mike Kovar, our CFO; and Jennifer Pritchard, our President of Retail.

Our second quarter net sales of $636 million represented an 18% increase from last year in constant currency. These sales results were higher than consensus estimates, even though we saw increasing currency headwinds during the quarter.

In addition the company delivered double-digit sales growth across all of our business segments. Please also keep in mind that last year our sales increased in the second quarter was a plus 35%. As a result of our broad based sales growth coupled with a gross margin and expense leverage that has surpassed our initial expectations our reported earnings per share of $0.92 significantly beat our guidance and represented a 15% increase over the prior year quarter.

At just less than $3 billion in sales projected for 2012 we’ve nearly doubled our top line in just three years time. Our aim has been to develop great product, augment our global infrastructure and a faster growth across our multiple channels of distribution, while continuing to deliver above average returns to our shareholders.

Our efforts in these areas continue to deliver positive results during the second quarter with specific highlights including sales growth acceleration across each of our wholesale business segment; continued growth in the sales of our Fossil brand and our multi brand large portfolio; positive contribution from the Skagen brand, which we acquired at the start of the second quarter; and the maintenance of a strong financial position.

In constant dollar sales growth North America sales rose 18% or 13% excluding Skagen primarily on the strength of our Watch business. All markets within North America reported solid results with the U.S. delivering 15% growth, Mexico 65% and Canada 23%.

Our wholesale business was challenging during the quarter due to some product mixes that we have identified in our correcting. Handbags in our own stores was plus 11% and we feel we have a large opportunity going forward. Jewelry also contributed to growth in the region, as the continued rollouts of Michael Kors jewelry more than offset the decline in our Fossil jewelry line, as we reposition the category for the launch of our new assortment this fall.

In Europe, constant dollar sales exceeded our expectations with a 14% increase or 7.5% excluding Skagen. This included solid growth in Northern Europe, partially offset by a challenging sales environment in Italy and Spain. Although the current macro environment remains challenging, we are still expecting this region to be a part of our sales growth for the second half of the year, albeit at a lower rate. Long term, we see strong opportunities for market share gains throughout Europe as we look to expand our existing own distribution footprint and take advantage of the strong appeal of the Fossil – of the Skagen brand in the region.

Our wholesale business in Asia increased 29% during the quarter, 4% of which was attributed to Skagen. Our business in China more than doubled during the quarter and while still small in scale, we are making a significant amount of progress in positioning our multi-brand watch business in the market. We also experienced accelerated growth in Japan and Korea during the quarter, and Asia continues to represent our largest growth opportunity, and we’re continuing to build our infrastructure there to support a much larger business. Over the longer term, we expect operating margins in the region to expand as we monetize the investments we are currently making and accelerating the opening pace of high return and high margin concessions.

Additionally, over the last several years, there’s been a large whitespace developing in Asia for watches and accessories, as luxury brands continue to elevate prices due to the strong demand for these categories. Specifically for watches, as the prices and demand have risen for Swiss watches has created a large opportunity for our products in the region. We believe the robust appetite for accessories coupled with the developing white space is a significant opportunity for both the Fossil brand and for our multiband watch portfolio. Fossil brand sales rose solidly during the quarter led by the other business which rose 11% primarily related to store expansion and watches, which grew 7%.

Direct-to-consumer sales were up 15% for the quarter. The comp store sales increased 2% globally following a 22% comp gain in last year’s second quarter and a 15% comp gain in Q2 of 2010. While the environment in Europe is placing some pressure on our store comps, we experienced solid double-digit comps in Asia and single-digit comps in North America. And we are pleased that we were able to deliver our 17th consecutive quarter of comp store sales increases.

As you may know, we have not run sales in our regular price Fossil stores over the last few years. Instead, we’ve been sending discontinued styles to outlet stores for clearance. This year for four weeks, the last week of June and the first three weeks of July, we had an end of season sale and some seasonal accessories in our stores and on our website. About 25% of the store was on sale and there were no watches included. This not only allowed us to clear product at higher margins versus what we would achieve in an outlet store, but also improved customer traffic, which spurred increased sales of regular price watches and accessories. This enabled us to engage more customers in the Fossil brand during the typical sale period; mostly other stores are on sale.

We plan on doing this type of controlled four-week prices sale twice a year after the Christmas holidays and during the summer sale period. As it relates to Skagen, the brand contributed $25 million in sales and $0.02 to earnings during the second quarter. We’re pleased to see a positive contribution as our first order of business was to begin – integrating the business into Fossil. Since acquiring the brand on April 2nd, we have completed the integration of their North America, Germany, UK and Hong Kong operations on to our platform representing approximately 90% of the company.

We also provided notification to certain Skagen distributors of our intentions to transfer operations to our own subsidiaries. By moving existing third party distribution relationships to our own subsidiaries around the world, we will not only capture the wholesales and margin value for Skagen products, but also be able to leverage our global distribution infrastructure.

As one would expect, this effort resulted in the Skagen distributor placing less emphasis on ordering new product. That said, we are encouraged by the opportunities for accelerating Skagen growth during the fourth quarter, as customer relationships are transferred to our own subsidiaries. Long-term, we continue to expect Skagen to become a sizable global lifestyle brand with a unique positioning within accessories given its rich Danish design heritage.

As to our financial position, our balance sheet remained strong. We ended the quarter with $139 million in cash after having invested over $100 million in cash towards the acquisition of Skagen and the purchase of 2.5 million common shares at the cost of $234 million since the second quarter of last year.

On an absolute dollar basis, we are projecting yearend inventories to be at or slightly above last year’s level, which will significantly increase our operating cash flows in comparison to last couple of years. We have been able to reduce our lead times in the factories and have focused on fewer SKUs, each driving more sales. This has enabled us to reduce our weaker supply and has improved our inventory position.

As Mike will outline with you shortly, we’re in effect revising our guidance slightly downward for the balance of the year. Most of this is due to the U.S. dollar being much stronger. In addition to that, there is a lot of uncertainty and lack of visibility in the global marketplace. We’re confident in our business going forward, but we feel it’s prudent for us to plan our guidance more considerably for these two regions. Our business model is very resilient and inherently profitable, and we’re positioned to capitalize on opportunities while we continue to move strategies forward in a focused and efficient manner.

In summary, as we begin the second half of the year, we remain optimistic about our growth prospects. Our brands remain strong and in high demand with consumers. Watch trends remain favorable and we see a considerable whitespace developing the additional runway to the business. We have a lot of opportunity to get better of what we do. The integration of Skagen is off to a great start and already generating positive returns. We believe the investments we’ve made in our talent and infrastructure coupled with the ongoing strength of the Fossil brand and our multi-brand watch portfolio will allow us to achieve our long-term growth and earnings targets. We will also continue to focus on managing our balance sheet, by delivering consistent earnings growth. We will further improve our already strong cash flow which will allow us to drive even higher returns to our shareholders.

And I’ll turn the call over to Mike for more details.

Mike Kovar

Thanks, Kosta, and good morning everyone. I’ll start off by highlighting our reported first quarter 2012 versus 2011 results from this morning’s press release. Net sales increased 14.3% to $636.1 million compared to $556.7 million. Gross profit rose 14.2% to $356.4 million compared to $312 million and remained constant at 56% of net sales. The income before income taxes increased 7.8% to $88.1 million or 13.8% of net sales compared to $81.7 million or 14.7% of net sales and diluted earnings per share rose 15% to $0.92 on 62.1 million shares compared to $0.80 on 64.1 million shares.

From a sales mix perspective, our wholesale versus direct-to-consumer mix remained relatively unchanged from last year’s Q2 levels. However, within our wholesale segment, Asia and North America both increased approximately 100 basis points, while Europe dropped just over 200 basis points. And specific to our wholesale operations, North American based sales which include our operating activities in the U.S., Canada, and Mexico, as well as sales to third-party distributors in South America grew by $37 million, or 17.2%, to $250 million, excluding approximately $2 million from unfavorable currency comparisons to Q2 last year, North America wholesale sales increased by 18.2%, including $11.2 million in sales related to Skagen.

Sales from our Europe wholesale operations increased by $6 million or 4.2% to $148 million. Excluding currency that unfavorably impacted sales by $14 million, Europe wholesale sales grew by 14% and included $9.2 million of sales related to Skagen. Sales from our Asia wholesale operations increased by $18 million or 24.3% to $84 million, and excluding currency that unfavorably impacted sales by $2 million, Asia wholesales sales grew by 27.2% and included $3 million of sales related to Skagen.

Relative to our concession business in Asia, we added 13 new locations during the quarter and closed one. We ended the quarter with 225 locations and we expect to open an additional 51 locations in the second half of the year, while closing eight. Specific to our direct-to-consumer business, sales increased by $20 million, or 15.2%, to $154 million, excluding currency that unfavorably impacted sales by $3.4 million direct to consumer sales grew by 17.7%. Constant dollar comps in our retail stores were 1.8% in Q2 and e-commerce sales increased 1.4% for the quarter or 3.8% on the constant dollar basis.

Globally, we ended the quarter with 413 stores, 196 of which were outside of North America. And we occupied 743,000 square feet, compared to 642,000 square feet at the end of same quarter last year, an increase of 15.7%. This included 249 full-price accessory stores, 146 of which were outside of North America; 116 outlet locations including 36 outside of North America; 34 clothing stores with two outside of North America; and 14 full-price multi-brand stores including 12 outside of North America.

This compares to 367 stores, 166 of which were outside of North America at the end of the prior year quarter. Last year’s total store count included 235 full–price accessory stores, 95 outlets, 27 clothing stores, and 10 full-price multi-brand stores. During the first six months of this year, we opened 25 new stores and closed 10, and we are currently on track to open an additional 50 stores by the end of the year while closing an additional 16.

From a watch and non-watch category perspective, total watch sales increased $77 million or $19.3%, 23.2% ex-currency, to $477 million and included approximately $25 million related to Skagen products. On the non-watch side of our business, leather product sales increased $5 million or 5.7%, 8.2% ex-currency, to $97 million and leather sales growth as Kosta mentioned was primarily driven by our direct-to-consumer segment.

Jewelry sales decreased $1 million or 1.8% but were up 4.8% ex-currency to $38 million. While the continued launch of Kors jewelry added $7 million in sales, this was partially offset by a decline in our Fossil Jewelry business as a result of the repositioning of the assortment. Gross profit increased 14.2% to $356.4 million in the second quarter in comparison to $312 million in the prior year second quarter. Gross profit margin remained constant at 56% when compared to Q2 last year.

Foreign currency exchange rate changes negatively impacted gross profit margin by approximately 90 basis points. Excluding the impact of currency, increases in the sales mix of higher margin watch product versus leather product, select price increases across certain watch businesses and an increase in the mix of sales from higher margin Asia-Pacific wholesale sales drove the improvement in margin on a constant currency basis.

While increases in the factory labor cost continue to be a headwind in terms of a margin performance, we are beginning to lap certain component increases that occurred in Q2 last year. For the second half of 2012, we expect gross margin to continue to benefit from price increases instituted earlier in the year, the higher mix of watch sales and the higher mix of higher margin Asia and direct-to-consumer sales. Also our plans are to clear more discontinued products through our own outlet channel versus lower margin liquidators.

However, due to the recent strengthening in the U.S. dollar, currency losses will be more impactful and at current levels more than offset the favorable improvements we’ve highlighted. Therefore, we estimate gross profit margin to decline 30 to 40 basis points below last year’s level over the balance of the year.

As a percentage of sales, operating expenses increased 42.2% in the second quarter compared to 40.5% in the prior year quarter. For the second quarter, operating expenses were favorably impacted by approximately $8.7 million as a result of the translation of foreign based expenses in the U.S. dollars.

Non-recurring costs associated with the Skagen acquisition amounted to $1.2 million during the second quarter and includes acquisition and transition related cost of $5.6 million, offset by a $4.4 million favorable purchase price adjustment. This adjustment relates to a mark-to-market gain on the contingent purchase price liability we’ve established for the expected Skagen earn out. Because this potential additional purchase price we paid in Fossil stock, the mark-to-market adjustment reflects the fluctuation in our stock from the quarter-to-quarter and in this case from the time we acquired Skagen at the beginning of the quarter to the end of the second quarter.

On a constant dollar basis and excluding non-recurring expenses related to the Skagen acquisition, operating expense increases were primarily related to the addition of Skagen operating costs, expenses associated with the increase in the number of company-owned retail stores, as well as expense increases across our wholesale segment.

Increased expense levels in our wholesale segments are primarily attributable to our continued strategic investments in the Asia region, primarily related to head count addition and additional concession related costs. Additionally, we recorded approximately $4.7 million of expense in connection with legal costs and accruals related to the expected settlement amounts of routine business litigation.

As a percentage of net sales, operating income decreased to 13.8% of net sales in Q2 compared to 15.5% of net sales in the same quarter last year. And this was primarily result of operating expense deleverage. As to currency, operating income was negatively impacted by approximately $9.2 million as a result of the translation of foreign-based sales and expenses in the U.S. dollars. However, when looking at pre-tax margins, the deterioration from last year was only 90 basis points compared to the 170 basis points decline in operating margin, primarily due to the gains generated through our hedging activities.

As a result of these hedging gains versus hedging losses last year, other income and expense improved favorably by $5.4 million during the second quarter. At prevailing foreign currency rates, we’re estimating that outstanding forward contracts with scheduled settlement dates in the second half of fiscal year 2012 will result in hedge gains of approximately $4.2 million and $4.7 million respectively in the third and fourth quarters.

Our effective income tax rate was 31.4% for the second quarter. We estimate our effective income tax rate over the balance of the fiscal year will approximate 31%, which is our current structural rate. This rate excludes any discrete events that may occur during the remainder of the year. Second quarter net income increased by 11.6% to $57.3 million, or $0.92 per diluted share inclusive of an unfavorable $0.04 per diluted share related to foreign currency.

Now turning to our balance sheet, at the end of the second quarter, we had cash, cash equivalents and securities available for sale totaling $139 million compared to $332 million at the end of the prior year second quarter. We also ended the quarter with $113 million of debt. The decrease in cash and increase in debt over the last 12 months was primarily related to the acquisition of Skagen during the second quarter and the continuation of our stock repurchase plan.

We just closed out our 10b5 plan acquiring $82 million or 1.2 million of shares over the last 90 Days and as of today and since the inception of the $750 million buyback authorization in August of 2010, we have repurchased $611 million of our common stock representing approximately 8.1 million shares, and based upon the current stock price and the historical parameters within our 10b5 plan, we anticipate closing out this authorization early next year. Inventory at the end of the quarter was $524 million, an increase of 16% in comparison to $451 million at the end of previous year quarter. And as Kosta mentioned on an absolute dollar basis, we’re projecting yearend inventories to be at or slightly above last year’s levels.

In comparison to last year, accounts receivable remained unchanged at $226 million. Day sales outstanding for our wholesale segments for the second quarter was 41 days in comparison to 47 days in Q2 last year. This reduction is primarily the result of improved collection cycles, a lower mix of European sales which historically have longer collection cycles and an increase in the mix of concession sales.

During the first six months of 2012, we had capital expenditures of approximately $50 million and are expecting fiscal year 2012 capital expenditures of approximately $120 million. Depreciation and amortization expense for the first six months totaled $30 million and we estimate full-year depreciation and amortization of approximately $65 million.

Now turning to our outlook, as a reminder we provide guidance based upon the current prevailing rate of the U.S. dollar compared to other foreign currencies for countries in which we operate. As it relates to sales, typically we expect balanced sales growth between Q3 and Q4. However, this year our third quarter will end a few days earlier than last year which will result in some sale shifting out of Q3 and into Q4 this year.

We also expect Skagen sales increases to be more impactful in the fourth quarter as we complete the transition of their third party distributor businesses into our subsidiary environment in early Q4. As a result, for the third quarter, we currently expect reported net sales to increase approximately 11% with constant dollar net sales increasing 15%.

For the fourth quarter, we expect reported net sales to increase approximately 16% with constant dollar net sales increasing 18%. Given the significant strengthening of the U.S. dollar since we last provided guidance in May, we expect currency to negatively impact our current second half and full year earnings guidance by $0.14 per diluted share.

We’re also including adjusted earnings per share estimates for the balance of the year. Adjusted earnings exclude the non-recurring cost associated with the acquisition of Skagen and a reconciliation of guidance on a GAAP basis to adjusted as presented in our earnings release. We’re currently estimating third quarter reported diluted earnings per share in a range of $1.09 to $1.11 with adjusted diluted earnings per share in a range of $1.15 to $1.17. In comparison with the prior year third quarter, currency changes are negatively impacting us by approximately $0.04 based upon today’s prevailing rates.

We estimate fiscal year 2012 reported diluted earnings per share in a range of $5.20 to $5.25 with adjusted diluted earnings per share currently expected in a range of $5.29 to $5.34. Our adjusted earnings expectations for the full year represent a 15% to 16% increase over fiscal 2011 earnings per share of $4.61.

And now, I would like to turn the call over to the operator to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Barbara Wyckoff from CLSA. Please go ahead.

Barbara Wyckoff – CLSA

Hello, hi everybody.

Kosta Kartsotis

Hi, Barbara.

Barbara Wyckoff – CLSA

Hi, Mike, can you talk about the preliminary findings in the state of the inventory and the distributors for Skagen?

Mike Kovar

The state of the inventory and the distributors for Skagen?

Barbara Wyckoff – CLSA

Yes.

Mike Kovar

Yes, as you know Barbara, we’ve been obviously in contact with our third-party distributors and are working out plans to effectively transition that business, so we can take over hopefully in advance of the fourth quarter and obviously bring those sales into our business. Right now, our expectations are that for most of those third-party distributors, we would just buy out their existing inventory to reflect a clean transition into the business and not have to worry about any activities of dumping inventory into those markets.

Kosta Kartsotis

Yeah, as the distributors, the amount of inventory that they were carrying is really not that much anyway.

Barbara Wyckoff – CLSA

Okay. And also, then can you talk about the performance of the new elevated leather bags in your own stores, are they distributed through all of your stores, is this sort of the way the bags are going to start looking and be priced going forward, I mean I think they look terrific?

Mike Kovar

Yeah, as you know, we’ve been increasing all the details, et cetera, on some of our upper hand bags and had a very good response to it globally. In fact, we’ve seen those type of products sell internationally very well and we had a higher units per store sales in France for example in that category than anywhere else in the world, so we have, I think, a very good opportunity there. Having said that, we also recognized we had an opportunity I think in Fossil to go back into some of the lower price points than what we’ve (inaudible) very good response at the high end, but we felt we have an opportunity to be more inclusive on price on some categories in leather goods and even watches at a more opening price especially with the economy being what it is. And I think that’s one of the – I think opportunities we are going to have going forward, back half of this year and next year. I think there is an opportunity first to be more inclusive while we still get that aspirational customer.

Barbara Wyckoff – CLSA

Great. Thanks. Good luck.

Kosta Kartsotis

Thanks Barbara.

Operator

Thank you. Our next question comes from Oliver Chen from Citi. Please go ahead.

Oliver Chen – Citi

Thanks a lot. Hi, Mike and Kosta, congrats on a great quarter.

Mike Kovar

Thank you, Oliver.

Oliver Chen – Citi

Regarding North America, the number they all looked pretty impressive ex-COG and at high teens. On a multi stack basis it’s still relatively challenging comparison in the back half. What’s happening there? Are the inventories pretty clean, what do you think about to say the inventories and business trends in North America wholesale especially given the mixed consumer environment?

Kosta Kartsotis

Well I think the, when we look at – looking at inventories and of course we stay really in close touch with that information, everything looks good. As the, watches has continued to be a strong category in the U.S. Cores are still very, very strong. We’re seeing growth in a number of other brands also. The stores are continuing to give more space and inventory and presence in the stores, you’ll see that on an ongoing basis through this year and next also as the – you get more capital remodeled stores et cetera. So the category itself continues to be very strong. Of course this is all high-value innovate merchandise sold at regular price, so we were very encouraged by the U.S. consumer even though the economy is not great, still responding strongly to the category.

Oliver Chen – Citi

Thanks a lot. And regarding the same-store sales comp, what should we think about regarding the run rate, the comparison is still double-digit in the back half, the number that you posted this quarter, could you help us understand the breakout between traffic versus ticket?

Kosta Kartsotis

Well, I think like everyone else we’re being impacted negatively by traffic in all environments that’s internationally and in the U.S. And in terms of our outlook all over for the balance of the year, we expect to see comps at kind of the same level that we perform that in Q2, although the closest point we think there is some opportunity in the leather category in the fourth quarter as we introduced some new assortments toward the end of Q3. And we think that from a regional standpoint, you’re going to see the comps perform again kind of consistently to where we were in Q2 with Europe being a drag, Asia continuing to report solid double-digit growth and the U.S. kind of low to mid-single.

Oliver Chen – Citi

Okay, thanks. And final question is related to the – it looks like the street has to rebalance third quarter versus the fourth quarter, why were those days so sensitive in terms of the shift in the fourth quarter. Could you just illuminate that a little bit more? Thanks.

Mike Kovar

Lot of our holiday assortments are shipped out beginning kind of the second part of September and as we are losing a couple days in terms of shipping days in September, we are going to see a shift to some of that business into Q4 of this year. In would also say that if you look at the estimates that were out there for Q3 on an implied earnings basis, the Q3 was – the Q3 earnings estimates imply greater leverage than Q4. That’s on sales base that less than $250 million than Q4 is expected to be. So, I think there were just maybe some disconnect there in terms of the expected leverage.

Oliver Chen – Citi

Okay, thanks. Congrats and good luck.

Kosta Kartsotis

Thanks Oliver.

Operator

Thank you. The next question is from Randy Konik from Jefferies. Please go ahead.

Shreya Jawalkar – Jefferies

Hey, guys, this is Shreya Jawalkar calling in for Randy. How are you?

Kosta Kartsotis

Great. How are you?

Shreya Jawalkar – Jefferies

Good. Thanks. I’m sorry if I missed this, but Michael Kors watches did you mention, what the growth rate was in 2Q?

Kosta Kartsotis

We – it was strongly up consistent with what we’ve seen in the several quarters, so that continues to be a strong player. One thing about Kors is that as you know we’re, as we continue to expand it globally, we’re seeing somewhat of the same response in some markets. So, we feel it can be kind of a catalyst for growth in other markets like it was in the United States, so we’re continuing to do that. A lot of that’s been instigated by, we have a watch and jewelry shop that we’ve started putting in some locations, both in the United States and outside, and we’re getting strong response to that, we think it’s a great way to communicate the brand, and the presence and the whole idea of (inaudible), watches, and jewelry. So, we think we’re in pretty good shape on that.

Shreya Jawalkar – Jefferies

Okay. And then just would like to touch on your (inaudible) week, can you just talk about the sequential progression of the trends within 2Q even, and also does it feel like this trend is stabilizing or does your guidance bake in for the deceleration?

Mike Kovar

Well, when we provided guidance for Q2, we were expecting the Europe constant dollar performance kind of at a low to mid single level, so we outperformed that coming in at 7.5% excluding the benefit of Skagen. I would say the overall macro environment has not improved. I think we’re finding that watches still tend to be a category that are outperforming, the balance of consumer discretionary and with the environment still rather difficult we’re being very cautious on the back of the year as Kosta mentioned in his prepared remarks.

Shreya Jawalkar – Jefferies

Okay. And then just lastly the jewelry repositioning, is this nearly completed or is there still more to go?

Kosta Kartsotis

Well, it’s in process – it’s in process, most of the new assortments will be in the stores and in our wholesale channel in the third quarter. So, it’s kind of a process through the back half of the year.

Shreya Jawalkar – Jefferies

Got it. That’s all I had. Thank you.

Kosta Kartsotis

Thanks.

Operator

Thank you. The next question is from Ike Boruchow from JP Morgan. Please go ahead.

Ike Boruchow – JP Morgan

Hey guys, congratulations thanks for taking my question.

Kosta Kartsotis

Thanks.

Ike Boruchow – JP Morgan

I guess Mike when you went over the direct to consumer business in the retail comp, could you also break that down by geography like you guys normally do with North America and Europe and Asia and then is it possible to also get what the concession comp was in Asia this quarter?

Kosta Kartsotis

On the retail side again the store comps were down double digits, low double digits in Europe, up mid singles in the U.S. and up strong doubles in Asia and as I mentioned that’s where we’re kind of laying out the balance of the year in terms of our guidance as well. As it relates to concessions, we saw a similar performance in Q2 that we saw in Q1. We were down 1.8% in Q1, came in just over down 2% in Q2 in the concession environment; however, we did see a better performance to the end of the quarter.

In June, the concession comps were up 4% and in July, the concession comps were up about 6%. So, as we talked about, we’ve got a lot of going on in Asia right now. We have a lot of resources and we’ve always felt like there was some opportunity in terms of bettering the performance metrics around our concession business. And I think those resources are starting to reach out and help manage that environment with our local country resources and I think longer-term we will continue to see improvement in that environment.

Ike Boruchow – JP Morgan

Okay, great. And just one quick follow-up. On the SG&A, tell me if I’m thinking about this right if you exclude the mark-to-market adjustment, it looks like your SG&A dollars would have been up more like 23%, 24%. Is that the way we should be thinking about the back half because I assume you won’t have any similar benefit in Q3 or Q4 this year?

Kosta Kartsotis

I think Q3 will be a similar situation where you won’t see any leverage or continue to see deleverage on the SG&A side. The gain on the mark to market on the acquisition activity was also offset by the – what we believe to be hopefully a onetime charge in terms of selling some litigation that was out there. So I think in Q3 you’ll see a slight improvement against Q2 and Q4 we think there’s some opportunity to generate some leverage given the fact that the sales in that quarter are far more productive than they are in Q3.

Ike Boruchow – JP Morgan

Got you. Okay, thanks a lot, best of luck.

Kosta Kartsotis

Thanks.

Operator

Thank you. The next question is from David Wu from Telsey Advisory Group. Please go ahead.

David Wu – Telsey Advisory Group

Thanks. Hi, good morning everyone and congrats on the great quarter. Firstly, on the DTC comp, could you talk about the self complexion between outlets and full pricing, how much of the comp do you think was impacted by more company specific issues such as the product mix that you’ve previously mentioned?

Kosta Kartsotis

I think we’re seeing slightly stronger comps than our outlet environment than we are in a full price environment. In terms of the product as we mentioned, and our stores are – leather goods still continue to perform a lot healthier than they are in our wholesale channel and I think that’s just the selling experience we give the consumer in that space versus the departments being kind of an open sell environment. But watches still continue to perform positively in our own environment as well. So, the only impact we’ve seen in terms of product category were we’re trending down against last year. In terms of comp it’ll still be the jewelry category and that’s primarily due to the fact that we are in this repositioning mode in terms of re-launching the line in the later part Q3.

David Wu – Telsey Advisory Group

And in those trends you think should start to reverse towards the end of Q3?

Kosta Kartsotis

Well, I think….

David Wu – Telsey Advisory Group

With the introduction to jewelry?

Kosta Kartsotis

Overall, we’re expecting the comp performance remain somewhat similar, so we’re being a little bit cautious on the outlook just given the prevailing environment, but I do think we believe that once we get the new jewelry in the store, we are expecting that to be a positive influence.

David Wu – Telsey Advisory Group

Great. And then on Europe wholesale, can you talk about how this sell-out rate versus the sell-in rates are tracking and if you think inventory levels at the retailers there are relatively healthier, or if you think there could be any potential risk for destocking there?

Kosta Kartsotis

You know that inventories looked to be in line of the environment’s not great and stores are not being aggressive with inventory and they are – we’re not seeing great sales increases. So it’s kind of all in line. We do think that we can continue to gain market share, we got a lot of new things going in the marketplace, new ideas, new categories and new brands in some cases. So we think we’re going to continue to gain market share there.

David Wu – Telsey Advisory Group

Excellent and then just lastly with the new hire price points Burberry watches coming out this fall, can you counter out your initiative to expand into the high-end watch category and what the potential opportunity is across your other brands such as Kors, Armani and if you are planning to bolster your own internal manufacturing capabilities in Switzerland?

Kosta Kartsotis

Well, as we said the Swiss watch market has been very, very successful in Asia especially in China and even China travelers buying Swiss watches around the world and the prices of those products have gone up dramatically and so has scarcity. I think given us, an additional white space opportunity for us to put Swiss made products in the Asian markets. So we – this launch of the Burberry Britton watch which is kind of an iconic style for them starting at $1,000 an incredible watch and it’s going to be launching in the next couple of months. It’s going to be a huge launch in their stores and throughout their digital media in addition to the best stores in the world and lot of it’s in Asia, where we think it’s going to be a great on tray for us into the more luxury world and be able to participate in the broader base of Swiss made watches.

We also are in the works of making a Fossil Swiss made watch, which will be tested in our stores throughout Asia, especially in the back half of the year, really in the fourth quarter I guess. And we are working on Swiss made watches for some of our other brands as well. So, we think that there is an additional crazy life based opportunity for us over the next several years to participate in this explosion of demand for Swiss made watches.

And we think with our global life style brands being able to participate and the consumers the way they think and how active they are in the category, we think it’s another big opportunity for us. So, we’re working on and we are in the process of enhancing our capabilities in Switzerland. We had acquired three companies 10 years for design prototyping and to facilitate the manufacturer of Swiss watches and we are adding more resources to that and getting prepared for us to able to do more business in that category. So, we are pretty excited about it.

David Wu – Telsey Advisory Group

Excellent. Thank you very much.

Kosta Kartsotis

Thanks David.

Operator

Thank you. The next question is from Neely Tamminga from Piper Jaffray. Please go ahead.

Neely Tamminga – Piper Jaffray

Oh, great. Good morning, guys.

Kosta Kartsotis

Good morning, Neely.

Neely Tamminga – Piper Jaffray

Good morning, just a couple of housekeeping items with the many facets of your business I want to make sure understanding. So as we look ahead to the EU wholesale growth that you are still anticipating for the back half of this year, is that going primarily tied to the license business or are you expecting Fossil to rebound there as well?

Kosta Kartsotis

We’ve actually seen actually seen Fossil do pretty well in that market. As we’ve talked about in the last couple of quarters, we have quite a lot of growth going on especially in France and in Europe, so we’re expecting it to be pretty broad based and we do have some additional – because Skagen course is new, that’s going to help us gain market share and grow over there as well.

Neely Tamminga – Piper Jaffray

Okay.

Kosta Kartsotis

Neely as we – as we also said, we’re not anticipating an improvement in terms of the European wholesale performance in Q3 from the 7.5% constant dollar ex-Skagen growth we saw in Q2. In fact we’re being a little more cautious by maintaining the guidance of where we were back in May at kind of a low to middle single-digit opportunity.

Neely Tamminga – Piper Jaffray

Okay. I’m just trying to size up, I guess overall the high level here at the Fossil versus the license branded sales, it seems that you’ve definitely accelerated and improved on the watch sales, which is encouraging, but was that driven again more by the licenses behind their watches or was it driven more by the Fossil brand?

Kosta Kartsotis

I’d say Fossil definitely participated in the overall watch business growth for the quarter.

Neely Tamminga – Piper Jaffray

Okay, all right. And then just one more final housekeeping here, on the outlet side of the business, I heard you said about outlet outperforming full price, there has been quite a bit of scuttle up there about what’s going on with the traffic levels at an outlet, can you speak to your traffic level specifically versus maybe just usual good work on conversion?

Kosta Kartsotis

Well, I would – we don’t have the information in front of us on the traffic outlet versus regular, but I would expect that the outlet traffic has been greater through the last couple of quarters and we would expect that to continue.

Jennifer Pritchard

Neely, it’s Jennifer. We haven’t seen that the kind of declines in the outlet traffic that we’ve experienced in the regular base mall environment. That being said, we continue to work on the selling metrics that are consistent with our strategies over the last couple of years to drive greater productivity out of all environments.

Neely Tamminga – Piper Jaffray

Thank you.

Kosta Kartsotis

Neely, In addition to that, a lot of our outlook growth is coming outside of the United States this year. So, as we’ve talked about, we’ve had a need to create an outlet environment in Europe and Asia to help us deal with the growth in our business there over the last two years instead of having to movable that merchandise back to the U.S. and trying clear it through the number of stores we have here. So, I think our experience is that we’re continuing to see travelers come into that outlet environment and our focus in terms of locations are these great kind of festive lifestyle outlet centers that people are in great moods and spending a lot of money.

Neely Tamminga – Piper Jaffray

That’s great. Thank you, guys. Good luck.

Kosta Kartsotis

Thanks.

Operator

Thank you. The next question is from Rick Patel from Bank of America Merrill Lynch. Please go ahead.

Rick Patel – Bank of America Merrill Lynch

Good morning. Thank you. Sales for your wholesale segment accelerated throughout all three geographies, but same-store sales and the DTC channel decelerated during the quarter. So, can you just talk about discrepancy there where your wholesale customers looking to restock a little bit more than usual during the quarter or is there something else going on there, just help us think about that?

Kosta Kartsotis

I think obviously our wholesale environment includes our entire global watch portfolio and as we mentioned earlier, we’re seeing some brands accelerate at a faster pace based upon the fact that they’re not as significantly penetrated in those channels as our Fossil business is. Additionally, the Fossil brand in terms on our retail comps as Kosta mentioned is coming up again some pretty significant two-year comps. We’re up 20% in Q2 last year and up 15% in the prior year quarter to that 2010. So, I think it’s just a little bit of a leveling out going on in that channel.

Rick Patel – Bank of America Merrill Lynch

Okay. And then can you provide some more details around your price increases. On the last call you highlighted getting some push back especially for pricing changes on the entry level product. Did you changed the prices for this products during the quarter and if so how was that received? And secondly, can you highlight which brand do you think has been the most resilient to price increases that may provide an opportunity in the back half of the year?

Kosta Kartsotis

Yeah, we did some of the price and we really saw a pretty good response to it. So we’ll know better through the back half of the year but so far so good. I would say specific to our Armani which we called out on the last call, we saw that brand increase to a double-digit growth pace in the quarter and improve tremendously in terms of the Europe environment where we dropped about $5 million in sales of Armani in Q1. So we have seen a much better performance as we’ve added some additional product to that entry level price point level for the brand.

Rick Patel – Bank of America Merrill Lynch

Okay, great. And just lastly can you provide a little bit more color on your North American wholesale growth. Was growth consistent throughout the different channels of distribution, department stores, mass et cetera and what do you see as the biggest opportunity for growth throughout your distribution channel going into holiday?

Kosta Kartsotis

Well the growth I would say was strongest in the watch area and in department stores. So across all our brands basically we had pretty good growth and we’re expecting that to continue into the back half of the year, all those time look good for us on that regard.

Rick Patel – Bank of America Merrill Lynch

Great. Thanks so much.

Kosta Kartsotis

Thanks Rick.

Operator

Thank you. The next question is from Omar Saad from ISI Group. Please go ahead.

Omar Saad – ISI Group

Thanks. Good morning guys.

Kosta Kartsotis

Good morning Omar.

Omar Saad – ISI Group

Wanted to follow-up with a question on the Fossil brand. Kosta you’d made some comments about maybe tweaking some of the entry level price points. I don’t know if you gave a number for the overall Fossil brand growth in the quarter, but I think the comp probably reflects a little bit of a slowdown there. Can you kind of help us walk through what’s going on with the brand and some of the strategic decisions you make around pricing? I know there is some noise with the jewelry business and some of the other pieces, but can you just kind of give us kind of state of the union address on the Fossil brand right now?

Kosta Kartsotis

Yeah, as you know, the brands growing quite a bit over the last five years and stack comps were in 30s and 40s range. I think just looking back so far the first half of the year, we – the economy changing I think globally. In addition to that, there are some trend changes. I think that we had some product mixes, a lot of that was based on I think when we said on the last call we didn’t have enough color. The other issue I think was we probably had migrated priced up in some categories probably more than we shouldn’t and kind of a evacuated that opening pricing what we described in handbags. So, we’ve done and come back and try to be more inclusive I think which is very good and also again another product mix is just our the transition of jewelries.

So on balance when we look at all these issues and keeping in mind that our lead times are relatively short, I think we have a very good opportunity going forward really lose that business. But all-in-all, we’re very pleased with the Fossil business. About half of it right now has done DTC and we think that’s a very good thing. We’re getting a very strong response throughout Asia. You saw our comps again.

We’re very strong and our stores were averaging $800 to $900 (inaudible) and I think there is increasing productivity. Again, the one thing that continues to be a huge advantage for us in our entire business model was the fact that dealing with accessories inherently much more profitable business, lead times are shorter, process bode us easily and there is this massive opportunity as the middle class in Asia grows and the response to Fossil has been strong and just continues to look like a very large long-term opportunity for us.

So again using our multi-brand watch business and our Fossil brand business, we got two big core businesses using shared services. It’s a very efficient model. We think we’re going to have increasing return on invested capital going forward. And we just keep on going and everything looks good as far as we’re concerned.

Omar Saad – ISI Group

Thanks Kosta. And then that’s really helpful. And then Mike, maybe you could just clarify a little bit on the third quarter or fourth quarter as we think about kind of the implied margins, the differential looks like third quarter margins are going to be down a few hundred basis points versus fourth quarter may be down 50 to 100. Just make sure help us understand what the differential and dynamics are on the margin line. I understand there is some days missing on the revenue side?

Mike Kovar

You’re talking operating margins Omar.

Omar Saad – ISI Group

Yeah.

Mike Kovar

Yeah. Again the biggest part of that is just productivity increase in terms of sales in Q4 versus Q3. Additionally, as we’ve said we expect to see a much better performance from Skagen in the fourth quarter. As get through transitioning some of these third-party distributor businesses and we start to see a lift in that business to offset some of the operating expenses we are taking on where we are leaving infrastructure in place, as it relates to the strategic spend going on in Asia, our expectations for growth in Asia continue to be 25% or higher and as we’re starting to lap some of that investment in that region that occurred towards the second quarter of last year.

I think we have an opportunity in a more productive quarter like Q4 to really start showing some leverage from that region. So I think we anticipate that while Q3 will still show deleverage some things similar to what we saw in Q2 may be slightly better because of the revenue performance increasing slightly. Q4 is the opportunity for bringing the leverage back in line.

Omar Saad – ISI Group

Got you, that’s helpful. And then last just any quick updates on watch station, what’s going on with that business and what you’re learning there? What you’re learning there?

Kosta Kartsotis

Well, Watch Station continues to do very well especially in the other channel we are – I think going to open about 20 more Watch Station outlets this year and even this year with about 50 total Watch Station stores. So everything looks good as far as that goes, we opened a number of stores (inaudible) in Asia, opened a pretty good store in Hong Kong. So everything looks good. We’re also learning a lot, we have very large opportunities you know in watch concessions especially throughout Asia, so we’re learning a lot on the direct consumer watch side. And our Watch Station stores, it can be applied to our concessions globally. So we think we’re in pretty good shape.

Omar Saad – ISI Group

Great, thanks. Nice work.

Kosta Kartsotis

Thanks Omar.

Operator

Thank you. The next question is from Anna Andreeva from FBR Capital Markets. Please go ahead.

Anna Andreeva – FBR Capital Markets

Great. Good morning guys.

Kosta Kartsotis

Good morning, Anna.

Anna Andreeva – FBR Capital Markets

Thanks for taking my questions. I was hoping to follow-up on the gross margin line, gross margins came in significantly better despite foreign currency being a better, bigger headwind for you guys. Can you may be extrapolate some of the drivers behind that and looking out to back half I guess why would gross margins be down in 3Q and 4Q? I understand the foreign currency although 4Q your Forex comparison does get a little easier. And then I was hoping to follow up on Europe, nice acceleration there from mid-singles to 7.5% and that despite right you said Italy and Spain were a little worse. So did Germany and UK accelerate, were there other markets that got better may be you can talk about that?

Kosta Kartsotis

Yeah I’ll talk about the gross margin question Anna. Currently, it’s obviously the biggest player there and when we provided guidance back in May, the euro at that was trading around $1.31 and today it’s trading below $1.25, most recently in the $1.24 range. So, it will be impactful for both Q3 and Q4, some of the benefits that we’re seeing in terms of the better performance in Q2 was, as we talked about on the prepared remarks, we’re seeing an increase in the mix of watch sales versus leather sales, and that’s primarily due to the fact that as we mentioned our leather business was down in North America. So, just that mix part benefits us because our watch margins are much higher in the wholesale channel than our leather margins.

Also, we’re continuing to see a greater mix of Asia versus the Rest of the World, and obviously with the concession environment we operate in Asia, that’s a much higher margin region than the rest of our segments. We do think that as we move towards the back half of the year, and then the fourth quarter, there’s a bigger opportunity for leather being additive to sales, and just because of the mix shift there from where we were in Q2. Q2, that is going to impact margins slightly negative, just because of this fair margins between watches and leather goods.

As far as Europe, it was pretty consistent across each region, as we mentioned Northern, our Northern Europe performing solidly better than Southern Europe. We’re still seeing kind of strong performance in markets like France, and the UK, specifically where we’ve been investing in the Fossil brand, we’re seeing Fossil brand grow quite nicely there are in terms of both the wholesale as well as our retail activities.

Anna Andreeva – FBR Capital Markets

Okay. And just a follow-up on the gross margin question, what was AUR during the quarter, did you guys quantify that?

Kosta Kartsotis

I think we saw AUR in terms of our direct channel increase from when we were in Q2, commensurate with were we’ve been for the first six months of this year.

Jennifer Pritchard

It’s actually commensurate where we were in the fourth quarter last year as well. So, it’s been pretty steady for the last three quarters.

Anna Andreeva – FBR Capital Markets

Okay, okay got it. Thanks so much. Good luck guys.

Kosta Kartsotis

Thanks.

Operator

Our next question comes from Liz Dunn from Macquarie. Please go ahead.

Liz Dunn – Macquarie

Hi, thank you for taking my question and congrats on a great quarter. So, just to follow up on some prior questions. In terms of the reduction to guidance, the currency has moved a little bit, there is an expectation of a mix shift that should have a bit of a negative impact on margins and then what’s the impact that you’re seeing from just the global uncertainty just in terms of last quarter’s guidance versus this quarter’s guidance?

Kosta Kartsotis

Well, I’d say that the biggest part of that is we’re dialing back our expectations on Europe given our performance in Q2 being a little bit better than we expected initially. Also we’re coming up against some pretty significant comps for the back half of the year on our North American wholesale operations and that’s not a region where we’re seeing a lot of door growth because obviously a lot of our businesses are already well penetrated into department store channel in North America. So, I think if those two things combined, a little bit less of an expectation for growth in Europe and a little bit tougher compared against the U.S. wholesale channel in the back half of the year.

Liz Dunn – Macquarie

Okay. And then I apologize if I got this wrong, but I thought I heard you say something about some women’s fashion problems and the watch category. Could you expand on that a little bit?

Kosta Kartsotis

Well, we thought we have some product misses. Part of it was I think we mentioned that we were not as inclusive as we probably could be on the lower side of our assortments. We had put a lot of products in the marketplace more aspirational, more expense and had a very good response to them, but especially I think with the macro environment and especially in Europe we saw that we probably moved up a little bit quicker than we’d like to and we’re – we think it’s an opportunity to go back and really capture that customer.

We also had seen in our stores small leather good selling extremely well better than handbags and of course the retails are lower. So and I think just that idea being more democratic and more inclusionary in getting customers engaged as average unit retail, it’s lower and moving then up to our – engaging them in the brand and given the ability to have them continue to stay with the brand and move up towards the higher price points which is being more inclusionary I think and that’s I think going to be a very strong thing for us for the next couple of quarters.

Liz Dunn – Macquarie

Okay, great. And then finally what is your capacity and interest in sort of new brands? I know we’ve got lot of (inaudible) coming for 2013 but, do you have the capacity and interest for new brands on the license side and would the only have to be – would you only consider them as they’re sort of I don’t know just what your interest there? Is there something abuzz in the marketplace about certain brands?

Kosta Kartsotis

First of all, and we’re extremely pleased with the brands we have, everything is doing extremely well and has a huge upside. So I think focusing on our existing brands has been big benefit to us and that’s ongoing. Of course we are – Skagen is going to be very fast grower for us and as we said earlier, once we get everything settled which is I think by the way I think the company has done an incredible job of integrating Skagen and very quickly getting all of the global teams together, both the Skagen people and ours, all working together towards the common end has been pretty inspirational from our standpoint. So we’re moving forward on that. Carl is going to launch in spring next year, relatively small start. So we’re going to have a select number of doors but there is lot of initiatives inside each and every one of our brands that is going to we think add potential growth to them.

And having said all that, we are continuing always to be in the marketplace to see what other brands are merging and what could be additive to our assortment and we will continue to do that and be optimistic.

Liz Dunn – Macquarie

Congrats, good luck.

Kosta Kartsotis

Thanks.

Operator

Thank you. I’ll now hand the conference back to Mr. Mike Kovar. Please go ahead, Sir.

Mike Kovar

Should you want to replay this conference call, it has been recorded and will be available from 10 a.m. Central time today until 12 midnight Central time tomorrow, and you can dial 303-590-3030 or 1-800-406-7325 for that replay, and the pass code is 4540220. Again, those numbers are 303-590-3030 or 800-406-7325, pass code 4540220.

The conference call has also been recorded by StreetEvents and may be accessed through StreetEvents’ Web site at www.streetevents.com or directly through our website at fossil.com by clicking on about us on our homepage and then on our 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 November for the release of our 2012 third quarter operating results.

Operator

Thank you, sir. Ladies and gentlemen, this concludes the Fossil Incorporated second quarter fiscal 2012 earnings conference call. Thank you for participating. You may now disconnect.

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