Fossil Group Inc (FOSL) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Fossil first quarter earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will by given for the question-and-answer session. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded today, Tuesday, May 10th, 2005. Please note that management has allowed us 60 minutes for today's call.

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

Good morning. I hope each of you has received a copy of our earnings release. If for any reason you did not, you may download it from Fossil's website at fossil.com by clicking on Investor Relations on the home page index and then on earnings releases. At the onset of this call we hope to provide each of you with some additional insight into the specifics surrounding our operating results and financial performance at the conclusion of the Company's first quarter.

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. Additional information concerning a number of factors that could cause actual results to differ materially from the information that will be discussed is readily available in our report on Form 10-K for the fiscal year ended January 1st , 2005 and on Form 8-K filed September 15th, 2004.

Now I'll turn the call over to Fossil Chairman, Tom Kartsotis.

Good morning. Thank you for joining us to discuss our first quarter fiscal 2005 results. Joining me are President and CEO, Kosta Kartsotis; CFO, Mike Kovar; and EVP, Randy Kercho. I will start off this morning's call by briefly providing an overview of our first quarter results, then Kosta will review the rationale behind our revised expectations and go over our first quarter sales highlights and current initiatives. Mike will then review our first quarter financials and outlook in more detail. At the conclusion of our update, we will open the call for any questions you may have for us this morning.

First quarter sales increased over 16%, but we were targeting even higher sales based on the level of our expenditures during the quarter. Diluted earnings per share exceeded our guidance; however, our operating results were below our original expectations and fell approximately $400,000 below last year's comparative period. First quarter net sales rose to $232.5 million and diluted earnings per share increased to $0.32, with income taxes benefiting us by $0.13 per share due to tax savings that we achieved through the American Jobs Creation Act of 2004.

Be assured that we are not pleased with these results. Our mission from this point is to remain focus order increasing our operating income through sales growth, with an increasing focus on expense management.

Kosta will now outline our strategies to report improved results in the second half of 2005. Thanks, Tom. This morning I will begin with the reason behind the slight decline in our operating results, and then highlight the first quarter performance of our watch and accessory brand. As we entered the first quarter, sales for our watch and accessory brands began solidly.

In the U.S., our latest watch and accessory designs gained traction in retail, and our new businesses, namely Michele and our mass market division, along with our Company-owned retail stores, continued to exceed expectations we set. At the same time, our non-European international businesses continued to provide solid sales growth.

In Europe, the quarter also started off well, as retailers placed orders after a fairly healthy 2004 holiday season. However, European retail sales slowed throughout the quarter, ending up with a dropoff in sales in March as retailers adjusted their inventories. On a positive note, sales growth for our newer licenses in Europe, including Burberry and Diesel continued robustly as we benefited from door expansion in the market.

We met our original guidance range for total sales for the quarter, but our internal expectations were somewhat higher. Mostly because both Michele and our mass market businesses were still new to the Company in that both started shipping in the second quarter of last year.

Our operating profits were also less than expected since our European sales generate a larger pretax margin than the total Company, primarily due to the higher selling prices and lower fixed costs of these subsidiaries. Additionally, expenses in Europe were planned higher, given our increased advertising commitment and infrastructure spending to support a much larger business going forward.

As you know, our goal has been each quarter to achieve a 15 to 20% top-line gain, while investing in the future growth of our brands and product lines. We once again had strong sales growth, but not as much as we had planned internally, and we did not react quickly enough to our -- on our expense management side to offset the spending. However, our experience in Europe has caused us to take a hard look at our planned expense structure.

We are currently implementing cost reduction initiatives throughout the Company and slowing down our expense growth in many categories, including marketing and infrastructure. We expect these savings to impact results beginning in the third quarter of this year.

Now to highlight the quarter. Domestically, our sales rose by 22.3% and included strong growth from many of our watch and accessory lines and continued momentum in our retail stores. Notably, total watch sales rose by 30% in the United States, primarily driven by new business initiatives.

FOSSIL watch sales declined by 3.7% during the first quarter, which is in comparison to the same period of 2004, but was a vast improvement over the 16% decline experienced in the fourth quarter of 2004. Continued newness being introduced into the FOSSIL line should continue to improve the line's results in 2005.

In accessories, sales rose by 19%. We saw strong growth in all categories, handbags, small leather goods and sunglasses. Our handbag business was particularly interesting in that we are rapidly gaining market share and momentum in this fast-growing category. There is a lot of interest in leather accessories right now, and we are in a great position to capitalize on the trend. This, of course, is a sizable opportunity, given that the handbag business alone is totally much larger than the watch business.

Our Fossil retail stores performed well, posting a 31% increase in total sales with a comp store increase of 12%, which was against a 20% increase in Q1 of last year. Another great performance for the stores. We continued to be pleased with the excitement that our stores generate for the FOSSIL brand and continue to think that retail is a big long-term opportunity for the Company.

We entered the quarter with 137 stores versus 120 stores a year ago. This includes 56 accessories, 59 outlets, 22 combination apparel-accessory stores and two modern watch company stores. During the year we expect to open about 30 stores, which will include some of these concepts.

Our Swiss business performed well, again, with a strong contribution from Burberry watches. Sales of Burberry watches rose by 89% in the quarter, driven by an improving assortment and door growth throughout the world.

We're also excited about the response we're seeing in the market relative to our ZODIAC brand. We have spent a number of years repositioning the line, and are now ready to expand the distribution quite a bit. The product looks great and is getting a lot of interest around the world. We have recently shipped both Neimans and Nordstroms in the United States, as well as a number of doors around the world.

MICHELE continued to do very well, it ended the quarter with 9.4 million for the quarter. We are seeing increasing demand in the United States for MICHELE and continue to expand the business globally.

Lastly, our other international sales, including the Asia-Pacific region and Canada, continues to be an area of strength for us. Our portfolio brands is gaining awareness in these markets, which is leading to an increased penetration in door growth.

As we look to the second quarter and the balance of 2005, we feel our competitive advantages in design, sourcing and distribution, coupled with a great portfolio of existing brands, as well as our new initiatives, puts us in a position for improving sales trends. We also face easier comparisons, both domestically and in Germany, which of course accounts for a large percent of our European sales. Equally as important, our plans call for a reduced cost structure.

We plan to add additional marketing and operating costs into the marketplace after we have seen increased demands, rather than in an attempt to accelerate the demand. That said, we believe it is prudent to revise our second quarter and full-year expectations as we expect the European marketplace could remain tenuous and at this point, we have limited visibility as to when it will strengthen.

Now let me turn the call over to Mike to review our financials and our guidance in more detail.

Thanks, Kosta. First, I would like to once again summarize the results of our 2005 first quarter compared to the first quarter of 2004. Net sales increased 16.6% to 232.5 million compared to 199.4 million. Gross profit grew 19% to 121.2 million, or 52.1% of net sales compared to 101.9 million, or 51.1% of net sales.

Operating income declined 1.6% to 24.5 million, or 10.5% of net sales, compared to 24.9 million, or 12.5% of net sales. Net income increased 46.2% to 23.9 million compared to 16.3 million, primarily on a reduction in income tax expenses. Diluted earnings per share rose 45.5% to $0.32 a share on 74.5 million shares outstanding, compared to $0.22 on 73.7 million shares outstanding. And excluding the tax benefit in the quarter, diluted earnings per share were $0.19.

The first quarter sales mix breakdown was as follows -- 44.3% from domestic wholesale activities; 11.9% from Fossil-owned retail store locations; and 43.8% from sales generated in over 90 countries outside of the United States. The 16.6% sales growth for the quarter consisted of the following increases and decreases by category and geographic region -- Domestic watch sales increased approximately 30% to 55.9 million compared to 44.5 million in the prior-year quarter.

New initiatives, including Michele and mass market, more than offset the slight decline we saw in the FOSSIL brand, as Kosta mentioned earlier. Other domestic sales, which include our accessory and sunglasses businesses grew 18% to 47 million compared to 39.7 million in the prior-year quarter. We experienced strong gains in FOSSIL women's handbags and belts, men's leather and sunglasses.

Sales generated from European-based wholesale operations decreased 1%, 5% excluding currency gains, to 65.9 million, compared to 66.8 million in the prior-year quarter. Solid double-digit growth in our FOSSIL jewelry line was more than offset by weakness in many other watch categories throughout most of Europe.

Other international sales, which typically consist of export sales to distributors and sales from our Canada and Asia-Pacific wholesale operations, increased 32%, 31% excluding currency gains, to 36.1 million compared to 27.3 million in the prior-year quarter. This increase was principally a result of solid sales volume increases across all licensed brand watches in that segment. In addition, the acquisition of our former Taiwan distributor, accounted for about $1.8 million of the increase in the segment.

Finally, sales from our own retail stores grew 31% to 27.6 million compared to 21.1 million in the prior-year quarter, as a result of comp-store sales increases of 12% and 12.5% growth in the average number of doors opened during the first quarter. Gross profit margin expanded by 100 basis points to 52.1% in the first quarter compared to 51.1% in the prior-year period.

As a result of the further weakening of the U.S. dollar in relation to primarily the Euro and British pound during the first quarter compared to the prior-year quarter, our international segment net sales translated into higher U.S. dollar amounts, resulting in an approximate 70 basis points increase in gross margin during the quarter.

Additionally, gross profit margins were positively impacted by higher mix of retail store sales and sales from our Asia-Pacific subsidiaries, which are offset partially by a lower mix of sales from our European segment. Gross profit margins from our domestic wholesale segment remain relatively unchanged from the prior-year period, as higher margin MICHELE watch sales were offset by lower margin mass market watch sales.

Operating expenses as a percentage of net sales increased by 300 basis points to 41.6% of sales in the first quarter compared to 38.6 in the prior year. The $20 million increase in operating expenses was primarily related to $10 million in personnel and other related costs associated with our new business initiatives. These initiatives relate to our Adidas and Swiss watch and jewelry product offerings, as well as costs associated with the consolidation of our European operations and continuation of the SAP system implementation.

Additionally, we experienced an approximate $5 million increase in advertising and marketing costs as we continued to invest in our brands and markets. As a percentage of net sales, advertising and marketing costs increased to 6.4% in the first quarter compared to 5% in the prior-year quarter. Also, included in the $20 million increase in operating expenses, and in the specific categories discussed above, are 1.3 million in additional costs related to the translation impact, stronger foreign currencies in the U.S. dollars, and approximately 4.9 million of expenses related to companies acquired after the first quarter of last year.

The increase in gross profit margin was more than offset by increased operating expenses, resulting in our first quarter operating profit margin declining by 200 basis points to 10.5% of net sales, compared to 12.5% of net sales in 2004. Operating income included approximately 1.9 million of net currency gains, related to the translation of foreign sales and expenses in the U.S. dollars.

Commencing in the first quarter, we began reporting currency gains and losses related specifically to the revaluation of open foreign currency account balances and other income expense. We also reclassified prior-year amounts resulting in Q1 2004 cost of sales increasing by 1.6 million, and other income and expense increasing favorably by 1.6 million, all in the prior-year quarter.

We believe accounting for these gains and losses and other income expense presents more accurately the comparative results of operations of the Company. Additionally, we believe this reclassification will result in our financial statements being presented on a more comparable format to our industry peers. Inclusive of this reclassification, first quarter other income expense increased unfavorably by 3.6 million when compared to the prior-year quarter.

This unfavorable increase is related to $2 million of currency losses related specifically to revaluation of open foreign currency balances during the first quarter compared to gains of 1.6 million in the prior-year quarter. The benefit for income taxes of approximately $2 million in the first quarter, primarily represents the reduction of deferred tax liabilities that were previously recorded for subsidiary earnings not considered indefinitely invested. During 2005, pursuant to the American Jobs Creation Act of 2004, we commenced our repatriation plan of subsidiary earnings, and as a result of this plan recorded net tax benefit in connection with the 85% dividend received deduction afforded by the Act.

Now turning our attention to the balance sheet. We ended the year with cash position of about 149 million compared to 163 million at the end of the prior-year quarter. Since the end of the first quarter last year, we have spent approximately $55 million on acquisitions. Working capital rose to 363 million, an increase of 24 million over working capital at the end of the prior-year quarter.

Inventory at quarter end was 195.6 million, an increase of 37.5% compared to the prior-year inventory of 142.3 million. As we stated during our year-end conference call, we saw some improvement during the quarter, but we're not expecting inventory growth to be in line with sales growth until the end of the second quarter. Accounts receivable increased to 130.3 million compared to 110.1 million at the end of the prior-year quarter, and our day sales outstanding increased to 51 days for the first quarter compared to 50 days in the prior-year period.

Capital expenditures for the first quarter were approximately $7 million and we are expecting full-year 2005 CapEx of about $30 million. Amortization and depreciation expense for the quarter was approximately $6.5 million, compared to approximately $5.5 million in the prior-year quarter, and we are estimating full-year 2005 depreciation and Amortization expense in the $28 to $30 million range. During the quarter we acquired 180 shares on our buyback program for a total cost of approximately $4.8 million, and we had about 240,000 shares available for repurchase at the end of the quarter.

Prior to discussing our earnings guidance, we thought it would be appropriate to provide a reconciliation of our first quarter reported diluted earnings per share of $0.32 against our original guidance. During our year-end conference call, we guided towards fully-diluted earnings per share of $0.26, with approximately $0.02 related to the tax benefits of the American Jobs Creation Act of 2004. We also guided towards a full-year tax benefit from repatriating certain foreign earnings of approximately $0.09.

Since that time, we've had the opportunity to review our plans for repatriating subsidiary earnings not considered indefinitely invested for purposes of taking advantage of the cash tax savings related to the 85% dividend exclusion. Accordingly, we have estimated a minimum amount of earnings to be repatriated during 2005 of approximately $125 million, of which we repatriated 50 million during the first quarter.

In accordance with FAS 109, we released previously deferred tax liabilities related to the full 125 million of repatriation anticipated for the full year in a net income during the first quarter. This resulted in fully-diluted earnings per share benefit of $0.13 or $0.11 more than we had estimated in our original guidance. Unless in a subsequent quarter in 2005 we change our repatriation plan, or we repatriate in excess of 125 million, our effective tax rate should revert back to a level near our 2004 full-year rate of around 36%.

Additionally during the quarter, we experienced realized losses of approximately $2 million, $0.02 fully diluted per share related to the effects of revaluating open foreign currency account balances. In accordance with the accounting standards, all open payable or receivable balances that are settled in a currency other than the country's functional currency, are revalued based upon the prevailing foreign exchange rate at the end of the reporting period. As the U.S. dollar strengthened appreciably from the end of the prior year to the end of our first quarter, we realized such losses upon revaluation. In comparison during the prior year quarter, we realized approximately 1.6 million in currency gains from this revaluation.

Commencing in the first quarter, we have reclassified currency gains and losses related specifically to revaluation into other income and expense. In prior periods we had reported these gains and losses as a component of cost of sales. We believe, again, accounting for these gains and losses and other income expense presents more accurately the comparative results of operations of the Company.

In excluding the effect of these two items in our net income for the first quarter and the prior-year quarter, our normalized fully-diluted earnings per share for the first quarter was $0.21 compared to our original guidance of $0.24 and a normalized Q1 last year of $0.21. As it relates to second quarter and full-year guidance for 2005, we are expecting second quarter fully-diluted earnings per share of approximately $0.14 compared to $0.21 fully-diluted earnings per share in the prior-year quarter, based upon current softness in sales volumes and higher expense levels expected.

We're not expecting any non-recurring type adjustments, inclusive of income taxes to our second quarter estimate. For fiscal 2005, we are currently estimating diluted earnings per share of approximately $1.48 compared to our previous guidance range of $1.53 to $1.57, and versus actual fiscal 2004 diluted earnings per share of $1.22. Excluding the effects of the tax benefit for the full year, we expect 2005 diluted earnings per share of approximately $1.35.

This guidance provision is primarily related to lower than expected first quarter results, and the reduction in forecasted sales volumes primarily stemming from our European-based businesses for the remainder of the year. We currently estimate fiscal 2005 sales growth in a range of 14 to 16% versus our previous guidance range of 15 to 17%, with second quarter 2005 sales at or slightly below the low end of the range.

Tom?

In conclusion, we remain focused to assure that the implementation of our current initiatives will enable us to resume operating income growth exceeding our sales growth. Our job going forward is to better manage spending and to insure it is in line with the overall strategy. We are confident that the strategies we have outlined today will enable to us strengthen our operating platform, and that will lead to increased momentum for our brands and product lines. We believe that we can refocus the organization in regards to expenses and that we will quickly get back to our pattern of providing shareholders with a sustainable growth in earnings.

And now I'll turn the call over to the operator to begin the question-and-answer portion of the call.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from Barbara Wyckoff with Buckingham Research. Please go ahead.

Hi, everyone.

Good morning.

Couple questions. I guess, Mike, could you talk about the inventory, where is the excess geographically? How is it age-wise? And what are you going to do to get it down? Second, I guess a question for Kosta, is the size of the mass market opportunity and do you have plans to cap it as a percent of total revenues? And then, Mike, if you could tell what the tax rate is going forward, what tax rate we should use for modeling.

As far as in the inventories, Barbara, where we really saw growth in the first quarter against last year was in our international operations, specifically Europe, as obviously we missed our sales plans there in the first quarter, and our retail stores. Our retail store inventories were up about 50%, but driving obviously great comps and overall sales growth of 30%. In our wholesale business, our inventories were up only about 16% against last year, so I think we are seeing, obviously, the effects of bringing our inventories back into line by the end of Q2 for the whole Company.

Okay. And the tax rate, Mike?

We would have you model something close to the historic level of 36% last year.

Okay.

As far as the mass market opportunity goes, we think it's sizable, partly because our resources and our sourcing design and distribution puts us in a position where we have a big advantage in the marketplace. As you know, I think Wal-Mart's business alone is in the $700 million of retail, so it continues to be a big opportunity for us.

And are you going to cap it as a percent of total revenues going forward, or just sort of see where it goes?

Well, I think as we said before, we're very interested in the businesses, as long as it meets our operating income percentage goals and it looks like it's going to do that. I don't think we put a cap on it as long as it looks like it's going be there

Okay. Great. Thank you.

Our next question comes from Elizabeth Montgomery with SG Cowen. Please go ahead.

Hi, guys.

Hi, Elizabeth.

I guess I have two questions. The first one, could you talk maybe a little bit more about Europe? Is the weakness there a result of consolidation or some other factor? And how does inventory look in the channel in Europe? And then, in the U.S. handbag business, I wondered if you could give us maybe some color about what sell-through at point of sale was relative to your shipments into the retailers in Q1.

Well in Europe, as you know, we've had incredible performance over there over the last five to seven years in every country, and the growth has been dramatic and the profits that those companies make are incredible. Part of it is just the opportunity we have with the brands over there. Globalization is driving where the portfolio of brands we have, these global brands are wanted by consumers instead of local brands. This growth has happened even though I think the total watch market in Europe has not been growing, we've been basically taking market share away from other people. So we continue to believe that's going to happen and we are in a position, I think to get continued sales increases.

And we did hear that retail sales in the first quarter in Europe had been slower than they had been even in the last several years and there may be some impact on that. We're really not sure at this point. One thing that we should note is the first quarter is a small part of the year in terms of watch sales, so we'll be watching it very closely to see where the opportunities are.

And in terms of handbags, we are seeing an accelerated sell-through percent even quarter to quarter where it looks like we are going to reach a point possibly where the FOSSIL handbag business even accelerates from where it is. We're just becoming somewhat in our category of the handbag to wear, and obviously, in the handbag business, which is a very emotional, almost a viral type of business, you can get really strong growth quickly there, so we're thinking that we're reaching a point of maybe somewhat in that situation.

Okay. So you don't have the feeling that you're losing market share in Europe relative to other watch brands?

No. Some of our information we got is that even our sales were slightly down that the market was probably even worse than we were.

Okay and then just to clarify one more thing. Could you maybe give specific numbers at the sell-through rate at retail in the handbag business?

Well, it's obviously different week to week, but just suffice it to say, it's faster than it was a year ago and faster than our competitors, so we seem to be in a pretty good position.

Okay. Thanks.

And our next question comes from Noelle Grainger with J.P. Morgan. Please go ahead.

Hi, good morning.

Hi, Noelle.

A couple of questions. First on Europe, I would like to go into that a little bit more. Obviously, Germany is the biggest piece for you, so could you address Germany specifically, and then maybe relative to your overall European performance. And then any other country or brand-specific comments in terms of particular areas of weakness. And have the trends changed materially either for the positive or negative relative to March and April and May? And then I have a follow-up question for Mike, please.

I think if you look at Europe, Noelle, we saw weakness across the board in all the countries we operate. I wouldn't say that Germany was any better or any worse than any of the other countries in Europe. We did see pockets of opportunities in that our FOSSIL jewelry business was up about 30% in the quarter in Europe, where we have obviously some growth afforded to us with launching that brand in Italy in the second quarter last year, and the business was still performing well in Germany.

And as Kosta mentioned in his section of the prepared remarks, we're seeing good growth with some of our newer license brands, like Burberry and Diesel still, but some of the more mature businesses and some of our core product offerings we did obviously see some weakness in relative to the environment. I know there was an article that I saw that came out this morning from the UK specifically that said I think their April retail sales were down 4.7% on the high streak. So there is some relative weakness at retail that we're seeing and we've experienced towards the end of March and on into April.

You said you had a follow-up question?

Yes. Could we talk a little bit more about the operating expenses, both in the quarter and as you look at 2Q versus the back half, would you be willing to quantify the sale shortfall relative to your plan and the magnitude of deleveraging that that created in Q1? Because, obviously the operating expense ratio was about twice, I think, what we had expected.

I think based upon the fact that we have given guidance of sales growth at 15 to 17% for the full year and during our year-end call in February, we said there wasn't going be any quarter that was significantly higher or lower than that. However, our internal expectations for the first quarter were a little bit higher simply because we weren't anniversarying the Michele in that market business until the second quarter, so we were expecting sales growth to be more in the high double-digit area, 19 to 20%, than the 16.6% that we recorded.

So I think if you just take that miss in sales, at the relative margin rate, because we weren't able to cut back on any expenses during the first quarter, that basically would cause a shortfall in the earnings for Q1.

Okay. Thanks. In terms of 2Q, how -- have you started to effect some of these adjustments in expenses or is that really why it seems like you've got a pretty big revision to 2Q as well?

2Q we will not be able to cut planned expenses back significantly, for two reasons. One, a lot of our advertising initiatives have already been planned for that quarter and you just can't pull back on that activity. Additionally, if you look historically, our Q2 expense levels have always been higher than our Q1 levels with sales being somewhat similar. So there's normally lower levels of earnings in Q2 historically than there have been in Q1. I think to some extent Q2 last year was a little bit of an anomaly in that we came in at $0.21 versus $0.22 and the Q1 2004 period, primarily on the strength of the acquisition in the Michele brand and the launch of our mass market business.

Q2 expenses are somewhat elevated above Q1 for a couple of reasons. One, Q2 is the time period that the [inaudible] Watch Fair takes place and we spend significant amounts of money in presenting our product, building booths, and sending people over there to support our businesses worldwide and meet with our distributors and subsidiary managers across the world at that show.

And then secondly, Q1 advertising expenses generally -- Q2 advertising expenses generally a little bit higher than Q1, simply because we're getting into more of a seasonal nature with Mother's Day, Father's Day and graduations going on, where we generally spend a little bit more with our department store retailers in the form of co-op and other activities.

Okay. Thank you very much.

Our next question comes from Dorothy Lakner with CIBC World Markets. Please go ahead.

Thanks. Good morning, everyone.

Good morning, Dorothy.

Could you -- you mentioned that some of the newer brands, Burberry in particular, were performing pretty well for you. I just wondered, you gave a number for MICHELE watches. I wonder if you could do the same for Burberry in the quarter relative to a year ago and what your expectations are for that brand this year?

Then, just a couple of questions for Mike, the 36% tax rate, you're assuming that that -- we should apply that beginning in the second quarter and for the rest of the year? And then lastly, just if you could give us a little bit more color on where -- where you're going to be making expense reductions? And I think that's it. Thanks.

Burberry sales for the first quarter of this year were about $6 million compared to just under 3 million last year. And our tax rate, yes, should be applied, the historical rate of around 36% for modeling purposes is what you should be using for Q2 forward for the year.

As far as the expense initiatives, a significant amount of our cost is primarily related to payrolls and advertising and marketing, and we're just looking at slowing the growth rate of those two areas and looking at other areas as well that are controllable, to reduce the planned level of expenditures to bring our earnings more in line with our reduced expectations on the top line.

One thing I would follow up on is we have over the last couple of years hired, obviously a number of people in the Company worldwide. We have some great talent around the world. I think it's time for us to maybe absorb some of that, give people more responsibility, redeploy people into the areas that are growing, and really look at giving some of our younger people, newer people some more responsibility. I think it's a good thing for the Company and I think we can get a lot of mileage out of it.

Just to go back again, for the full year in terms of where we're going to be looking at modeling gross margin and expenses, I would assume we begin to see lesser growth and expenses as you begin to put forth some of these initiatives, but should we assume that gross margin continues to -- continues to expand? And relative to the first quarter where are we going to be?

I think in looking at the gross margin for the remainder of the year, there's obviously some opportunities for expansion in Q2 and Q3, simply because at the current level of the exchange rate between the U.S. dollar and the Euro and British pound, we're still seeing a slight increase over what the average rate was for those two quarters last year. As we get into the fourth quarter, we come up against a much tougher average Euro, average pound comparison than we do in the next two quarters.

I don't think you'll see any significant increase or decrease in gross margins for the remainder of the year. We're planning them to be slightly up from last year simply because with the European sales being planned down as a percentage of the mix, we obviously lose some of the benefits of our higher margin structures in those countries.

Great. Thank you.

Our next question comes from John Rouleau with Wachovia Securities. Please go ahead.

Good morning, guys. I guess a lot of my questions have been asked, but I'll take a crack in a couple different ways. Kosta, maybe first is just the watch market, I don't know, what -- can you kind of summarize what's going on there? In the past I think we had said -- at least in the U.S., handbags was taking a little bit of share out of the watch category. And then I think recently we've kind of said that the high end of the watch business, the more premium product to higher priced product was holding up better than some of the lower priced product. Can you give us an update on where we stand, kind of maybe U.S. and Europe as far as watches are concerned? Are watches as a category kind of going out of favor or what's going on?

It's an interesting question, but it looks like after something like 15, 20 years of growth in this category of branded watches globally, that there seems to be for the first time maybe a leveling off and we see that in the United States, obviously, started seeing it last year where the total market slowed down and, obviously, we're a big part of that because we had a big decrease. There seems to be through last year and also this year an increasing awareness and reception to handbags. People are buying handbags in multiples like they have been buying watches over the last several years. And some of the resources of the stores is probably moving in that area, open to buy, sales people, floor space, et cetera, and there's a lot of interest in that.

We also are hearing somewhat of the same thing in Europe now where a lot of interest in handbags, but increasingly in jewelry, branded jewelry. The great thing for us is that the diversification of our Company enabled us to take advantage of these opportunities. Our jewelery growth in Europe continues to be good, and remains a big opportunity for us with branded jewelry. And our position in handbags in the United States is enabling us to take advantage of that.

So in addition to that, we also are seeing a situation where the positioning we've made in the upper end over the last couple of years of Michele, Burberry, Armani and Zodiac has really put the Company in a very good long-term position. And that area of business, the higher price is obviously, really is what consumers are moving the direction of and we think we've got a platform now globally where we can optimize that business as it goes forward, so part of this is, really shows the strength of the diversification we've done the last several years. And we think we're in a good position long-term and that we have the ability to maximize businesses in different categories as they grow in different areas, because long-term, these businesses are all cyclical and that's what -- the positioning we're in, I think puts us in a good place where we can long-term take advantage of that and increase our predictability.

Okay, and then given the strength in the handbag segment, and obviously the jewelry segment, I know you're building infrastructure and going after the jewelry opportunity, but handbags has been primarily -- it's all U.S. distribution. Do you perhaps change your thinking in terms of where you distribute handbags? At some point will we be a Michele rollout of handbags? How do you look at the handbag opportunity?

Well, handbags increasingly is an opportunity for us. We think there's several avenues. We are doing some testing internationally with handbags and leather goods in Germany, we've been doing it for a while and we're starting to do it in some other markets to find out what the reception is.

We also feel like we have the opportunity potentially to do additional brands maybe on the higher end in the United States, because our expertise and designing [inaudible] distribution really puts us in a position where we think we can do that. And then we continue to think that there's an opportunity for us in jewelry in other parts of the world and we think we're in a good position for that as well

Okay. At what point might we see additional jewelry licenses and at what point might we see additional, kind of high-end handbag products, whether it be Michele or somebody else out there? Are we still pretty early in that or could we see something like that end of this year, early next year?

Nothing probably would be launched this year, but we are working on both jewelry and handbags and that will be into the market in the MICHELE name in the next couple of years or so.

Okay. And then, Mike, real quickly on inventory, the inventory at retail was up you said about 50%. I know that's driving comps nicely, but are you planning inventory kind of that high to drive the comps, or is the inventory high and you're driving the comps? What's going there?

I think our opportunity for the retail business was seen for the last couple of years in adding a lot more product into some of our stores to drive comps. We don't expect that for the balance of the year that we're going to continue to see inventory growth that out of line with sales growth, again, 50% inventory growth with 30% sales growth. It could be distorted from quarter to quarter based upon when we open some of these -- the 30 new stores Kosta talked about for the balance of the year, but in whole, we will be continuing to look at reducing our inventories at retail, but specifically staying aware of those categories where we want to have more inventory to drive the comps.

Okay. Thanks.

And our next question comes from Monica Brisnehan with RBC Capital Markets. Please go ahead.

Good morning. Just a couple questions. Can you talk a little bit about the success of the introduction of the watch bar so far in the department stores, how that's being received, and if you're seeing the same interest there that you did in your own retail stores?

Yes, actually reception has been very strong through the first quarter. For those of you don't know, it's a thing we tested in August last year in our own stores where customers can basically make their own watch from components we have in the store. We introduced that in department stores in the first quarter, and we're in the process of rolling out to more doors. It's actually done very well at retail.

We actually -- Kosta, have we launched that on the Web yet?

Yes, you could see it on our website. We actually have an interactive portion on our website where you can actually build your own watch online and order it that way. It's been very successful online

Great. Can you also talk a little bit what is driving the comps at retail by category, at your own retail stores?

We are seeing in our own stores, we've said this before, our comps have obviously been very strong and watches has been, as we see in department stores and other stores around the world, watches has not been the best of part of the store. We're getting stronger growth in sunglasses and leather goods, and in handbags and other categories, so we're seeing the same thing in our own stores that we're seeing around the world. Watches are somewhat soft.

Is there anything -- you had mentioned increasing newness in the FOSSIL brand watches, anything new on the horizon we should be looking for there?

Our design organization and sourcing organization is always coming up with new ideas and we have done a number of things that we're putting in the marketplace this year. One of the things we're doing that is rather large, is we're doing a major global relaunch of our Big Tick brand, which is going to be in August in the United States and throughout the rest of the world.

One of the things we're going to be doing is in [inaudible] Square, we're going to have all the windows on the Broadway side and all the collateral and banners throughout the whole store, it's really unusual for a watch company to have the all the windows on the Broadway side of that store and make a big launch similar to a cosmetic company does, but it's going to be really incredible. There's a lot of great ideas and the visual is going to be very strong, so we're looking forward to that in New York in August, second two weeks of August.

Great. Thanks

Our next question comes from Oz Tangun with Southwest Securities. Please go ahead.

Good morning. Can you guys talk about the expenses? Was that 10 million additional higher than what you were originally planning or was it more of a deleveraging, not getting the sales?

I think for the total Q1 expenses, our expenses came in right on plan, but unfortunately that was against lower levels of sales specifically out of Europe, which caused the deleveraging.

All right, and if I'm understanding your comments right, you're basically saying you're going to slow down the growth of payroll and kind of let the structure catch up with sales, or -- and I guess lower advertising. Is that fair? And can you give us some sense as to where advertising should be second quarter, full year versus last year?

One, that is correct. We've talked about slowing the rate of growth in those two categories over the second half of this year. Advertising specifically, I think you recall, Oz, in the February call we talked about increasing our marketing initiatives on a percentage of sales basis by about 50 basis points year-over-year, so I would say that's probably going be more in line with last year's percentage of sales. And, again, to Kosta's comment based upon where we think we can drive sales, we're going to continue those efforts, but we're going to look at things that aren't creating ROI on the business. But on the balance of a comparison between Q -- or 2005 and 2004, I would say our advertising will probably remain at or slightly below sales on a percentage of sales basis.

Okay. And either Kosta or Tom, maybe one of you guys can answer this, where do you see the handbags as a percentage of your sales three or five years from now? This may be a tough question to answer, but any thoughts on this?

Well, I mean it's a tough question. We do think it can grow, but we've got so many other things growing, our global watch business continues to be a very large long-term opportunity, probably second largest in terms of dollars and percentage would be jewelry. There's a big looming demand out there for branded jewelry globally that we're trying get ourselves positioned where we can supply it. So it's kind of moving target. We will have growth in handbags and we think it is a big long-term opportunity, but it's probably the third one behind those other two.

And I guess in terms of the initiatives, selling handbags outside the U.S., you'll focus on other brands than FOSSIL?

No, it would be FOSSIL products and that is something that you can imagine in Germany where our brand is very strong, we would have the ability to leverage our brand into stores that we sell watches to because there are some department stores over there similar to the United States that would want to carry a more wide array of products from FOSSIL.

Do you think outside Germany, though, the FOSSIL handbag will get the attention you want?

Well, one of the things that's interesting is the stores we build in the UK, for example, we opened two, and we're actually going to open a third one this year in Manchester, have really increased the awareness of the brand and we are selling leather goods in those stores, so we're seeding the market with the fact that we do make all these other categories and we are getting requests from stores in the market that they want to carry some of these products. So we will be testing in the UK, as well as parts of Asia and other parts of Europe to see what the potential is. And our brand is becoming more well known around the world as we continue to penetrate in watches and put some stores around the world, so we think there is an opportunity.

And how will you guys address the inventory buildup in Europe?

One thing we do, as you know, we have a global inventory system that allows us to move inventory into markets where more styles are selling, so if there is some slowdown in specific styles within the European theater, we can move that in Asia-Pacific or move it in the U.S. The one thing we're doing as well to bring our inventory growth back down to a more consistent level of increase with sales, as we've talked about on prior calls, is actually slowing down the production side of things. And that's one thing that we've been doing over the last couple of quarters to insure that by the end of the second quarter that our inventory growth on a consolidated basis is more in line with our overall sales growth.

Sure. And so in terms of new licenses or new -- in terms of jewelry and handbags, Michele would be next and then maybe others will follow? Is that fair to say that?

Yes, I think we're studying, as we said, Michele in both handbags and jewelry and we're continuing to put ourselves in a position in the jewelry infrastructure where we can add additional brands similar to what we have done in watches.

And in terms of Europe, I guess, I mean Germany, the economy has been not that great for a while. Do you guys sense these trends -- looks like you had a big change in trends the last couple months. Do you have, other than just general weakness, do you have any other sense what may be causing this?

Obviously Germany is our largest sub and we've always said the growth is slower because our penetration is larger. The only thing that we're seeing and we're hearing from our people there is what I mentioned earlier, which is that there seems to be a general softness in the watch business and we may have actually been gaining market share there even though we're slightly down in sales, so we're just generally seeing that and there's more interest in jewelry. I'm not sure if the economy is any worse or better than it's been in the last five years. It may just be a category situation.

How are the early responses to you're new introductions with the FOSSIL, with more embellishments and so on?

There's a number of things going on in the FOSSIL line. We're really on a point now where we're just changing as much as we can. We feel like part of the reason why the watch business may be somewhat soft is just that it had so much growth in the same categories over the last five years, and so we're basically reinventing the categories, we're putting as much different-looking product in the market as possible, changing quite a bit, actually raising the average of the retails by putting more details and treatments and embellishments on it.

We do think, as we said on the last call, we feel FOSSIL watches may be positioned too low in price and we're moving that up because customers slightly moved up and they want more embellishment, detail treatment and they are willing to spend more for something a little more special. That's somewhat different than what has been happening in the last several years. You probably could see that in our handbag business in that our handbag business actually positions higher than our watch business in that most of our handbag business is leather.

Average retail there is pretty high relative to the store's average retail, around $100 or so. And we're benefiting from customers moving in our direction in handbags and that's why we're thinking that we want to move watches in that direction as well. We also are seeing some of our best selling items are actually our higher priced items, so we definitely feel some movement there.

Thank you so much.

And our next question comes from Bill Baldwin with Baldwin, Anthony Securities. Please go ahead.

Yes, good morning. Mike, could you give us some color as to how the FOSSIL watch brand did -- performed in Europe and in Asia here this most recent quarter?

Total globally FOSSIL was basically I think down about 2% to last year in all markets. Europe, a little bit softer than the U.S. where we saw 3%, 4% decline, and Asia-Pacific was soft as well, so overall, no significant deviation in our FOSSIL business in any of the markets that we participated in.

Can you also offer some color as to the FOSSIL jewelry, what -- how the business kind of broke out percentage-wise by countries over in Europe?

Yes, it's still predominantly in Germany, Bill. We did launch it in Italy last year. It probably did about about 2 million of the total 35 million in FOSSIL jewelry in Italy. The remainder would have been primarily in Germany.

Okay.

We're seeing great growth in Italy, but still it's dominated by the market in Germany

Any plans to launch the FOSSIL jewelry in additional markets overseas this year?

One thing we've been talking about is broadening our product development group, our design group and our production environment to afford us the availability to open up new markets, and that's part of the jewelry infrastructure spend we've been talking about that's going on.

Right.

We're finding that jewelry's a little bit different than watches as far as a global assortment, that you do have to make certain tweaks to the assortment to meet the consumer preference for styling, so that's where we think it's important that we have the necessary design talent to be able to help each of these countries kind of identify what styles may be better selling styles in those markets, but still continue with the core base of the line.

But you do think you'll be in a position to broaden that out distribution-wise this year?

I think it will occur over the next couple years as we obviously continue to build the infrastructure to support that.

And lastly, Mike, can you give us some insight as to how Armani jewelry performed here this quarter? Armani jewelry business was up low double digits in the quarter against last year. And we're still expecting strong double-digit growth in that brand as we continue to see new door openings available to it. It's only about two years old. We launched it kind of mid 2003, so we'll continue to see growth, giving that that is still a pretty small business for us. Is that also primarily a German business?

No, it probably tracks the overall distribution of Armani watches more so than it does Armani jewelry.

Okay. Thank you.

Our next question comes from David Turner with BB&T Capital Markets. Please go ahead with your question.

Thanks. Good morning. I was just curious about the disconnect between how strong you company on retail stores are doing. You're going up -- you're still comping low double digits against tough comparisons versus the domestic wholesale. I understand that you have complete control over the merchandise and the mix, but is there -- is the product that much different than what's in the domestic wholesale channels, or is there any other way to explain the disconnect between the two channels?

Well, I think part of it is just as we've mentioned before, we've -- our retail environment that we've got has been totally adjusted, restructured a lot of our functions and they totally reengineered the whole department where we're getting benefits and ongoing benefits of operating those stores better, better visual, better planning, better support, et cetera, and I think there is an ongoing process for that. We also are seeing where, as I mentioned earlier, the business in our stores and launches have been somewhat soft and as we're seeing in department stores is being helped by the increasing awareness in leverages and the sell-throughs and that, so that's helping those stores as well. They also have a more full assortment in our stores and slightly newer stuff also, so we do, as you know, a lot of testing in our stores of new ideas and that I think is helping as well.

Okay. And just curious about the gross margin. I think, Mike, you said there's some room for a slight improvement, but yet the inventories are outpacing sales growth. Is this just a function of being able to clear it through your outlet stores at a favorable margin or is the aging okay or you're comfortable with where the aging is? I guess in other words, given where the inventory is, there's not going to be incremental -- you don't envision incremental gross margin pressure at this point?

No, we believe the inventory levels, part of the plan to get them down to more of an increase in line with sales growth is something that's very endemic to our business, and that we'll continue to clear our discontinued styles through our outlet stores and on the newness that we're bringing in and any of the core styles that are still in the inventory. What we're doing there is obviously adjusting our production levels. So I don't envision that we'll see any significant pressure from having to clear obsolete inventory through our outlet stores at a pace significantly different than we've done historically.

Okay. Thank you.

And our next question comes from Steve Martin with Slater Capital. Please go ahead.

Hi, guys. Can you talk about the startup expenses in Adidas and is that going to continue to ramp? As well as what's going on currently with the Tech Watch? And the results at the two modern watch stores? And last but not least, now that you're repatriating the cash and your stock is down at these prices, you've had a buyback in place for a while, but not aggressively, can you talk about that?

I'll take a couple of those. I'll let Kosta talk to the modern watch stores. As it relates to the Adidas ramp-up in cost, obviously we are incurring levels of operating expenses there without the benefit of revenues, as the brand will not launch until January next year. Probably estimating somewhere in the $2 to $3 million range for operating costs, primarily associated with obviously putting the team of people across the world, and support the brand and development in managing the brand, and looking at marketing opportunities, and building relationships with our customers throughout the world.

That's 2 to 3 million over the course of this year or -- ?

This year, this year.

Okay.

Your other question, Steve?

The Tech Watch and the buyback in modern watch.

The tech watch, that's -- we basically have seen our efforts in the area of technology, specifically for the PDA and the wrist net, not proved to be what we thought it could be early on, so we basically have been pulling back a lot of the infrastructure in that area, and to Kosta's point, putting them in a position to help us as they have gained a lot of knowledge in the area of technology, as it could relate to some of our other businesses and brands. We think that with acquiring the Adidas license and the performance side of that business, some of the things that we've learned in looking at the production of our Tech Watches could be utilized in a part of the assortment for Adidas. Kosta, modern watch stores?

As you know, we opened two modern watch company stores, about 800 square foot. One is in the Aladdin Center in Las Vegas and the other one is in Glendale Gallery in California. I would say it's still too early to tell. Both of those stores recently opened. We are opening at least one more in Roosevelt Field in New York the next couple months, we would like to get a couple, three more. We are making a number of changes to the new stores we are opening, we learned a lot from the other ones. There's a lot of things we're tweaking in there, we're changing the decor and the assortment. We do feel like it's a big long-term opportunity and probably global, so we're continuing to proceed with it, but it's probably too early to tell.

Can you you talk about what you've learned positively or negatively?

Well, a number of things, partly we feel like we spent too much money to build the stores and the next stores will be less expensive, a little more casual, not as dressy. I think one thing we found out is we built a very lux store and customers are coming in there wanting to buy even more expensive watches than we even make, so we're just toning it down a bit, which is obviously going to cost less money, it's going to be a little younger, a little more fun, I think.

We do want and do feel like we need to have additional brands in there, so as we add additional brands over the next couple of years, I think that will help the performance quite a bit. We think it's a great opportunity for us. We've seen some great stuff happening in there. The stores have actually done very well with some of our brands that don't have a lot of distribution like Michael Kors and Zodiac and there's some unique product in there and it seems like it's going to be a very fine opportunity for us long-term.

All right. Last but not least, can you address the buyback question?

Yes, as you mentioned, Steve, we do have a current buyback in place, which is really a small amount of shares that have been approved by the Board, basically to reduce the dilution impact from our stock option program. As I mentioned on my part of the call, we have about 240,000 shares available under that arrangement for repurchase, so we always look at the opportunity based upon the relative value of the stock, but again, that's something we'd have to go to the Board with to get approval.

Is there any restriction when you look at your cash and the new rules about repatriating that cash, are there restrictions? Do you have free cash to use or --?

There's no restrictions related to it. The actual legislation as it's written to my knowledge, and it's still being tweaked, I can check with my tax person, but I don't think it includes the repurchase of Company shares as a part of the reinvestment of those funds in the U.S.

Kosta, since you and Tom are both on the call and you are the collectively the largest shareholder, can you talk about how you would view the use of your cash to buy back stock?

Well, obviously we feel like the Company has got huge long-term opportunity and we do have some opportunities out there, both on the retail side, potential acquisition side, and we're really focused on what we have been the last several years, making the Company a much larger Company. So having said that, I mean we also are cognizant of what our value is in the marketplace and we'll be watching it very closely.

Thank you.

Our next question comes from Justin Thomas with [inaudible]. Please go ahead.

Thanks. My question's been answered.

Sir, we have no further questions at this time. Please go ahead with any closing comments.

Thank you. Should you want a replay of this conference call, it has been recorded and will be available today from 10:00 a.m. Central time until 5:00 p.m. Central time tomorrow. And you can call 303-590-3000 and enter reservation number 11027212. Again, that's 303-590-3000, reservation number 11027212. The conference call has also been recorded by StreetEvents and may be accessed through StreetEvents website at www.streetevents.com or directly through our website at fossil.com by clicking on Investor Relations on our home page and then on webcasts.

Finally, should you have any questions that did not get addressed today, please give Kosta or myself a call. Thanks, again, for joining us today. Our next scheduled conference call will be in August for the release of our second quarter 2005 operating results. Thank you.

Ladies and gentlemen, this concludes the Fossil first quarter earnings conference call. You may now disconnect. Thank you for using AT&T teleconferencing.