Fossil Group Inc (FOSL) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Fossil third quarter earnings conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question and answer session. (Operator Instructions). As a reminder, this conference is being recorded today, Tuesday, November 8, 2005. I would now like to turn our conference over to Ms. Allison Malkin of Integrated Corporate Relations.

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 homepage 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 position at the conclusion of the Company's third quarter ended October 1, 2005.

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 1, 2005, and on Form 8-K filed September 15, 2004.

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

Good morning and thank you for joining us to discuss the third quarter of fiscal 2005 results. Joining me are President and Chief Executive Officer Kosta Kartsotis and Chief Financial Officer Mike Kovar.

I would like to start off this morning providing an overview of our third quarter results, then Kosta will review our sales by major brand and category and also provide an update as to our current initiatives. Mike will then review our third quarter financials and outlook in more detail. At the conclusion of our prepared remarks, we will then open the call for any questions you may have for us this morning.

Although we met our guidance for third quarter earnings, this fell short of last year's record results. Diluted EPS of $0.30 represented a $0.01 reduction compared to prior year's third quarter. Sales were $257.5 million, an increase of 9% over last year and continue to include mixed results of our many brands and businesses around the world.

Our European businesses were better than expected and we continue to record level of accessory sales, but a weak domestic watch market persisted. Our Fossil brand watch sales declined 13% in the United States market but performed extremely well internationally. And despite the fact that we believe there has been some shift to consumer purchasing dollars out of watches and into handbags, we recognize that part of this shift was caused by us as our own fashion watch offerings were not compelling enough to drive stronger sales growth.

We will continue to focus our resources on the Fossil brand and are confident that we can once again regain the momentum in this business that we have benefited from for over most of our public life. Our efforts will be focused in these three areas.

Creating compelling offerings. As Kosta mentioned last quarter, we have realigned our design groups in Dallas and Hong Kong to reinvigorate this business. We believe this group will deliver newness and excitement in our assortments that will recapture the attention of consumers, resulting in more discretionary dollars moving back into the fashion watch category.

Product innovation. Although fashion is foremost in continuing our leadership role in the watch business, we believe innovation also sets us apart from the competition. Whether it be animated dials or analog-digital combinations, we will continue to develop new ideas to capture our customers' attention.

Marketing. We have recently hired a Senior VP of Marketing who will lead the effort in further defining the image around the world. We will also focus on our core demographic to better understand their wants and needs in making fashion accessory purchases.

In addition, we will focus on improving results across our global businesses by capitalizing on our newer businesses. Our Swiss watch and mass-market businesses continue to evolve and have the capacity to add significant revenue to the Company for many years to come. We will continue to add new businesses. We believe Adidas to be launched in January of '06 will add a strong sports performance category to our global watch portfolio. We are also focused on expanding our jewelry category as evidenced by our recent announcement of Diesel jewelry. And, we will leverage our competitive advantage in design, sourcing and distribution by adding additional brands to these businesses in the future.

And, on the financial front, we will focus on a disciplined approach in managing our infrastructure needs with the goal of leveraging sales growth against our expense base.

By succeeding in the efforts just described, we are confident that we can regain the momentum in our businesses over the long-term. We will remain diligent in our effort to deliver sales growth and financial results that will once again make Fossil an attractive opportunity for those looking for a solid long-term growth company. And now I would like to turn the call over to Kosta to review our sales highlights in more detail.

Thanks, Tom. As mentioned, sales rose for the quarter by 9%, or 11% if you exclude the special market sale of 4.7 million in last year’s third quarter. Overall, domestic sales rose by 4%, but watches declined by 6.9%, primarily due to a 13.4% decline in the Fossil brand. Obviously we're disappointed by this performance and we recognize that Fossil domestic watches is our most mature business, and therefore, most affected by watch industry trends.

We believe newness introduced in our Fossil watch line during the past couple of months, combined with our planned marketing initiatives for the holiday season, will lead to better comp results in this category in the fourth quarter.

That said, our guidance assumes no improvement in trend for Fossil watches domestically. Additionally if you've not seen our Fossil catalog that was launched during back-to-school, I would encourage you to visit our website and take a look. It provides a strong positioning statement for the brand, communicating our image and lifestyle. We will be dropping another mailing of 500,000 catalogs before Thanksgiving this year.

In addition, recent research indicates that Fossil continues to be a top brand among our core customers. In our domestic accessories business, sales rose by 21.4%, accelerating from our strong first half of the year performance. We continue to see a lot of demand in the handbag category, which we're capitalizing on, successfully growing market share for the Fossil brand.

We also experienced robust sales growth in sales of women's belts and small leather goods and eyewear. We believe this strong accessory trend will continue. Retailers are committing more research to the category and we're positioned to continue to gain market share in the fourth quarter and in 2006.

Internationally, sales increased 12.7%, or 12.6% excluding currency gains, despite having to anniversary a $4.7 million special market sale in last year’s third quarter. Excluding currency, we posted a 21.2% increase in Europe, which was especially strong considering our results in this segment during the first half of the year. We experienced strong contributions from our Fossil watch and jewelry offerings and Diesel and DKNY licensed watches. Europe's sales increases were positively impacted due to the initial sales and delivery disruptions caused by Germany's SAP implementation in August of 2004.

That said, our Fossil watch business still recorded impressive growth outside of Germany as the brand continues to expand in many of our smaller European markets.

Third quarter sales results in our other international segment, which includes the Asia-Pacific region, Canada and our U.S. export business, were up 13% excluding the prior year's 4.7 million special market sale. We believe this segment to be a significant growth opportunity in the short and long-term. Our portfolio of brands is gaining an awareness in these markets which is leading to increased penetration and door growth. We have begun to explore new opportunities for developing distribution into China and are currently developing plans to introduce some of our brands in this market in the coming year.

Our current brands already have a presence there, and Adidas is particularly strong in this market, so we believe we're in a good position to expand our business there over the next few years.

Sales at our company-owned stores increased by 12.9% with contributions from new stores partially offset by comp store declines of about 2%. You may recall that in the last couple of years, our comp increases in '04 were plus 12% and in '03, plus 19%. As you know, we have seen tremendous improvement in our retail business over the last two years and we believe this segment represents a solid growth opportunity, both domestically and overseas. As we mentioned in our previous call, we have added a new Senior VP of Stores for Europe and we expect to see some expansion of our existing store base in this market in 2006.

We ended the quarter with 157 stores, including 91 full price stores, including 28 outside of the United States, and 66 outlet locations. This compares to 128 stores at the end of the prior year quarter that included 70 full-price stores, including 23 outside of the U.S. and 58 outlet locations. We expect to end the year with a total of 167 stores, including 96 full-price stores and 71 outlook outlet locations.

Turning to our new business initiatives, our sales for the mass-market channel contributed $4.8 million in the quarter. Sales are performing well and we are continue -- we expect to continue to see sales increases --we'll expect to do over $25 million this year and expand in the next few years.

In our luxury area, Michel watches had a positive comp during the quarter as it continued to perform well in its core upscale department store accounts. Our plans are to grow the Michel watch business globally as well as to develop the brand into more of a lifestyle brand with the addition of jewelry and accessories over the next couple of years.

Zodiac, the Swiss brand that we own, has begun to move out of the incubator stage and is gaining momentum at retail in stores around the world and at Neiman Marcus and in Nordstrom's in the United States. Sales for our Burberry watch brand continued to increase at a double-digit rate with particular strength in the United States and Asia.

And lastly, our jewelry business increased 46% during the quarter with Fossil jewelry more than doubling. Jewelry continues to represent a great complement our watch product offering, allowing us to leverage our sales organization and our customer base around the world.

While we're pleased with pockets of our company's performance, we certainly have higher expectations. Despite the current difficulties we are experiencing, we remain confident that our long-term business model is solid and will result in sales and earnings growth that will reward investors in the future. Our long-term expectations for sales growth continue to be 15 to 20%. We believe there are numerous opportunities to expand our watch business by expanding our current brands and by adding additional brands, as well as by expanding into other markets. We see opportunities on the jewelry side to expand growth by adding brands as well as penetrating the existing markets where we have a captive customer.

We also believe that our accessories and store segments represent solid opportunities for growth. However, we recognize that currently some of our core businesses are not delivering the type of growth we expect over a longer-term period. Given that, we would expect 2006 sales growth to be slightly less than the 15 to 20% of long-term goal.

Finally, we are pleased to report the Board approval to expand our existing stock repurchase plan. The additional 3.5 million share authorization is in addition to an approximately -- approximate 700,000 shares remaining from their previous authorization. As we come out of our quiet period later this week, we plan to take full advantage of the authorized share of repurchases with the intention to accumulate a significant portion of the buyback by year end. We believe this additional authorization represents a vote of confidence by our Board regarding the Company's ability to meet its long-term growth objectives, as well as a signal to our investor base that we believe the current valuation represents an opportune time to invest in our company. Now I will turn the call over to Mike.

Thanks, Kosta. First, I would once again like to summarize the results of our 2005 third quarter compared to the third quarter of 2004. Net sales increased 9.1% to 257.5 million, compared to 236 million. Gross profit grew 11.1% to 134.8 million, or 52.3% of sales compared to 121.4 million, or 51.4% of sales. Operating income was 35.2 million, or 13.7% of net sales, compared to 38.1 million, or 16.1% of net sales and net income totaled 22.3 million, or $0.30 per diluted share, compared to 23.4 million, or $0.31 last year.

The third quarter sales mix breakdown was as follows -- 40.3% from domestic wholesale activity, 15.3% from Fossil-owned retail store locations and 44.4% from sales generated in over 90 countries outside of the U.S.

The 9.1% sales growth for the quarter consisted of the following increases and decreases by category and geographic region. Domestic watch sales, as Kosta mentioned earlier, decreased approximately 7% to 57.1 million, compared to 61.4 million in the prior-year quarter. Decreases in Fossil watches were partially offset by sales volume growth from Zodiac, Diesel and Burberry watches, as well as sales resulting from the launch of the Mark Jacobs collection.

Other domestic sales, which include our accessory and sunglass businesses, increased by approximately 22% to 46.7 million, compared to 38.4 million in the prior-year quarter. As Kosta mentioned, we continued to see success with our leather products area, specifically women's handbags and belts.

Sales generated from our European-based wholesale operations increased approximately 21% to 78.5 million, compared to 65 million in the prior-year quarter, primarily resulting from sales volume growth in Fossil, Diesel and DKNY watches and Fossil jewelry, partially offset by sales volume declines in imported Armani watches. Excluding the $4.7 million special market sale in the prior-year third quarter, other international sales increased approximately 13%, 11% (indiscernible) currency gains to 35.9 million, compared to 31.7 million last year. This increase was principally related to sales volume growth in Fossil and Diesel watches.

Finally, sales from our own retail stores grew approximately 13% to 39.3 million, compared to 34.9 million in the prior year quarter as a result of door growth, offset by comp store sales decreases of about 1.7%. Excluding the gross profit margin related to the special market sale in the prior year quarter, gross profit margin increased 20 basis points to 52.3%. This increase was primarily the result of a higher sales mix internationally that generally produced higher gross profit margins, partially offset by a higher sales mix from our domestic accessory businesses that generally produced lower gross profit margins. Currency changes from the prior year had no material impact on our third quarter comparable gross profit margins.

As a percentage of net sales, operating expenses increased to 38.7% in the third quarter compared to 35.3% in the comparable prior-year quarter. Operating expense increases of $16.3 million to 99.6 million compared to 83.3 million last year were primarily attributable to increases in payroll costs and advertising expense.

In comparison to the prior-year quarter, payroll increases were primarily due to acquisitions and new businesses, new company-owned store openings and infrastructure additions. However, on a sequential quarter basis, payroll costs have remained relatively unchanged from the first- and second-quarter levels of this year.

Advertising expenses as a percentage of net sales increased to 5.8% in the third quarter compared to 4.3% last year. This increase is related to the fact that we shifted a sizable amount of advertising from Q3 to Q4 in the prior year. As a result, we're estimating fourth-quarter fiscal 2005 advertising expenses as a percentage of net sales to be below the comparable prior-year quarter.

Increased operating expenses more than offset gross margin improvement, resulting in our third quarter operating profit margin declining to 13.7% compared to 16.1% last year. On average, third quarter currency exchange rates remained unchanged from the prior-year quarter. Thus, operating income for the third quarter was not materially impacted favorably or unfavorably by currency rate fluctuations.

Third quarter other income and expense increased unfavorably by approximately $1.2 million when compared to the prior-year quarter. This unfavorable increase is related to currency losses stemming from (indiscernible) during the quarter, as well as revaluation at the end of the quarter of certain foreign open receivable and payable balances denominated in currencies other than the functional currency of the related entity.

Our effective income tax rate for the third quarter decreased to 32.4% compared to 37.1% last year, primarily due to higher levels of pre-tax income from lower tax foreign subsidiaries and the release of certain tax reserves on foreign earnings.

Now turning our attention to the balance sheet. We ended the quarter with a cash position of $89 million compared to 104 million at the end of the prior-year quarter. Working capital rose to 365 million, an increase of 37 million over the working capital at the end of the prior-year quarter. The inventory at quarter end was 261 million, an increase of 25.5% compared to the prior-year inventory level of 208 million.

As discussed in the August call, we continue to experience inventory growth in excess if sales growth primarily related to the following -- elevated levels of luxury watch inventories stemming from longer lead times and aggressive buying earlier in the year; Asia-Pacific inventory increases primarily due to lower than expected sales growth in this region during the third quarter and slightly higher retail inventory levels. In comparison to the prior-year quarter, the Company's U.S. retail store inventories increased by approximately 20%, down significantly from the 55% increase in the second quarter of fiscal 2005. Increases related to our fashion watch inventories in the U.S. and Europe and our domestic accessory inventories on balance were consistent with third quarter sales growth. We believe that the 25.5% increase in inventory at the end of the third quarter can be roughly cut in half by year-end while maintaining gross margin rates at current levels.

Accounts receivable increased approximately 6.1% to 151.8 million, compared to 143.2 million and days sales outstanding decreased one day to 54 days from 55 days last year. Capital expenditures for the nine months ended October 1 were approximately 26 million and we expect full year 2005 capital expenditures in excess of 40 million, in line with our estimates given during our August call. Amortization and appreciation expense for the first nine months of the year were 20 million, compared to approximately 16.6 million last year and we're estimating full-year 2005 depreciation and amortization expense of approximately 28 million.

Since in the beginning in the year, we have acquired approximately 600,000 shares under our buyback programs for a total cost of $14 million. We currently have 678,000 shares available for repurchase at this time form previously authorized buyback and the additional 3.5 million shares from the additional buyback authorization announced today.

As it relates to fourth-quarter guidance, we're expecting fourth-quarter fully-diluted earnings-per-share of approximately $0.48 compared to $0.47 fully-diluted earnings-per-share in the prior-year quarter. We expect a fourth-quarter net sales increase of approximately 8% in comparison to the prior-year fourth quarter.

Our sales guidance has been lowered from the previous range of 10 to 12% given during our August call as a result of the continuing weakness in our domestic watch market, continuing comp decreases in our company-owned retail stores and the expectations for European growth in the mid-single digits, compared to the 20% plus growth we experienced in the third quarter. Tom?

While we exceeded our previously released third-quarter earnings-per-share estimates, the Company is not firing on all cylinders. Our focus remains on turning around areas of our business which are currently struggling and maximizing our other businesses and opportunities.

And now I would now like to turn the call over to the operator to begin the Q&A session.

(Operator Instructions) Neely Tamminga, Piper Jaffray.

Thanks. This is Erin Murphy (ph) for Neely Tamminga. Just a couple of quick questions. One, going forward, how should we be thinking about the tax rate?

This was discussed on I think the prior call. We would have you guide for or model toward the 37% rate for both Q4 and future years.

Great thanks. Also, could you shed some light on the initial store rollout plans for 2006? Will you be expanding into any new markets?

Not necessarily in new markets. We are going to accelerate our growth in Europe. We have I think seven stores are now, and as we mentioned earlier, we hired a new Senior VP of Retail over there and we're putting together a plan to expand to more markets in Europe. We could potentially open six to eight stores over there next year.

In addition to that, we do have a couple of things we're working on in the United States. As you know, we're expanding our Fossil accessory store in the U.S. We also are working on the Modern Watch Company. We open two of those stores so far, probably going to open three to four in the first half of next year. And then we are looking very closely at the Asian market and China and Hong Kong. And we have hired some additional retail people that are based in Hong Kong and we have hired some people in Shanghai also and we're looking very closely at how we would go about that market, whether it would be a combination shop and shops and retail stores. But we would expect to add potentially some stores there next year and then accelerate it from there.

Great, thanks, that is very helpful, good luck.

Elizabeth Montgomery, SG Cowen.

Hi, guys. I guess my first question is also about the retail stores. Can you maybe talk about what the trends were during the quarter that led to the comp decline, and if there has been any kind of change in the comp store sales trends so far in Q4? That's my first question.

As we mentioned before, we had comps the last couple of years of 19 and 12, so we're up against some pretty strong numbers. Also considering somewhat of the headwind we have in watches, we're seeing in our own stores small declines in watches and increases in handbags and other leather goods and sunglasses that are --. But that was probably the reason why the combination of those two things -- high comps from prior years, plus the headwind we're experiencing in watches.

In regard to the catalog that you sent out for back-to-school, can you talk a little bit about the reads that you got from that, whether you were able to identify any new styles or categories that might be working really well? And then the additional 0.5 million that you plan to drop before Thanksgiving -- is that the same catalog, or is that a holiday catalog?

The catalog we did in the third quarter was actually our first effort 32 page catalog and the response was actually very positive both in terms of what we got direct over the phone and also the traffic that was directed to our website which continues to do very well. We have, by the way, had a year-to-date, a 33% increase in sales on our Web and traffic was similar to that. So that continues to be our biggest marketing vehicle other than our stores. But in any case, we had very good response and we expanded it for fourth quarter. It's actually a new catalog.

I don't believe that catalog is up on the website yet, the new one that's coming out for holiday. I think it's going to be up there in (ph) a couple of weeks. It is printed and we're going to the distribution outlets pretty soon, but it is totally different catalog. (indiscernible) 32 pages. And as you can tell from the website when you look through the one that's up there, you can see that it identifies very clearly the customer going after -- it has a very strong point of view and we think it is a great branding vehicle. So we're kind of a situation where we have the catalog and our website and our stores very strongly communicating, a very edited, focused point of view to the consumer. We think it's a great opportunity to continue to build awareness for the brand.

And I also mentioned earlier on the call that we had seen some research most recently from Piper Jaffray that indicated that the Fossil brand is still top of mind with our core consumers. So we're starting at a good place, we just want to accelerate and intensify the brand identity and the strength of it to the consumers and we think we can grow our sales on a continuing basis from there.

Okay. And then in regard to the revenue guidance for Q4, have you seen -- did you see something in Q3 that led you to believe that some of -- like the better performance in Europe was not sustainable going into Q4?

As we talked about, Elizabeth, we did pick up some growth in Q3 from Europe in anniversarying the SAP launch there last year, which caused some minor disruptions in sales. And I would say that going forward, our guidance would include Europe at more of a mid-single digit level for the fourth quarter than the 20% plus increase we saw in Q3.

So if you strip out the benefit that you got from kind of anniversarying that last year, did you grow mid-single digits in Europe in Q3, or was it higher?

It was a little bit higher than that; it was a low double-digit growth if you strip out 4 to 5 million we expect that shifted in the fourth quarter last year.

Okay. And then in regard to Armani, that's the second quarter I think that it has been a little bit weak. Is there something specific going on there, or is that just like a difference between sell-in and sell-through?

What we've seen on Armani, is we have a lot of new sales going in the marketplace right now that are doing very well and they're actually somewhat of replacements for some existing sales we have in the line. So we're kind of in a transition phase where the new styles have not been fully distributed, but we're getting good response on it. So we think we're in somewhat of a transition period and we're going to starting having faster growth in the next several quarters.

Thanks.

Dorothy Lakner, CIBC World Markets.

Thanks, good morning everyone. Just wanted to touch on the new Fossil design teams and when we can really expect to see some impact there, how long that's going to take. And secondly, kind of as a corollary I guess, what you're seeing in the U.S. department store business, how much of the weakness there do you think is simply consolidation, and how much of it is really attributable to your product difficulties I guess? Thanks.

First of all, in the United States in department stores, the watch business overall is difficult and slightly down. So it's not just Fossil. Of course, we're still the biggest part of it by far and we still have the largest market share probably by double over anyone else in the business. And we also have similar space to what we had a year ago. So our mission right now is to try to do as much as we can to change the way our cases look and the way the department looks as much as we can with new styles, new ideas, new platforms. We have a new in-case program that we're rolling out to the stores which includes in a lot of doors these flat-screen TV's that we're putting that are very strong at retail.

We also are -- really the reason we're interested in this catalog and really accelerating our brand awareness is we think we can draw more people to the case by doing that, and we think that's a big part of it also. But it really is a trend we're seeing across (indiscernible) in all department stores.

Is that happening for holiday?

Yes, it's happening right now. We have a lot of rollouts going on right now. The consolidation is not, we don't feel, is going to impact us to any large degree. First of all, May and Federated combined is about 10 or 11% of our total business next year. We also feel that we're going to get additional distribution. A lot of the May Company doors do not carry currently some of our brands, such as Diesel and Armani. DKNY is not fully penetrated there, and also Michael Coor (ph). So we feel like we're going to get some additional distribution as that sorts out.

We also feel that we're going to get additional leather goods penetration, especially in what is now Macy's North, which is the Marshall Field stores, because we don't sell them leather goods currently. So we're going to get the benefit of that. Of course, these businesses, both accessories and watches, are very, very profitable for the stores and we're a very important partner to Federated. So we feel like long-term, we're going to be a beneficiary of the combination and we think it's very good for the business in general.

Barbara Wyckoff, Buckingham Research Group.

I guess, Kosta, this is a question for you, about Adidas. Can you talk about bookings for Adidas? Have you shown it? How are the bookings relative to plan? I think you're starting to ship it in January in Europe and launching it March in the United States. And then I guess a secondary question with Adidas is, have you had to clean up any old product from the prior license fee? If not, do you anticipate having to do this? And if so, what would be the projected impact on gross margin, and when?

Well, we're actually showing it this week in the New York market, which is where I am right now, and we've shown it to a few customers, getting good response. We've also shown it to a few international partners that had a good response to it also. So we're pretty confident it's going to be at least 30 million, which is what we're saying it is right now.

As far as the cleanup goes, there is some small amount of that that will be going on, but we don't think it's material. But overall, we think it's a great starting point for us. It's going to be distributed to all different types around the world, different types of stores, including department stores in the United States as well as distribution in Asia, which is going to be very strong. The interesting thing we're finding out is that Adidas has a huge awareness and presence in China, which we think is going to help us penetrate that market. So there's a great benefit to us having that and we're pretty excited about making this a very large business.

Will Adidas be in travel retail up front, or it is that down the road?

It will be in travel retail; that's part of the whole strategy. The Adidas business has got several components to it and the heritage, which is fashion all the way to high-performance. So it's a very broad customer base and a very broad assortment. So there's in assortment that we can put in almost any different type of distribution, whether it's a sports store or a department store or travel retail or whatever, and that's one of the great things about it. It's a very diversified, broadly distributed brand that has a lot of differentiation in it and we think is going to be, just based on the momentum the brand has on its own, plus the addition of the World Cup next year, which Adidas is a sponsor of, it's going to be a great thing for us to get it started.

Okay great. And so right off the bat, you will be in sporting goods stores as well?

I'm sorry -- in what stores?

Sporting goods stores.

Yes. It will be in sporting goods stores in the United States, department stores, specialty stores and then normal distribution around the world, especially in Europe where we will sell both watch stores and sport stores over there, too. And then in Asia and in China, there's going to be a lot of stop-in-shops (ph), et cetera, that have it, and then our own distribution as well.

Just I guess last question. Are you showing it out at the Fossil show? I know you have a separate show on Adidas.

One of the things we've just recently done is we've taken another floor in this building, so we have some expanded space. We're actually moving it up to the third floor. But we're currently showing it in our complex here.

Okay, thank you.

John Rouleau, Wachovia Securities.

Hey, good morning guys. First question just really has to do with the expense side of the business. I know you've kind of tried to right-size that towards the slowing top line. The top line continues to moderate a little bit here. I guess I'm just wondering, as far as expenses are concerned, is there more room to cut? Are you basically at the level where you want to be or need to be? And then given some of the marketing initiatives that you may look to put in place with the new SVP of Marketing, what can we expect on the marketing side and maybe the expense side?

John, I would think for the near-term, if you look at the guidance we gave for Q4, we are expecting further decreases year-over-year in our operating expense base. To that point, we have talked about starting to see the leverage in our business in Q4. And even though our sales expectations have been reduced to 8% growth, we are expecting our offering increases to be at 5% or slightly below. There's obviously some benefits there from currency as we're going up against a much weaker euro in Q4 this year than last year. There is also some benefits there as well from the fact that we are shifting some of the advertising that was done in the fourth quarter last year has shifted into the third quarter of this year. So we're expecting about a 200 basis points decrease in advertising expense as a percentage of sale on a comparable quarter basis for the (indiscernible).

There's always more room to cut. We're being very diligent about it, as Tom mentioned. It's one of the focus areas we have going into 2006, to continue to look for opportunities to slow the growth of our expense rate without obviously impacting the opportunity for sales growth across the world (ph).

With the new SVP of Marketing coming on and likely making a few changes or helping reposition the Fossil brand a little bit, can we look for marketing to increase? Can we look -- how should we think about marketing? What sort of changes can we maybe expect on the marketing side, whether it be qualitative or quantitative?

The first thing is to take a look at our total global advertising spend, which is what we're doing now, and to consolidate it and to make it more efficient and more targeted. The person that has joined us came from a very large ad agency in the United States. And really the effort is for us to put best practices and really targeted and focused advertising that's more efficient and not necessarily that's going to be generating additional expense as much as getting probably more efficient and more ROI-based. As you know where we spend the most money on advertising is on our website, which generates a huge amount of traffic, but it also has an ROI that is measurable every single day. And that's generally what we like to see in the rest of our advertising and have a very strong, efficient best practice base global advertising program that has a high ROI on it so it's not necessarily additional expenditures.

Regarding Asia-Pacific, I think this is the first quarter that business started to slow a little bit, maybe it was a bit below expectations. That's a very profitable side from an operating income basis. And maybe Mike, you can take a minute just to explain why those profits are so high versus everything else, and maybe just add a little color as to what's going on in the Asia-Pacific region.

I would say Asia-Pacific as far as the profitability structure of those subsidiaries are probably very similar to that in Europe. In fact, we probably have some subsidiaries in Europe that are generating more operating margin relative to some of our business is in Asia-Pacific. We have been investing in our expense structure in those markets over the last couple of years. We've been getting great growth in those markets, and yes, we have seen a bit of a slowdown in the third quarter. But we're still expecting healthy double-digit growth.

What we're trying to do is obviously put ourselves in a position to be able to grow that business at the pace we've seen over the last couple of years. And I think with the addition of some of the Swiss watch brands that are just now going into that market, with Adidas coming onboard and with the expansion of some of our retail opportunities, whether they'd be stop-in-shops or full retail stores or concessions, we expect that area to probably be our highest component of growth relative to the prior year.

So nothing really specific, just kind of running into some higher growth in previous years and looking to reaccelerate that?

Yes. If you look at the back half of last year, I think our growth in Asia-Pacific was over 50%. So we're coming up against some of that. We're still seeing great growth in a number of markets. There are some challenges as we're finding in the U.S. with some markets, as far as our fashion watch, and more specifically, our Fossil watch business. But on balance, we expect Asia-Pacific to continue to be a leader in the growth for this company.

Okay, and then two more quick ones. Mike, maybe your fourth quarter guidance, does that assume anything on the share repurchase side?

It does not.

And then last one. Kosta, for Europe the stores that you're opening up in Europe, is that the smaller accessory store footprint? Is that the larger store? You have a couple of different concepts going right now. What are you opening in Europe?

Well, they're very small stores. The ones that are there now are generally in the 500- to 900 square-foot range. And as we mentioned before, they're actually more profitable in the stores in the United States, so they generate a high sales per foot and high profitability. So that's generally the kind of spaces we're looking for right now. We have one store I think signed already in Hamburg that I think was about 700 square feet that will be opening in the first quarter.

Okay great, thanks.

Oz Tangun, Southwest Securities.

Can you guys talk about the sales volatility you have seen outside of the U.S. over the last year or so? Is that maybe the growth that you experienced? You mentioned that for Asia-Pacific, it had something to do with it? And what kind of longer-term growth do you expect in Europe and Asia over the next five years?

I can take the second question there; I'll let Kosta talk to the first question. But our expectations are to continue to see double-digit growth throughout our international businesses as we move forward. As we've talked about many times, outside of Germany and Europe, our businesses are still relatively small and we think we have opportunities to further penetrate for all of our brands as well as obviously take advantage of new brands and businesses that we're adding to those markets.

On the Asia-Pacific side, we're still obviously a very small base in that part of the world relative to total watch businesses -- business that is done. And at the same time, there's some pretty significant markets that we're just now starting to look at, as Kosta mentioned, hopefully we will be taking a certain position in and introducing our brands in 2006, specifically China. We still feel that India, Russia, even some of the Eastern European countries that we may be working with a distributor in those markets are prime opportunities for additional sales growth throughout the world.

As far as the volatility is concerned, I think part of it is just generated by our situation last year in Europe in the third quarter where we installed SAP and had a slow quarter, where initially we had a big quarter. I don't think that we will continue to see kind of volatility long-term because we do expect big growth certainly of course in Asia, and also in Europe, and that should be more consistent.

And when you look at accessories, I guess a couple of questions there. When will we see accessories achieve some meaningful sales growth or sales outside the U.S.? You mentioned you are developing Michel, you've tested other things in Europe. Can you give us some sense as to some time line and some flavor, some color as (ph) accessories outside of the U.S.?

As we mentioned, we're doing testing right now and we've had pretty good response so far, so we're going to be expanding outside the United States into a lot of markets next year. So we probably are doing about $10 million outside of the United States right now in leather goods. So you will see that grow quite a bit next year and then additionally after that. Probably one of the best ways to expand our legacy business is through our own store network because that's where we can get a lot of space and the presentation is correct, et cetera, so that's going to be a part of it. But we do expect that that will accelerate in the next couple of years.

And in terms of your store growth in Europe and outside the U.S., how many stores is reasonable to assume over the five-year time horizon? And do you see yourself expanding much faster outside the U.S. in terms of number of stores?

Yes, we do. We think that we could potentially have in a couple of years 30 stores or so in Europe. And in Asia where we already have a number of stores in Austria and Singapore, we think that Hong Kong is an opportunity and then shop-in-shops and possibly stores in China could be an opportunity for us. We also I think are opening a store in Taiwan, so there's in Asia a big opportunity. And we had recently hired a person over there to accelerate the growth in retail and we're studying the markets right now and putting together a plan. But we do think that we could have a significant number of stores in Asia as well.

So when it's all said and done, you may end up having more stores in Europe and Asia, or at least as many as you will in the U.S.?

Well, we're also going to grow the U.S. also, especially with the Modern Watch Company too, so it's kind of a moving target. But long-term, we do have a huge opportunity for retail outside the United States because potentially even the Modern Watch Company store could be a big thing for us around the world.

(multiple speakers) full price (indiscernible) basis, we don't anticipate growing to the significant number of outlets stores outside of the United States that we have inside. We'll still clear (ph) most of those international discontinued products through our U.S. stores.

And the trend in accessories, obviously they have been strong and you guys take market share. How do you think this is going to end? Where do you think -- at the end of today, you mentioned some open to buys, maybe shifting from watches to accessories. Do you think this is a cycle that will be worse, or do you think five years from now, the accessories market is going to be a bigger percent -- if you look at the whole market, it will be a bigger percent?

I think that's definitely cyclical trends in these businesses, and this has obviously been going on for years. Generally speaking, the whole accessories complex -- watches, plus leather goods, sunglasses, jewelry, et cetera -- has been growing at a very fast rate for 10 years and probably will probably continue to. If you look at the profitability and the sales per foot of those areas for stores, department stores and other stores, it's clearly far ahead of apparel. You could almost say that accessories is still way underserved and apparel is overserved. So I think that's a longer-term trend.

Within the accessories complex, there has always been and probably will continue to be cyclical trends where jewelry is hot one year and the next year, it's scarves. Belts is a good example of that where three years ago or so, our belt business was relatively small because most of the apparel was low-rise jeans and people weren't wearing belts. Now that trend has totally changed where our belt business has been on fire for a year and probably will continue because the styling has changed. Handbags is a similar situation. Now with all of the embellishment that's going on in handbags, people cannot buy just one handbag and wear it for a year because there's too much change going on, so they're buying multiples. And it's a very high awareness, top of mind sort of thing as you can tell from all the research that you see.

And of course, that will someday change and they will be back into collecting watches like crazy like they have the last several years. And that's really what we're trying to do is put our entire design and marketing teams to really sort of reinvent the watch business and put a lot of excitement in there so it stops people in the aisle and they're buying watches instead of some of these other things. But overall, the great thing for us is that we're in a position where we can continue to optimize our business through the diversification of categories that we have in accessories, which is long-term going to be obviously a great business.

Sure. And you don't expect these trends to change in the next couple of years? You think the accessories, the handbags, belts and so on will continue to be strong the next couple of years?

I certainly think all of those businesses -- handbags, et cetera -- are going to be strong. Whether it's going to be as strong as it has been in the last couple of years, it's hard to say. But it's definitely going to be a strong business.

What should we expect from Michel is terms of performance in '06 and going forward?

One of the things we're doing is we have a big initiative on the design side with Michel to put additional products in the marketplace and it really invigorates the point-of-sale, and that's what we're doing now. We're also going to be adding jewelry in '06 for sure and potentially some other categories. But at least we know jewelry will be in there and that will give it more space in the stores and create a somewhat more of a lifestyle brand so we'll get a little more momentum in the stores and a little more advertising on a different category. So that should be very exciting for the brand.

Oz, one additional comment to your point about the volatility of Europe and why we're seeing such swings in growth. The mid-single digit guidance we gave for Europe in Q4 obviously has us working against a headwind on the currency. Average currencies in Q4 last year compared to this year were about 5% higher. So there's probably somewhere between 6 to $8 million of sales that will drop out just from pure currency.

Thank you so much.

Brad Stephens, Morgan Keegan.

Good morning guys. When we look to the long-term growth rate being slightly -- or next year, being a little bit below the 15 to 20%, is that just a continuation of what you're saying for the fourth quarter of the domestic business remaining difficult? Or, is it due to other things, maybe in the other international arena?

I would say it's more of a reflection on the current environment for our core Fossil product offering in the U.S..

Okay. And can potentially you elaborate little bit on the comp performance during the quarter of your full price versus your outlet stores?

Across all of our stores, the comp was relatively at the same level. We didn't see -- we came in about 2% below last year on a combined store effort, and each concept was within that range.

Alright. And we're looking at the end of the year here. Where should inventories ideally end up at? And do you feel the need at current inventory levels to maybe clear a little bit more through a third party to get them more in-line for next year?

As we mentioned on the call, our expectations are to be able to cut the growth in half in inventory from what we saw in the third quarter, so basically, going down to a range of 12.5% compared to 25% increase in Q3. We don't anticipate that we will have to clear any good through any alternative channels. We expect that we can receive any product we're discontinuing through our outlet stores at margins similar to what those stores were producing last year.

I applaud the buyback of the shares. I think that's fantastic.

Dave Turner, BB&T Capital Markets.

I was curious about the sales, the domestic sales dynamic as you look into '06. You have a very obviously large market share within the department stores, but yet at the same time, you have some brands coming out of incubation as well as a handful of new ones set to launch. Some are obviously distinct channels, some seem to be some overlap. So I'm curious if there's any cannibalization or baked into that long-term growth of 15 to 20% overall. Obviously, there's international in that as well. So I guess just how you see the domestic market playing out as these new brands come into the pipeline?

We should start to see, especially since we're up against some small numbers, some growth in Fossil, which is one thing that we're trying to see. We also are going to some additional rollouts with some of our existing brands. As I mentioned before, we will gain some additional doors from the Federated-May combination. And then we have additional products that are going in there. One thing that we're doing is we're rolling out the Zodiac brand to a larger number of doors, and that will grow at a faster rate. And then of course Adidas in the United States is going to give us more momentum. So there should be pretty strong growth in the United States next year.

And then just on the Guess? license, and not necessarily what -- I guess what that business would have provided that's not currently in the pipeline, or maybe was it and opportunistic type of where it was presented and you wanted to act on it; you weren't necessarily looking for something in the segment that they offer?

Yes, I would say it was opportunistic, and not really necessarily for us to make our long-term 15 to 20%. We saw an opportunity that could potential accelerate that, and we went into it, and that was basically what it was.

Thank you.

Robin Murchison, Suntrust Robinson Humphrey.

Just a few questions. Kosta, what is your take on when this embellished cycle ends?

Robin, that's a very good question.

A lot of what I'm seeing in Women's Wear Daily is certainly suggesting next year, and you can't help but think about it in terms of translation to the accessory group, and then what it might mean for you guys; positive or negative.

Honestly, I look at -- I'm in New York shopping the stores here, and I see all of this embellishment and it's just driving me crazy, it's just too much. It looks like a lot of companies have jumped the shark. But in our case, if you look at our handbag assortment, for example, because so much of it is leather and so much of it's core, and we are probably the largest leather supplier in handbags to department stores. Our assortment looks very good in that we have some embellishment, but it's not throughout the whole line and we have a good amount of basics and core leathers. And so we think we're in pretty good shape and that's why we think we're going to continue to gain market share. We're just in the right position.

And speaking of small leather goods, Michel gift with purchase, did you all make that? One of your vendors, one of your retailers, is doing a Michel gift with purchase. Is that a leather thing that you all made, and are you finding -- is this the first time you've done that? Can you give us a little color on that?

Actually, I'm not even aware of that, Robin. I wasn't aware we were doing that.

If you look at the Neiman-Marcus Web site, there is Michel gift with purchase (inaudible). Okay, well that's all I have. Thanks very much.

Thank you. At this time, I'd like to turn our call back to management for additional comments.

Thank you. Should you want to replay this conference call, it has been recorded and will be available today from 10:00 AM Central time until 5:00 PM Central time tomorrow. You can call 303-590-3000 and enter reservation number 11031698. (OPERATOR INSTRUCTIONS). The conference call has also been recorded by StreetEvents and maybe accessed through StreetEvents Web site at www.streetevents.com, or directly through our Web site at fossil.com by clicking on investor relations on our homepage, and then on web cast.

Finally, should you have any questions that did not get addressed today, please feel free to give Kosta or myself a call. Thanks again for joining us today. Our next scheduled conference call will be in February for the release of our fourth quarter and full year 2005 operating results.

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