Fossil Group Inc (FOSL) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Fossil fourth-quarter earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Tuesday, February 21, 2006. At this time I would like to turn the conference over to Allison Malkin, 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 located on the lower center of 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 position at the conclusion of the Company's fourth quarter and fiscal year ended December 31, 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 8-K dated September 14, 2004, and our Form 10-K and 10-Q reports filed with the SEC. In addition, Fossil undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

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

Good morning, and thank you for joining us to discuss our fourth quarter and fiscal year 2005 results. Joining me are President and CEO Kosta Kartsotis and CFO Mike Kovar.

I would like to begin by providing an overview of our fourth-quarter and 2005 full-year results. Then Kosta will review the fourth-quarter sales trends and results and an update on our current initiatives. Mike will then provide additional specifics surrounding our fourth-quarter financial results and 2006 outlook. At the conclusion of our prepared remarks, we will then open the call for any questions you may have for us this morning.

The fourth quarter ended a very challenging year in the watch segment of our business. The advantages of our global operating platform, which have historically lead to strong growth for us, were not able to offset a marked decline in fashion watches and an unfavorable currency environment during the back half of the year.

That said, we were still able to grow our global watch market share in 2005, and achieve solid growth in a number of our lower-penetrated watch businesses, such as luxury, mass-market and (indiscernible) watches. We also continue to experience double-digit sales growth in accessories, jewelry, and our company-owned retail stores.

However, significant sales decreases from our global FOSSIL watch business [provided] too large to report -- to report the type of results we have historically become accustomed to. Additionally, with headwind from currency and with the mix of our fourth-quarter business skewed towards lower gross margin segments and geographies, our gross margin declined well below last year's level.

While we took steps to reduce expense growth midyear, these efforts did not fully compensate for our weakened sales and margin results during the fourth quarter. Accordingly, fourth-quarter consolidated net sales grew -- rose 1.8%, or 4.8% excluding currency, and diluted earnings per share were $0.31 compared to $0.47 in last year's fourth quarter.

For the year, sales rose 8.4%, or 8.7% excluding currency, and diluted earnings per share were $1.07 versus $1.22 last year. The current year results included an approximate $0.17 per diluted share benefit related to repatriation of foreign earnings. Additionally, currency negatively impacted fourth-quarter earnings by approximately $0.08 per diluted share when compared to the prior year quarter.

During 2005 we were successful in our efforts to expand our watch and accessory platform as we announced new watch and accessory lines. Some of the notable 2005 initiatives were --

We announced a partnership with Wal-Mart to develop and grow the George brand and the watch category. We began distributing to 550 Wal-Mart stores during the fourth quarter, and anticipate the number of doors will almost double during 2006.

We announced product extensions under our proprietary MICHELE brand and licensed DIESEL-branded jewelry which will launch during 2006.

And finally, we prepared for our (indiscernible) DOS watch launch, which began shipping in January of this year. We believe (indiscernible) DOS will add more than $30 million to our topline sales during fiscal 2006.

As we develop these initiatives and look to add new businesses, we believe we can further reduce our dependency on the fashion watch segment. We believe these initiatives will benefit our overall growth in time for the global watch business may not be performing to our expectations. This should enable us to become a more predictable and resilient company as we move forward.

While we can't predict the future, we know that in our almost 13 years as a publicly-traded company, we have experienced negative watch cycles in the past which have lasted between 18 months and two years. In the meantime, it is our goal to successfully improve our business regardless of the cycle. We offer some of the world's most premier brands which drove market share gains in 2005. We also possess a highly talented team that is motivated and eager to deliver a better performance. By working harder, smarter, and more creatively that our competitors, we expect to rejuvenate our FOSSIL fashion watch business, our largest and most mature brand, which will assist us in returning to a more normalized growth level.

And now I would like to turn the call over to Kosta to review our sales highlights and businesses in more detail.

Thanks, Tom. Domestic watch sales dropped by 4.1%, but we did have solid growth in MICHELE, ZODIAC, BURBERRY and ARMANI. The U.S. FOSSIL watch performance again was disappointing, down almost 19%. The fashion watch market is in a state of disruption, and research shows that consumers are generally less interested in watches for whatever reason. It is our job to reverse this trend by coming up with innovative, differentiated products that reverse the trend, and that is exactly what we are focused on.

Internationally, sales were also disappointing, declining 5.3% and up slightly 1% excluding currencies. In Europe, sales fell 8.4%, down 1% excluding currency. We had increased sales of licensed watches such as DIESEL and BURBERRY, and a double-digit increase in FOSSIL jewelry sales that was more than offset by lower sales of FOSSIL watches.

Our licensed watch and FOSSIL jewelry lines are particularly under-penetrated in these markets, offering continuing growth opportunities. In addition, our launches of ADIDAS watches and DIESEL jewelry should play well in the European marketplace.

Other international sales rose by 4.7%, increasing 7.1% excluding currency, which includes the Asia-Pacific region, Canada and our U.S. export businesses. The growth was primarily attributable to increased sales of licensed watches. We believe that these markets hold significant growth opportunity for our brand as we raise the brand awareness. We also believe China and India are tremendous growth opportunities for us, and are excited about the prospects of our current brands within these markets. Additionally, ADIDAS, which already enjoys particularly strong brand recognition in China, will assist us in expanding our portfolio into the region.

Turning to our luxury business, it represented one of our strongest-performing categories during the quarter. MICHELE continued to generate strong results in the United States, where sales rose in the quarter by 30%. We are reviewing the opportunities for expanding MICHELE internationally, and have just recently made our first shipments of MICHELE jewelry to Neiman Marcus. The ZODIAC brand continued its strong performance in the fourth quarter, especially at Nordstrom, and we are in a position for future growth with this unique Swiss-made brand. The BURBERRY brand generated robust growth in the fourth quarter, with sales rising by 20%, 23% excluding foreign currency impact, with all three regions showing strong gains, the United States, Europe and Asia.

On the other end of the distributions spectrum, sales from our mass-market business more than doubled over the prior year to 22.5 million, but finished just slightly below our expectations for 2005. We remain confident about growing our presence in this channel, and will continue to see opportunity for significant penetration over the next several years.

Our accessories business continued the solid performance from the first three quarters of the year, posting a 20.7% sales increase in the fourth quarter. We had strong increases and market share growth all year long in FOSSIL handbags, belts, small leather goods and sunglasses, and we are in a position for this trend to continue in 2006.

Our success in the handbag business is particularly notable because of its visibility with consumers and because the size of the market is much larger than watches. Our future plans include expanding the FOSSIL business internationally, as well as looking to add additional variance to this category. We also had a strong performance in RELIC accessories during the quarter.

And finally, our jewelry category reported strong gains internationally. Over the last couple of years we have invested in this business, and will be launching DIESEL jewelry and [just shipped] MICHELE jewelry, and we'll also be expanding FOSSIL jewelry to the United States in 2006. By leveraging our existing infrastructure and customer base, we believe we can add to the probability of these brands and this product category.

On the retail side, our company-owned stores' sales rose 18%. A 24% increase in average number of stores was partially offset by a 2% decline in comp store sales. There were a couple of factors here. Our comp sales increases were plus 7 and plus 15 in the fourth quarters of 2004 and 2003, respectively, and the challenging environment in the FOSSIL watch business affected this year's comps as well.

We ended the year with 171 stores, including 99 full price stores, 28 of which were outside the United States, and 72 outlet allocations. This compares to 136 stores at the end of the prior year that included 76 full price stores, including 22 outside of the United States and 60 outlet locations. We expect to open between 25 and 35 stores in 2006, with a more than normal number of stores being opened in both Europe and Asia than the last few years. Our Fossil retail stores represent an excellent way to expand brand awareness while contributing to our bottom line.

A main focus of the Company is to put our significant resources to work to rejuvenate our FOSSIL watch business. The first step is differentiation. We are changing the assortment as much as possible -- the categories, the details of the watches, how we look at retail. We have to give the customers something different than they already own and give them a reason to buy.

We are also very encouraged by our brand-building efforts throughout our Website, stores and with our new catalog business. We delivered 1 million catalogs during the fourth quarter and got a very good response in terms of measurable sales directly attributable to the 32-page book. We believe this can be a cost-effective way of enhancing the brand and driving sales at the same time. We will continue to utilize this vehicle to drive brand awareness and sales for the FOSSIL brand.

Importantly, our FOSSIL brand equity remains strong with consumers. Market research, and the strong performance of our FOSSIL handbags, belts and small leather goods, validates that FOSSIL is a top brand with its core demographic. It is important to note that combining all product categories, Fossil retail sales in department stores comped up about 5% in 2005. Of course, we were down in watches, but way up in leather goods and sunglasses.

In 2006 we expect to continue the momentum in our accessories and jewelry offerings. Our accessories business is poised for another year of double-digit expansion, based on the current performance we're experiencing now. We also expect to expand the distribution for accessories to select international markets. This year, as I mentioned, we will also extend our jewelry reach with the launch of DIESEL and MICHELE.

In terms of financial goals, we are focused on reducing our expense -- our expenses to bring them in line with our sales outlook by taking a more disciplined approach to cost controls. We will focus on reducing inventory levels by changing our planning and supply chain methodology, and we will be selling discontinued merchandise through our company-owned outlets and through off-price channels. As an indication of our confidence in our strategy and ability to attain stronger growth in the future, we completed the 3.5 million share repurchase program we announced in November last month. We will continue to evaluate the opportunities for utilizing cash generated by our operating model. Mike?

Thanks, Kosta. First I would like to once again summarize the results of our fourth quarter. Net sales increased 1.8% to 324.2 million, compared to 318.4 million in 2004. Gross profit decreased to 160.5 million, or 49.5% of net sales, from 172 million, or 54% of net sales in 2004. Operating income totaled 33.4 million, or 10.3% of net sales, compared to 48.3 million, or 15.2% of net sales in the prior period. Net income declined to 22.2 million, compared to 35.1 million in 2004, and diluted earnings per share totaled $0.31 on 72.1 million weighted average shares outstanding, compared to $0.47 on 74.7 million shares outstanding in the prior year.

The fourth-quarter sales mix breakdown was as follows -- 23.9% from domestic wholesale watch sales, 15.6% from domestic wholesale accessory sales, 16.8% from company-owned retail store locations, and 43.8% from sales generated in over 90 countries outside the United States.

The 1.8% sales growth for the quarter consisted of the following increases and decreases by category and geographic region. Domestic watch sales decreased approximately 4%, as Kosta mentioned, to 77.2 million compared to 80.5 million in the prior year quarter. Other domestic sales, which include our accessory and sunglass businesses, grew 21% to 50.7 million, compared to 42 million in the prior year quarter. Sales generated from European-based wholesale operations decreased 8%, 1% excluding currency impact, to 104.2 million, compared to 113.8 million in the prior year quarter. Other international sales, which typically consist of export sales to distributors, sales from our Canada and Asia-Pacific wholesale operations, increased 5%, 7% excluding currency impact, to 37.7 million, compared to 36 million in the prior year quarter. And finally, sales from our own retail stores grew 18% to 54.4 million, compared to 46.1 million in the prior year quarter, as a result of a 24% increase in the average number of doors opened during the fourth quarter this year, partially offset by comp store sales declines of about 2%.

Fourth-quarter gross profit margin declined to 49.5% compared to 54% in the prior year. In addition to an approximate 200 basis point decline associated with the stronger U.S. dollar, fourth-quarter gross profit margins were negatively impacted by the following.

First, the reduction in the sales mix related to our international businesses, which generally carries higher gross profit margins. This was further impacted by mix changes within this segment toward lower gross margin-producing businesses. Secondly, an increase in the sales mix of our domestic accessories business, which generally produce lower gross product margins. Third, increases in outbound and inbound freight costs, primarily due to fuel surcharges, and to a lesser extent, slightly higher markdowns as a percentage of net sales.

Operating expenses as a percentage of net sales increased to 39.2% in the fourth quarter, compared to 38.8% in the comparable prior year period. Fourth-quarter operating expenses were unfavorably -- were favorably impacted -- I'm sorry -- by an approximate $3.7 million reduction in expenses related to the translation impact of a stronger U.S. dollar in comparison to the prior year period.

Excluding this benefit, operating expense increases were manly driven by increased payroll expenses, which was partially offset by reduced advertising. Advertising expense declined approximately $3 million to 10.5% of net sales, compared to 11.6% of net sales in the fourth quarter of fiscal 2004. As a percentage of sales, advertising came in slightly higher than our expectations for the fourth quarter, primarily due to the shortfall in our expected sales.

Our full-year guidance for 2006 is not projected to yield significant operating expense leverage. And furthermore, leverage will be more pronounced in the second half of the year due to the seasonality of our sales.

During the fourth quarter, lower gross profit margins combined with increased operating expenses resulted in operating profit margin declining to 10.3% of net sales, compared to 15.2% of net sales in the prior year quarter. Operating income for the fourth quarter was unfavorably impacted by approximately $5.9 million as a result of the translation impact of a stronger U.S. dollar, and this compares to a $9 million benefit in the fourth quarter last year as, obviously, the U.S. dollar was much weaker.

Fourth-quarter other income expense decreased unfavorably by approximately 3.1 million when compared to the prior year period. This unfavorable decrease is related to significantly higher currency gains associated with settlement and the marked-to-market impact of certain foreign currency payables and receivable balances in the prior year. As you may recall, the U.S. dollar has strengthened appreciably against the Company's other major balance sheet currency since the end of 2004.

Our effective income tax rate was 36.1% during the fourth quarter and 24.6% for the full-year, compared to 33.7 and 35.8%, respectively, in the prior year comparable periods. For the year, a diluted earnings per share benefit of approximately $0.17 was realized in connection with the repatriation of foreign earnings pursuant to the American Jobs Creation Act of 2004. For fiscal 2006, we estimate our tax rate will approximate 37%.

Now turning our attention to the balance sheet. We ended the year with a net cash position, that is cash plus short-term debt, of 55 million compared to 165 million in the prior year. Working capital of 322 million was $41 million less than the 363 million in the prior year, primarily due to cash expended in connection with the common stock repurchases.

Accounts receivable at year end declined to 142 million compared to 155.3 million in the prior year. Days sales outstanding decreased to 40 days for the fourth quarter, compared to 44 days in the prior year period. This decrease is primarily due to a sales mix shift from the international sales to domestic sales, and an increase in sales mix in the company-owned stores. Generally, collection cycles for our international businesses are longer when compared to that of our domestic businesses.

Inventory to fiscal year end 2005 rose by 34.5% to 241 million, as compared to a prior year ending inventory of 179.2 million. The increase in inventories is mainly attributable to the following factors -- first, actual fourth-quarter sales falling below the Company's original expectations; second, higher levels of luxury watch inventories, primarily due to longer production leadtimes; third, increased levels of in-transit inventories related to accessories, primarily to support continued growth in this segment and timing of those receipts in 2005 compared to 2004; and fourth, inventory increases associated with new businesses that we acquired in 2005. If you remember, at the beginning of the year we acquired our distributors in the Scandinavia region and in Taiwan.

Our inventory position will not likely improve during the first quarter and only slightly improve in the first half of the year. Stock level increases associated with our increased retail store count, ADIDAS brand watch line rollout, new jewelry business initiatives that Kosta mentioned, and stock associated with the acquisition of our Mexico-based distributor will partially mask the reduction in our wholesale watch inventories.

That said, we are working diligently to reduce inventory growth with two key initiatives in place. First, we will tighten our inventory purchasing to match trailing trend results. Rather than purchasing based on estimated but perhaps optimistic growth expectations, we will now purchase based on prior trends. And second, we will also carefully pursue the reduction in our excess inventory through our outlet channels, which clear the most volume goods during the summer months, in addition to other discount channel customers. As we close out 2006, it is our goal to report negative inventory growth while reporting positive sales growth.

Capital expenditures for the full year were approximately $56 million. We are expecting 2006 capital expenditures of approximately 40 million. This includes the purchase of new offices for our United Kingdom subsidiary, automation of our distribution center in Germany, as well as normal capital expenditures related to maintenance and retail store growth. Amortization and depreciation expense for the full year was approximately $27 million, and we are [estimating] fixed depreciation and amortization in the $30 million range.

As it relates to 2006 guidance, for the first quarter of fiscal 2006, we estimate diluted earnings per share to approximate $0.12 a share, as compared to the first quarter of fiscal 2005 diluted earnings per share of $0.32, or $0.19 excluding an approximate $10 million tax benefit related to repatriation of foreign earnings.

For the 2006 fiscal year, we are projecting net sales growth of approximately 9%, with sales in the first half of fiscal 2006 expected to rise about 7%, and the second half increasing by approximately 10%. This is primarily due to two factors. One, we have tougher currency comparisons in the first half of the year, and two, the launch of the new business initiatives will be more heavily weighted toward the second half of the year.

We estimate fully diluted earnings per share for fiscal 2006 of $1.05, which includes a $0.03 to $0.04 per diluted share negative impact from the implementation of FAS 123 share-based options -- share-based payments, as well as a $0.06 per share diluted benefit from a lower share count given that we recently completed our 3.5 million share repurchase program in early January. This compares to actual fiscal 2005 earnings of $1.07 per share diluted, or $0.90 per diluted share excluding tax benefits. This guidance reflects the current prevailing currency exchange rate between the U.S. dollar and foreign currencies of other countries in which we operate. Tom?

In conclusion, we believe 2005 is an anomaly in comparison to the opportunities for long-term sales and earnings growth which our business model is predicated on. We are by no means pleased with our performance and are intently focused on positioning our company for sustained growth in sales and profits. With our competitive advantages that include a global platform, the most talented design team and world-class brands, and with the commitment for our entire organization, we are confident that our performance will improve as we move through 2006.

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

(OPERATOR INSTRUCTIONS). Dorothy Lakner, CIBC World Markets.

Could we go back to inventory a second? Just if you could give a little bit more color to the changes in supply chain methodology, I think you were talking about, and what we can expect going forward, how you're going to get the inventories back into line. And I think you mentioned specifically concentrating on the outlets for getting rid of that inventory. So, if you could just give us a little more color on that. And then, looking at some of the newer businesses, just a little bit more color on the jewelry launches, what kind of distribution you're expecting to see there. And also on the ADIDAS side, if you could give us a little bit more color on your expectations for that brand in '06.

On the inventory side, obviously, there's a couple of things we're doing. One is that we are changing our methodology the way we buy and forecast inventory. It's really more trend-based rather than forecast-based because, obviously, we're in somewhat of a state of disruption, and predictability has been somewhat difficult for us. So we're just being more conservative on that side.

The other thing that we're doing is we have a major initiative on our supply chain, really to increase speed to market. And that is something that we think we can make some improvements over the next two years that will enable us to get the inventories down to a more reasonable level. And as you know, that's always been one of our strengths is the inventory turns in supply chain. And as we've gotten larger and the business has gotten somewhat unpredictable, we've kind of lost our way a bit. So we're refocusing on that quite a bit.

As far as liquidation, the outlet stores, as you know, can liquidate inventory. And that organization as a stand-alone entity actually make a profit, so that is something that we'll be focusing on to move those goods through. And then we will be using, as we did some last year, we will be using some third party, which also is typically sold at above our [landed] cost. So we're using those two things as well.

Some color on the jewelry thing -- we just recently shipped Neiman Marcus MICHELE jewelry. I think it went to just a small number of doors just recently, so we're very interested in seeing what the progress of that is, because that could be a pretty nice business for us. And we have two other initiatives. One is DIESEL jewelry, which will be launching to a relatively small number of doors globally, I think, in the third quarter or so. But it is piggybacking on our global distribution, so our sales reps around the world that sell DIESEL watches will now carry an additional line of jewelry, so it has that leveraging impact.

And then the other thing that we're somewhat interested in is, as you know, we have a very successful FOSSIL jewelry business, mostly in Europe. And we're going to be bringing that business, adapting the styling and the assortment, and bringing that business to the United States in the third or fourth quarter this year, both in our stores and also at some department stores. So, we're kind of interested in that. But I think we're making progress on the jewelry front. We've gotten some additional design and infrastructure there that we're starting to make some progress on. And we still think it's a large opportunity.

Then on the Avia question, as you know, we started shipping early this year. I think our shipments actually started off slow. I think our -- got started a little slower than we would have liked, but we're getting a lot of interest globally. And we think that it's going to be significant business long-term, but we think we're going to do pretty well this year as well. So we're very excited about that, and we think it's going to add to our global platform. As we mentioned, it's going to help us in some places in the world, such as China, where they're very heavily penetrated, and other markets as well. But it also -- it adds to our portfolio in that it's something that's different than the rest of what we have, so it kind of rounds out our portfolio pretty nicely.

One other question, just on the licensed brands. You had some very strong growth from brands like BURBERRY. And, obviously, that's great, all three regions of the world. What are your expectations for that brand in '06?

We're expecting continuing growth. It's a great business for us, we're seeing very strong growth in the United States as well. And at that price point, when it starts selling quickly it can add up pretty quickly. So we're very interested in that long-term. It fits a niche. It's about a $400 average retail. It fits a niche that we don't have covered anywhere else -- a Swiss watch. So we're pretty excited about that long-term.

One last thing. On the mass market efforts, how many stores do you expect to be in this year?

I think right now with Wal-Mart, we're probably -- with replenishment programs on the private-label activity, excluding their George business, I think we're in probably 1500 to 2000 doors, so there's some obvious growth available to us there, as there is also growth available within those doors to become a more significant supplier of that private-label business.

With the George brand, as Kosta mentioned, we're in about 550 doors, based upon the launch of that business in November last year. And we're expecting that business to double in the size of the doors we'll end up with by the end of this year. 90% of our business is still with Wal-Mart. There's obvious opportunity for penetration in watches with Target, and even Kmart down the road.

Barbara Wyckoff, Buckingham Research.

I guess a couple of questions. Firsts, of the shortfall in the Fossil sales -- Kosta, I guess this is a question for you -- what percentage would you say is due to the mix and the look of the watches versus sort of weakness in the sector?

It's hard to say. We do know that the total watch business in the United States in the fashion watches was down, so that impacted it. But of course, we're the largest part of that, so you could say that we accelerated it by not having the right assortment and styling and newness. So I'd say since we are a bigger part of it, then it's really up to us to change that trend. And that's exactly what we're doing. We think that we have a lot of new ideas and a lot of platforms in there. We're really focusing on changing the whole way it looks and feels, and it's going to be a bit more upscale and the branding is a bit more aspirational, more derivative sort of of luxury watches, rather than more fashion trendy watches. We think we've got some good ideas in there that can change the trend, but I would say it's a combination of just less interest in watches because of lack of newness, and that's really our responsibility. So we're doing everything we can to change that.

And if you had to do the year over, 2005, what would you have done differently?

We would have gone right past it and go right to 2006. It's obviously a tough year. We're disappointed in the results, but if you look at on balance the situation we are in, and the state of disruption we're in, we're looking at it opportunistically and saying, okay, how can we gain market share in this time? How can we bring our resources to bear on our competitors and get stronger in the marketplace? So, on balance I would say we've been through this a few times before, and we came out of it much stronger. So, we're being very aggressive in going after the business and just basically sticking to our business model, which is big and global. And we've got the most resources, and just looking at every piece of it, and changing the pieces that need to be changed. We're changing a lot of the structure in our company and we're moving people around and putting them behind businesses that are growing, and making a lot of changes, just making the organization stronger. I think in a certain extent, something like this can be a wake-up call to say, okay, let's refocus again and get stronger. And that's what we're using it for.

What delivery will the newness that you just talked about be pulling in the store?

It will be an ongoing process. We have some stuff that's in the stores now that is in this ilk and doing very well, and there will be more and more of that through the next couple of months. But as you know, January-February is a slow time of the year for watches, so you can't really -- don't get enough receipts to change the assortment quickly, and you also don't get the kind of traffic that drives big sellthroughs, but we are seeing encouraging signs out there.

Do you think we'll see more of it in the second quarter and then into back-to-school?

Yes.

Neely Tamminga, Piper Jaffray.

Kosta, could you talk a little bit about this inventory, maybe how we should be thinking about the complexion of the inventory, maybe if the biggest contributor of the inventory increase was related to sales being below our expectations? Was it the lion's share of the growth in inventory on a year-over-year basis? Or how should we be looking at inventory growth as we go throughout 2006? If it's up 35% now, how might it look at the end of the first half?

The way we're looking at it is if you look it how the trend will progress through 2006, what we've said is we didn't anticipate that there would be much of a decrease in the levels year-over-year by the end of the first quarter. And by midyear, the trend will get a lot better, but a lot of the inventory on the discontinued side will be cleared out through our outlet stores and alternative discount channels. And most of that business occurs during the summer months, obviously, when people are vacationing and hitting a lot of the outlet environments. So we are expecting that you won't see significant year-over-year inventory decreases on our part until we in the back half of the year. But the way we're planning the business for the end of the year, our expectations, as we already stated, are for our inventories to be below year end levels in 2005, albeit with hopefully a sales increase in the high single-digit range.

As far as the components of inventory, about 10 to 12 million was probably related to just a pure sales miss. We had brought those inventories in thinking we were going to originally achieve our sales expectations. I would say there's probably 12 to 15 million associated with our luxury brand. Some of that is due to longer production leadtimes. Because that product goes through Switzerland, it's not as efficient as our Hong Kong factories. Additionally, in that area, as Kosta mentioned on the call, some of those brands are our fastest-growing businesses right now, so we are, obviously, bringing more inventories in to feed that growth. We had about 9 million more in accessory inventories that was primarily related to timing of in-transit shipments from the Far East. As basically a lot of suppliers shut down for Chinese New Year late January, they try and get as much stuff out the door as they possibly can. And what we had was in-transit inventories being put on boats prior to our year end this year, where last year a lot of those inventories didn't go out until the first week of January. So we expect the accessories inventory to right itself by the end of the quarter, based upon the timing. And then there's probably an additional 3 million in inventories at year end related to the new acquisitions we talked about, both our Scandinavian and Taiwanese distributors.

That's very helpful. I guess maybe since I have you on the line here, in terms of some of the restatements that occurred in fourth quarter, there seems to be some movement between cost of sales, as well as selling and distributed in the other income line. Can you talk a little bit about what was going on with those line items?

The biggest part of that was, if you remember, in Q1 this year we restated or reclassified certain costs within the income statement. We historically accounted for any marked-to-market gains based upon our currency gains or losses associated with having to restate foreign currency balances in U.S. dollars in Q1 to basically reclass for Q4, specifically about $4.5 million worth of gains that in the prior year were recorded in cost of sales, down to other income and expense. And then the other and much smaller reclassification to prior year amounts was related to moving freight expense for our Web business that had been carried down in the SG&A line up to cost of sales.

Just one last -- I'm just trying to get my head around -- obviously, you guys are doing some great things in jewelry and non-watch accessories. I'm just trying to get a sense of at the end of '05, kind of what that penetration was as a percentage of total sales, and how that might move into '06, those percentages might change.

Globally, the non-watch portion of the Company's sales was 34%. Obviously, we had growth last year in that percentage number by a couple of points, probably. It's interesting to note that in the United States and in department stores, where we're most penetrated in non-watches, we actually in department stores last year did about 70% of our business in non-watches, which is an indication of the kind of growth and strength we have in not only the brand, but in these categories.

And how might that look in '06, Kosta?

Obviously, the positioning we're in right now, the trend of the non-watch categories, both leather goods having big growth and continuing to this year, as well as jewelry having growth, that number probably will continue to go up, especially when we're looking at this somewhat of a headwind in watches. So we think that probably the non-watch portion of growth is a percentage.

Elizabeth Montgomery, SG Cowen.

Can you talk a little bit about how inventory in the channel looks, not only for your brands but for other competing watch brands as well? And then I'm curious to know what your sense of the impact of the Federated May acquisition may have, not only on the watches but also on the accessories. My final question would be, for your accessory business in the U.S. that is sold into department stores, does your expectation for revenue gains in that business in '06 assume additional door growth, or just increased sales per door? Or does it assume additional brands get layered on to the FOSSIL accessory business?

As far as the impact on Federated, I think we've discussed this before. We have a situation where there may be some short-term disruption as they sort out the store closings and all the changes they've done in their business model. But over the long-term, it's going to be a benefit to us for a couple of reasons. One is that the May company stores were not carrying as many brands from us as Federated was. So some of those brands that were not in May are going to get penetrated in some of the newly formatted Federated stores. So we'll get a benefit from that.

In addition to that, one of the divisions of the new Federated, which is Federated North, which is the Marshall Field's, was not carrying anything from Fossil except watches. So we're going to get a pipeline fill in an ongoing business there that could be pretty significant, so we're going to gain there. I think the other piece of what could happen that will benefit us is I think Fossil accessories overall will become over the long-term a bigger part of the business, because we're a pretty significant strategic partner with Federated, and they've seen the growth that we have had there, and I think they're a big supporter of ours. So we think it's a plus long-term. And of course, as they close some of those stores, what may happen in some of those stores is they will become Penney or Niemans or Nordstrom, which we also sell in as well. So, we think we're going to pick up over time in those areas.

But you have factored a shorter-term hit to sales in your expectations for the first half of the year?

I would say we don't expect any big hit, but there could be some short-term disruption. I don't know that it's going to be even a noticeable or significant number, because of our large ongoing businesses that we had with May and Federated. I don't think there's going to be anything significant, really. There may be some discussion just as they assimilate the stores, etcetera.

But the other question you asked, which is are we going to get additional distribution in the United States for leather goods, the answer is yes. And it will be through the Macy's North or prior Marshall Field's company, which could be significant for us. In addition to that, we just feel we are in a position to continue to gain market share. The handbag business specifically has had very strong growth as a total business over the last three or four years in department stores. And our growth over the last year has accelerated, and our market share gains have been significant. And we think we're in a position to continue that trend.

And inventory in the channel?

That's another good question. We actually, as you saw, we had about a 19% decrease in wholesale shipments in the fourth quarter. We did not have a 19% increase in retail sales, which means that the inventories are pretty lean. I would say they're in very good shape, and positioned well for us to change the trend in the marketplace, because there's not a lot of inventory retail in the United States.

David Turner, BB&T Capital Markets.

Kosta, I think, in your prepared marks you had mentioned that overall the FOSSIL brand comped up 5%, showing some strength for the brand. I was wondering how historically the brand has behaved during lousy watch cycles. Has it exhibited similar growth overall, or is this kind of a reacceleration of the brand? And I know it's not apples-to-apples, because you've got new product lines, and I don't know if you could just give an idea or some sense of how the -- what the brand has done during previous cycles.

Obviously, if you go back to previous cycles, the brand was still growing at a very fast clip because of the addition of new categories. And the way you'd look at this and say, okay, in one of our worst years ever in FOSSIL watches we had an increase of 5%. We do know from information in our own stores and on our Website that some of our customers that might have bought watches from us in the past are now buying handbags from us. And research also shows that consumers are a lot more interested in handbags and small leather goods now than they are in watches. So we're getting the benefit of that.

The point is, I think, of all this is that even in our worst year we still had a pretty strong comp increase at retail. And that, I think, shows the strength of the brand, as well as some research we've done -- focus groups and other research we've done recently says that the brand is very healthy and in a position to get, we think, significant upside, in terms of brand relevance, and to develop more of an emotional attachment to the brand. And that's really what the 32-page catalog is all about, in addition to all the activities we do online. We think that we can kind of reposition and make the brand much more stronger. You could describe it as having more heat with the brand, that brings those customers into the categories that we're developing and building there. And just crosses all our categories and develops a more significant increase. So we think we're in a great position to do that in the next year or so.

Also, it sounds like you -- or it's fairly transparent that these cycles typically last seven to eight quarters. We may not be there yet, but it looks like we're getting closer to that point. Are there any things within the industry or within the markets that would suggest you can either shorten or lengthen it? I know you guys are doing what you can. I guess more from like a top-down view, is anything moving within the industry that is going to extend it or shorten this cycle?

I think it's too early to tell in the year, I think, for us to get an indication. Because as I said earlier, it's a slow time of the year. Inventory turns are generally not that fast. We are getting some response to some new things that we think are very encouraging, and we're going as fast as we can to implement them in the marketplace. So we're hopeful and we think we're on a good track, but until you see it happen in a large way, you hate to give any indication of that. But it's basically just sticking to what we do and then accelerating it. And that's what we're in the process of doing.

The catalogs that you mailed out in Q4, I was curious about the geographic distribution of them. Were they focused in markets (technical difficulty) you've got a lot of retail stores now, so it may not be an obvious answer. But was there any -- were you trying to drive traffic to the retail stores, or were you trying to drive to wholesale? Was there any thought behind how they were distributed? Or was this just a test, and it was really not that much science to it?

It wasn't really geographic as much as demographic. There was a million pieces that we shipped out to our own mail list, which includes prior Web customers and warranty customers, etcetera. In addition to that, we tested a number of other lists (indiscernible) other catalogs. It was very encouraging. We had the ability to take somewhat small quantities of someone else's mailing list, test it, and then if it works, you can expand the next time. It's a great measurable advertising vehicle that also drives sales. So we were very encouraged by the response that we got, because this was, as you know, our second catalog. It was all done in-house, and the response was very strong and encouraging.

So, what he have is somewhat of a three-legged stool. We want to continue to increase our brand awareness and position the brand, make it more aspirational with three things. One is the Web, the stores and the catalog. And AS you know, our Website gets very strong traffic and continued to last year. We had about a 30% increase full year, and very strong traffic all during the year. Our stores, obviously, are big traffic and brand-building vehicles. And the catalog, we think, has got a big potential to drive sales to both the store and the Website. And that's exactly what we saw. A significant number of the sales that we were able to track from the catalog were actually purchased through the Website. We can do that through a computer model of match-backs. Basically we're very excited about it and we are going to continue to do it this year. And we think it's a great vehicle, because it's basically a 32-page advertising vehicle that can potentially make money. So it's, we think, a great opportunity for us.

John Rouleau, Wachovia Securities.

A couple of questions. Mike, without quantifying anything, just wondering if you can kind of maybe rank or talk a little bit about the product segments and the gross margins associated with it. Obviously, your mix is shifting a bit here. We want to think about gross margins in that context. So, maybe both from a category standpoint -- luxury watches, fashion watches, handbags and jewelry -- I'm assuming that they kind of stack up high to low in that order. And then maybe a comment on domestic versus international. Any color around that would be helpful.

As we've always talked about, our most profitable business, both from an operating margin and a gross margin perspective, are our international operations, primarily due to gross margins being higher due to the fact that we are, obviously, able to price our products at amounts slightly higher than the U.S. equivalent wholesales and retail. And in a number of those countries we're doing business with smaller mom-and-pop boutiques that, obviously, allow us to be a little more focused on driving margin.

If you look at the domestic businesses, our accessories business is generally a 40 to 45% type of margin producer. And that depends somewhat within that range on the mix of FOSSIL versus RELIC. RELIC is a little bit lower margin than that, obviously, because we're selling to J.C. Penney's and Kohl's, and we allow those guys be promotional with the RELIC product, whereas with the FOSSIL product it's primarily done at full price.

As it relates to the domestic watch business, our FOSSIL watch business, which is the largest piece of that, is obviously a significant contributor as far as margins, probably 50 to 55% range. But what we have seen domestically is some of the gains we've seen from the increase in the MICHELE business and some of the other luxury brands have been offset by growth in the mass-market channel as well that, as we've talked about before, performs at a much lower level than our typical fashion or luxury watch business.

And then the retail stores on average are going to be a little bit better than our domestic watch business, simply because we have the opportunity to sell at retail in those stores, and on a full price basis, drive margins near the 75% level. But due to the mix of our outlet stores, which obviously sell at much lower margins than that, our retail business is probably coming in in the 55%-plus range as well.

Just drilling down on the accessories a little bit, much of a difference between handbags and jewelry. Maybe is jewelry a little bit lower just because of the newer status of that business?

I would say from a gross margin perspective, jewelry is actually a little bit higher. But from, obviously, an operating margin perspective, we're still not leveraging the infrastructure that it has taken to build that business. The addition of MICHELE and DIESEL watches in 2006 will go toward that leverage.

Switching gears a little bit, the handbag market has been great for the last couple of years. You guys are obviously taking some share there. If you look at what's driving your U.S. handbag business, is it door count, or is it expected to be door count? Is it a higher number of SKUs? Is it increases in ASPs? Give us an idea of kind of where the growth is coming from in handbags.

As we mentioned earlier, we are going to get additional door growth with that Macy's North division. That will be significant. We also -- our average unit retail is going up, and that's going to be a benefit to us. And we're getting more space, basically, in the rest of the doors that we're already selling in. So in some cases, what's happening is there are some lower-priced manufacturers that are going to be dropped out of their assortments in some of the stores, and we're going to benefit from that. We will become sort of a -- the positioning that we're in, if you say three years ago we were rather high-priced in that assortment. In the next couple of years or so, as the department stores drop out some of those lower prices, we become more of the moderate or opening price guy, which gives us even more benefit and sellthrough in more space.

Regarding the FOSSIL jewelry launch of that here in the U.S., I'm assuming that we'll probably see that in the retail stores first. I'm also assuming that will probably be positioned from a price standpoint kind of in line with the handbags and the watches, or maybe somewhere in between. And then, when might we see that at wholesale?

You're right; it's going to be consistent pricing with the watches and the handbags. So, it's going to be somewhat moderately priced; a lot of great styling and value for the money. And we're going to be launching most likely end of the third quarter or early fourth quarter, and probably to a small number of department stores, in addition to our own stores.

Okay, so simultaneously. Last question. BURBERRY is doing quite well on the watch side. Correct me if I'm wrong, I don't think there is a jewelry license out there by anyone held by BURBERRY. Maybe you could just talk about that opportunity, and other opportunities to perhaps sign jewelry licenses in instances where maybe you don't have the current watch license.

That's right; BURBERRY does not currently have a jewelry license, so we have had some discussions with them. So that, I think, potentially is possible at some point in the future. We do have a rather large opportunity with FOSSIL alone. If you look at what's happened in Europe, we expanded that to Asia and the United States. And in addition to that, we are just starting both MICHELE and DIESEL. So we've got some things on our plate. So if that happens sometime in the future it would be nice. But as we've said before, we do think long-term there is an opportunity for us to piggyback jewelry with watches globally in different brands, and it has the ability to both leverage the Company and give us a larger potential long-term size of the Company. So, we think it's a great opportunity for us.

Ladies and gentlemen, this does conclude our question-and-answer session. Mr. Kovar, please go ahead with your closing remarks.

Thank you. Should you want to replay this conference call, it has been recorded and will be available from 10 AM Central Time today until 5 PM Central Time tomorrow, and you can call 303-590-3000 and enter reservation number 11049336. Again, that number is 303-590-3000, reservation number 11049336. 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, if 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 May for the release of our first quarter 2006 operating results. Thank you.

Ladies and gentlemen, this does conclude the Fossil fourth-quarter earnings conference call. You may now disconnect.