Fossil Group Inc (FOSL) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Fossil third quarter 2007 earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Tuesday, November 13, 2007 and at this time I would like to turn the presentation over to Allison Malkin with ICR. Please go ahead.

Thank you. Before we begin you should be aware that during this conference call certain discussions will contain forward-looking information. Actual results could differ materially from those that will be projected during these discussions. Fossil's policy on forward-looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is readily available in our form 10-K and 10-Q report filed with the SEC.

In addition, Fossil undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. If any non-GAAP financial measure is used on this call a presentation of the most directly comparable GAAP financial measure and a reconciliation of the non-GAAP financial measure to GAAP will be provided as supplemental financial information to this release, under the earnings release section of the Investor Relations heading on Fossil's website.

Please note that this call is being webcast live on Fossil's website. It will be available for replay on the website under the Investor Relations heading after the conclusion of the call. And now I would like to turn the call over to Fossil's CEO, Kosta Kartsotis.

Thanks, Allison. Good morning and thank you for joining us today. Also with us today are Mike Barnes, President and COO and Mike Kovar, our CFO. This morning we will give you an overview of our Q3 results plus some additional insight into our operations and initiatives. At the conclusion of our prepared remarks, we will welcome your questions.

The Company performed very well during the third quarter as we continue to execute on our key growth strategies and margin expansion initiatives. While we have experienced moderate growth in the United States, we are continuing to reap the benefits of our global business platform as we experienced strong growth in Europe and other parts of the world. This allowed us to exceed our financial expectations.

In addition to our solid financial performance this quarter we also continued to advance each of our key strategies including maximizing the potential of our brands internationally, expanding our direct to consumer businesses and increasing the Fossil brand worldwide. In total, third quarter net sales rose 19.6% to $359 million driven by our international, direct to consumer and accessories businesses. On an adjusted basis, including costs associated with our equity granting practice review, diluted EPS for the third quarter increased by 48% to $0.46 per share.

During the third quarter we continued to broaden our product offerings through our launch of Fossil jewelry, cold weather accessories and our upscale, premium priced Fossil Fifty Four handbag collection. In addition to these highlights I would like to point out a couple of areas of our business that continue to deliver solid performances. International sales rose 25% excluding currency impact and for the quarter more than 50% of the total Company sales were done through overseas wholesale activities. European sales advanced 18% in local currencies with sales increases in all markets and in all of our major businesses. We are also pleased to announce that our leather goods business at wholesale grew 41% in Europe so we are making inroads there, as well.

Additionally, we are experiencing significant gains in Eastern Europe and the Middle East. Our shipments to distributors in these areas increased by 65%. Our other international segment, which consists of the Asia-Pac region, Canada, Mexico and our export sales from the United States continued its growth with sales advancing 40%. We are continuing to grow our market share in many of these underpenetrated markets in the segments. We remain focused on maximizing our international expansion opportunity, especially given that the mark is vast and that our international business is our most profitable business.

Fossil brand of net sales in all categories rose 15% during the third quarter as we capitalized on expansion opportunities in watches, Fossil retail, accessories and jewelry as well as the previously mentioned new product initiatives. Global Fossil watch sales increased 14% excluding currency impact and off price sales, with our Europe segment increasing at a 21% rate and our other international segment expanding at a 42% rate. We believe successful innovation in our watch offerings as well as the ongoing repositioning of the Fossil brand to be the primary driver of these results.

Additionally, we are continuing to broaden the brand's awareness through our retail store expansion, increased catalog mailings and an expanding Web presence as evidenced by the launch of our Ecommerce business in Germany during September. Our direct to consumer segment reported healthy gains on top of strong results a year ago with net sales increasing 18.5%. And more importantly, we experienced a robust 13.4% comp globally in our accessories store concept which as you are aware is the focus of our retail expansion plan.

We are also very pleased with our financial performance as we continue to make progress towards our stated goals. Our gross profit margin expanded 270 basis points to 52.1%. This was due to three things, the currency impact, our companywide margin initiatives and to the mix towards more international businesses. The operating margin rose 250 basis points to 13.5% of net sales, 14.4% excluding option related expenses. And for the first nine months of the year our operating margin excluding option related expenses has increased to 12%, a 51% increase from the prior year.

We believe the progress we are making to date on our gross profit and operating margin expansion has us well positioned to meet our long-term financial objectives. We also improved upon an already healthy balance sheet. Cash rose by $117 million to $193 million and inventory once again ended below last year's level despite our double-digit sales growth. We also ended the quarter with only $15 million in debt.

Given the strength of our balance sheet and the completion of all prior stock buyback programs, we are pleased to announce today that our Board has authorized the buyback of up to 2 million shares which we expect to begin this month. Now I will turn the call over to Mike Barnes for more details.

Thanks, Kosta. Good morning, everyone. I am going to start with a review of our domestic business. The domestic wholesale watch shipments increased by 5.7% excluding discontinued product sales from the current prior year quarter. This performance was primarily the result of sales growth in licensed watches and our own Michele and Relic brands, which was partially offset by sales declines in Fossil and mass-market watches. Sales of licensed watches rose by 29.4%, driven by sales increases in DKNY, Michael Kors, Burberry and Marc by Marc. Sales growth was aided by continuing door growth for our DKNY and Burberry brands primarily through our US department store locations. Both Michael Kors and Marc by Marc are still relatively new being in only their third and second year of existence, respectively. The bulk are performing extremely well at retail and gaining market share.

Additionally, we are optimistic about gaining further leverage in certain of our licensed watch businesses as the brands continued to increase overall. Michelle wholesale shipments were up 24% for the quarter and the brand remains the best selling luxury fashion watch in Nordstrom's. Michelle was also highlighted at Neiman's during their 100th anniversary celebration. Additionally, we are going to be launching Michelle sunglasses in the spring of 2008 with a signature line priced from $295 to $395, and a diamond collection priced from $395 to $1195. Finally, we remain on target for our Michele jewelry launch in Q2 of 2008, as well.

Fossil watches reported a 6% decline in domestic wholesale shipments excluding off price sales reflective of an uneasy retail environment which has resulted in the tightening of inventory levels at our retail customers. Fossil watches represent our largest US business with sales increases dependent on comp store growth versus door growth in the wholesale segment. However, it is important to note at the sellout level Fossil watches continued to generate solid sell-through rates in our department store accounts, specialty retail stores and our own stores which we believe reflects the improved innovation in the product range and modern vintage design in the current assortment.

Our mass-market business posted a sales decline in the third quarter, as well, primarily due to a shift in shipments into the second quarter. If you recall, during the second quarter we reported a 69% increase in wholesale mass-market shipments. Year-to-date our mass-market shipments are consistent with our expectations, and we expect this business to grow on a full-year basis. We've recently launched Callaway brand into Target chain. We believe this initiative in addition to our current positioning in the channel will provide us with long-term growth opportunities.

Regarding accessories, our domestic accessory business enjoyed a strong rebound from last quarter with shipments increasing by 12.3%. Our strongest performing category was handbags, and we saw strength in both Fossil and Relic. Increases in handbag shipments were partially offset by declines in our small leather and belt categories. Fossil women's handbag wholesale shipments increased by 18% during the third quarter. As you recall, we had a difficult spring in handbags primarily due to missing the mark on our fabric lines. As we move into the fall winter season, leather becomes a much higher component of our handbag assortment, and we are seeing better selling results in many of the new groups we launched during the quarter which are replacing much of our legacy core leather product. We are also experiencing average unit price increases of 20% plus in comparison to last year as we continue to add value to the products. And consumers are responding favorably to these higher price point items. Men's bags, although it is not a significant business at this point, continue to show impressive results with wholesale shipments of 86% during the quarter.

Finally, we are pleased with the results we are experiencing with the initial launch of the Fossil Fifty Four handbag line into approximately 50 department store doors. We are confident that this product can grow to a much larger presence long-term. And the Fossil Fifty Four productline continues to show strong performance in our own retail stores. Our core Relic bag line continues to perform well at Penney's and Kohl's, and we are seeing great response to the new executive totes that have recently been added to the collection. Additionally in our continued initiative to broaden our accessories business internationally, we are planning to launch Relic handbags into Germany during the second quarter of 2008.

Now I will give a little color on the international markets which drove over 50% of our overall Q3 sales and even more on a wholesale base. Our total international business had a terrific performance for the quarter with net sales increasing 32.3% or 24.9% excluding currency. In Europe the sales rose 28.1% or 18.4% ex currency, with contributions across all markets. We experienced strong growth from our Fossil and our licensed watch brands as well as our Fossil and Emporio Armani jewelry businesses with all of our major markets in Europe achieving double-digit sales increase.

In our other international segment wholesale shipments rose by 42.1% or 39.9% ex currency. We experienced strong double-digit growth across all of our major owned and licensed watch and jewelry brands in the segment and all of our operating subsidiaries experienced double-digit sales growth. As we've mentioned on previous calls, our shop-in-shop concepts in the Asia-Pacific region continue to build awareness for our brands and are allowing us to gain market share within the department store environment. Our China distribution business which we launched in the fourth quarter last year, generated about $1.3 million in sales during the third quarter. While this represents an insignificant piece of our consolidated revenues, we are beginning to build awareness for our brands in this region, and we believe it will result in significant revenue growth over the longer-term.

We also just opened our subsidiary in India. Similar to China, we believe India represents a significant opportunity for our global watch and jewelry business especially considering the significant retail developments we see occurring in this country today.

Our Mexico subsidiary which we acquired in February of 2006 continues to outperform our expectations. We experienced a 61% increase in wholesale shipments during the quarter. In addition to increasing the presence of our global watch portfolio in the market, we've developed a solid accessories business in Mexico with non watch product accounting for about 23% of the sales here today. And as we've mentioned before, Mexico also provides us with a solid opportunity for broadening our North American retail presence in the future.

On the global jewelry front wholesale shipments of branded jewelry rose by 39% during the quarter, primarily as a result of continued sales volume and door growth in Fossil and to a lesser extent Emporio Armani jewelry. Additionally, the launch of the Fossil accessories jewelry line into approximately 550 US department store doors during the third quarter contributed approximately $2.4 million to the overall jewelry increase. Early retail selling results have the line performing at sell-through rates in excess of the overall department store jewelry category. We believe branded jewelry is a significant growth opportunity, and we are continuing to explore options to broaden the presence of this category through both brand extensions and expansion of our current geographical footprint.

Now turning to our direct to consumer businesses. On a global basis we experienced solid contributions from our retail stores during the third quarter. Sales from our direct to consumer segment rose by 18.7% or 17.1% excluding currency. As a result of a 14.5% increase from retail store door growth and a 5.9% comp store increase in 178 stores, and a 14% increase related to our Ecommerce business. Store sales from our 63 full price Fossil accessories stores actually increased by 13.4% on a comp basis globally. While overall global store comps were negatively impacted by lower comps in our outlet stores due primarily to the reduction of our discontinued styles, it resulted in vastly improved outlet store gross margins.

Globally, we ended the third quarter with 225 stores, including 97 full price accessories stores, 48 of which are outside the US; 79 outlet locations including 5 outside the US and 33 apparel stores and 16 multibrand stores. This compares to 191 stores at the end of the prior year quarter, which included 69 full price accessories stores of which 29 were outside the US and 76 outlet locations with 3 outside the US, 32 apparel stores and 14 multibrand stores.

During the third quarter we opened 24 new doors including 19 full price accessories stores with no store closings. For the fourth quarter we expect to open an additional 19 stores, 18 of which are full price accessory stores with equal distribution between locations inside and outside the US. For 2008 we are planning to open between 80 to 85 stores concentrating on the full price accessory concept with firm commitments in place right now for about 36 locations.

The trailing twelve-month performance on our full price accessory stores is as follows. The average sales per square foot is about $558. Our four wall pretax contribution margins are 25.9%. Return on invested capital, 44% with a payback in approximately 27 months. Our typical accessory store build up is about $500,000, and our average inventory level in a new store is around $62,000.

At this time I am going to turn the call over to Mike Kovar to discuss our third quarter financial results.

First I would like to once again summarize the results of our third quarter in comparison to the prior year quarter. Net sales increased 19.6% to $358.6 million compared to $299.7 million. Gross profit grew 26.2% to $187 million or 52.1% of net sales compared to $148.1 million for 49.4% of net sales.

Operating income increased 47% to $48.5 million inclusive of $3 million of expenses related to our historical equity granting practices review which I will refer to here on out as the grant review. And that is compared to $33 million in operating income last year.

Net income rose 41.4% to $30.5 million inclusive of $1.9 million of grant review related expenses compared to net income of $21.5 million. Diluted earnings per share increased 38.7% to $0.43 inclusive of $0.03 per diluted share of grant review related expenses, and this compares to $0.31 per diluted share last year. And finally, diluted weighted average common shares increased 2.3% to 70.3 million compared to 68.7 million shares last year.

The mix breakdown for the third quarter was as follows; 17.4% from domestic wholesale watch sales; 15.3% from domestic wholesale accessory sales; 17.3% from worldwide direct to consumer businesses; 33.6% from European wholesale sales; and 16.4% from wholesale sales and other international locations. The 19.6% sales growth for the quarter consisted of the following increases and decreases by category and geographic regions.

Domestic watch sales decreased approximately 1% to $62.6 million compared to $63.2 million in the prior year quarter. Other domestic sales, which include our leather, sunglass and jewelry businesses, increased 12.3% to $54.8 million compared to $48.8 million in the prior year quarter. Sales generated from European based wholesale operations increased 28% to $120.6 million compared to $94.2 million in the prior year quarter. Other international sales increased 42.2% to $58.6 million compared to $41.2 million in the prior year quarter. And finally, sales from our worldwide direct to consumer businesses grew 18.5% to $62 million compared to $52.3 million in the prior year quarter and as Mike mentioned this was the result of 14.5% growth in the average number of doors open during the quarter. Comp store sales increases of 5.9% globally and a 13.9% increase from our Ecommerce based businesses.

Third quarter gross profit margin increased by $38.9 million to $187 million compared to $148.1 million in the prior year quarter and this reflected a 270 basis points increase in gross profit margin to 52.1% in the third quarter compared to 49.4% in the prior year quarter. The gross profit margin was favorably affected by an approximate 140 basis point improvement as a result of a weaker US dollar. Additionally, a sales of mix shift toward higher margin international sales and improved gross margins as a result of our focus on product margin improvements, inventory initiatives including reduced levels of low or no margin off price sales, and higher store outlet margins contributed favorably to the increase in gross profit margins.

Operating expenses as a percentage of net sales increased 20 basis points in the third quarter to 38.6% compared to 38.4% in the prior year quarter. Total operating expenses increased $23.3 million in comparison to the prior year quarter to $138.5 million which included $3 million of grant review expenses. Excluding the expenses associated with the grant review, third quarter operating expenses increased $20.3 million or 17.6% in comparison to the prior year quarter and as a percentage of sales decreased to 37.8% from the 38.4% (inaudible) in the prior quarter. This overall operating expense increase is primarily driven by an $8.2 million or 33.6% increase in our direct to consumer segment. This is primarily due to retail store growth including preopening costs and related infrastructure additions including a new merchandising system and increased field sales personnel and construction resources to support global retail store growth.

Operating expense increases also included $3.5 million in expenses related to the translation impact of foreign-based expenses as a result of a weaker US dollar. Additionally, operating expense increases included costs related to new category launches during the quarter and increases in expenses as a result of higher levels of sales. One item to point out excluding the direct to consumer and grant review related expenses, our operating expenses increased 13.3% in relation to a 19.9% increase in our global wholesale net sales.

Operating profit increased 47% in the third quarter to 13.5% of net sales compared to 11% of net sales in the prior year quarter as a result of increased gross profit margins partially offset by a slight increase in operating expenses as a percentage of sales. During the quarter operating income was favorably impacted by approximately $7.2 million as a result of the translation of foreign sales and expense into US dollars.

Interest expense of $174,000 during the quarter decreased from $1 million during the prior year quarter. And this decrease is principally due to the payment of previously outstanding borrowings on our U.S.-based revolving line of credit at the end of fiscal year 2006. It, which you recall was used primarily for common stock repurchases made in late 2005 and early 2006.

Other income and expense increased favorably by $1.4 million during the third quarter. This increase is primarily related to increased interest income resulting from higher levels of invested cash balances and increased foreign currency transaction gains. Income tax expense for the third quarter in prior year quarter was $19.2 million and $10.4 million respectively, resulting in an effective income tax rate of 38.7% and 32.6%, respectively. The lower effective rate for the prior year quarter was a result of a reduction in our 2005 federal income tax liability and the result of reconciling our 2005 tax provision to our return filed in September of 2006. For the fourth quarter of fiscal year 2007 we estimate our effective tax rate will approximate 37% to 38%.

Now turning to the balance sheet, at the end of the third quarter cash, cash equivalents and short-term investments totaled $193.4 million compared to $76.5 million at the end of the prior year quarter, and we had approximately $3.4 million of long-term debt which was added in Q3 as a result of the purchase of our previously leased European headquarters office in Basel, Switzerland.

Accounts receivable increased by 20.6% to $203.4 million as compared to $168.7 million at the end of the third quarter of last year. Days sales outstanding for the third quarter increased slightly to 52 days from 51 days last year. And this increase in DSO was primarily due to higher levels of international sales that generally result in slightly longer collection cycles than those experienced in the US.

Inventory at quarter end was $266.2 million representing a decline of 1.4% from the prior year quarter inventory balance of $269.9 million, despite an additional 34 retail doors being opened since the end of the prior year quarter and a much weaker US dollar. Todate capital expenditures totaled approximately $24 million and we're expecting full-year 2007 CapEx to be between $35 to $40 million, with the increase in the fourth quarter primarily related to additional retail store growth and additional building improvements to our Richardson corporate offices as well as normal maintenance CapEx type items.

Depreciation and amortization expense for the first nine months of the year was approximately $24 million, and we're estimating full-year 2007 depreciation and amortization expense of $33 million. As it relates to guidance for the remainder of the year, we estimate fourth quarter and full-year 2007 diluted earnings per share on a GAAP basis will approximate $0.67 and $1.67, respectively. Excluding grant review expenses of $0.12 per diluted share, diluted earnings per share is expected to be around $1.79 for the full-year 2007. We estimate net sales growth in the 13% to 15% range for the fourth quarter of fiscal 2007, and our net sales and earnings guidance reflects the current prevailing rate of the US dollar compared to other foreign currencies, primarily the euro and the pound.

In summary, we are very pleased with the results for the quarter and the strength of the business across geographies, brands and categories as we begin the fourth quarter and holiday season. We believe our diverse business model is one that will support our long-term goals. We expect to increase sales by approximately 13% annually reaching $2.5 billion in total sales in 2012. Retail expansion, international growth and the expansion of the Fossil brand globally are expected to drive these increases. We also expect the increases to result in higher levels of profitability.

We are committed to the strategies that are expected to lead to the strong earnings growth and increased value for all Fossil stakeholders. We also would like to give a special thanks to all Fossil employees around the world for such a terrific performance. The Company has come a long way and is in a position to do even better. And now we will turn the call over to Q&A.

(OPERATOR INSTRUCTIONS) John Rouleau, Wachovia Securities.

It seems like on the international side that there is really strong breadth across your sales growth. Could you talk a little bit more about that? Is it really just pretty evenly split between the license watches, the Fossil watches? I guess the Fossil handbags and the jewelry, both on the Armani and the Fossil side?

John, as you know, our international business is quite a diverse business as it relates to markets that we operate in and as well as even becoming more diverse in the products that we offer. As Mike mentioned I think in his portion of the call, we saw double-digit increases in all major subsidiary markets during the third quarter, and that would include both Europe and the Asia-Pacific region. On a product or category basis we're seeing strength across the board in both Fossil watches and license watches as well as both of our Armani and Fossil jewelry categories. I think Kosta mentioned that Fossil in Europe was up 21% for the quarter, and again Europe is a little more penetrated than the Asia-Pacific region where we saw a 42% increase in Fossil and the license brands were having similar type increases across the international marketplace, as well. So I think we are well positioned. We've got a lot of strength behind all of our businesses in those regions and we're expecting that obviously to continue for the balance of the year.

Also John, I would mention that the world is a big place, and there is a lot of undeveloped opportunity still out there. What we see in some of our lesser penetrated markets or some of the smaller markets like even places like Eastern Europe, we are seeing great sales gains. China is just starting to get off from its fourth quarter opening last year and we just opened our offices in India. So there is a lot of opportunity to further develop the international market, and that will continue to be one of our main focuses going forward.

Terrific and kind of switching gears a little bit to the US wholesale environment particularly on the watch side, Kosta or Mike, at some point should we expect to see some increases in Fossil watches here? You made two comments one, the business was down a little bit but two, that the sell-throughs were actually pretty good or the sales rates are actually pretty good. So is this more a function of the department stores bringing inventory levels down, or how should we think about that?

Well, the fact is, John, is that our business has changed quite a bit. And the fact we are last quarter our Fossil domestic wholesale watch business only 20% of it is found in the United States. So it is a small number. It is also because of the wholesale nature of it, it doesn't always track our sales. We've always said that. For example if we are slightly down last quarter it doesn't mean our sales were down at retail. The best indicator right now is probably our retail stores and I think we are, our comps for the US were up 9.6% in our accessory stores. That is really a better measure of the brand because the wholesale shipments flow different every quarter. So I would look at that.

And the one thing I would say is obviously the retail traffic looks to be somewhat of a headwind in the United States. But our repositioning and what we are doing with the brand is putting us in a position where we're going to have increases in the United States; the brand is going to get stronger. We are going to build more stores. We are sending more catalogs out. The Internet is going to grow. And with this repositioning we are only part way into it, but it is going to put us in a position where we are going to grow the brand and I think pretty dramatically over the next several years, in the United States.

And then last question is the Fossil jewelry at wholesale and the cold weather accessories, I believe you ship that at wholesale, as well. Any early read on some of the sell-through rates in those two newer categories at wholesale?

The jewelry I think went to about 550 stores in the second quarter and is doing very well. It's going to expand next year so it is on a good track, that's for the United States. Cold weather accessories just hit, and we have seen some strong results even though the weather has been a little warmer in the United States. So that's probably going to be a good business for us also; even though it is small, it will be a good business.

Great. Keep it up. Thanks.

Neely Tamminga, Piper Jaffray.

Let me just add my congratulations to just a stellar global business. A couple things here just want to ask about; Kosta, from your perspective, from a merchant perspective, particularly jewelry I think is clearly going to be just a category choice. You are indicating you are seeing some pretty good reads on the initial stuff that you have in stores right now. Just wondering do you think that this is from your perspective something that has legs to it? I mean this jewelry cycle that we're going into and I just have a related question to handbags after.

I think, as you know we do quite a bit of business globally in jewelry and it's a big opportunity for us with fast growth and it has been in the past one of our most efficient businesses, most profitable, not very much obsolescence of inventory and we're just expanding that experience to the United States. So we think it is going to be good here. They are so small at this point, we're just starting that it is hard to say what the result is going to be long-term. Except to say the positioning of the brand in the department stores in the United States is in a very strong position. There are some brands in the department stores that are leaving that environment and the Fossil brand is getting stronger in that environment. So we are very optimistic about the future and the expansion not just in jewelry but all our other accessory categories, leather goods and obviously watches as well in the United States in department stores.

Then in terms of handbags and things, in terms of handbags do you think that you are gaining share from brands around you? Do you think it is a price point trade down from other brands into your brand? Clearly the product does look better, and I think it is resonating with the consumer. But just wondering, all indications right now is that the handbag category right now doesn't seem to be expanding. So do you think you are taking share from others around you?

You'd have to say with an 18% growth we are probably gaining market share. And again I think it gets back to positioning. We are not the most expensive guy in the department and not the less expensive but we, as the brand gets stronger and as our position and the repositioning of the brand gets stronger we feel like we have a large opportunity. And our leather bags, the 54 that went in there, kind of a leadership price point did extremely well in a small number of doors and it is going to expand.

We also have an opportunity I think as kind of a moderate leather handbag guy long-term there that will give us a larger opportunity. And I think if you look at this repositioning we are doing with the catalog, it has the impact I think of potentially putting us in a position where we can grow handbags even faster in the United States and around the world. We also are doing a test in the fourth quarter of a handbag-only catalog that we're going to mail to some of our customers, try to accelerate that. And if you go into one of our stores right now you will see that little handbag catalog in the store next to the handbags. So I think long-term we are in a position, because the handbag business is so strong, because our brand positioning, I think we are long-term in a position where we can gain more space and more market share.

And just one more housekeeping item for Mike. In terms of the store openings for next year, the 80 to 85 cited, is that on a gross basis or a net basis? And then just kind of generally speaking what do you think is happening with respect to sourcing costs coming out of China? Are prices going up? Are we holding flat or is this your full price sell-through or just busting any sort of price increases?

On the store side we think we're going to open between 80 and 85. There may be a few closures, probably the most would be 5 but the 80 to 85 is a net number.

Your question on sourcing in China is that we are seeing -- we have seen some pressure on the cost of raw materials, but the reality is that the cost of raw materials such as stainless steel, etc., is not a big part of the cost of our products. There is some tightening of the labor market in China, as well, that is something we are keeping our eye on very closely and we're doing a lot of research as to how to guarantee the future of our sourcing in the future.

Thanks, guys, and good luck.

Elizabeth Montgomery, Cowen & Company.

Congratulations on the quarter. I guess I had a couple questions about the European business. Could you just review for us how big Germany is as a percentage of the whole; maybe give us an update about how the brand is growing in some of these newer markets like the UK?

We generally don't try and get that time granular in the analysis. I would say that Germany is our largest market in Europe, primarily due to the fact that we owned that business since we went public back in 1993. So we've had an opportunity for many years of penetrating. The other specific thing about Germany is it is probably more penetrated in the Fossil brand in the market than we are in the US, so it is a very strong market for us. I would say all the other markets that we distribute through in Europe are significant opportunities for us for larger levels of growth just due to the fact that we are nowhere near the penetration levels we are in Germany.

But overall in Europe we are seeing strength across the board. There is not just one or two markets. We are seeing it in every market that we have a subsidiary company in, as well as the distributor market. So the strength is definitely across the board and not in one or two places.

Okay, that is helpful. And I had a follow-up on, I guess it was Kosta saying that the leather goods business in Europe was up 41% at wholesale. I know that is not a significant business so far but I wondered in terms of the price of those products versus what the handbags are in the US, are they priced comparably to the US or are they priced a little bit higher? And where do they fit in relative to the competition in the European market like a Furla and Longchamp and all those brands?

The price is probably on average I would say 30% or so higher than the US which is typical for all our products. And we are seeing very strong growth there. We think a lot of that is being accelerated by the stores we are building there. I think we're going to end the year something like 26 stores there. Potentially that could double next year so as we've been talking about, we are working on a companywide initiative where we as a Company would put more resources in Europe and try to grow it even faster. It is a less competitive market, they love American brands. It is a more profitable business plus there is a euro impact so for us to continue to push it in every way we can, we think is a big opportunity for the Company and we are seeing great results out of the stores. And as Mike said, in every market that we go into. So it is a very interesting thing for us, and we're expanding it as fast as we can.

All right. Thanks, guys, and congratulations.

Barbara Wyckoff, Buckingham Research Group.

Great job. I have two questions; outside of entering China and India, what countries and regions are logical next steps toward sort of big growth either by acquisition of subsidiaries or joint ventures? You mentioned Eastern Europe, Middle East; what about South America, if you could comment on (inaudible) and I have a second question.

As far as the growth internationally, we have really expanded our subsidiaries over the last five years throughout Asia. South America is a market that we're paying a lot of attention to, particularly we just bought our Mexico subsidiary last year. And we have focused on our distributors in South America particularly in Brazil which is a very large market for us there. So that is probably going to remain to be a third-party distribution business for us but it is something that we are getting more involved with and we're getting focused on it, and we are working a lot more in conjunction with our distribution partners in South America than we ever have in the past.

The same thing for Asia. I would say there is a big opportunity for us to continue to grow our businesses in Asia. We just opened China last year in the fourth quarter and India this year just recently actually. So that is going to be a huge focus for us. We continue to work with our distribution partners. We have great distribution businesses that we do not own in places like Korea. We did open our own office in Korea within the past year to focus on some of those businesses, but we still have a third party distributor, as well. Places like Thailand, etc. are also opportunities.

Europe has a big opportunity for us I think possibly in some of the ex Eastern Bloc type countries. We are seeing big increases in the economies in places like Poland and Czech Republic, Hungary. Those could be opportunities for us in the future. We're going to stay opportunistic. If we see an opportunity to either open our own offices or work with somebody on a joint venture basis, we are going to look at that very closely. Meanwhile, we're going to continue to develop our third-party distributors which are doing an excellent job for us. And many of these people have been with us for a number of years and they continue to grow the businesses at a rapid pace.

Thank you. Last question. Could you please update us on the status of Adidas? What is going on with that?

Adidas is pretty much the same as we discussed the last time, and that is we launched it last year, and it was the biggest launch we ever did. It was global. We kind of read the results of it this year. We are seeing where the consumer is voting on what type of products, the digital, the analogs, the different looks and we are adjusting to that. And so this year is really kind of a flat year for us in Adidas, where we are getting those reads, we're making adjustments for the future, and we think the next year is the best opportunity for us to begin growing the brand again.

Okay, thanks. Keep it up.

Robert Samuels, JPMorgan.

Just one question. Was curious about how we should think about SG&A growth as we move into next year. I guess as retail continues to become a larger piece of the business.

If you recall in the analyst day presentation a few weeks ago we talked about in the five-year plan the expectation for SG&A leverage was minimal. I think we talked about 30 to 40 basis points into the future. Primarily due to the fact that retail is expected to grow at a much faster pace than our wholesale operations. And as we've said then, the retail component of SG&A is more significant as a percentage of sales than that of our wholesale businesses. And obviously, the margin component of our retail businesses is much more significant as well. So what we expect to see next year, and next year will really be the first year I think it becomes somewhat pronounced, is probably SG&A leverage slightly improving as our wholesale businesses continue to leverage the investments we've made over the last few years. But the investment in our retail organization to build out the construction group to be able to manage 80 to 85 door openings, to broaden our field management and to bring on some additional system needs, will probably pull the SG&A leverage down slightly.

Great. Thanks very much.

(OPERATOR INSTRUCTIONS) Cliff Greenberg, Baron Capital.

Congratulations. Can you give us a little more color on where you opened accessory stores in the third quarter and where you're hoping to in the fourth quarter and how they are doing so far? Or just whatever color you can give, it seems like the rollout is going very well.

We are opening a number of stores around the world, quite honestly in Europe and the US. We just opened a store in Hawaii. There's one opening in Las Vegas this week. So it is a pretty busy time for us, and what we've said before is that obviously the European stores as we mentioned before have actually outperformed stores in other parts of the world, but we are seeing a very strong experience everywhere we open stores. In Austria it was very strong; it started last year and every store we've opened there has been very strong. We are now getting very good experience out of the stores we opened in Hong Kong last year, they started off very slow and now they are very strong. So Asia looks like a big opportunity.

We are opening a store in Beijing right next to the Olympic Stadium next year which we think is going to be a good store for us. Just about everywhere in the world it is really interesting when we put this accessory assortment in the store format in our new repositioning customers come in and buy from us, and the stores do very well. So we are very bullish on the retail in long-term.

Are you opening up different footprints in different locations and what is the mix between accessories and watches or other in the stores at the moment?

Stores in the United States are, I think we are targeting 1500 square feet. Outside of the United States stores are smaller especially in Europe. Typically slightly less than half the business is watches. And if you look at the store in the new footprint it looks like an accessory store. One of the things we are trying to do is grow the accessories business, the leather goods business is a part of it because it is much larger business totally than watches is and there's a big potential for us to grow. For example, if handbag currently is 15% of our retail business, it has the potential to be 30% or so, so it should add comps long-term as we get more and more traction in leather goods.

Great. Okay, good luck. Thank you.

John Rouleau.

A couple more. As far as gross margin is concerned you obviously benefited from the mix shift in the euro but I am wondering you got this big margin initiative in place. I know that was due to kick in in the second half, predominately I guess I think in the fourth quarter. Wondering what kind of margins you are getting out of some of your newer watch styles. I think that was an area that you were targeting from a cost perspective or perhaps a productivity perspective. Wondering if you could just talk around that a little bit.

Generally speaking, John, the watch margins on the new product that we are landing or have landed over the last three to six months are significantly higher than a lot of the old core styles that we had in the assortment. As we mentioned on the call in Q2 we expected some improvement in margins from the margin initiative we have going on, we thought that would be limited in Q3 simply because of the timing of when we got started on that initiative this year. But we do expect a more robust impact in the fourth quarter as we should see a full quarter of our efforts in that area flow through the income statement.

Terrific. And then just a follow-up. The new store is obviously performing extremely well; given that any more thoughts on perhaps remodeling a few stores next year or some sort of remodeling program?

Yes, we do actually have a program in place to remodel existing stores as those leases come up. We remodeled some last year. We did some this year. And I think the strategy is over the next three years is the rest of them will be redone and redesigned.

Terrific. Thanks, guys.

Management, at this time there are no additional questions in the queue, and I like to turn the conference back to you for any closing remarks.

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Finally, should you have any questions that did not get addressed today, please give Kosta, Mike Barnes or myself a call. Thanks again for joining us. Our next scheduled conference call will be in February for the release of our 2007 fourth quarter and full-year operating results.

Thank you, sir. Ladies and gentlemen, at this time we will conclude today's teleconference. We thank you for your participation on the program. You may now disconnect, and please have a pleasant day.