Fossil Group Inc (FOSL) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Fossil Inc. third-quarter fiscal 2010 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). This conference is being recorded today, Tuesday, November 9, 2010.

I would now like to turn the conference over to Allison Malkin with ICR. These go ahead, ma'am.

Thank you. Good morning, everyone. Before we begin, you should be aware that during this conference call certain discussions will contain forward-looking information. Actual results could differ materially from those that will be projected during these discussions. Fossil's policy on forward-looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is readily available on 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 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 direct comparable GAAP financial measure and reconciliation of this non-GAAP financial measure to GAAP will be provided as supplemental financial information to this release under the earnings release section under the investor relations heading on Fossil's website. Please note that you may listen to a live webcast or replay of this call by visiting Fossil's website and then clicking on investor relations at the bottom of the home page and then on webcast.

As a matter of course this morning the call will begin with prepared remarks from Fossil's CEO, Kosta Kartsotis, and CFO, Mike Kovar, after which they and other members of Fossil's executive team will be pleased to take your questions.

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

Thanks, Allison. Good morning, everyone, and thanks for joining the call today. With us today are Mike Kovar, our CFO; Mark Quick, our Vice Chairman; and Jennifer Pritchard, our President of Retail. Notably absent this morning is our President and COO, Mike Barnes, who as you know is leaving Fossil after 25 years to be the CEO of the Signet Group. We will all miss Mike and wish him well in his next venture.

Now turning to our Q3 performance. The quarter clearly shows the positive results from the many initiatives we have shared with you in the past. We have increased our efforts toward design and innovation, toward brand building, geographic expansion and on improving our financial position.

We have aligned our resources around our two core business units, the Fossil brand and our multibrand watch businesses and both have kicked into a higher gear. We are seeing increasing momentum in both areas, and we now believe the upside opportunities for both of these are larger than we thought just a short while ago.

The Fossil brand with its increase in awareness and its unique positioning is a huge long-term global opportunity as a head to toe lifestyle brand. And our multibrand global watch business is also in a unique position to gain market share in a category that is in a significant cyclical upturn.

As a result of these things, we again reported record results which even by our measures surpassed our expectations. Some of our highlights for the third quarter included the Company had a 40% increase in consolidated net sales, measured in constant currency reaching $524 million. Just as a reference point, this is the highest percentage increase we've had in any quarter over the last 13 years.

Other highlights are the global watch sales increased 49%. We had double-digit growth in our leathers business led by women's handbags which were up 19% in North America. Our jewelry wholesale shipments increased 44% with a 59%, 38% and 54% increase in North America, Europe and Asia Pac, respectively.

Our North American-based wholesale shipments increased 50%. Our European-based wholesale shipments increased 34% led by our four largest countries, Germany, the UK, France and Italy. And Asia Pac-based wholesale shipments increased 44% given by a more than doubling of our business in Korea and strong double-digit growth throughout all our other markets.

Again back to our two core businesses. The Fossil brand is doing extremely well all over the world. Our objective has been to give the brand a more focused point of view and to communicate this globally through our stores, web and catalog. To that end, we have accelerated our marketing efforts and will be increasing our catalog mailings from 11 million last year to 20 million this year and taking it global.

We also have dramatically increased our web exposure globally and will continue to ramp this up with additional search, social media and CRM initiatives into next year.

We also plan to accelerate our Fossil store openings next year and are working on that now.

Fossil brand highlights during the third quarter include the following -- a 28% increase in Fossil brand sales globally; a 35% sales increase in Fossil watches worldwide; a 20% increase in global comp store sales and our own retail following a 6.4% comp increase in the third quarter of last year.

We also had a 19% increase in global comp store sales in our Fossil accessories store. The US and Asia Pac were both up 25% and Europe was up 12%. We had a 20% comp store sales increase in our outlet stores and generated record gross margins. We had a 63% increase in e-commerce sales on top of a 7% gain last year, which was led by a 59% and 79% increase in the US and Germany, respectively. And on a trailing 12-month basis, we recorded net sales per foot of $635 versus $516 last year in our stores.

As to our overall watch business, continued innovation featuring new materials and platforms across all our brands has resonated with customers seeking new and exciting looks in watches. Our positive trend in this category is being magnified by a favorable cycle in watches which started in the United States at the end of last year and which we believe is still in its early phase.

Additionally, sales trends we are witnessing on a global basis lead us to believe that this favorable cycle is extending well beyond the United States. Retailers have definitely taken notice of the trend by placing more emphasis on the category. This is manifesting itself in more retail space being allocated to watches, increased open to buy, larger marketing initiatives and an additional allocation of staff to service the watch customer.

As a result, we were able to achieve the following third-quarter highlights in our watch business. North America-based wholesale watch shipments increased 74%, including sales gains of at least 30% across all our brands. Europe-based wholesale shipments increased 34% with broad-based growth across all Fossil and licensed brands. And Asia Pac-based wholesale watch shipments increased 44% with strong double-digit growth across each of our major brands.

With nearly all cylinders firing, our increasing profits have afforded us the opportunity to invest more aggressively in global marketing, which has resulted in a further acceleration of sales and market share gains. Based on the positive results to date, we intend on increasing our marketing spend in the fourth quarter of this year.

Our profitability for the third quarter was highlighted by a 93% increase in operating income, an almost doubling of our earnings per share, and us reaching an operating margin of 21% for the quarter. We also have gotten to an operating margin of 17% year to date, which as you know has been a significant objective of the Company.

In summary, there are a lot of exciting things and important initiatives going on throughout the Company. Although we were up against a very solid performance during the holiday season last year, we are expecting a strong fourth quarter in 2010. Our growth initiatives are working well, the Fossil brand is growing dramatically and we are utilizing our strength and capital resources to accelerate our growth and profitability.

Given our strong balance sheet and cash flow we have acquired as of today $130 million of Fossil stock out of our recent $750 million buyback authorization of which $57 million had been completed by the end of the third quarter. It is our intent to purchase another $100 million by the time we announce our fourth-quarter and full-year results in February.

Before turning the call over to Mike, we would like to thank all of our Fossil team members and partners globally for their collective spirit and their ongoing pursuit of excellence. Mike?

Thanks, Kosta. I will start off by summarizing our third-quarter 2010 versus 2009 results from this morning's press release.

Net sales increased 37.4% to $523.8 million compared to $381.4 million. Gross profit rose 41.8% to $298.7 million compared to $210.7 million. Gross profit margin increased 170 basis points to 57% compared to 55.3%. Operating income increased 94% to $111.3 million or 21.2% of net sales compared to $57.4 million or 15% of net sales.

Net income increased 93.2% to $68.2 million compared to $35.3 million and diluted earnings per share increased 92.3% to $1 on 68 million shares compared to $0.52 on 67.4 million shares.

The sales mix breakdown for the third quarter with comparable prior year levels was as follows -- 39.6% from North American wholesale activities versus 36.3%; 26.2% from Europe wholesale activities versus 29.2%; 11.6% from Asia-Pac wholesale activities versus 10.5%; and 22.6% from worldwide direct to consumer businesses versus 24%.

The 37.4% increase in reported net sales for the third quarter consisted of the following increases by segment. Sales from our North America wholesale business, which include our operating activities in the US, Canada and Mexico, as well as sales to our third-party partners in South America, grew by $69.2 million or 50% to $207.7 million. Excluding about $600,000 from favorable currency comparisons to Q3 last year, North America sales increased by 49.6%.

Sales from our Europe wholesale operations increased by $25.9 million or 23.3% to $137 million. Excluding currency that unfavorably impacted sales by $[12.4] million in comparison to Q3 last year, Europe sales grew by 34.5%.

Sales from our Asia-Pacific wholesale operations increased by $20.8 million or 51.9% to $60.9 million and excluding currency that favorably impacted sales by $3.1 million in comparison to Q3 last year, Asia-Pac sales grew by 44.1%. Sales from our direct to consumer businesses increased by $26.5 million or 28.9% to $118.2 million and excluding currency that unfavorably impacted sales by approximately $1.3 million, direct to consumer sales increased by 30.4%.

Globally we ended the quarter with 358 stores and occupied 629,000 square feet compared to 616,000 at the end of 2009. This included 226 full priced accessory stores, 123 of which were located outside of North America and 91 outlet locations including 20 outside of North America.

Additionally we ended the quarter with 31 clothing stores and 10 multibrand stores. This compares to 342 stores at the end of the prior-year third-quarter including 208 full priced accessories stores, of which 109 were outside of North America and 88 outlet stores including 13 outside of North America plus 33 clothing stores and 13 multibrand stores.

During the third quarter, we opened 11 new doors and closed seven. For the fourth quarter, we plan on opening an additional eight doors, primarily under the full priced accessory concept leaving us with 366 doors at the end of the year.

As a result of increased net sales and gross margin expansion, gross profit increased by 41.8% to $298.7 million in the third quarter in comparison to $210.7 million in the prior year quarter. Gross profit margin increased by 170 basis points to 57% compared to 55.3% in the prior year quarter. The 170 basis point increase was primarily driven by an increase in the mix of sales of higher-margin watch products in comparison to leather products including a greater mix of higher-margin licensed watch brands.

Additionally, component costs associated with some of the new materials that are driving the watch business are slightly less expensive than that of a typical stainless steel bracelet or leather strap watch and we've been able to maintain retail prices on these styles and in many cases even raise prices.

In comparison to Q3 last year, a slightly stronger US dollar unfavorably impacted our third-quarter gross profit margin by approximately 75 basis points. For Q4, we expect gross profit margin to increase by a minimum of 100 basis points in comparison to Q3 levels. We expect our product mix to remain consistent with that of Q3 but will benefit from a greater percentage of direct to consumer sales during the holiday quarter.

We are aware that there has been some concern recently about input costs increasing and like everyone else we are experiencing some labor cost increases in China and prices for certain materials such as leather are increasing as well. However, labor costs are not a significant component to the overall production costs of a watch and we are confident that we can work around other input cost increases without any material negative impact to our existing margin structures.

A higher-than-expected net sales increase including the 19.9% comparable store sales increase in our retail stores group in the third quarter resulted in operating expenses expressed as a percentage of net sales to decrease to 35.8% compared to 40.2% in the prior year quarter. In absolute dollar terms, operating expenses in the third quarter increased by $34.1 million as compared to Q3 last year and included a $2.4 million favorable reduction from the translation of foreign-based expenses as a result of a stronger US dollar.

In constant dollar terms operating expenses in our wholesale segments, direct to consumer segment and corporate cost areas increased by $20.8 million, $6.6 million and $9.1 million, respectively, compared to the prior year quarter. At a line item level, the increase was primarily related to marketing and compensation costs, but we also experienced certain variable cost increases as a result of the 37.4% increase in net sales.

Additionally, the strong comp sales performance in our retail stores resulted in a more than 800 basis point improvement in SG&A leverage in this segment.

As it relates to Q4, with normalizing our spend and certain expense areas back to 2008 levels, and upgrading certain IT applications as well as committing an additional $12 million in marketing to further build global awareness primarily for the Fossil brand, we expect that SG&A expenses as a percentage of sales will be slightly higher than last year's levels. However, the improvement in gross margin is expected to offset this investment thus resulting in operating margin at or slightly above the level experienced in the prior-year quarter.

Operating income increased to 21.2% of net sales in the third quarter compared to 15% of net sales in the prior year quarter, and this resulted from increased net sales, gross profit margin expansion and a decrease in operating expenses as a percentage of sales.

During the third quarter, operating income was negatively impacted by approximately $7.4 million resulting from the translation of foreign-based sales and expenses into US dollars.

Q3 other income and expense remained relatively unchanged from the prior-year quarter. Foreign currency transaction losses from mark to market and hedging activities improved from last year's levels but were offset by an increase in net income attributable to noncontrolling interests.

Income tax expense for the third quarter was $39.8 million resulting in an effective tax rate of 36.9%. For the comparable prior year quarter, income tax expense of $18.8 million resulted in an effective tax rate of 34.8%.

The prior year quarter ETR was favorably impacted by a reduction in certain federal income tax liabilities while the current quarter rate included certain discrete events that resulted in a slightly higher rate. We are estimating our fourth-quarter effective tax rate at 35%, reflecting the structural rate of the Company. This rate does not include any additional discrete events.

Finally, third-quarter net income increased by 93.2% to $68.2 million or $1 per diluted share and this was inclusive of an unfavorable $0.05 diluted share impact related to the stronger US dollar and compares to $35.3 million or $0.52 per diluted share in the prior year quarter.

Now turning to the balance sheet. We ended the third quarter with cash, cash equivalents and securities available for sale totaling $371.6 million compared to $306.7 million at the end of Q3 2009, and we have $8.4 million in total debt.

During the third quarter, we completed the $20 million share buyback approved by our Board of Directors during the second quarter of fiscal 2010 by investing approximately $8.8 million to repurchase approximately 235,000 shares. Additionally on August 30, 2010, we entered into a 10b5-1 plan for the purpose of purchasing $130 million of our outstanding common stock pursuant to the $750 million authorization by our Board in August.

We completed the repurchase of all $130 million of common stock under this program, representing approximately 2.4 million shares as of November 4, 2010. And as Kosta mentioned, was approximately $57.1 million or 1.1 million shares being purchased during the third quarter.

The inventory at the end of the third quarter was $388.3 million representing an increase of 38.9% from the prior-year third quarter balance of $279.6 million. If you recall last year's third quarter inventory declined 16% on a 9% decrease in sales.

Accounts receivable increased by 40.1% to $258.4 million on October 2 compared to $184.5 million at the end of the prior-year quarter primarily due to an increase in wholesale shipments during the third quarter. Third-quarter days sales outstanding for our wholesale segment was 57 days in comparison to 56 days in the prior year quarter.

During the first six months of 2010 -- that should be first nine months of 2010, we had capital expenditures of $37 million and are expecting fiscal 2010 full-year capital expenditures of approximately $65 million to $70 million. The majority of this spend will be related to new store openings, store remodels and the continued rollout of our SAP POS system to our retail stores in Europe as well as additional maintenance CapEx.

Depreciation and amortization expense for the nine months of 2010 totaled $29 million and we estimate full-year 2010 levels of $41 million to $42 million.

As it relates to guidance for 2010, in addition to the solid [beat] in the third quarter we are raising our previous guidance for fiscal year 2010 based upon the favorable sales trends we are experiencing. Specifically for the fourth quarter, we expect reported net sales to increase in a range of 21% to 23% with constant dollar sales in a similar range.

Fourth-quarter 2010 diluted earnings per share are expected to begin a range of $1.26 to $1.30 and this includes the $0.02 unfavorable currency impact related to the translation of a slightly stronger dollar compared to last year's fourth quarter. Our fourth-quarter guidance also includes a $0.04 benefit resulting from our recent share buyback activity but conversely as a result of our increasing share price, we do expect additional dilution related to common stock equivalents to negatively impact Q4 EPS by about $0.01.

Our guidance is always based upon the current prevailing rate of the US dollar compared to other foreign currencies for countries in which we operate.

And now I would like to turn the call back to the operator to begin the Q&A portion.

(Operator Instructions) Neely Tamminga, Piper Jaffray.

Good morning and congratulations, you guys. I was wondering if Kosta could help frame up qualitatively or quantitatively his comments about how we are early in on the watch cycle. It has been probably one of the more difficult things for us to assess here on the sell side but yet we continue to see strength and adoption of some of the key watch styles that really came onto the scene last year. So just wondering if you can either help us frame up what you mean by early and what signs you are looking for for that momentum to continue to build? That would be really helpful. Thanks.

Obviously we've seen these cycles before, as we've said. And it's hard to say how long it will last except what we are seeing is very broad based and consistent sellthrough metrics across all our brands in the United States especially and we are now starting to see that going into Europe and we had some meetings last week in New York with some of our European retailers and they are starting to see this percolation as well.

A lot of this in the past and it looks like right now has been driven by a major shift in the trend. So if you go back the last time this happened to us, which was over 10 years ago, almost every watch we made was a leather strap watch, and then the trend changed to stainless steel bracelets. So we changed our line, put it out in the market and we went through a several year trend of pretty significant growth. And this has happened to us before going back 18, 19 years ago when the fashion watch business really first exploded.

So there is a lot of moving parts to it, and it is not just one new material. It is across a lot of different materials across all our brands. Part of what you might say is in the last five years, the watch business has been relatively flat, somewhat of an assortment business. There has been a huge amount of interest in handbags and discussions about the "it" handbag and people were buying handbags every week.

There is now a thought process that it is now about the "it" watch and everybody wants to own a watch and they are important in the fashion world. And it seems to be gaining momentum.

One additional thing I would add is this is being driven by mix materials, new materials, things that look different. There is a reason to buy a watch, and it is not about telling time. And I think it is going to be accelerated increasingly by all the Swiss guys that are putting new products in the market especially during this holiday season and these are all typically what they are showing for -- new for holiday is all mixed material also. So I think the momentum is just going to continue to proceed.

That is really helpful. Thanks again. Good luck for holiday, and congratulations.

Matt McClintock, Barclays Capital.

So Kosta, with all the strength and the broad-based strength in the watch business, I was wondering if maybe we could shift the topic and talk a little bit about the strength that you are seeing in the leathers business in Europe. First off, could you maybe provide some frame of reference for the current size of that business?

And then what is the balance of growth in that region between your retail stores and your wholesale partners? And then last, bigger picture, in the past you have mentioned that you believe that that market is underserved, particularly in leathers. What exactly is driving the strength at Fossil in that region? And is there maybe a -- maybe are you seeing a general shift of consumer preferences in the European region?

There are a lot of moving parts to all of that. One thing I would say is that as the Fossil brand has gained momentum, it is somewhat -- it is more aspirational and affordable. It is vintage and modern. It has a stronger, more focused point of view. It's authentic and it's unique and it plays all over the world.

One of the biggest benefactors of that enhanced image is going to be handbags because it is a very emotional, visible purchase for people. And I think that is what we are seeing and quite honestly that is one of the main reasons for our accessory store concept being -- it focuses a lot of space and windows on leather goods.

So what we are trying to do basically is take this idea of more aspirational handbags and penetrate the world with it by opening stores and with our websites and our catalogs. Our stores have actually shown in Europe that they do a bigger percentage of leather goods than our stores there than we do in the United States. So the customer is really responding to kind of Fossil type more aspirational mostly leather handbags. So we feel it is a big opportunity as we move forward.

And if I may one more, Mike, can you perhaps remind us how the Company ships product? Is that air or container? And does the condensed or small nature of the underlying product limit the impact of inflationary freight costs?

Yes, definitely. We ship all of our watches around the world via air, and obviously the cost relative to the retail value to do that is insignificant. Whereas with some of the larger products like handbags, belts, etc., we generally use ocean liners for that, and that increases a little bit of the reaction time to market, but obviously those items take up a lot more space and it's far more efficient to put them on boats rather than planes.

I will give you a data point on the leather business in Europe. We have been talking about the significant growth we've had there and just the opportunity to leverage what is happening with our retail stores in that region to really broaden the base of the Fossil product assortment beyond just watches and jewelry. But to date, our leather offerings for the nine months in 2010 still only represent less than 5% of our wholesale business there. So we have a huge opportunity in front of us.

Great. Thank you very much.

Scott Krasik, BB&T Capital Markets.

Thanks, guys, and let me add my congratulations. Can you just characterize the department stores and your wholesale customers in the US? Have they caught up on the sell in? Are they still adding additional selling space? Are they building more back stock? Are the results now based on just the better sellthroughs? What is the dynamic in US wholesale?

It's Mark Quick. Let me take that question. We continue to see an acceleration of retail performance with our department store partners. They are driving that through enhanced stock levels, increased physical positions in their stores. They are paying a lot of attention to key operational issues like flow of goods from warehouse to store, stock room to floor in addition to how they are staffing their areas. This has got to be one of the big percent increase in volume drivers for them in the stores, not only for the first three quarters based on the performance we've seen, but what they are expecting for fourth quarter as well.

Generally speaking obviously you don't know the future, but spring, there shouldn't be any letdown. It could even increase a little bit more.

Well, we do have some visibility into spring because as Kosta said, we were in New York market last week, and we've seen plans that these guys are pulling together because they have to project purchases and intentions for spring. And we don't see a significant slowdown coming.

One of the interesting things that has happened is if you look back the last five years, the watch business relative to GDP has probably been flat and not generally that exciting. We've grown because we've gained market share, and we've had some great global growth. But now that the stores are putting more salespeople, space, inventory, visual marketing behind this because they are seeing huge increases, we have one of the big department store groups in the United States that is actually seeing 100% increase year to date in watches. So they are getting behind us in a pretty big way and what they are saying is they think this is going to continue.

One way to think about this watch thing is that the watch business globally is a relatively small industry relative to apparel or to telephones for example. So if 1% of the people that were buying pieces of apparel or buying a cell phone or a video game, 1% of those people decide okay now I want a watch, the impact on the watch business is huge. And that is partly I think what we are seeing out there is increase in awareness, increasing fashionability of watches can have a dramatic impact on the watch category and therefore us, because we have a pretty good share of it. So I think that is partly what's happening.

That's a good explanation. Then just last, if I may, just remind us are you selling Michael by Michael Kors in Asia yet? And what is the outlook for your licensed brands in Asia specifically?

The interesting thing about Kors is that we are seeing obviously very dramatic growth and most of that is in the United States. One of our big initiatives for next year is actually to take Kors global because where we do have it both in Asia and Europe, we are seeing the same kind of sparks and sellthrough percent that we saw in the United States 12 and 18 months ago. So all our metrics are telling us that this Michael by Michael Kors business is going to be huge.

One other thing I should mention is just in terms of our future growth, the Fossil brand has obviously grown at a very fast rate, 28% year to date and we are going to accelerate that with more stores and more marketing. It has clearly hit somewhat of a tipping point and it is going to grow very quickly.

Then as far as our watch business, we got the cyclical change that is driving the total market up and we are gaining market share in that. And a lot of this is being driven by obviously we have what we think are the best brands in the world in addition to that, the best innovation, sourcing and we are putting more new materials in the market than anybody else. So we are gaining market share there pretty rapidly.

But we are in a unique position to take all these things and go global with them. As we said, this mixed material thing has not really manifested itself very much in Europe yet but we know it is already starting to happen and it hasn't really even started yet in Asia. So we have a number of opportunities just in our total watch business, which is taking Kors global was going to be huge.

The Armani business is really getting stronger and stronger. We think it has a much larger potential especially in Asia and China, than we thought even a year ago.

Interestingly, the AX business is on fire and we have a relatively small number of doors but the inventory turn is very fast and it is looking like somewhat like Michael Kors did two years ago. It really looks explosive and it's going to be a big business for us globally.

The Marc by Marc brand is gaining in importance and we are seeing somewhat of the same kind of sparks, especially in Asia and we think it is going to be very big in China as well.

And then Diesel, DKNY, and Adidas are all growing and are showing even larger global opportunity. In addition to that, we think that in the future we will have additional brands through acquisitions or additional licenses. So we think we are in a very good position. It seems like both our businesses, the Fossil brand and our total watch brands seem to have hit a tipping point and we think we have a much bigger opportunity than we did in the past.

All right. Thanks. I look forward to seeing how far this goes.

Anna Andreeva, JPMorgan.

Good morning, guys, and congrats.

Thanks, Anna, and welcome back.

Thanks. Kosta, you mentioned you guys already exceeded your previous operating margin goal of 17%. Is there a new margin that you could share with us? Do you guys see margins getting closer to 20% or so assuming the strength in the watch business continues? And I was also curious about the delta in profitability of watches versus accessories, especially curious licenses versus your Fossil brand.

This is Mike. I will take the most part of that question. If you look at the year to date operating income margin we've been able to achieve, it is in excess of kind of that long-term stated goal that we had at 17%. And obviously with the fourth quarter ahead of us, we will continue to add to that for the balance of 2010.

But as we've always said, 17% was just the target, and as we mentioned previously once we reach that goal, we would reassess the opportunity on a go-forward basis. And part of that will be obviously looking at the opportunity to continue the growth perspective of the Company.

So we are not providing obviously any guidance beyond the fourth quarter this year, but we will discuss what our expectations are for 2011 when we have our February call in the fourth quarter. Can you remind me of your second question?

I'm just curious if you guys could talk about how much profitable of watches -- your merchandise margins on watches versus accessories and licenses versus Fossil.

Generally what we find is that watch and jewelry margins are much higher than leather product margins. Generally the leather products groups are in 40% to 45% range depending upon whether it is a handbag, belt, small leather good etc. Whereas the watch business and the jewelry businesses generally starts at 50% plus for the fashion brands.

And as you move higher up in price, generally the higher margin associated with that brand even after the royalty payment. So something like Burberry, Armani, Michael Kors would be some of the highest margin producing brands that we have. Michele as well the highest margin business we have based upon the highest retail value that we have. So that is the way I would think about it in terms of the mix.

And as we said, the margin improvement year-over-year is stemming from the fact that our watch business is growing much faster than our leather goods business and a mix of that watch business is much higher towards some of these licensed brands d businesses.

Okay, that's great. That's very helpful. Just on the store growth plans into 2011, you mentioned you would be accelerating that. Just wondering if you could give us a little bit more color on that, what kind of growth are you expecting maybe by region and also type of real estate?

We are working on that now. We do, as I said, think we'll have a standard roll out next year. We will probably detail that for you in the next call for the end of the year. Right now we are working on that globally. We think that there is a number of opportunities for us to put stores in the United States where we had been somewhat slow in the last couple of years. We think there is now a bigger, broader real estate opportunity for us there.

In addition to that, there is a number of stores that we are putting in Asia, flagship stores in Tokyo and in Seoul and in Hong Kong, for example, to help us accelerate our brand awareness in Asia.

And then Europe continues to be very strong, and we are as you know, we put some apparel and clothing stores there as a test. We opened one in Wiesbaden that is doing very well. So there will be some of that going on next year, both in Europe and in the United States.

So we're putting together a strategy and it is going to be accelerated and we will give you more detail later.

Okay, great. Thanks so much and best of luck for the holiday.

Eric Beder, Brean Murray.

Let me add my congratulations. Could you give us a little update about the apparel store? I know you guys have been playing around with a new format and how are you looking at the apparel stores? And also what do you see going forward in terms of the multibrand or the watch station chain for the (inaudible) Company?

Okay, on the clothing stores, as you know, we had a number of stores that have been open over 10 years that we are in the process of closing. So I think there was 10 over the last -- over a couple years that are going to close. So we are in the process of opening some more.

And of course we opened the Stonebriar flagship; it is doing extremely well. We just opened and remodeled King of Prussia, which is doing very well. There is a couple more clothing stores going in this year in the United States and I think one more in Europe in addition to Wiesbaden.

So I would say it is doing well. We are expanding our presence online and our catalog. Having said that, it is still kind of an incubator status. We do think that there is a big, long-term opportunity for us but we are really just getting ready for prime time and that is the process we are in.

One thing I should mention, is that there absolutely is no intent ever to sell clothing at wholesale. It is basically part of our direct channel store web catalog and so we will limit our exposure on that and move it forward.

On the watch of station situation, we have about 10 multibrand orders from around the world, a couple in Singapore and we are continuing to move forward looking at this. It looks very interesting. We have some, a few outlet stores in the United States with a watch station brand that are doing phenomenally well, and we are kind of looking at that and expanding it.

And we are going to be putting together a strategy over the next year or so to really look at this business closely and see how we roll it out over the next several years.

Can we get an update on Michele? And you talked a little bit about M&A or licenses. What are you looking for in terms of that?

One of the things we've done in the last 12 months or so is really as we said, focus our resources around our two big businesses, Fossil brand and our watch business. So an acquisition or an additional brand would be based on something that leverages that. So an additional watch brand maybe that is already existing that we could get from someone else or a new branch showing up or it could be an acquisition of a watch brand. So we are continuing to look at those.

One interesting thing, and we've talked about this over the last several years, is that each of our brands has a huge potential for increasing growth. We talked about Armani a little bit ago. Armani has the potential someday to be in the $200 million range. It could double or even more over the next several years as it really gets penetrated in Asia and China. So we are really -- we spend a lot of time just focusing ourselves on our existing businesses.

We do have a couple of brands this year, watch brands that will add $100 million. Fossil brand and Michael Kors will both add $100 million in sales this year. So you can see the power of just focusing on our existing businesses.

Having said that, we are going to be opportunistic, and we are really interested in this total watch business, us being the big player protecting that position, adding additional [hands] and just building that out. So we will continue to do that.

Eric, it's Mark. Let me take your Michele watch question. We are very pleased with the performance of Michele. As you know, it is one of the dominant brands in the luxury tier of distribution. Strong, strong performance in third quarter that is roughly equivalent to our year-to-date performance. Very, very strong double-digit increases there. So its wholesale performance is roughly equivalent to what we are seeing in total watches.

And as you know, it is done at an average price point with a diamond watch in the range of $1500. We've introduced a new line of silicone strap watches in there that run in the $300 range that we've had very strong performance with as well.

Final question, is the ceramic still a very hot trend?

Ceramics are doing well but one thing as we mentioned before, there is a number of new materials, looks, colors, etc. So it is pretty broad-based. This trend is not just based on one single idea, which is we think a very good thing long-term.

But ceramic is an important trend, and we've now introduced it as a platform in every brand we do business in starting with Relic, where it will retail in the $185 range all the way up through Michele, where the highest retail is $2000.

Congratulations again.

Robin Murchison, SunTrust.

Also congratulations. I've got about four questions here, so let me start with Mike. You mentioned the labor. In terms of input costs, labor leather -- wanted to get you to address factory. I also wanted to get you to address the implications for the January increase in the UK VAT tax.

Thirdly would be infrastructure needs. And then fourthly, maybe kind of piggybacking off of Eric's ceramic, we know there has been a trend in the black on black and the blue face on the black. And if you could enlighten us on how that is --if that is gaining momentum?

On the input cost side, Robin, we obviously have been seeing labor cost increases for some time now since the Chinese government raised the minimum wage standard there. And although obviously being a public company and paying minimum wages already, it has caused us a slight increase obviously on top of that as everyone else has elevated to that level.

But again, the input costs on a watch as it relates to labor is not that significant. If you look at a $30 watch, maybe 15% of that watch is a labor component and if that is going up 10%, that is a 45% or $0.45 increase in the cost of the watch and at the relative retail, it is not significant.

And we are in a pretty strong cycle right now for being able to move retail prices especially as we are working with a lot of these new materials and components.

Mike, I'm sorry, let me be clear, I was asking more about the factories, if there is anything to say there? Capacity.

I think our -- what we've done is we've talked about the importance of the supply chain and that is something we always have our eye on and it is quite remarkable if you think about where we were last year at this point and the production level of those factories. I think Kosta mentioned on the call back in August that in the second quarter we were basically able to double the output in watches from our production factories in China compared to where we were last year. So we have the ability to continue to ramp up our needs to produce more watches.

One thing we've done much better this year is basically been able to smooth that production so we don't have the ups and downs and cause those guys grief with having to maintain labor forces over the long term. So I would say from our planning organization being more in line with our production organization, the factories are far more consistent and far more efficient and have been able to continue to support the types of increases we've been dropping on them relative to the watch business.

As far as the VAT increase that is going in place in the UK in January, we are not expecting to see that significantly impact our business. We've been through VAT increases in other countries over the years and generally that has not implied any type of decline in the momentum we see in our businesses and we don't expect that to be the case in the UK as well.

Okay.

As far as the infrastructure needs, we are always looking forward as to supporting the growth of the business. I did mention in my portion of the call that there are some IT infrastructure areas that we are going to bring into 2010 that were otherwise planned in 2011. There is about $4 million worth of cost that we will absorb in Q4 as it relates to updating some of our software products that is across our global organization. Retooling our needs in terms of some of the equipment we use as well. And we just think that we have the opportunity to do that much earlier than we otherwise would have and we are bringing that on in Q4.

I think your last question was more on new trends with ceramics and black on blue and that type of product, Kosta.

As I said earlier, we are seeing just a reception to newness. It is not a traditional stainless steel or leather or stainless steel watch we are seeing response to. It is really manifesting itself across many different platforms, materials etc. The best thing I would say is if you just look in our stores or go online, you can see some of these things and you get an idea of what kind of things are working.

Thanks.

Ronald Bookbinder, The Benchmark Company.

Good morning and congratulations. You mentioned that the mixed material really hasn't hit the European market yet or I think maybe the Asian market also. Is Europe just being driven by your expansion in branded watches there?

I think we have some of this mixed materials merchandise in Europe and that is partly what is driving the trend in addition to just the increased awareness and increased fashionability of watches, I think has hit there first. We don't have as much mixed materials in Asia, but where we do have it, we are seeing pretty strong response.

So that is partly why we are thinking that there is going to be -- this cyclical trend is going to be a wave starting in the United States and ongoing and then continue through the rest of the world. I think it is a big opportunity for us.

Is Asia just primarily being driven by the fact that it is an emerging market?

I think it is obviously a smaller business for us with a big upside, so the increases are dramatic. I think that it has the potential to have these kind of increases for a long period of time, quite honestly.

Ron, as you know, over the last several years, we've opened up new offices in China, Korea and India and those emerging markets are obviously helping the growth in that region. Korea itself was probably half of the growth we saw in the Asia wholesale market in Q3, and we are not even fully transitioned in taking that business from a previous distributor and putting it into our own hands. We expect that to be completed by the middle of next year. But we think there is a huge opportunity to see continued expansion of our business in Europe and continue to increase the efficiency of those concessions as we own them.

But the growth was very broad-based across all of the markets that we are in. We didn't have a single market that reflected a decrease throughout Asia. So it is not only about the emerging markets, but what the watch cycle is like for a lot of these existing markets we've been in for 10, 12 years.

But we still can expect if the growth of the mixed material watch from the US translates into Europe and Asia, there could be still some phenomenal growth ahead just in this trend. Is that correct?

Yes, we think that's right.

Now Latin America, are you going to look to expand into some of the emerging markets down there? And are you continuing to look at buying third-party distributors and capturing the middleman margin?

We do have a substantial third-party distributor that services South America for us and our business is on fire down there right now and has been over the last couple of quarters. Again, that is coming off a pretty significant decline in the previous year. But the business is much larger than it once was.

You know, we believe that all of our third-party distributors at some point in time represent an opportunity for us to take an ownership position in a market. I would say at this time South America is not in our plans. It is still a pretty volatile environment from a currency perspective. And we are currently comfortable with the relationship we have with our third-party distributor there.

I would say that Eastern Europe represents some opportunity from acquiring distributors into the future. Again, there is nothing in the pipeline there to speak of today but as we continue to work at those markets and provide them the knowledge and the ability to get these markets to a point where we think it makes sense to have ownership, that is definitely an opportunity.

Okay, great, and continued success.

(Operator Instructions) Randy Konik, Jefferies.

Hi, guys. It's Taposh Bari filling in for Randy. Nice quarter. So I guess our question was around the wholesale business. Obviously a lot of success in the watch category. Just trying to get an understanding of how momentum in the watch category is translating into a sell in or open to buy in the non-watch business. Obviously you are trying to make strides in accessories. Footwear is a new initiative. So maybe give us some color on that, if you can.

One of the good things -- this is Mark -- that has been happening in the leather business and wholesale domestically is we've seen continuing quarter-over-quarter improvement. And what I'm really talking is retail performance with our retail partners rather than wholesale performance because I think that is more indicative of where we are headed.

As Kosta mentioned earlier in his remarks, we are working very hard to upgrade the Fossil brand offering in terms of quality of material and uniqueness of design, and I think that is really resonating well. We're having strong third-quarter retail performance with leather goods.

And additionally in our own stores, we've seen in the third quarter strong comp increases quarter-over-quarter from second to third quarter. But the initiatives we are taking with that product is clearly resonating. And as Kosta also mentioned, we have a high degree of penetration in our own stores in Europe with accessory product. So that is the reason we believe that we have ability to significantly grow that business outside the US as well.

Footwear, strong sales increases as a percentage. It is still a very small base for us. But we are seeing encouraging signs of sellthrough and believe it will be a key element in our head to toe dressing in the Fossil brand. Additionally with footwear as we've mailed out increased catalogs, it has significantly and consistently been one of the best performing parts of our direct-mail effort.

Just a quick follow-up. Mike, you talked about labor not being a big percentage of the total cost of your watches. Can you maybe give us a sense of how big labor is as a percentage of the cost of a watch -- the cost to manufacture a watch versus the cost of manufacturing an apparel garment -- just some perspective would be great. Thanks.

To be honest, I have no idea what the labor content of producing apparel is. Obviously we buy our apparel from third-party and don't own the factory, so we don't have that type of granular information.

I could tell you though on an accessory product, it is very similar to a watch. It represents about 15% in handbags or any of the other accessory products we would have.

Got it. Thanks a lot, and best of luck for holiday.

Barbara Wyckoff, Guerrilla Capital Management.

Hi, everyone. Great job. Could you elaborate on your growth in China? The channels, the outlook, how big is the market now? How big could it be two to three years out? And then could you comment on your initiatives in India?

Our China initiative is started by us opening an office there probably four or five years ago and it's probably the biggest opportunity we have and probably the most difficult. We have put a team of people in there and we are using some other resources to really figure out how to do this and go about it. Obviously our luxury brands, Armani, Burberry, Marc Jacobs are going to help us penetrate the market pretty well. But we are in the process of formulating a strategic plan to go after it in a more aggressive way. And we have a number of positions in Asia that we want to hire to really accelerate our growth over there.

So we think it is going to be pretty significant growth, but we are just trying to figure out the nuts and bolts of it right now.

As far as India, we have our own subsidiary there. We started that several years ago. It is still relatively small, showing very strong results, great group of people there. And as that market develops, we think we are in a pretty good position to gain share there and continue to grow, so we are looking at that also.

Great. Good luck. Thanks.

Thank you. I am showing no further questions at this time. I will now turn the call back over to management for any closing remarks you may have.

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Finally, should you have any questions that did not get addressed today, please give me a call. Thanks again for joining us today. Our next scheduled conference call will be in February for the release of our 2010 fourth-quarter and full-year operating results.

Ladies and gentlemen, that does conclude the Fossil, Inc. third-quarter fiscal 2010 earnings conference call. Thank you for using ACT Conferencing. You may now disconnect.