Fossil Group Inc (FOSL) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Fossil, Inc. first-quarter 2011 earnings conference call. At this time, all participants are in a listen-only note. And following the presentation, instructions will be given for the question and answer session. (Operator Instructions). As a reminder, this conference is being recorded today, May 10, 2011. I would now like to turn the conference over to Allison Malkin of ICR. Please go ahead.

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 our 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.

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

Thanks, Allison. Good morning, everyone, and welcome to our first-quarter call. Joining us today are Mike Kovar, our CFO; Mark Quick, our Vice Chairman; and Jennifer Pritchard, our President of Retail.

Continuing the strong momentum in our business from 2010, this morning we reported earnings of $0.86 a share, reflecting a 62% increase in earnings on a net sales increase of 37%. Our unique business model and our focus on our two core businesses, namely the FOSSIL brand and our multi-brand watch portfolio, have led to sustained rates of growth for the company.

Leveraging our innovative ideas and materials across our product portfolio and utilizing our global distribution platform to efficiently get the product in front of consumers, has allowed us to amplify our business in this favorable watch trend, which we believe is still in its early stages.

Around the world, consumers are responding enthusiastically to our product offerings, allowing us to accelerate our brand-building initiatives, to gain market share, expand geographic penetration, and to provide profitable returns for our shareholders. Additionally, we have stepped up our marketing expenditures and retail expansion, as well as other strategic initiatives in order to take advantage of the opportunities our sales growth has provided.

During our 2011 first quarter, the most significant contributor to sales growth was our global watch business, which increased 44%. Both our FOSSIL brand as well as our portfolio of licensed global brands contributed nicely to the overall increase. Our watch design teams have done a remarkable job of continually offering innovative ways of keeping our watch assortments fresh and relevant. And our supply chain teams and assembly facilities have continued to do an excellent job of flowing great product around the world in spite of difficult challenges due to the increases in sales.

Examples of what we were able to achieve in sales growth during the first quarter include a 142% increase in Michael Kors; a 54% increase in Burberry; a 129% increase in Armani Exchange; a 36% increase in DKNY; an 82% increase in adidas; and a 96% increase in Relic; and a 21% increase in FOSSIL.

We are also very pleased with the ongoing strength and growth of the FOSSIL brand. During the first quarter, sales of the FOSSIL brand increased 19% globally with balanced growth across categories, including a 21% increase in watch sales and an 18% increase in non-watch sales. Our non-watch categories, which are far less penetrated globally in comparison to the watch category, were led by a 34% increase in FOSSIL women's handbags and a 30% gain in FOSSIL jewelry.

Our direct-to-consumer sales rose 28%, driven by a comp store sales increase of 21.3%, which is on top of a 19.4% comp gain last year.

Comp store sales for our FOSSIL Accessory Stores rose 14.7% globally and included an 18% increase in North America, a 7% increase in Europe, and a 25% increase in Asia. Our store expansion is on track to open 80 to 85 stores this year with a global focus on expanding our Accessory Store concept.

Our e-commerce sales also rose strongly, up about 27% in the quarter. Our retail stores, Web and catalog, work in harmony to support a unified and focused brand message and distribution platform. In addition to opening these new stores, we are launching this year e-commerce sites in Japan, Korea, France, Italy, and Austria. We will also continue to expand our catalog distribution globally to help communicate the FOSSIL brand message.

And to further support these initiatives, we have embarked on a customer relationship management program, CRM system, with phase 1 of this project completed a couple weeks ago. This will allow us to measure our brand building initiatives more efficiently and to develop targeted marketing programs to increase our dialogue with the growing fossil customer base.

In our overall business, we were also pleased to see strong growth outside the United States, as Europe and Asia Pac regions reported sales gains of 34% and 57%, respectively. While both of these regions offer significant opportunities for many of our businesses in the short and long term, Asia Pac perhaps offers the most opportunity due to the dynamic changes going on in those markets. Asia today represents only 14% of our global sales and could be a full third of our business over time.

To accelerate our opportunity in this region, we are focusing on aggressively adding retail concessions in established stores, principally in China, Japan, and Korea. We have added a number of new management people in these markets, and in addition, have sent several Fossil team members to Asia on an ex-pat basis in an effort to accelerate our growth there.

Before Mike goes into detail regarding more information on the quarter, we would like to update you on our situation regarding the unfortunate disaster in Japan. Our Fossil team members there were all safe and have shown inspirational resolve and determination, as has all of Japan. The events there have slightly impacted our sales in the market, but we consider this to be somewhat of a short-term situation, and we feel we have a very significant long-term opportunity there. Japan represents about 3% of the sales of the company.

We also source the majority of our watch movements from Japan. The factories that make these movements were not damaged but were impacted by the infrastructure problems that affected all of Japan for several weeks after the disaster. This affected our flow of movements for a time, but the factories have since returned to production and are expected to be at full capacity soon. The companies that make these movements are large, world-class Japanese companies that are very determined and very committed to the production of high-quality, innovative watch movements over the long term. And although we had a disruption in movement flow from Japan, we had movements on hand in our factories in Hong Kong when the crisis happened in addition to having a healthy level of finished goods inventories in our warehouses around the world. The bottom line of all this is that we do not expect the situation to have any significant impact on our sales expectations either in the short or long term.

In summary, we are very pleased with the strong showing during the quarter on both the overall FOSSIL business and in the multi-brand watch business. We feel that both of these businesses have kicked into higher gears and are strongly positioned for long-term growth. And we would like to thank and congratulate all Fossil team members, partners, and suppliers for their ongoing commitment to excellence.

And now I will turn the call over to Mike.

Thanks, Kosta. I will start off by summarizing our first-quarter 2011 versus 2010 results from this morning's press release.

Net sales increased 36.6% to $537 million compared to $393 million last year. Gross profit rose 37.6% to $301.8 million compared to $219.4 million. Gross profit margin increased 40 basis points to 56.2% compared to 55.8%. Operating income increased 80.6% to $92.6 million or 17.2% of net sales compared to $51.3 million or 13% of net sales.

Net income increased 55.5% to $55.8 million compared to $35.9 million, and diluted earnings per share increased to 62.3% to $0.86 on 64.8 million shares compared to $0.53 on 68 million shares.

The sales mix breakdown for the first quarter with comparable prior-levels was as follows -- 38.5% from North American wholesale activities versus 39.1%; 28.3% from Europe wholesale activities versus 28.6%; 11.9% from Asia-Pacific wholesale activities versus 9.9%; and 21.3% from worldwide direct-to-consumer businesses versus 22.4%.

In connection with our wholesale operations, sales from our North American wholesale business, which included our operating activities in the US, Canada, and Mexico, as well as sales to third-party distributors in South America, grew by $53 million or 34.5% to $206.8 million. And excluding approximately $800,000 from favorable currency comparisons to Q1 last year, North American wholesale sales increased by 33.9%.

Sales from our Europe wholesale operations increased by $39.3 million or 34.9% to $151.8 million. And excluding currency that favorably impacted sales by approximately $600,000, Europe wholesale sales grew by 34.4%.

Sales from our Asia Pac wholesale operations increased by $25.5 million or 65.9% to $64.2 million. And again, excluding currency that favorably impacted sales by $3.3 million, Asia Pac wholesale sales grew by 57.4%.

Highlighting some notable increases from a major product category perspective, total watch sales increased by $117.8 million or 46.2%, 44.4% ex currency, to $372.7 million.

Drilling down into our global watch business, FOSSIL watch sales increased $19.5 million or 21.8%, 20.5% ex currency, to $108.7 million. Michelle watch sales increased by $3.8 million or 30.8% to $16.2 million. License watch sales increased by $92 million or 69%, 66.5% ex currency, to $225.5 million; Relic watch sales increased by $4.3 million, or 96% to $8.8 million.

And on the non-watch side of our business, leather product sales increased $15.8 million or 21.1%, 19.8% ex currency, to $90.5 million and jewelry sales increased $8.2 million or 24%, 23.3% ex currency, to $42.2 million.

Moving to the direct-to-consumer segment, sales from our direct to consumer businesses increased by $26 million or 29.5% to $114.2 million. Excluding currency that favorably impacted sales by $1.2 million, direct-to-consumer sales increased by 28.1%. Constant dollar comps in our retail stores maintained their strong double-digit performance coming in at 21.3% in Q1, the 12th consecutive quarterly positive comp and the sixth consecutive double-digit quarterly comp.

Globally we ended Q1 with 362 stores globally, and occupied 632,000 square feet compared to 638,000 square feet at the end of Q1 last year. This included 233 full-price Accessory Stores, 141 of which were located outside the United States, and 92 outlet locations, including 24 outside the US. Additionally, we ended the quarter with 27 clothing stores and 10 multi-brand stores. This compares to 355 stores at the end of Q1 last year, including 220 full price Accessory Stores with 119 outside the US and 89 outlet stores, including 17 outside the US plus 33 clothing stores and 13 multi-brand stores.

During the first quarter, we opened six new doors, including five Accessory Stores and closed eight doors, four of which were clothing stores. For the full year, we plan on opening 80 to 85 doors equally distributed between the US and international locations. And from a concept perspective, as Kosta mentioned, we will continue to focus primarily on the full-price Accessory Stores. As always, door growth is predicated on appropriate locations and terms.

In addition to the eight doors we closed in Q1, we expect to close another 18 to 20 doors over the balance of the year, and we believe this strategy to close less productive locations will continue to improve the overall productivity of the portfolio.

As a result of increased net sales and margin expansion, gross profit increased by 37.6% to $301.8 million in the first quarter in comparison to the prior-year quarter.

Gross profit margin increased 40 basis points to 56.2% compared to 55.8%. The increase in gross profit margin was primarily driven by an approximate 40 basis point favorable impact as a result of a weaker US dollar, an increase in sales mix of higher-margin Asia-Pacific-based wholesale sales, and increased gross margins achieved in our outlet stores. Partially offsetting these increases in gross profit margin was an increase in the mix of sales of lower margin sales to third-party distributors and a sales mix decrease from our direct-to-consumer segment in comparison to the prior-year quarter.

We are experiencing some increases in some component prices and labor. As a result, we could experience some input cost pressure over the balance of the year, and as a result, now expect gross margin for the year to be slightly below the initial 57% level we guided back in February.

Q1 operating expenses increased by $41.1 million compared to the prior-year quarter and included approximately $3.4 million of expenses associated with the translation of foreign-based expenses as a result of a weaker US dollar.

For the first quarter, operating expenses expressed as a percentage of net sales decreased to 39% compared to 42.8% last year, primarily the result of a stronger sales performance than we originally expected.

On a constant dollar basis, operating expenses in our wholesale segments, direct-to-consumer segment, and corporate cost areas increased by $22.6 million, $12.7 million, and $2.4 million, respectively.

Expense growth in the wholesale segments was principally a result of increased marketing expenses throughout all markets as well as door expansion and compensation cost increases more heavily associated with our international businesses with a heavy weighting toward Asia.

On the direct-to-consumer side, increases were primarily attributable to the expansion of our catalog mailings, increased Web-based marketing expenditures, and costs associated with the development of our North American-based CRM initiative.

Operating income increased to 17.2% of net sales in the first quarter compared to 13% of net sales in the prior-year quarter as a result of increased net sales, gross profit margin expansion, and lower operating expenses as a percentage of sales.

During Q1, operating income was favorably impacted by approximately $1.9 million as a result of the translation of foreign-based sales and expenses into US dollars.

Given the operating leverage generated in Q1, and a slightly improved currency situation over the last 90 days, partially offset by the reduction in gross margin expectations over the balance of the year, we believe fiscal year operating margins will be slightly better than the original 17% to 17.5% guidance we provided on our call in February.

On the investment side of things, a significant portion of the $25 million to $35 million strategic spend we discussed in the context of our original guidance is still yet to be spent over the remainder of the year. And just as a reminder, currency rate changes, as well as deviations from our current expectations in sales mix over the balance of the year could influence individual quarter and full-year gross margin and operating margin performance.

Other income expense decreased unfavorably by $5.6 million during the first quarter in comparison to last year, and this was principally the result of net mark-to-market foreign currency transaction losses this quarter in comparison to net mark-to-market gains in last year's first quarter. These gains and losses are primarily related to our core contract hedging activities.

Income tax expense for the first quarter was $31.2 million, resulting in an effective income tax rate of 34.9%. For the prior-year quarter, income tax expense was $16 million, resulting in an effective income tax rate of 29.9%. We estimate our fiscal year 2011 effective income tax rate will approximate 35%, including any discrete events. I should say excluding any discrete events.

First-quarter net income attributable to Fossil, Inc. increased by 55.5% to $55.8 million or $0.86 per diluted share, inclusive of an approximate $0.04 diluted earnings per share reduction related to currency. This $0.04 loss represents losses of $0.06 from mark-to-market activity included in other income and expense, partially offset by per-share gains of $0.02 included in operating income from favorable currency translation rates in comparison to the prior-year quarter.

Turning to the balance sheet, we ended the quarter with cash, cash equivalents and securities available for sale totaling $355.3 million compared to $458.2 million at the end of Q1 2010, and we have $9.7 million in total debt.

In connection with our share repurchase program, during the first quarter we purchased $94.5 million of our common stock, representing 1.2 million shares. Since the inception of our $750 million buyback authorization last September, we have repurchased approximately $310 million of our common stock to date. This buyback represents 4.7 million shares at an average price of approximately $65.

Approximately $440 million remains open for additional share repurchases in connection with our $750 million authorization, and it is our intention to complete this buyback by its December 2013 expiration date.

Inventory at the end of the first quarter was $402.6 million, representing an increase of 61% from the prior-year first-quarter balance of $250.3 million. Higher inventory levels resulted from accelerating inventory purchases to compensate for the watch sales trends globally while continued smoothing of factory production resulted in a slight increase in factory lead times. This smoothing has the impact of increasing inventory during the first half of the year when sales are seasonally lower than the second half of the year.

We expect inventory increases to slow over the balance of the year with projected year-end inventory slightly higher than the prior fiscal-year level, against a backdrop of strong double-digit sales growth expected for the full year.

Accounts Receivable increased by 34.2% to $219.7 million compared to $163.7 million at the end of the prior-year first quarter, a result of the 38.6% increase in global wholesale shipments. First-quarter days sales outstanding for our wholesale segment was 46 days in comparison to 47 days in Q1 last year.

During the first quarter of 2011, we had capital expenditures of approximately $12 million, and are expecting fiscal year 2011 capital expenditures slightly north of $100 million. The planned increase in CapEx levels are related to accelerating new store openings and concession buildouts, leasehold improvements related to our new corporate office that we will be moving into in late Q3, and also adding increased infrastructure capacity across our sales, marketing, distribution, supply chain and other back-office functions.

Depreciation and amortization expense for the first quarter totaled $10.3 million, and we estimate full-year 2011 depreciation and amortization of approximately $50 million.

As it relates to guidance for 2011, we are projecting fiscal 2011 net sales growth in a range of 21% to 23% with higher percentage net sales increases in the first half of the year in comparison to the second half. For the second quarter of 2011 specifically, we see net sales increasing in a range of 28% to 30%. Second-quarter 2011 diluted earnings per share are expected to be in a range of $0.70 to $0.73 and includes an approximate $0.09 benefit from currency in comparison to Q2 last year. This includes an $0.11 gain in operating income relative to currency translation rates, partially offset by an expected $0.02 loss for mark to market and other translational currency activity reported in other income and expense.

Additionally, Q2 this year is unfavorably impacted by $0.26 as a result of a much lower than normal effective tax rate in the second quarter last year. For fiscal year 2011, we are projecting diluted earnings per share in a range of $4.44 to $4.54, which includes $0.10 of favorable currency, including a $0.36 gain in operating income relative to currency translation rates, partially offset by a $0.24 loss from expected marked to market and other transactional currency activity reported in other income and expense. Considering shares repurchased to date, in addition to our expected level of repurchases for the remainder of fiscal 2011, we are estimating a $0.27 diluted share benefit and comparable year-over-year earnings as a result of a lower outstanding share count. However, a higher planned effective tax rate for 2011 in comparison to 2010 is expected to unfavorably impact year-over-year comparable diluted earnings per share by $0.29.

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

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

(Operator Instructions). Randy Konik, Jefferies.

Thanks a lot. Just Kosta, is there any color you can provide us on where -- you know you think -- you said the watch cycle is in the early stages. How do you think about the watch cycle across different geographies -- Asia, Europe and the United States? Any differences in the innings of the ball game in those different regions? That's my first question.

Well, we're seeing this as more of a trend I think than a cycle, and I think it's similar, as some of the analyst reports have said, to what happened in handbags several years ago, where there was a five-year upward trend where the handbag business grew, it got more space, it got more attention, more resources, more salespeople, therefore, landed at a much higher level of business. I think we're seeing the same thing in watches.

In the United States, we had obviously big sales increases at retail last year. What happened was the store subsequent to that gave the category more space, more inventory, and more salespeople which gave them even higher sales increases. The number of our accounts in the United States are actually trending in a higher percent increase this year than they did last year just due to the additional space and resources and especially salespeople.

So as we said before, we saw this start to happen a year and a half ago I guess in the United States and continuing I think somewhat of a spiral effect as it gets more resources and space, it's trending up even more. There's a lot of awareness in watches. It's enabled us to use it as a platform for a lot of new ideas and materials in there. We have a very large audience for innovation right now across all our brands and that's been driving even more sales and awareness.

We also had said that we were maybe a bit slow in getting that kind of approach into Europe, but when we started doing it earlier this year we saw pretty good sales increases.

And then of course, we're kind of looking at Asia as a couple things. One is I think the macro overall trend is probably much bigger than a watch trend, and we are playing into that in addition to those people being very predisposed anyway towards watches. So we've got several things going on at one time, all of which look like they are in our favor.

Great. And then just my last question, two-parter, is just on your comment on Asia, getting to about a third of the business over time, is there a little bit more clarity you can give us on the comment of over time, meaning how fast you think it will take to get there?

And then, can you just give us a little bit more perspective on the Asian investment, what types of things are you doing from an infrastructure standpoint to get ready for concession growth, et cetera, just getting a little more color on that SG&A spend. Thanks.

I guess you could say, in today's world, if you had a fully mature merchandising company that was global, you might say that the sales would be a third Asia, a third Europe and a third US. Obviously, the huge changes going on in Asia are -- at some point those numbers will change where Asia probably would be larger, depending on what category you are in and whether it's luxury or what level the business is. Obviously luxury is going to end up -- probably already is -- a majority of the business, so long-term, we think that we have a big opportunity, and it could be a third of the business. But the issue we have now is that the US is growing so fast and we're getting big growth in Europe so it's kind of a moving target.

So as to say how long it will take us to get to a third, it's very difficult because we're focused on growing the entire world, and at the same time we're putting significant resources in Asia to capture that market.

So as to the expenditures we're making there, we have a whole re-organization, a huge work chart that we've been hiring into. We've hired a number of key players throughout the region, including some senior management people. And as I said on the comments earlier, we have sent a number of ex-pats there to really accelerate the learning. So we've sent people over there to help train and get people up to speed on our operating model, et cetera.

And there's a number of other investments that we are making throughout the region to add management and people to manage concessions, open concessions, do visual presentations, do construction and facilitation of fixturing. There's a number of large initiatives that they're focused on over there and we are supporting them as much as possible. And we are really very, very active in the market right now.

Randy, to add to that as well -- and Kosta talked about it a little bit on his part of the call -- we are continuing to ramp up our e-commerce activities. And we've got e-commerce plans for a number of countries in Asia that we think will facilitate the FOSSIL brand in those markets. And we will also support that in our expanded catalog mailings, which we would expect to occur as well as we get those websites up, so we will have a similar situation, albeit to a much lower base in terms of store Web and catalog to really facilitate the promotion of the FOSSIL brand in that region.

Great. Thanks, guys. Thanks for taking my questions. I appreciate it.

Matt Mcclintock, Barclays Capital.

Hi, yes, good morning, and congrats on the quarter.

So, my first question is, maybe could you provide some more color on the trends that you are seeing in Europe, perhaps discuss the progression in sales that you saw throughout the quarter? And what are you seeing so far quarter to date in the second quarter?

I think as we talked about and Kosta mentioned it a little bit on his earlier response to the first question, is that because of the distribution in Europe being a lot more diffused than it is in the US, and in saying that, what we mean is that in the US we sell to a lot of department stores, so it's easy to make big statements -- merchandise big platforms across a lot of the brands.

In Europe, it's a much more fragmented customer base with a lot of mom-and-pop shops. So the time it takes to roll out these assortments individually versus having the opportunity to talk to one buyer that controls 640 stores in the case of Macy's, had us believing all along it would be a little bit longer period of time before we saw those trends take root in Europe as well.

In addition to that, as we've said, the US kind of went into the recession a couple of years ago a little bit quicker than Europe did and we expected Europe to come out of it a little bit later, and I think that is playing into it as well.

Our trends remain solid in Europe. Again, we're seeing it broad-based across all of our brands. The FOSSIL brand store growth is still happening there. We're getting great comps. We are seeing significant increases, albeit on a lower base in some of our non-watch categories under the FOSSIL brand as well, both in handbags and in jewelry. So we think that's an opportunity that allows us to continue to elevate the FOSSIL brand in that part of the world and should allow us to continue the strong growth we've seen there over the last nine months.

Great, thank you.

And then one more if I may. Can you -- the increase in inventory is pretty significant. I was just wondering if you could maybe break it out into the buckets that you outlined. How much of the increase -- and just maybe rough estimates or just generalizations so we can understand it better; how much of the increase is related to the smoothing? How much of the increase is related to accelerating purchases, direct-to-consumer growth, et cetera, et cetera?

Don't know that we have it broken out in those buckets, but what we would say, Matt, is that if you look at the quarter-end balances, it would definitely be higher finished good levels, primarily due to the fact that we are increasing sales at a pretty robust pace.

In addition, as we talked about, the fact that we have allowed the production -- or the assembly production factories to have more lead time to smooth their production levels out has increased the level of finished goods that we carry also in addition to that.

On top of that, we're also carrying higher raw material costs as we go into the second half of the year. And I would also say that if you look at the two-year compare, in the first quarter last year, our sales were up 17% on a 12% decline in inventory, so looking at it from a two-year perspective, we're much more in line with sales and inventory growth than we were reporting a 61% increase on a 37% sales gain.

The other comment we should make is that obviously we're driving very large sales increases across the company and across all geographies and businesses. The inventory that we have is actually very current, and you can see it in our outlet stores and margins going up; sell-throughs are very high. So the inventory happens to be very, very current.

Great. Thank you very much.

Anna Andreeva, JPMorgan.

Thanks so much. Good morning, guys. Congrats on a great quarter.

I was hoping to talk about gross margins, just hoping you could break down the impacts from the third-party distributors in the first quarter. And should we expect that to continue as we go through 2011?

And what's the magnitude of sourcing inflation that you guys are seeing? Just trying to understand the guidance for down gross margins for the year. It just seems like you will be benefiting from the positive mix shift through direct to consumer in the fourth quarter and the mix shift to international as it continues -- so it just seems that maybe that guidance is a little conservative.

On the distributor side, the increase in the distributor sales above the overall sales increase for the company impacted gross margins by about 10 basis points. Again, relatively speaking, that business only represents about 10% to 12% of total sales around the world.

In the context of the increase, we expect on a go-forward basis, I would say that it may be slightly higher than the overall sales guidance that we gave. We are seeing a tremendous amount of opportunity with our distribution partners in Eastern Europe, in the Middle East; South America is on fire right now as well. I think that business was up more than double in Brazil for the quarter. So it's something that's going to be ongoing and continuing.

From a component perspective, as everyone is seeing labor prices across the board in China increase, we too are being impacted by that, and there's a long-term trend for that to continue. I think there was a Wall Street article yesterday that talked about substantial increases in China, labor costs over the next five years. And like everyone else, that's where most of our goods are manufactured.

From a other than labor costs, we are seeing component cost increases in certain raw materials that are influencing our decision to take down our gross margins slightly for the balance of the year.

As we have done over the last two years, we will continue to look at engineering our gross margins relative through potentially increasing pricing to keep our margin performance consistent, but we have to stay aware of how the consumer is going to react to those situations as we add new assortments or new styles to our assortments around the world.

So with these slight differences in margin we think are short term because you are correct; in the long term as we have more Asia business and more retail, our margins over time will go up.

Okay, okay, okay. That makes sense. And just looking out to the second quarter, what should we be expecting for gross margins?

Well as we said in the call, something slightly below the 57% level that we guided to back in February. Last year, we were at 57.4%, but we had a higher mix of direct-to-consumer sales; I think our direct-to-consumer business was almost 24% of the total company in Q2 last year. We're expecting that to be slightly lower this year as we start ramping up our store growth initiatives. As we get to the back half of the year, I think you will see that direct to consumer will be more of a mix benefit to us throughout the third and fourth quarters.

Okay, okay, got it. But conversely SG&A leverage was much better than expected. Were there any timing shifts in the quarter? And I guess could we expect to see similar magnitude as we go forward?

No, no real timing shifts. I would say it's very consistent with what we saw last year, Anna. And that anytime we can beat our sales plans, there's a high marginal impact to operating income relative to 17% -- or 57% sustainable margins -- gross margins. So it's just a flow-through impact of that sales beat that is so accretive to earnings at the end of the day.

Got it. Okay. Okay, that's great. And I'm not sure if I missed this. What we are comps by division, just looking for US versus Europe and Asia Pac?

I think -- Kosta, do you have that in your section?

US -- and this is for the quarter -- North America was up 25.6% for Q3. And that was on a 23.9% -- Q1, I'm sorry. And that was on top of a 23.9% last year Q1. Europe was up 8.1% on a 7.8%. And Asia was up 26.5% on a 13.5% last year.

Okay. Okay, perfect. Well, thanks so much. Best of luck, guys.

Scott Krasik, BB&T Capital Markets.

Thanks for taking my question this morning. The first question -- couple questions on Asia -- maybe talk about the brand recognition right now for FOSSIL versus your licensed brands, how you would characterize the progress there first. Thanks.

Well, we have I think right now about 51 stores in Asia. We just opened a number of stores in Japan. Matter of fact I was in Tokyo a couple weeks ago, saw a couple stores we opened there that are really incredible locations, great brand building. We also are in the process in Japan for example as -- we're going to open an e-commerce site there in June and we will start distributing our catalog there. And with the emphasis we have on the CRM project, we think that we can go in there in a market like that and really build the brand, especially with these stores there and then add concessions in department stores. We think we're in a great position to grow there. So, that business in Japan started with our license brands.

I think Diesel is actually our largest brand there, and all the other brands are -- grew pretty readily just because of the brand awareness. And we have come as a follow-on and put some FOSSIL stores in the market. I think we have 14 in Japan right now.

We're building a website and we'll start doing the catalog. And we're getting a great response to the FOSSIL brand in general. It seems to be working all over the world.

The same thing is true in the other markets. So the plan is to go into Korea and Hong Kong, China, and build stores in great locations, then put FOSSIL concessions inside department stores, and then also, accelerate that with e-commerce sites.

One thing I would mention is that these e-commerce sites we're putting around the world -- we will have 10 FOSSIL e-commerce sites around the world. These are all directly owned and managed out of our existing buildings and warehouses, etc. and go through our system. These are not outsourced.

We have -- because we have these companies all of the world, we kind of have an early-mover advantage both on retail now and e-commerce we're able to do this ourselves to help facilitate the growth.

So if you could say in general, the whole idea was to -- we go in with a multi-brand portfolio of watches which gives us immediate critical mass and we're selling products there and we -- depending on the market, we put resources in the market to help build the FOSSIL brand. You can see from the comps we're getting in our stores and the response to the business, they love the FOSSIL brand.

And if you look at the long-term demographics of the region, there's going to be hundreds of millions of additional people in the middle class, which is really the FOSSIL customer all through Asia, so we're very excited about the future. The response to the brand has been very strong. And it's just a matter of just building out the network.

Thanks, Kosta. And when you talk about having concessions, are these mono-brand concessions? Are you doing the multi-brand concept yet? And how many concessions are you at and how many can you get to?

So if you look at our business model, we have basically two core businesses -- the FOSSIL brands and then the multi-brand watch business. So in Asia, for example, we're developing a group of people that will build the FOSSIL brand, so there will be stores, websites, and concessions -- FOSSIL stores inside of department stores.

We also have a multi-brand watch business in those markets where there will be concessions and potentially Watch Station Stores in those markets as well. So in some of the stores throughout Asia, we will have a FOSSIL store inside a department store. And in that same store we will have a multi-brand watch concession. And this all ties back in with our long-term Watch Station strategy to really study closely how we are as a direct vertical retailer of the watch category in really an effort to gain market share, and to communicate the whole idea of fashion watches around the world and the brands that we carry. So we think the Watch Station idea globally kind of dovetails in with our concessions strategy, especially in Asia, as we move forward. So it's a big, long-term strategy on both the FOSSIL brand and on the multi-brand watch business.

Can you give rough numbers now how many you have and how many in two years maybe?

Well, we have something like 300 concessions around the world right now, and I think that includes our House of Fraser in the UK and we have some in northern Europe as well. And we will add hundreds more. That is what the whole infrastructure build in Asia is about. So there will be hundreds more. China alone could be hundreds by itself, so that's partly what the whole strategy is.

That's excellent. And then, Mike, just lastly, in terms of the investment spending this year, can you quantify or maybe identify what pieces are truly one time or will fall off after 2011? Obviously you are going to continue to add growth in Asia. So --

Yes; obviously this is an ongoing situation with certain areas of opportunities for growth, but I would say that the $7 million that we have estimated that will be spent on the CRM initiative this year, most of that will fall off. There will obviously be an ongoing maintenance charge related to the software of that application as we move forward.

The new building, about $4 million of that will be a one-time move; write off of some old fixturing and existing buildings that will happen in the third quarter. And then, 50% or more of that $25 million to $35 million that we've identified in investment spend is geared toward Asia. And I would say over the next couple of years, we could see that as ongoing.

Again, our investments will be determined based upon how successful we are in moving our businesses forward in each of those markets as well.

All right. Thanks very much. Congratulations.

Barbara Wyckoff, CLSA.

Hi, everyone. Can you talk about how many concessions do you have now by country in Asia? And can you talk about the mechanics of how they run? Are they different -- China, Japan, Korea? Or they have different sort of -- are they all pretty much the same? And then can you talk about the four-wall margins in your own stores? And is there a difference between the legacy versus the new stores?

On the concessions, we don't have the numbers by country, but the way it works is basically, we go in and pay a percentage of sales; we own the inventory; and these are our sales people.

The great thing about the concessions and probably the reason for Korea's growing so fast is we capture full retail. And the operating margin on those operations is very, very strong. So it's a great way to grow and also the capture of bigger part of the retail picture and also to control our own destiny.

The number one thing is to have our own people and our own visual presentation, presented the way we want to with the right amount of inventory flowing correctly, and really drive significant sales if it's done correctly, which is what we're focused on. Mike, on the four wall?

Yes, Barbara, on the four wall we (multiple speakers) -- go ahead?

Just talk about the four wall and then I will come back.

Yes, on the four wall, as you've seen over the last two years, we've seen significant improvement in the contribution of four-wall margins from our direct-to-consumer business. We've always said that with a little store base and with building the infrastructure we've built to that organization over the last four, 4.5 years, that as we added new store to the base, we would see great returns on our investments there. In fact, in 2010, we improved overall operating margin contributions from our direct-to-consumer segment by over 300 basis points, and we see that as something to be ongoing.

We are focused on productivity as we mentioned. That's why we're obviously very open to closing down locations that either don't meet our expectations; are locations that are not the same demographic that they were 10 years ago when we opened the store.

We are seeing the improvement across all regions. I would say from a sales productivity, Europe continues to be the most productive store base that we have, but Asia with the comps, it's been able to add on 40% two year combined for the first quarter, is quickly challenging Europe on that metric.

And the US has obviously improved substantially as well with over -- or almost a 50% comp increase on a two-year basis. So overall, we expect the improvement in the operating margin contribution from the direct-to-consumer business to be ongoing. And we think that will happen in both -- in terms of our retail stores as well as from our e-commerce businesses that we're increasing around the world.

And just totally how many concessions do you have? I don't have it by country, but just roughly, rough number, 200, 300?

We have about 300, Barbara, with most of those being in Asia, and they're really spread out across each country. I would say highlighting -- our model in Korea is all concessions at this point in time. At the end of the first quarter, we ended up with 58 of those concessions, and there's a total of about 65, so we have about seven more concessions that we'll be taking over from our former distributor there over the next couple of months.

Japan is a market we're focusing on. China is a market we're focusing on. We have concessions in Asia, and Hong Kong, and Macao. And then as Kosta mentioned, we operate the House of Fraser store watch department, which is a concession. And we have a couple of customers that we operate concessions in the Netherlands and in Austria.

Okay, thanks. Great quarter.

Eric Beder, Brean Murray.

Good morning. Congrats on a great quarter.

Could you talk a little bit more in depth about what you were trying to accomplish with the CRM in terms of -- what you're trying to do with the CRM program down the road? How long do you think it's going to take to layer that in?

Well we just finished the first phase of that, which has basically given us what we call a single view of the customer. What it's basically enabling us to do is to identify Fossil customers and Fossil fans that are buying from our stores, website or potentially even department stores, so we are compiling information on them and trying to identify who they are; and it will help us communicate more efficiently with them, identify what types of products they are buying from us, and it also will give us the ability to measure the effectiveness of our different marketing programs.

So for example, if we sent a catalog out to a certain region, we can measure the comp store sales in our stores from it and really measure the effectiveness of all of our marketing vehicles, including e-mail, store traffic, et cetera. So it's a very robust CRM program that we think is going to have a pretty quick and very strong ROI on it.

In terms of the domestic stores, what's the focus in terms of that? How many of these split -- in the 80% to 85%, how many is going to be domestic and how many is going to be US -- how many is going to be international?

Yes, as we said, Eric, expectations are about 50% of those will be open in the US and 50% outside the United States. Again, as I mentioned in my portion of the call, we're always subject to having the right location and making sure that the terms are what we would like them to be. But I would say our intention is to have those stores equally split.

This is the first year we have really ramped back up growth in the US because a lot of the stores that we opened in 2008 weren't hitting our pro forma objectives. Those stores have substantially improved in terms of operating performance over the last two years. And the overall comp situation in the stores as I mentioned earlier has improved significantly. And we are very positive on adding the US back to the store growth.

And what about the closures? Are most of those going to be in the US or are they also split?

I would say there will be some across all markets. A number of those are a number of the clothing stores that we have that were opened 10, 11 years ago that just aren't in the right locations for how we envision that concept moving forward.

In addition, we do expect to open some additional clothing stores as well. We're continuing to test the model. We talk about Stonebriar being kind of the flagship store; that store continues to amaze us with its performance. We just remodeled KLP. We've got a few stores in Germany as well that are doing quite well. So we're going to continue to roll out some additional doors on the clothing side. And then we have normal stores that we close down and outlets that are just coming up on leases and other stores that may be facing lease termination that we don't want to move forward with are leases or stores that aren't performing to our expectations and we have terms that offer a kick-out clause.

Great. And last question, what should we be thinking about in terms of the share count, given all the repurchases you've done from Q2 and beyond?

Well, we estimate for the full year somewhere between probably 63.5 million to 64 million in the outstanding share count for purposes of diluted earnings per share calculations.

Obviously, it's not as impactful as we originally thought due to the fact that obviously the stock has kind of gone on a run. And I think when we announced the share buyback back in September last year, the $750 million represented 25% of the market cap of the company. Obviously, it's much less than that with the stock price nearly tripling since that time.

It's a nice problem to have. Congratulations.

Robin Murchison, SunTrust.

I'll add my congratulations. Wanted to just clarify or get a little more color. You are not raising prices at this point. Is that correct?

We have put a number of new ideas in the market in all categories, watches, handbags etc., that have additional details and materials. You will see in our leather handbags for example we're much upgraded, better hardware and the retails are higher. So we're not raising prices on like for like. We're just really innovating into a more aspirational brand outlook and that's the -- average in retail is going up because of that.

Okay, so, but not on watches; on similar styles or repeated styles versus last year, you're maintaining your price points, correct?

We do have some examples of in our company of where material costs have gone up. For example, there is increase in price in diamonds that may cause us to raise prices in Michelle, for example. So there are some specific circumstances where we may be doing that, but not broadly and not generally across the board.

Okay, good. And then I think Mike mentioned labor. Just are you seeing anything in terms of capacity, or capacity constraints or factory movements or anything along those lines?

Since the business got very strong a year ago, we've had great challenges in just producing the kind of quantities that we are needing in the market, so that's been what the initiative has been for smoothing, which has had the -- it's had the impact of somewhat slowing down our leadtime.

One thing I would say is our entire supply chain in our factories has done an amazing job all through this, and really getting very scientific about priorities and what they're making and when they're making it and how they're flowing it. We've gotten really, really good at doing this so we've been able to minimize the impact of having a longer leadtime.

So for example, during a relatively slow month in the factory that normally we would not be up to capacity, what we are producing during that time may be our quick response styles, styles that we know are going to sell for a long period of time. And we're reserving space in the factory during peak time, say August, September, for new, fast-selling items that we need to be produced. So we've gotten I think very, very good at doing that which has minimized the impact on what the capacity restraints would do to our leadtime.

Now, over the long term, we have a number of initiatives over there to raise our capacity so we can -- actually so we can be faster. And the labor component of this is -- we have had increases in labor. We did last year, this year. I would say one thing that we saw and partly why we are slightly lowering our margin expectations because we are seeing labor prices increase probably more than we expected to a certain degree. And we are very willing to pay them because the efficient flow and product is much more important than that number. So we are working through this, and we think that over the long term, we will have additional capacity. We're very focused on shortening our leadtimes, which is a -- we think a strength of the coming, enabling us to be resilient through good times and bad. And we're just moving forward.

Thank you, guys.

Alex Fuhrman, Piper Jaffray.

Thanks a lot, guys. Just wanted to chat briefly I guess on your different store formats, specifically, the clothing store format. You mentioned the KOP store earlier. I was actually at the store about a month ago and certainly, it looks great -- it's a much bigger store. My understanding is that these clothing stores have a much higher productivity and they are certainly a small percentage of the store fleet right now. So just trying to get a sense of what is the productivity benefit from some of these stores that you have remodeled into that concept? And where would you expect the productivity of these stores to come out relative to the rest of your fleet?

And then kind of thinking about clothing, it seems like intuitively, that's a lower merchandise margin category, but probably has a quicker inventory turn, so just trying to get a sense of what the impact of that is on four-wall margins for that format.

Well, I'll just give you a perspective on the whole thing. It basically is an incubator and we are studying what this could mean. The one thing that we have found out is that having apparel and clothing in our catalog website has been a great brand builder for us and it has really helped us on our mission to become an accessories-based lifestyle brand. You may notice that some clothing brands are now wanting to be accessories-based lifestyle brands. The accessories business long term has got so many benefits that that is the right place to be.

Having said that, we are, we think, getting increasing brand awareness because of our great photography and our great shots that we use on our catalog and website; it really communicates the brand very well.

The one thing that we said earlier is that those stores that we have -- there was 31 at the end of last year, we also actually had a four-wall profit last year. So far this quarter, through the first quarter we had a 17% comp again.

The one thing we saw in Stonebriar as Mike mentioned, it's beating expectations. And if you look at a mall or even on the Internet, the apparel business, the clothing, business is so much larger than the accessory business. People are shopping for clothing all the time both online and in the malls. What we found is that in our Stonebriar stores that we're getting more customers to come in the store because there's clothing in there, and what we're selling in fact is more accessories. That store is actually doing more accessories business than our average accessory store is. So we are basically going through this. We're studying it.

We're going to close eight stores this year, probably open 12 to 15. We will probably end up at the end of the year about 35 to 40 stores. In addition to that, it's going to stay on our website and catalog, and we have a great design team. We've got some new people down there. They're doing a great job. And we think it's very additive to the business.

It can be a long-term benefit to us. We have seen great productivity in those stores, and we're very pleased with the business. And having said all that, it's still an incubator and we're focused on the accessories concept.

Alex, one more point to add on that. This is a category that we only see in our own stores, in our own distribution channels. We would never take the clothing into department stores. To your point, that's a much messier business, so we will control it through our own distribution.

Right. That's very helpful. Thanks, guys.

And then just kind of curious -- I was in Central Europe a few weeks ago and was in one of your stores in Vienna, and noticed that it looks like from a couple -- on a couple like-for-like items in the watch category and women's handbag category, that some of your prices are maybe 20%, 30% higher in some of these European markets. Would you say that's accurate? And does that translate into a higher margin there or is there maybe something on the labor or real estate side that tempers that?

You know, it does translate to a higher margin, and in general in Europe, we probably see prices, excluding that on their end, excluding sales tax on our end, at probably a 15% to 20% premium across the broad region.

In Asia, you could see 30% to 40% premiums in certain markets like Japan and Korea and China. If we look at our retail stores around the world, on average, the international stores deliver about a 600 basis point improvement in gross margins because of the premium pricing that they are afforded. But, generally, real estate costs are higher in Europe than they are in the US. Whereas in the US, we're working within malls.

A lot of the locations that we build stores in Europe are generally street locations that are individual landlord-owned buildings that have been in the family for many of years. Additionally, the labor component in Europe is a little bit more expensive in that it's primarily more of a permanent situation then a lot of part-time or temporary that we find in the US. But all in all, the productivity of those stores on a gross margin basis and on an operating margin basis are opportunities for us as we move forward.

Great. That exactly answers my question. Thanks a lot and good luck this year.

Cliff Greenberg, Baron.

Congratulations. As you discussed the clothing store before, can you explain your thinking on Watch Station now? It sounds like it has a bigger future in your plans potentially in Asia. So how many stores do we have now? When do we start testing this concept of using that for a multi-brand retail strategy in Asia or wherever? Thank you.

I would say it's an incubator as well. I think we have 16 multi-brand stores now, and I think we just opened something like eight more. The Watch Station Stores in the United States are outlet stores basically with the exception of one. And we have just recently hired a new senior VP to manage that business, got a lot of experience in single category global retailing, so we are very interested in what the long term of this could be.

We also are very interested in -- especially in emerging markets; some places like Asia and some other emerging markets, they don't have a natural distribution for fashion watches. There's not department stores that carry fashion watches. And in those situations we may be a concession and the concession long-term may be branded Watch Stations.

There also could potentially be a franchise situation in some emerging markets where we get an investor -- investment group for some large real estate company to build out some kind of network of Watch Station Stores. And all these things are, we think, a very long-term part of our strategy to really fill the world with this category and be a big market share player in it.

And, we think that there is an opportunity for us to present watches in our own environment in a very creative and kind of aficionado way that would even give more life to the category and be able -- would enable us to communicate the brands that we have even stronger across the world.

Got it. So perhaps in this year are you going to do any of these Watch Station Stores in emerging markets or Asia? Or you'll start playing around with that next year?

Mostly North America this year.

Okay. Great. Thank you.

Rick Patel, Bank of America Merrill Lynch.

Good morning, everyone. Just a quick follow-up on the earlier pricing question. Do you expect -- when do you expect to take prices higher this year on like-for-like products? And what is your level of confidence your customers will be willing to accept those higher prices?

Well, we actually are not raising prices on like for like in very many instances. As I said, I mentioned one, which was Michelle, and just to give you the price of diamonds increasing, so there are some key styles in there that are ongoing that will have to go up in price just because of the pure increases in diamonds, but across the board we're not raising prices on categories. What we're doing basically -- and we've been doing this for a couple years basically is as we innovate and put new materials into the market in all the brand, what we're finding is the customer is willing to spend more for more higher-level componentry, detail and materials. So it's not like for like the same item being more expensive. It's more expensive construction details and materials.

Especially in FOSSIL, where we have been on this mission to make the brand more aspirational. We've actually dropped some lower-priced items from the lines in all categories, some things that maybe didn't represent the brand the way we want to, so we've actually dropped some lower-priced items. And as we've added more expensive materials, details et cetera, both on the watch side and on the leather goods side -- as I mentioned before, we have our leather handbags right now have much more aspirational, heavier hardware; they looked much more directional and the averaging retails are higher than maybe what we might have sold a couple years ago, which might have been fabric and maybe not as much hardware, et cetera. So we're kind of reformulating. We're not really raising prices on the same item across the board with very few exceptions.

And can you talk a little bit more specifically about the trends you are seeing right now in terms of innovation and new materials and how well you are positioned to take advantage of those?

Yes, I think we -- you can go on our stores or online and you can see all the new things that we have out there. I think the overall impact is that we started putting a lot of these new things on the market last year, got great responses to it. And a lot of those things are still selling in very large numbers. We've just added additional new materials and new categories that are adding even more sales. So I think it's partly what we described earlier in that we have a much larger voice. We have a bigger footprint in the stores. Stores are [giving] more salespeople that the customers are more interested, and therefore they're buying probably multiple watches and there's just a lot more interest in the category.

And anything that we put in there that's new seems to be additive and not necessarily taking away from other categories. So I think we're in a really good position going forward.

That's helpful. Thanks a lot, and best of luck.

And at this time, I would like to turn the call back over to management for any closing comments.

Thanks, Craig. Should you want to replay this conference call, it has been recorded and will be available from 10 AM Central time today until 12 midnight Central time tomorrow by calling 303-590-3030, or 1-800-406-7325 and entering pass code 4434391. Again, those numbers are 303-590-3030, or 1-800-406-7325, pass code 4434391, followed by the #.

The conference call has also been recorded by StreetEvents and may be accessed through StreetEvents' website at www.streetevents.com, or directly through our website at Fossil.com, by clicking on Investor Relations on our home page, and then on Webcast.

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 August for the release of our second-quarter 2011 operating results.

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We do thank you for your participation. You may now disconnect your lines at this time.