Fossil Group Inc (FOSL) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Fossil Inc. Q2 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, August 9, 2011.

I would now like to turn the conference over to Allison Malkin of ICR. Please 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 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.

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 call covering Fossil's second-quarter results. Joining us today are Mike Kovar, our CFO; Mark Quick, our Vice Chairman; and Jennifer Pritchard, our President of Retail.

Mike will provide a detailed review of our financial results later in the call, while Mark and Jennifer will be available for questions at the conclusion of the prepared remarks. We were pleased to announce earlier this morning the double-digit sales increases across all of our geographies and categories, as well as through our owned retail stores, allowed us to achieve a second-quarter sales record. As a result, our $0.80 per share earnings for the quarter significantly surpassed our previous earnings guidance.

The second-quarter sales increase of 35% represented the fifth consecutive quarter of at least 25% topline growth. The FOSSIL brand is continuing to show strong growth and we are in what we believe to be the early stages of a strong watch trend which is driving watch sales increases on a global basis through our wholesale, retail and e-commerce distribution channels. Our intense focus on design, innovation and brand development combined with the ongoing success of our global expansion continues to provide us with a powerful formula for growth.

During the quarter watches again led our performance, rising 32% in constant currency. Our emphasis on newness, new materials, new ideas and unique designs are allowing us to capitalize on the increasing importance of the category around the world. During Q2 Fossil watch sales grew by 13% while other noteworthy increases included Marc by Marc Jacobs, which rose 156%, Armani Exchange 136% and Michael Kors 91%. All our watch brands experienced double-digit growth.

On an aggregate dollar volume increase, Michael Kors and FOSSIL were the two largest contributors. The Michael Kors watch brand continues to surpass our expectations. The brand is maintaining a strong momentum in North America. It's just beginning to expand into Europe and is still small but showing huge potential in Asia.

By the end of the year we expect Michael Kors to reach an annual sales volume level of approximately $300 million, representing a more than $100 million increase over the prior year. And while Armani Exchange and Marc by Marc are still in the early stages of their growth, we're experiencing similar trends in these two brands that we saw in the Kors business early in its stages. These new and developing watch brands, in addition to our core brands and coupled with the strength of our design, product development and supply chain teams, and anchored by global distribution platform, serve as the foundation for our continued profitable marketshare growth.

In addition to solid increases in our watch business, sales of Fossil accessories grew 22%, resulting in an overall FOSSIL-branded sales increase of 17% during the second quarter.

Sales in the accessory category were led by a 44% increase in women's bags. A portion of the growth is due to an increase in our average unit retails and primarily a result of introducing a growing selection of higher-quality details and fabrications. We believe the handbag category will continue to benefit greatly from the increase in awareness of Fossil as a lifestyle brand.

Our overall leather category also continues to make significant headway in Europe and Asia, increasing 64% and 39% respectively during the second quarter and providing a glimpse of the growth opportunity in the category.

The other significant contributor to sales growth in the second quarter was our direct to consumer business, consisting of our owned retail stores and e-commerce sites. Our owned stores delivered another outstanding performance with a global comp store sales growth of 22% on top of a 15% increase in the second quarter of last year. It represents a 13th consecutive quarter of comp increases and the seventh consecutive quarter of double-digit comp increases.

The emphasis we have placed upon engaging our customers within our redesigned store environment and the focus on improving our selling metrics is increasing store productivity and paying strong dividends in terms of ROI.

Our accessory store concept comps grew over 16%, increasing its sales per square feet to $742 a foot compared to $685 last year. Our outlet store comps were even higher at 30% plus, as we continue to rage our average unit retail on the outlets through a reduction in promotional activity. From a geographic perspective, North America led our comp performance with a 25% increase, followed by Asia with a 19% gain and Europe which rose 12%.

In terms of our store expansion, through the first half of fiscal 2011 we have opened 15 new stores and closed 11. For 2011 we now expect to open approximately 58 to 62 new stores and close 20 existing locations.

This compares to our previous expectation of opening 80 to 85 stores and closing 26 to 28. The reduction in openings is primarily due to us getting a late start and not having enough deals in the pipeline to open that number of stores. We have since added additional real estate resources around the world and it is our intent to accelerate our store expansion in 2012. We currently have substantially more commitments in hand at this point for 2012 locations than we did for 2011 locations a year ago.

Our global e-commerce sales rose 20% during the quarter with our two principal sites in the US and Germany increasing 14% and 41% respectively. Currently, we have full e-commerce capable sites in five countries and are on track to launch additional FOSSIL-branded sites in Japan, Korea, France, Italy and Austria by the end of the year.

In addition, we will be launching our first Watch Station website in the United States in September. The objective here is to raise the awareness of the innovation in our various watch brands and support the Watch Station stores.

Our largest opportunity, however, remains our continued expansion into the Asia-Pacific region. We are intently focused on the expansion of our two core businesses in Asia and continue to expect the region to represent an increasing percentage of our global sales. We increased our overall sales in Asia by 35% during the second quarter principally through watch sales in Korea, Japan and Australia as well as through 39% growth in our non watch categories, although it was off a smaller base.

We're putting a lot of energy into optimizing our business in the Asia region, including expanding our concession and retail store footprint, investing in our back-office infrastructure in Hong Kong as well as acquiring additional management team members to facilitate the growth. Additionally, we are expanding our resources in visual presentation, real estate and construction, environmental design, inventory planning and training, all to facilitate our long-term strategies.

The growing recognition of the Fossil brands and our globally recognized portfolio of licensed brands is opening a number of doors for us as we expand into the region.

In summary, while there are many positive developments and milestones achieved during the second quarter, we also began to see the impact of higher production costs into our overall gross profit margin. And we certainly cannot overlook the recent negative economic events taking place. Even though we continue to experience very favorable trends across our brands and geographies, we would not expect to be immune to consumer spending cutbacks.

Having said that, we remain optimistic and confident about our growth potential over the next several years. We believe very strongly in the resilience and the growth opportunities that our business model provides us. The demand for FOSSIL and our multi-brand watch portfolio remains very strong and the investments we're making in talent and infrastructure position us to capitalize on the significant growth opportunities we see in Asia and other parts of the world.

Now I will turn the call over to Mike for more color.

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

Net sales increased by 34.9% to $556.7 million compared to $412.6 million. Gross profit rose 31.7% to $312 million or 56% of net sales, compared to $236.9 million or 57.4% of net sales last year. Operating income increased by 34.1% to $86.3 million or 15.5% of net sales compared to $64.3 million or 15.6% of net sales.

Other income and expense decreased unfavorably by $4.2 million. Income taxes increased to $27.7 million resulting in an effective tax rate of 33.9%, compared to $8 million resulting in an effective tax rate of 12.3% last year. Net income attributable to Fossil Inc. decreased by 5.7% to $51.4 million compared to $54.5 million. And diluted earnings per share remained constant at $0.80 a share on 64.1 million shares compared to 68.3 million shares last year.

The sales mix breakdown for the second quarter with comparable prior-year levels was as follows. 38.3% from North America wholesale activities versus 37.8%, 25.4% from Europe wholesale activities versus 26.1%, 12.2% from Asia Pac wholesale versus 11.2%, and 24.1% from our worldwide direct to consumer businesses versus 24.9%.

In connection with our wholesale operations, sales from North America wholesale businesses -- which include operating activities in the US, Canada and Mexico as well as sales to third-party distributors in South America -- increased by $57 million or 36.7% to $213 million. Excluding approximately $1 million from favorable currency comparisons to Q2 last year, North America wholesale sales increased by 36%.

Sales from our Europe wholesale operations increased by $34 million or 31.7% to $142 million. Excluding currency that favorably impacted sales by $16 million, Europe wholesale sales grew by 16.8%. And as a result of some late inventory deliveries we experienced a shift in shipments out of June and into July which negatively impacted the reported European growth in Q2.

In fact, our constant dollar shipments in Europe were up by over 35% in July.

Sales from our Asia Pac wholesale operations increased by $21 million or 46.3% to $68 million. And excluding currency that favorably impacted sales by $5 million, Asia Pac wholesale sales grew by 35.3%. However, when excluding Japan that was obviously impacted by the tragic events of Q1 and our decision to discontinue certain non-branded, non-licensed businesses, Asia Pac's constant dollar sales increased 48% during the quarter.

Highlighting some notable increases from a major product category perspective, total watch sales increased $111.8 million or 38.8%, 32.1% ex currency to $400 million. Drilling down into this number you will find that our proprietary brand watch sales increased by $24.3 million or 20%, 14.6% ex currency to $146 million. And our license watch sales increased by $88.4 million or 58.3%, 50% ex currency to $240 million.

And on the non watch the side of our business, leather product sales increased $24 million or 34.8%, 30.4% ex currency to $92 million. And jewelry sales increased $6 million to 19.5%, 8.7% ex currency to $38 million.

Moving onto the direct to consumer segment, sales from direct to consumer businesses increased by $31 million or 30.5% to $134 million. And excluding currency that favorably impacted sales by $5 million, DTC sales increased by 25.7%. And as Kosta mentioned, cost in dollar comps in our retail stores maintained their strong double-digit performance coming in at 22% in Q2.

Globally we ended Q2 with 367 stores and occupied 642,000 sq. ft. compared to 619,000 sq. ft. at the end of the prior-year quarter. This included 235 full-price accessory stores, 132 of which were outside of North America; 95 outlet locations including 22 outside of North America; 27 clothing stores, including three outside of North America; and 10 full-price multibrand stores, including nine outside of North America. This compares to 354 stores at the end of the second quarter last year, which included 222 full price accessory stores with 120 located outside of North America; 88 outlet locations including 17 outside North America; 31 clothing stores including two outside of North America; and 13 full-price multibrand stores, including 12 outside of North America.

Gross profit of $312 million in the second quarter represented a 31.7% increase from $236.9 million in Q2 last year. The increase was a result of increased net sales partially offset by a reduction in gross profit margin. Gross profit margin decreased 140 basis points to 56% in Q2 compared to 57.4% last year, inclusive of a 150-basis-point favorable impact stemming from a weaker US dollar.

The decrease in gross profit margin was primarily driven by production cost increases, and to a lesser extent, a larger percentage of lower margin product sales in the sales mix. Lower margin US wholesale sales and sales to third-party distributors and off-price retailers increased as a percentage of the sales mix, negatively impacting the gross profit margin.

This year we have experienced a 32% increase in labor rates in our China-based watch factories, which includes appreciation in the RMB. In fact, both labor and material costs are running higher than our previous expectations for 2011.

We made a strategic decision not to raise prices on core watch styles despite expected increases. Our plans were to engineer higher prices on newness in order to mitigate the impact of increased costs on core. Although we have done that to some extent, it wasn't enough to compensate for the overall impact that increased costs are having on our core styles.

Given the more rapid increase in pricing than we originally expected, we're reviewing opportunities to revisit our pricing strategies. Nevertheless we will experience year-over-year as well as sequential margin deterioration in Q3.

We currently estimate Q3 gross margins just above 55%. However, we expect Q4 margins to be more in line with last year, but lower than we guided to in May. The impact of newness and a higher mix of direct to consumer and higher margin Asia Pac wholesale sales are expected to partially offset our ongoing labor and material cost increases.

As a percentage of sales, operating expenses decreased to 40.5% in the second quarter compared to 41.8% in Q2 last year. Even with the increased expenses associated with our longer-term strategic initiatives, our better-than-expected topline growth allowed us to generate some nice SG&A leverage during the quarter. Total operating expenses increased by $53 million from the prior-year quarter, primarily the result of increased costs associated with sales growth and $12.4 million of unfavorable impact from the translation of foreign-based expenses due to a weaker US dollar.

On a constant dollar basis, Q2 operating expenses in our wholesale segments and corporate cost area increase by $17.6 million and $10.7 million respectively. Expense growth in the wholesale segments was the result of increased infrastructure spending in the Asia-Pacific region, and increased payroll costs and marketing expenses in North America and Europe. Expense growth in the corporate cost area was primarily associated with increased payroll costs including stock compensation and higher levels of professional fees.

In our direct to consumer segment, operating expenses increased by $12.4 million compared to Q2 last year primarily due to store growth, costs associated with the launch of our CRM initiative, expansion of catalog mailings and increased web-based marketing and infrastructure expenditures.

Regarding our planned strategic investments for this year, through the first half of fiscal 2011 we have spent approximately $10 million with 70% of this spend in the Asia-Pacific region. For the second half of 2011 we're projecting another $24 million in strategic spend, including 75% of this earmarked for Asia. The remainder of the $24 million relates to the completion of our CRM initiative and costs associated with the move and increased occupancy costs of our new headquarters in Richardson, Texas.

As a percentage of net sales, Q2 operating income remained relatively unchanged from 15.5% of sales compared to 15.6% of net sales in Q2 last year. Q2 operating income was positively impacted by approximately $10.8 million as a result of the translation of foreign-based sales and expenses in the US dollars when compared to last year.

We estimate our operating profit margin for the full-year in the 18% range. And just a reminder, currency rate changes as well as deviations from our current expectations and sales mix over the balance of the year could influence both gross margin and operating margin performance.

Other income and expense decreased unfavorably by $4.2 million during the second quarter, and this decrease was primarily driven by unfavorable foreign currency changes resulting from mark-to-market, hedging and other transactional activities.

At prevailing foreign currency exchange rates, we estimate that outstanding forward contracts with scheduled settlement dates in the second half of fiscal year 2011 will result in hedge losses of approximately $5.1 million and $6.3 million in the third and fourth quarters respectively.

Income tax expense for the second quarter was $27.7 million, resulting in an effective tax rate of 33.9% compared to an effective rate of 12.3% last year. As you recall, included in the 12.3% effective tax rate in the prior-year quarter we had a 21.8% rate reduction from our structural tax rate related to the recognition of previously unrecognized tax benefits as a result of certain audit settlements. We estimate our effective tax rate for the third and fourth quarters will approximate 35% excluding any discrete events.

Net income attributable to noncontrolling interest, which represents the minority interest portion of subsidiaries in which we own less than 100%, increased by $600,000 during the second quarter. And this was primarily the result of increased net income related to our less than 100%-owned watch assembly facilities.

Second-quarter net income attributable to Fossil Inc. decreased by 5.7% to $51.4 million or $0.80 per diluted share, inclusive of a favorable $0.07 per diluted share increase related to foreign currency. This $0.07 foreign currency gain represents gains of $0.11 included in operating income from favorable currency translation rates, partially offset by losses of $0.04 from mark-to-market activity included in other income and expense.

As a reminder, last year's earnings of $0.80 per diluted share included a $0.22 benefit as a result of a reduction in certain income tax liabilities identified earlier.

Now turning to the balance sheet, we ended Q2 with cash, cash equivalents and securities for sale of $332.2 million compared to $443 million at the end of the prior fiscal year second quarter. Since the end of the prior-year second quarter we have invested approximately $343 million to repurchase 5.2 million shares of our common stock.

Inventory at the end of the second quarter was $450 million, an increase of 51.5% from last year's Q2 balance of $298 million. Higher inventory levels resulted from continued smoothing of factory production throughout the year which results in higher inventory levels in the first half of the year due to sales being seasonally higher in the second half of the year. Although we expect inventory increases to slow over the balance of the year and expect our fiscal year and inventory growth to be in line with sales growth.

Accounts receivable increased by 38.8% to $226 million compared to $163 million at the end of the prior-year quarter. This increase was primarily due to an increase in wholesale sales in comparison of last year's Q2. And our days sales outstanding for the wholesale segment increased one day to 47 in comparison to 46 days in the prior quarter.

During the first half of fiscal 2011, we had capital expenditures of approximately $44 million and are expecting fiscal year 2011 capital expenditures of approximately $125 million. The bulk of CapEx spend is related to new store openings and concession build outs, as well as leasehold improvements related to our new corporate office that we will be moving into later this month.

Depreciation and amortization expense for the first half of the year totaled $21 million, and we estimate full 2011 depreciation and amortization of approximately $47 million.

As it relates to guidance for 2011, for the third and fourth quarters we expect reported net sales to increase in the range of 22% to 24% with constant dollar net sales increasing in a range of 18% to 20%. Third-quarter 2011 diluted earnings per share are expected to be in a range of $1.00 to $1.03 while fourth-quarter diluted earnings per share are expected to be in a range of $1.78 to $1.82. This guidance results in an estimated fiscal year 2011 diluted earnings per share of $4.44 to $4.50 compared to last year's actual diluted earnings per share of $3.77.

Our forward guidance as always is based upon the current prevailing rate of the US dollar in comparison 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 Q&A portion.

(Operator Instructions) Randy Konik, Jefferies & Company.

This is Amanda Sigouin on for Randy. I guess first just want to make sure I understand the margin picture for the second half of the year. What is the expected gross margin impact from the higher sourcing costs in the third quarter? And why does this seem to be coming on stronger than originally expected?

As you look in the second quarter, the impact of higher than expected production costs resulted in about 180 basis points of deterioration in our gross margin. We expect that to continue into Q3 and somewhat into Q4, although we've got a better opportunity in terms of mitigating that in Q4 in terms of a much higher expected mix in sales toward our higher-margin Asia-Pacific wholesale activities and direct to consumer segment activities.

We are primarily finding that labor rates are increasing at a slightly faster rate than we expected early on. There has also been some appreciation in the RMB that is impacting us in terms of those labor rates.

And we're finding cost increases in certain materials that we weren't expecting as well. In fact, our movement costs are up about 9% from where we were last year and that wasn't expected.

We did expect obviously to have some challenges with production given the events that occurred within the factories in Japan in the first quarter. And we have been able to see that ramp up in terms of production to meet our needs for assembly, but we weren't expecting a 9% increase in movement costs.

Okay, thank you. And then on the strategic investments I think you said $24 million is still going to be spent in the balance of the year. Could you give us the breakout between Q3 and Q4?

Yes. You will see probably, of that $24 million, around $10 million of that being spent in Q3 and the remainder in Q4. Q3 will be a little bit heavier in terms of the completion of our move into our new facility, as well as the completion of our CRM initiative, whereas Q4 will be more impacted by our continuing investments in the Asia region.

Okay, thank you.

Neely Tamminga, Piper Jaffray.

Hey, Mike, I just have a couple questions for you, dissecting again a little bit more on Q2. So if about 180 basis points were tied to the production cost increases, am I right in thinking that lower merchandising mix was closer to about 110, 100-ish sort of basis points impact? And how much of that is tied to the delayed shipments for European wholesale in terms of distorting the percentage of sales mix?

If you look at what happened in terms of sales mix quarter over quarter, we gave up about 30 basis points of margin in terms of lower contributions, in terms of our direct to consumer businesses, which is kind of interesting given we had 22% comps in our retail stores. But we actually lost sales mix because the rest of the Company was growing faster. So, combined, on a sales mix basis we saw about 30% unfavorable or 30 basis points of unfavorable mix toward the overall gross margin performance.

In terms of Europe, we're talking in terms of probably instead of coming in at 16% had those shipments hit our warehouses more timely, Europe would have been probably slightly over 20% for the third quarter and obviously a little bit less than 35% increase we saw in July of this year.

So, overall, just to be very clear, you're not looking for -- you have not experienced nor are you looking for some sort of increase in markdown rate or obsolescence tied to the inventory and all of the different moving parts; is that correct?

That's correct.

Okay, I just wanted make sure that that is amply clear.

So -- and then going back to the guidance, labor obviously is the big aha moment I think over the last quarter relative to where you guys were a quarter ago to now. And how much also of the slowed down store openings might be contributing to the guidance kind of coming in a little bit? Or is that not as much of a factor?

It's not really an issue in terms of our total picture. We actually this year will do more in retail sales than we planned, even though we will be have fewer openings, just due to the increase in the productivity.

Okay, that is great. One last question on the cash, obviously there's been some interesting evidence that have occurred in the market over the last week or two. And your stock is obviously going to take it on the chin today. Just wondering how you guys might view some strategic redeployment of cash as you continue to throw it off at a great rate.

Since we announced the buyback back in September last year, as you recall we've been pretty active every quarter in buying back shares. We just completed our last buyback under a 10b-5 plan last week and will continue to look at the opportunities as we move forward.

Great, thanks you guys and good luck.

Thanks Neely.

Ike Boruchow, JPMorgan.

I guess a couple questions; the first question I would ask you is, in Europe it sounds like due to the inventory issue the topline has really picked up in July. Can you comment about any other regions, whether it be wholesale or DTC, what you are seeing quarter to date?

I would say what is implied in our guidance is 20% to 24% increase in sales for the third and fourth quarter. I would say we're coming up against the impact of some pretty large numbers that we threw out last year, sales increasing in excess of 30% last year.

On a segment basis we would expect to see the growth in the US wholesale markets to, you know, drop somewhat in terms of where we've been operating over the last five quarters as we start to anniversary some of the significant increases we saw from Kors and some of the other brands here. While picking up some of that activity in terms of Kors and growing the Europe region with that brand as well as some of our other growth brands, I would say the mix change that you will see is a slight reduction in the overall US wholesale piece and favoring higher growth levels in terms of our international wholesale, including Europe and Asia.

Okay. And then in terms of the investments you guys are making, a lot of that going over in Asia and China specifically, what kind of -- in terms of the concessions or wholesale sales, what kind of a ramp up are you kind of looking at 2012 and then maybe a year or two out from there?

Well, what we're doing in Asia as we mentioned last time is mostly concession based. As we put more infrastructure over there in every category from the sales associate to the management to inventory flow planning, visual presentation, etc., gives us the ability to open more of the concessions. So we do expect pretty dramatic growth over there over the next couple of years.

We're seeing some of our initiatives in China really starting to show some good fruit of the labor there, good inventory turns. Starting to be a buzz about the brands there, so we're starting to see some signs that we are on kind of a fast growth track the next couple of years and we're accelerating all of the efforts that we have on all categories. We just hired a couple of new management members over there that have a lot of experience in the region.

So, also looking at the types of sell-throughs and the products and what other customers in the region are telling us, and the predisposition towards the increasing numbers of consumers interested in watches and jewelry, we think we're in a very good position. And we're really moving very quickly to capture that business in the future.

Okay. And lastly with the DTC, some of the store openings are getting pushed out. You gave us what you're thinking for 2011. But since you are pushing some of those previous openings into '12, what should we be thinking about for 2012 in terms of net new store openings?

Well, we will probably detail that out for you in a later call. We don't really have it all finalized, except to say we have significantly more stores in the pipeline this year than last. We hired a couple of new real estate people, one based in Hong Kong and some other assets in the United States as well as in Europe. We are, we think, seeing some pretty advantageous deals.

And obviously our performance is opening our eyes to some even more important locations, for example. If you get a chance to go by and see our new Times Square store, we just doubled the size of it. It is showing an incredible performance. It is really a great flagship location and the results are very, very strong.

So we're kind of looking around the world at more flagship type locations. And I think in the real estate community's eyes, we're becoming a more important tenant and getting better looks at better locations. And that obviously is very good for the brand globally, so we think we're in a very strong position in terms of moving forward with DTC.

Thanks guys. Good luck.

Omar Saad, ISI Group.

Thanks. Good morning. Just a couple of clarification questions, then I have one business question. Mike, on the guidance, SG&A -- if I think about the fact that you're looking for similar topline growth rates in Q3 and Q4, and I guess maybe a little bit more gross margin pressure in Q3 than Q4, it really is a significant amount of SG&A falling in the third quarter. And a lot of that is driven by headquarters. I just want to make sure I am interpreting that correctly.

Yes, a lot of that is driven by the investment spend we're talking about. And in terms of the productivity of the quarters, if you look at the implied guidance that we gave, the expectations for Q4 revenues are to be somewhere in excess of [$200 million] greater than Q3 revenues. So there is a larger opportunity to leverage some of those increased strategic spends in the fourth quarter than there are in the third quarter.

Perfect. Got you. And then on the business side, Kosta, can you talk about -- you had some really nice watch numbers. And thanks for laying it out kind of by brand, in some of the brands where you are seeing tremendous growth.

The FOSSIL brand and watches continues to grow nicely well but obviously not -- it is a little bit further penetrated than some of the other brands you license. Can you talk about your opportunities in FOSSIL as a lifestyle brand and how you're thinking about that as you think about how to spread your CapEx and investment spend around, versus the opportunity to really leverage your scale in the watch business across your existing brands including FOSSIL? And then maybe other brands in the future as you invest to build out the supply chain?

Well, the way we look at the Company, we have two core businesses. And I think over the last 12, 18 months I think has kind of crystallized into what we think is a much larger opportunity than we thought in the past.

On the FOSSIL side, if you think of FOSSIL as a head to toe lifestyle brand, an accessories-based lifestyle brand, it is running about half the size of the Company; very strong comp growth. We're seeing increasing awareness of FOSSIL around the world and just a sense of kind of presenting this American vintage image in Asia, in Europe, we think is a very strong long-term proposition.

And when we communicate that through our stores, Web and catalog, the customer really gets it. So, you know, you could say over the last couple of years us taking control the brand, presenting it the way we wanted to our stores, Web and catalog has really accelerated people's affinity for the brand and accelerated the awareness of it.

I think simultaneous to that we've also got much better, I think, at showing our categories of product with clarity and telling stories, and being clear on what our offerings are. And that has resonated very strongly with consumers also.

So if you look at the comp increases we had, I think in the last couple of years our stores have increased something like 42% in sales and even the year before that was strong. We still think we have increasing productivity we can get out of our stores. But we are thinking that FOSSIL can be much larger than we thought even a couple of years ago.

The watch brand continues to be very strong. We will probably add close to $100 million this year probably. We're on track to do that.

We're now in a position, because of our voice through our store, Web and catalog we're able to say what we think is important, set our own trends, set our own direction. So I think that is a huge thing for us.

Then on the other core business, on the multi-brand watch business, we call it the machine. It's a huge amount of resources we have for design and innovation, a big R&D team, great sourcing in China and a lot of people around the world working on putting new ideas in there, and some great brands that resonate very strongly all over the world.

And both of those businesses have -- since they're both pretty much accessories-based, 70% of our business is watches, we have a huge amount of advantage in the global market place in terms of the risk profile of the Company. We have somewhat our own ecosystem. We have a huge amount of planning resources around the world [to] appropriately flow [the] product to those stores.

And watches is in this great category [to operate] in. It is not as -- there's not a weather-related component to it. There aren't sizes in it. Styles tend to stay around for a longer period of time. Lead times are shorter.

So in good times and bad, I think we have shown we can be very resilient and operate at a very high profit level. And we're focused. The whole Company is putting a lot of energy and we're relentless on building the platform for a much larger infrastructure, to grow a much larger business around both of those two ideas. So we think we're in a very strong position.

Okay, thanks. If you could just address the supply chain, some of the stuff is going on there caught you a little bit by surprise. Do you have to really work with your partners to invest to grow that supply chain to kind of keep costs under control? Or are those really external issues around wages that might over time force you to move out of China into some other regions to keep product cost under control? Thanks.

That's a good question. We actually we saw, as we said, prices increasing faster than we expected. And we had seen labor increases over the last couple of years, but it increased in the last six months higher than what we expected.

We also, as Mike mentioned, we got hit with -- the situation in Japan caused our movement prices to go up 9%. And that is a big part of our margin drop.

We do think that will moderate back over time. The factories in Japan are really ramping back up to speed and there's even discussion about building additional facilities. So we think over time that will moderate a bit. So, on the cost side, we do think we're going to see some things in the future that would moderate back.

On the long-term sourcing there's a couple of things. We have an initiative in building now a supply chain initiative to use some technology and some other demand planning techniques that can help us quite a bit.

And we also, interestingly enough, have got a situation where in the factories in China we're starting to do more automation. They started this probably five years ago. And we think there is increasing amounts of that that can be done that really would enable us to make more watches with fewer people.

So we're really interested in that. I think that's a great opportunity for us also. So, all in all, I think we're in a pretty good position.

Thanks guys. Good luck.

(Operator Instructions) Barbara Wyckoff, CLSA.

A couple of questions. First your domestic business has been very, very strong. How does this compare -- a lot of it is in department stores. How does this compare in the department stores to store trends and the watch department trends, number one?

And then could you remind us the breakdown between department stores versus specialty? And do you see any new channels of distribution? And I have a follow-up.

You know, interestingly, Barbara, for the last couple of years we actually have globally fewer points of sale than we have ever had. And in fact, in a lot of cases we're closing some doors around the world -- smaller, less productive, not as important doors. And what we're finding is we can do a lot more business in our existing doors, especially the largest ones, so we're spending a lot of time focusing on the top 20% of our doors because they probably do a significant part of our business.

We have seen -- this watch trend continues. And we're seeing very, very strong sell-throughs around the world, including the United States, even though it has grown dramatically over the last couple of years. Though -- all the signs and the metrics we read are very healthy.

We're seeing very strong response to new items and new categories and new things that we put out there, especially when we do it with clarity. I think this is an example where scale matters. When we can put an idea in the market place and tell people it is important, we see a jump in sell-throughs on it.

So I think if you just look at the health and the turn of the inventory globally in this category, we're very, very pleased. And we think there is a huge amount of additional sales opportunities out there in some of the lesser developed parts of the world that we can fill into.

Barbara, this is Mark. Also in answer to your specific question about performance relative to domestic department stores, watch departments generally -- in our brand specifically within domestic department stores are significantly outperforming the overall comps we're seeing in those outlets.

Okay, great. That's terrific.

Can you just comment on the AUR this year versus last year, say maybe year to date?

I would say the average unit retails are -- I'm just -- off the top of my head guess they're probably 10% higher than a year ago. We're seeing that across the board.

A lot of that is due to, in FOSSIL for example, we put additional details. Materials and leather goods for example, we have a lot more hardware, finer materials, etc. So we've been able to really -- I think as part of the FOSSIL brand transition to a more aspirational brand we've lowered -- we've taking out some of the lower-priced items. That in effect has raised our average unit retail and the customer, I think, is responding very strongly to it.

Okay, and just a couple more questions. Sticking on domestic a little bit, you didn't talk about Relic.

And then just moving onto Asia Pacific, can you talk about how many concessions you have now in China, Korea and then maybe separate out Hong Kong out of the China? And then how many do you think you will have by the end of the year? And if you would give us just a ballpark by the end of 2012 for say China, Korea, Hong Kong?

I will take the question on concession. We have currently in our growth markets -- which would be Japan, Korea and China -- around 300 concessions. We expect to grow that over the balance of this year.

And a lot of the investment spend we talk about in terms of Asia-Pacific is for building concessions in those markets, and even looking at broadening our representation of our multibrand and the FOSSIL business through concessions in markets like Hong Kong as well. I'm not going to call out a specific number we're targeting. I will just say that a large amount of the initiative and increasing the spend in Asia is going toward growing our market share for our representative brands.

In terms of Relic, the Relic brand had a great performance for the second quarter and the year to date period as well. I think what we're seeing there is that category in those department stores, the Penney's, Kohl's of the world is starting to catch up to the overall trend in watches. They were a little bit late coming to the party in terms of some of the newness that we were driving in our more fashion brands, FOSSIL and others. But we've had a solid performance in Relic during the first half of this year.

Part of our excitement about the growth in Asia is that, as we said before, it would largely be concession based which gives us the ability to capture the little the full retail of it and the margins are much higher. We can also control the entire distribution ourselves. We have our own sales associates and our own assortments, so it's a much clearer, cleaner and more efficient business in terms of inventory usage as well, as well as being a higher margin and higher profitability.

So, of the business in Asia-Pacific, how much is now wholesale, or [set] year to date has been wholesale versus your own concessions? Or do the concessions go into the direct to consumer?

Concessions are still reported in our wholesale segment for reporting purposes. And that business is still an insignificant piece of the total wholesale activities going on in Asia today. But we expect that to grow quite significantly over the next several years.

Okay. And so how many stores -- how many concessions conceivably could you open in the next two years?

Well, over the next two years it's literally hundreds. So as we described before, the whole strategy for Asia is that in the major department stores throughout the region Japan, Korea, China, etc., we are going to have -- in those stores we will have a Fossil accessory store concession inside that store, and also a multi-brand watch concession in that store.

So in different parts of the area, like in Korea the growth we've had there was pretty dramatic. It was because the watch concessions are -- have been going in place and they're generating obviously huge returns and they're growing very, very quickly.

We still have not started any significant growth in the Fossil side there, so Korea has a good has start in watches, but not so much in the accessory side. In Japan where we have opened -- we have a wholesale business there that we have sold to for a number of years. We're in the process now of opening more of those watch concessions and those Fossil concessions in addition to putting some Fossil flagship stores in the market to kind of communicate the brand.

In China we have concessions in the market and the numbers of concessions are growing very quickly. Some of that is done through third-party partners, etc. The difference I think in China is that it is a very fragmented market in terms of department store groups. There's not a big chain there that you can go to immediately, so it's going to take a little bit longer time.

But the idea is, in all those groups, to have a Fossil concession and a multi-brand watch concession. So the answer to your question is hundreds in the next couple of years and potentially thousands of the next five to six years. So us and our entire organization over there, we have kind of got a restructuring going.

We are hiring a lot of additional people in every category, from the management all the way down to the visual presentation down to sales associate. Just building a much larger infrastructure to handle what in effect is going to be a direct to consumer business.

On that regard, we're internally talking about we're going to have to figure out how to communicate more how do we count the number of locations we have globally, how much of them are actual stores and concessions. It is something we're going to figure out over the next several months [and] how to clearly communicate exactly what that means, so you can see it clearly.

Okay, great, thanks.

Scott Krasik, BB&T Capital Markets.

Actually, [Kelly Halter] calling in for Scott. I just had a couple questions going back to your pricing strategies. You said this quarter that you were unable to offset some of the higher costs that you saw coming out of China.

I was just wondering, what is your strategy with pricing going forward? Coming into your largest selling season, do you expect to raise prices more? Or are you, given the higher costs you are seeing out of China now, do you think there will be a bigger increase going forward?

As Mike said on the remarks, we are working on increasing prices in a lot of different categories and different geographies. Some of that is actually going to start right away. And we do think we have some places, locations, etc. where that can happen right away.

And then some of it will happen through the balance of the year and then it will be a bigger initiative next year. But we do think that just based on the rates of sale that we see and the health of the business in general globally, we do think there is opportunity for us to increase our prices and therefore our margins.

Okay, so I guess in terms of gross margins going into the back half of the year do you see -- you are expecting a larger benefit from higher pricing relative to Q2?

I'm not sure it will be significant enough for Q3 and Q4, but we're moving in that direction.

Okay. My next question is in terms of your leather business. It really accelerated this quarter.

Going and looking at the back half of the year, how do you see that playing out in your gross margin? Do you feel it's going to continue on this run? Is it going to accelerate? Or was just Q2 just largely a one-time thing?

The one thing I would ask you to do is if you go and look at our website, and our catalog is actually on our website as well, or go and look in our stores. You'll see the clarity of offering, the kind of iconic looks we're doing in handbags right now, it's something we've been working on for a while, is really resonating with customers.

I think we are becoming somewhat of -- because of the increasing awareness of the FOSSIL brand, the more aspirational nature of it, FOSSIL handbags are becoming more of the handbag to wear kind of thing which, as you know, is a very emotional and viral purchase for consumers. I think just the increasing awareness and the affinity for the brand gives us a big, huge, long-term opportunity in handbags.

Also if you look at our accessory store, in fact the whole strategy was not to be a watch store, but to communicate clearly that we are an accessories-based lifestyle brand. And obviously handbags is the biggest part of that. It is part of the long-term strategy to communicate our ability in our handbag business globally, and I think we're really just starting to get into it right now.

Okay. My last question is in terms of your repurchase program. I don't know if I just missed this, but could you quantify how many shares you bought back in the quarter?

I don't have that information in the quarter. What we said is we purchased 5.2 million shares since we commenced the program back in September. Just estimating, I would say our purchases would have been -- the last 90-day period under the 10b-5 plan was probably somewhere in the 300,000 plus range.

Okay, great, thank you very much.

Thanks.

I'm showing no further questions at this time. I will now turn the call back over to Mike Kovar for any closing remarks you may have.

Thanks. Should you want to replay this conference call, it has been recorded and will be available from 1000 AM Central Time today until 1200 midnight Central Time tomorrow by calling 303-590-3030, or 1-800-406-7325 and entering passcode 445-6794. Again those numbers are 303-590-3030 or 1-800-406-7325, passcode 445-6794.

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 www.Fossil.com by clicking on the Investor Relations on our Homepage and then on Webcast.

Finally, should you have any questions that did not get addressed in today's call, please give me a call. Thanks again for joining us today. Our next scheduled conference call will be in November for the release of our 2011 third-quarter operating results.

Thank you. Ladies and gentlemen, that does conclude our conference call for today. We would like to thank all of you for your participation and you may now disconnect.