Q3 2007 Earnings Call Transcript
Good morning, Ladies and gentlemen, and thank you for standing by. Welcome to the Fossil, Third Quarter 2007 Earnings Conference Call. During today's presentation all parties will be in a listen only mode. Following the presentation the conference will be open for questions. Please go ahead.
Thank you. Before we begin, you should be aware that during this conference call certain discussions will contain forward looking information. Actual results could differ materially from those that will be projected during these discussions. Fossil's policy on forward looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is readily available in our Form 10 K and 10 Q report, filed with the SEC. In addition Fossil undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise. If any non GAAP financial measure is used on this call a presentation of the most directly comparable GAAP financial measure and a reconciliation of the non GAAP financial measure to GAAP will be provided as supplemental financial information to this release under the earnings release section of the investor relations heading on Fossil's website. Please note that this call is being webcast live on Fossil's website. It will be available for replay on the website under the investor relation heading after the conclusion of the call.
And now I'll like to turn the call over to Fossil CEO Kosta Karsotis.
Kosta N. Karsotis Chief Executive Officer
Thanks Allison. Good morning and thank you for joining us today. Also with us today on are Mike Barnes, President and COO and Mike Kovar our CFO. This morning we will give you an overview of our Q3 results of some additional insight into our operations and initiatives. At the conclusion of our prepared remarks, we will welcome your questions.
Fossil performed very well in the third quarter as we continue to execute on our key growth strategies and margin expansion initiatives. While we have experienced moderate growth in the United States, we are continuing to reap the benefits of our global business platform as we experienced strong growth in Europe and other parts of the world. This allowed us to exceed our financial expectations. In addition to our solid financial performance this quarter we also continue to advance each of our key strategies including maximizing the potential of our brands internationally. Expanding our direct to consumer businesses and increasing Fossil brand worldwide. In total, third quarter net sales rose 19.6% to $359 million driven by our international, direct consumer and accessories businesses.
On an adjusted basis, including cost associated with our equity granting practice review, diluted EPS for third quarter increased by 48% to $ 0.46 a share. During the third quarter we continued to broaden our product offerings pandora bracelets with charms through our launch of Fossil jewelry, cold weather accessories and our upscale premium priced Fossil 54 handbag collection.
And in addition to this highlights I would like to point out a couple of areas of our business that continue to deliver solid performances. International sales rose 25% excluding currency impact and for the quarter more than 50% of the total company's sales were done through overseas wholesale activities. European sales advanced 18% in local currencies with sales increases in all markets and in all of our major businesses. We are also pleased to announce that our leather goods business and wholesale grew 41% in Europe, so we are making inroads there as well. Additionally we are experiencing significant gains in Eastern Europe and the Middle East, our shipments to distributors in this area increased by 65%. Our other international segment which consists of the Asia Pac region Canada, Mexico and our export sales from the United States continued to grow with sales advancing 40%. We are continuing to grow our market share in many of this under penetrated markets in the segment. We remained focused on maximizing our international expansion opportunity especially given that the market is vast and that our international business is our most profitable business.
Profitable brands in that sale in all categories rose 15% during the third quarter as we capitalize on expansion opportunities and launches, Fossil retail accessories and jewellery as well as the previously mentioned new product initiatives. Global Fossil watch sales increased 14% excluding currency impact on off priced sales. With our Europe segment increasing at an 21% rate and our other international segment expanding at a 42% rate. We believe successful innovation on our watch offerings as well as the ongoing reposition of the Fossil brand to be the primary driver of these results. Additionally we are continuing to broaden the brand's awareness through our retail store expansion, increased catalogue mailings and an expanding web presence as evidenced by the launch of our e commerce business in Germany during September.
Our direct to consumer segment reported healthy gains on top of strong results a year ago with net sales increase in 18.5% and more importantly we experienced a robust 13.4% comp globally in our accessories store concept which as you are aware with the focus of our retail expansion plan. We are also very pleased with our financial performance as we continued to make progress towards our stated goals. Our gross profit margin expanded 270 basis points to 52.1%. This was due to three things, the currency impact, our company wide margin initiatives and to the mix towards more international businesses. The operating margin rose 250 basis points to 13.5% of net sales, 14.4% excluding option related expenses and for the first nine months of the year our operating margin excluding option related expenses that increased to 12%, a 51% increase from the prior year. We believe the progress we are making to date on our gross profit and operating margin expansions has us well positioned to meet our long term financial objectives.
We also improved upon an already healthy balance sheet. Cash rose by $117 million to $193 million, inventory once again is below last year's level despite our double digit sales growth. We also ended the quarter with only $15 million in debt. Now I will turn the call over to Mike Barnes for more details.
Michael W. Barnes President and Chief Operating Officer
Thanks Kosta. Good morning everyone. I am going to start with the review of our domestic business. The domestic wholesale watch shipments increased by 5.7% excluding discontinued product sales from the current prior year quarter. This performance is primarily the result of sales growth in licensed watches and our owned Michele and Relics brand which was partially offset by sales declines in Fossil in mass market watches. Sales of licensed watches rose by 29.4% driven by sales increases in DKNY, Michael Kors, Burberry and Marc by Mark Jacobs. Sales growth was aided by continuing door growth for our DKNY and Burberry brands primarily through our US department store locations. Both Michael Kors and Marc by Mark Jacobs are still relatively new being in only their third and second year of existence respectively. But both are performing extremely well at retail and gaining market share. Additionally we are optimistic about gaining further leverage in certain of our licensed watch businesses as the brands continue to increase overall. Michelle Motto shipments were up 24% for the quarter and the brand remains the best selling luxury fashion watch in Nordstrom's. Michele was also highlighted at Neiman's during their 100th anniversary celebration. Additionally we are going to be launching Michele sunglasses in the spring of 2008 with a signature line priced from $295 to $395 and a diamond collection priced from $395 to $1195.
Finally we remain on target for our Michele jewellery launch in Q2 of 2008 as well. Fossil watches reported a 6% decline in domestic wholesale shipments excluding off priced sales, reflective of an uneasy retail environment which has resulted in the tightening of inventory levels at our retail customers. Fossil watches represent our largest US business with sales increases dependent on cost for growth versus door growth in the wholesale segment. However it's important to note at the sell out level Fossil watches continue to generate solid sales growth rate in our department store accounts, specialty retail stores and our own stores which we believe reflects the improved innovation in the product range and modern vintage design in the current assortment. Our mass market business posted a sales decline in the third quarter as well, primarily due to a shift in shipments into the second quarter.
If you recall during the second quarter we reported a 69% increase in wholesale mass market shipments. Year to date our mass market shipments are consistent with our expectations and we expect this business to grow on a full year basis. We have recently launched Callaway brand into Target chain. We believe this initiative in addition to our current positioning in the channel will provide us with long term growth opportunities. Regarding accessories our domestic accessory business enjoyed a strong rebound from last quarter with shipments increasing by 12.3%. Our strongest performing category was handbags and we saw strength in both Fossil and Relic. Increases in handbag shipments were partially offset by declines in our small leather and belt categories. Also women handbags wholesale shipments increased by 18% during the third quarter. As you recall we had a difficult spring in handbags primarily due to missing the mark on our fabric line. As we move into the fall/winter season, leather becomes a much higher component of our handbags assortment and we are seeing better selling results in many of the new groups we launched during the quarter which are replacing much of Pandora Silver Gold Yellow Charm 092 our legacy core leather products. We are also experiencing average unit price increases of 20% plus in comparison to last year as we continue to add value to the products and consumers are responding favorably to these higher price point items. Men's bags, although, it's not a significant business at this point continue to show impressive results with wholesale shipments of 86% during the quarter.
Finally we are pleased with the results we are experiencing with the initial launch of the Fossil 54 handbag line into approximately 50 department store doors. We are confident that this product can grow to a much larger presence long term and the Fossil 54 product line continues to show strong performance in our own retail stores. Our core Relic bag line continues to perform well at Penney's and Kohl's and we are seeing great response to the new executive totes that's recently been added to the collection. Additionally in our continued initiative to broaden our accessories business internationally, we are planning to launch Relic handbags into Germany during the second quarter of 2008. Now I will give a little color on the international markets which drove over 50% of our overall Q3 sales and even more on a wholesale basis. Our total international business had a terrific performance for the quarter with net sales increasing 32.3% or 24.9% excluding currency. In Europe the sales rose 28.1% or 18.4% ex currency with contributions across all markets.
We experienced strong growth from our Fossil and our licensed watch brands as well as our Fossil and Emporio Armani jewellery businesses. With all of our major markets in Europe achieving double digit sales increase. In our other international segment, wholesale shipments rose by 42.1% or 39.9% ex currency. We experienced strong double digit growth across all of our major owned and licensed watch and jewellery brands in this segment and all of our operating subsidiaries experienced double digit sales growth. As we have mentioned on previous calls our shop and shop contest in the Asia Pacific region continued to build awareness for our brands and are allowing us to gain market share within the department store environment. Our China distribution business, which we launched in the fourth quarter last year, generated about $1.3 million in sales during the third quarter. While this represents an insignificant piece of our consolidated revenues, we are beginning to build awareness for our brands in this region and we believe it will result in significant revenue growth over the longer term. We also just opened our subsidiary in India. Similar to China we believe India represents a significant opportunity for our global watch and jewelry business especially considering the significant retail developments we see occurring in this country today. Our Mexico subsidiary, which we acquired in February of 2006, continues to outperform our expectations. We experienced a 61% increase in wholesale shipments during the quarter. In addition to increasing the presence of our global watch Pandora Silver Gold Yellow Charm 092 portfolio in the market, we developed a solid accessories business in Mexico with non watch product accounting for about 23% of the sales year to date. And as we've mentioned before, Mexico also provides us with the solid opportunity for broadening our North American retail presence in the future.
On thomas sabo leeds the global jewelry front, wholesale shipments of branded jewelry rose by 39% during the quarter primarily as the result of continued sales volume and door growth in Fossil and to a lesser extent, Emporio Armani jewelry.
Early retail selling results have the line performing it's sell through rates in excess of the overall department store jewelry category. We believe branded jewelry is a significant growth opportunity and we are continuing to explore options to broaden the presence of this category through both brand extensions and expansion of our current geographical footprint.
Now, turning to our direct consumer businesses. On a global basis we experienced solid contribution from our retail stores during the third quarter. Sales from our direct consumer segment rose by 18.7% or 17.1% excluding currency, as a result of a 14.5% increase from retail store door growth and a 5.9% comp store increase in a 178 stores and a 14% increase related to our ecommerce business. Store sales from our 63 full price possible Fossil accessories store actually increased by 13.4% on a comp basis globally. Our overall global store comps were negatively impacted by lower comps in our outlook stores to primarily to the reduction of our discontinued style. It resulted and vastly improved our store gross margins. 32 apparel stores and 14 multi brand stores. During the third quarter, we opened 24 new doors, including 19 full price accessories stores with no store closings. By 2008, we are planning to open between 80 to 85 stores concentrating on the full 2012 Pandora Crystal Bead 058 price accessories concept with firm commitments in place right now for about 36 locations. The trailing 12 month performance on our full price accessories stores is as follows. The average sales per square foot is about $558, our four wall pretax contribution margins are 25.9%. Return on invested capital 44% with the pay back in approximately 27 months. Our typical accessories store build out is about 500,000 and our average inventory level in a new store is around $62,000.
At this time, I'm going to turn the call over Mike Kovar to discuss our third quarter financial results. Mike?
Mike L. Kovar Senior Vice President and Chief Financial Officer
Thanks Mike. All right, I would like to once again summarize the results of our third quarter in comparison to the prior year quarter. Net sales increased 19.6% to $358.6 million compared to $299.7 million. Gross profit grew 26.2% to $187 million or 52.1% of net sales compared to $148.1 million or 49.4% of net sales. Operating income increased 47%, to $48.5 million inclusive of a $3 million of expenses related to our historical equity granting practices Tiffany Co Bead Bracelet review, which I'll refer to here on out on the graph review and that's compared to $33 million in operating income last year. Net income rose 41.4% with $30.5 million, inclusive of $1.9 million of grant review related expenses compared to net income of $21.5 million. Diluted earnings per share increased 38. 7% to $0.43 inclusive of $0.3 per diluted share of grant review related expenses and this compares to $0.31 per diluted share last year and finally diluted weighted average common shares has increased 2.3% to $70.3 million compared to $68.7 million shares last year.
The mix break down Pandora Silver Gold Yellow Charm 092 Pandora Silver Gold Yellow Charm 092 for the third quarter was as follows: 17.4% from domestic wholesales watch sales; 15.3% from domestic wholesale accessories sales; 17.3% from worldwide direct to consumer businesses, 33.6% from European wholesale sales and 16.4% from wholesale sales in other international locations. The 19.6% sales growth in the quarter consisted of the following increases and decreases by category in geographic regions.
Domestic watch sales decreased approximately 1% to $62.6 million compared to $63.2 million in the prior year quarter. Other domestic sales, which include our leather, sunglasses and jewelry businesses, increased 12.3% to $54.8 million compared to $48.8 million in the prior year quarter. Sales generated from European based wholesale operations increased 28% to $120.6 million compared to $94.2 million in the prior year quarter. Other international sales increased 42.2% to $58.6 million compared to $41.2 million in the Pandora Silver Gold Yellow Charm 092 prior year quarter
And finally sales from our worldwide direct to consumer businesses grew 18.5% to $62 million compared to $52.3 million in the prior year quarter, and as Mike mentioned this was the result of 14.5% growth in the average number of doors opened during the quarter. Comp store sales increases of 5.9% globally and a 13.9% increase from our e commerce based businesses.
Third quarter gross profit margins increased by $38.9 million to $187 million compared to $148.1 million in the prior year quarter and this reflected a 270 basis points increase in gross profit margin to 52.1% in the third quarter compared to 49.4% in the prior year quarter. dollar. Additionally, a sales mix shift towards higher margin international sales and improved gross margins as a result of our focus on product margin improvements, inventory initiatives, including reduced levels of lower or no margin off price sales and higher store outlet margins contributed favorably to the increase in gross profit margins.