Eric M. Cerny - Investor Relations Contact Kosta N. Kartsotis - Chairman & Chief Executive Officer Dennis R. Secor - Executive Vice President, Chief Financial Officer and Treasurer Gregory A. McKelvey - Executive Vice President, Chief Strategy Officer & Chief Digital Officer.
Omar Saad - Evercore ISI Ike Boruchow - Wells Fargo Securities LLC Dorothy Senghas Lakner - Topeka Capital Markets Cecile Origenes - Cowen & Co. LLC Edward J. Yruma - KeyBanc Capital Markets Christof R. Fischer - Piper Jaffray & Co. (Broker) Simeon A. Siegel - Nomura Securities International, Inc. Rick Patel - Stephens, Inc.
Lindsay Drucker Mann - Goldman Sachs & Co. Anna Andreeva - Oppenheimer & Co., Inc. (Broker) Betty Chen - Mizuho Securities USA, Inc..
Good day, ladies and gentlemen, and welcome to the Fossil Group's Fiscal 2016 First Quarter Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Mr. Eric Cerny, Investor Relations. Please go ahead, sir..
Thank you for joining us and welcome to Fossil Group's first quarter 2016 earnings conference call. I'd like to remind you that information made available during the conference call contains forward-looking information, and actual results could differ materially from those that will be projected during this call.
Fossil Group'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 reports filed with the SEC.
In addition, the company assumes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Please note that you may listen to a live webcast or replay of this call by visiting fossilgroup.com under the Investors section.
Now, I'd like to turn the call over to the company's Chairman and CEO, Kosta Kartsotis..
design, product development, and the ability to leverage our extensive global distribution network. The team has also been hard at work over the last several months developing and producing the Chaps line of watches that has just shipped into the market.
As with all of our launches, we expect the brand to start small as we learn from the initial assortment and position the brand for long-term sustainable growth. We believe this brand complements our existing brands in the portfolio, allowing for new distribution and price points across a unique assortment.
So while we have plenty of headwinds making our business challenging at the moment, we believe these newer brands, combined with our strategic advantages and our ability to optimize our portfolio can help drive momentum in our business.
Additionally, the successful launch of our Fossil Q assortment and the acquisition and integration of Misfit's innovative technology and functionality further enhance our competitive advantage and leadership position in the watch category. More on that in a moment.
And second, igniting our own brands, Fossil and Skagen, and driving sustainable long-term growth. We believe the long-term value for Fossil Group lies in our ability to be strong lifestyle brand builders and to leverage that strength to grow our licensed brands.
For that reason, we will continue to invest in our own brands, Fossil and Skagen, and are encouraged with the progress made during the quarter. With 12% constant currency growth in Skagen, led by product innovation and a solid performance in watches, we continue to be excited about the opportunity this brand represents.
Growth in each of our three regions demonstrates the global appeal of the brand. Fossil's performance for the quarter was slightly better than our expectations, given the strong quarter last year.
We are very encouraged by the growth in Europe and Asia, as well as the strength in women's leathers, a category we have been focused on improving, adding innovative designs, colors, and unique assortments.
Our brand-building activities, social media efforts, elevated websites, and CRM initiatives are all contributing to increased customer engagement enabling better interaction with our brands, and we expect to continue to see results from these investments.
Which leads me to our third priority for the year, which is leading in digital through enhanced omni-channel and e-commerce capabilities. These efforts are very much in support of growing our own brands.
As shopping patterns continue to evolve and mall traffic declines, our investments in digital, CRM initiatives, and e-commerce platforms should continue to support growth in Fossil and Skagen.
Being in touch with our customers and providing them with an enjoyable online shopping experience and a platform to learn more about the brands and product offerings is essential for the future.
The insights we gain through CRM efforts and creating deeper and more meaningful connections with our customers should drive repeat customers and support future growth in our brands.
The investments made in our omni-channel roadmap have proven to be beneficial, resulting in double-digit growth in the e-commerce channel through last year, a trend that continued during the first quarter. And finally, building our presence in the connected accessories market.
This is a strategic priority that extends across our entire portfolio of brands and is top-of-mind for all of us at the moment. Technology is driving innovation in watches. It's the fashion trend of today, and adding incremental functionality to watches and jewelry is a consumer-driven trend.
Our ability to provide that functionality into great-looking accessories with various lifestyle brands that customers can identify with is clearly a strategic advantage for us. This was very clear to us at the Baselworld Watch Show in Switzerland earlier this spring.
In light of the current challenging environment for traditional watches, we presented a roadmap to our partners and our customers around competing in this new environment. Providing innovative functionality in watches and jewelry and combining that with our design and branding expertise, we will lead the way in this category.
The feedback from the trade and the media was very positive in this regard.
We are uniquely positioned to lead the convergence of style and technology given our design, production, and global distribution capabilities, and now layering in the Misfit technology platform provides an alternative to the customer, adding additional functionality that will make the category more relevant to consumers.
At this event, we announced the launch of connected devices in eight of our brands, six of which will be new in 2016.
While each of these brands, Chaps, Diesel, Emporio Armani, kate spade new york, Michael Kors, and Skagen, will announce their own details regarding product launches, we are looking forward to launches across multiple categories in time for the fourth quarter.
From our brand partners' perspective, they are extremely excited to be participating in this space given the demand for connected devices from their customers and are also looking forward to the incremental customer engagement the platform will provide them.
Our wholesale partners are also excited about the opportunity to drive new customer to the stores and providing the technology devices their customers has been asking for. Beyond the licensed portfolio, we remain very pleased with the performance of the Fossil Q assortment and the updated styles introduced following our Q4 2015 product launch.
During the quarter, the Fossil Q display smartwatch was again our top-selling SKU in all of our full price retail stores. We are now working towards integrating the Misfit platform into the Fossil assortment just as we are with our licensed brands, and rolling out new product in the second half of the year.
Looking to the remainder of the year, while our focus remains on the long term and executing against our strategic priorities, we expect a challenging retail environment and pressure on the traditional watch category to persist.
Given those pressures on the business, we will continue to be mindful of our areas of investment and prudently manage our expense structure in order to direct our resources to the areas of greatest opportunity and pull back where we see less compelling opportunity for immediate impact.
As we did last year, we will continue to evaluate our infrastructure and investment needs, ensuring an efficient organizational structure and one that is well-equipped to compete in this evolving retail environment.
As retailers around the world remain cautious and are managing inventory tightly, we believe the advantages of our nimble manufacturing and an operating platform have us well prepared to capitalize on opportunities as we head into the back half of the year.
We continue to expect 2016 to be a year where we can see our momentum improve as we deliver our wearables product across our portfolio of brands and we look forward to updating you on our progress as we move through the year.
Although the business is tough right now, it is clear to us that our advantages of creativity, scale, and our portfolio of brands now combined with our technology platform puts us in position to increase share in the traditional watch business and also to capture share in the rapidly growing wearables business.
The combination of these two strategies, we believe, will dramatically improve our long-term sales growth and profitability. And now, I would like to turn the call over to Dennis for more detail..
Thanks, Kosta, and good afternoon everyone. Our first quarter performance while below the prior year was in line with our expectations as we anniversaried a relatively strong performance in Q1 2015, continued to face the challenging retail environment and navigated ongoing headwinds in the traditional watch category.
Overall, first quarter reported net sales decreased 9% to $660 million and on a constant currency basis declined 7%. Sales declined in each of our region which also reflects a relatively strong first quarter performance last year.
You may recall, constant currency and comparable calendar results increased 5% last year with a very strong performance in Europe and growth in most of our portfolio brands, particularly our larger brands. We continue to be encouraged by the performance of Fossil and Skagen, particularly in light of the strong performance last year in both brands.
While Fossil's first quarter sales were flat compared to last year's 6% first quarter growth, Skagen grew 12% compared to last year. For the quarter, we delivered diluted earnings per share of $0.12 compared to $0.75 last year.
The comparison to last year's results was largely driven by lower sales given the challenging retail environment and pressure on the traditional watch category.
Gross margin also declined as our pricing initiatives were offset by changes in foreign currency, higher markdowns, and more promotional activity in outlets than we had planned, part of our effort to stimulate sales.
The sales and margin headwinds were partially offset by a decrease in infrastructure expenses and we had fewer gains on foreign currency contracts compared to last year. From a sales perspective, the Fossil brand was flat to last year in constant dollars.
We were particularly encouraged with growth in the quarter for the leathers category led by women's handbags. Growth in leathers was offset by a decline in jewelry and a slight decline in watches in the Americas. Sales growth in Europe and Asia was offset by a decline in the Americas.
Globally, our retail stores delivered a 3% comp decline with a strong comp in Europe partially offsetting declines in the Americas and Asia. In our full price stores, our marketing message and the buzz around Fossil Q are helping to drive traffic to our stores and drove a positive comp.
Our performance was different in our outlet stores where promotional activity drove improved conversion but was not able to offset the decline in traffic. Skagen sales grew 12% in constant dollars with growth across all three categories led by watches and growth in each region.
In constant dollars, our multi-brand watch portfolio declined 8% compared to last year. As the traditional watch category continues to be challenged from technology-enabled devices, wholesale sell-throughs declined and our wholesale partners have reacted with tighter buys, putting pressure on our top line.
While we continue to benefit from the addition of newer brands to the portfolio, the majority of the brands in the portfolio declined compared to last year and larger brands in the portfolio continue to be hindered by strong historical growth. In the Americas, first quarter reported sales decreased 8% to $336 million, a 7% constant dollar decrease.
The decrease was driven by watches, with jewelry and leathers also contributing to the decline. Across brands, we continued to benefit from the addition of kate spade new york to the portfolio and constant dollar sales increases for Armani were offset by declines in nearly all of the brands in the portfolio.
Within the region, our full price stores performed well and delivered positive comps with strong performances in wearables and women's handbags. This strong performance was more than offset with weaker outlet sales where traffic continues to be down. Constant currency growth in Canada and Mexico was offset by a decline in the United States.
Constant dollar wholesale sales declined during the quarter, largely driven by further pressure on the watch category in U.S. department stores.
After three consecutive quarters of fairly stable watch sell-through headwinds, we observed a significant step-down in that trend that sustained itself throughout the first quarter, affecting most of our portfolio brands. Our business also softened in Latin America, particularly in travel retail where sales fell well short of expectations.
We did shift some, though not all, sales to off-price partners, which obviously impacted both sales and our margins. In Europe, reported sales decreased 10% to $210 million. Constant dollar sales decreased 8% with a decline in watches and jewelry partially offset by an increase in leathers.
Within the region, growth in Fossil and Skagen was offset by a decline in the licensed portfolio. By country, modest constant currency growth in France and Germany was offset by a decline in the U.K. and in our distributor markets, which includes the Middle East and Russia.
Similar to what we experienced in the U.S., the data we received from many of our wholesale partners in Europe showed a significant decline in sell-throughs. The retail channel grew in the quarter, supported by a strong comp store sales increase with promotional activity in outlet stores driving improved conversion despite ongoing traffic declines.
Full price stores also delivered positive comps in the quarter. In Asia, reported sales decreased 8% to $114 million, while constant dollar sales decreased 4%. The decrease was driven by watches and jewelry, partially offset by modest growth in leathers.
Solid growth in India was offset by declines in most markets in the region, particularly Hong Kong and China, where our business continues to be challenging. Growth in Fossil and Skagen, and the addition of kate spade new york, were offset by declines in most of the other brands in the portfolio. Comp store sales declined slightly in the region.
In the quarter, gross profit decreased to $348 million and gross margin declined 250 basis points to 52.8%, roughly 160 of which was related to the stronger U.S. dollar. Our gross margin rate was lower than we expected coming into the quarter given increased mark-downs and promotional activities in our outlet stores.
A higher level off-price sales compared to last year and an increased mix towards leathers, a lower-margin product, contributed to the rate decline and was partially offset by our pricing initiatives. First quarter operating expenses decreased 3% or $11 million to $334 million compared to $345 million last year.
A reduction in infrastructure costs and lower store expenses were partially offset by an increase in expenses associated with Misfit including roughly $7 million in purchase accounting costs and strategic marketing investments.
Excluding the favorable impact of currency and the $12 million in restructuring costs that occurred in 2015, expenses increased 2%. Our first quarter reported operating expense rate was 50.6% compared to 47.5% last year.
Operating income decreased to $14 million including a $13 million unfavorable currency impact, and operating margin decreased to 2.2% including a 180 basis point headwind from currency. Interest expense increased to $6 million given our higher debt levels.
First quarter other income decreased $5 million to $2 million due to lower gains on foreign currency contracts compared to the prior year. Our effective income tax rate for the quarter was 30.7% compared to last year's 31.3%.
First quarter net income decreased to $7 million due to lower operating income given the sales and gross margin decline as well as a reduction in other income due to the prior year benefit from hedging activity. Now turning to our cash flows and balance sheet.
For the quarter, we generated operating cash flow of $35 million and drew down a net $14 million on our revolver. We invested $20 million in CapEx and $4 million in our share repurchase program and expect share repurchases this year will be minimal.
We ended the quarter with roughly $307 million in cash compared to $237 million last year and debt of $823 million compared to $643 million a year ago. We ended the quarter with inventory of $630 million, in line with last year.
We believe the composition of our inventory is in good shape, with increases in newly launched product categories and brands and significant reductions in traditional watches and jewelry. Accounts receivable decreased by 11% to $237 million, and wholesale DSOs were flat to the prior year.
Depreciation and amortization expense totaled $25 million for the first quarter. Moving on to our outlook. Let me provide an update on trends in the business and how we expect that they will impact our operating results this year. First, our strategic initiatives to drive growth in the Fossil brand supported by our digital investments are working.
They began delivering results last year and we believe will continue into this year. We are seeing momentum in the brand, including positive comps in our full price stores and a solid online performance.
Second, our confidence has been bolstered by a strong performance in our wearables assortment that began with the product launch in the fourth quarter and continued into this year. We expect to build on that momentum as we quickly develop more connected products and launch more brands incorporating our Misfit platform.
We remain extremely bullish on our ability to gain share in the fast-growing wearables market as we leverage our unique position to fuse technology with brands and fashion. We are on track to deliver a wide assortment of new products that will be available in the second half of this year.
So with one quarter behind us, we believe those initiatives remain on track. Third is the performance of the traditional watch business and the wholesale channel, which is certainly the biggest change in our business.
As we exited 2015, we expected continued challenges in the traditional watch category, though based on our fourth quarter performance and the wholesale sell-through trends our partners reporting for some time, we anticipated some level of stabilization.
Overall, for 2016, we expected top line headwinds would persist in the first half with the opportunity to return to growth in the second half as we launched more connected products. That stabilization in the traditional watch category and wholesale does not appear to be holding.
During the first quarter, the data we received from our wholesale partners indicated a meaningful sustained deceleration in wholesale sell-throughs, not only in the United States, but also with wholesale partners in Europe. Mall traffic remains difficult, and many of our wholesale partners have announced transitions in their own businesses.
Our Latin America business also did not perform as we had anticipated. With the lack of visibility in this part of our business, we believe it is prudent to adjust our outlook to reflect these new trends and to provide for further wholesale softening.
We are adjusting our forward inventory buys and expect as we did in the first quarter to rely more heavily on off-price partners to manage inventory levels appropriately.
In the first quarter, we also invested more in promotions in order to drive sales in our European outlet stores and expect that we will maintain this level of activity to drive business in those stores.
Given those factors, we expect these intensified headwinds will result in both lower sales for the year and tighter gross margins with the wholesale sales softness representing by far the most significant driver of the change.
As we manage our wholesale traditional watch business in 2016 and anticipating lower sales now than we had originally planned, we have once again reviewed our infrastructure and investment plan and identified areas where we can reduce and delay. We will continue to look at opportunities to optimize our overhead structure for the longer term.
In addition, we have reevaluated and reprioritized our market investments for the year, reducing investments where we don't believe we will see immediate returns by continuing to invest in initiatives that are already working, like Fossil or digital initiatives, and supporting our second half wearables launches.
Therefore, for the full year, we now expect constant dollar revenues to decline between 0.5% and 4% which includes a 100 basis point headwind due to currency. Our biggest obstacle this year to quarterly growth will be leveraging our wearables launches offset the headwinds in our wholesale traditional watch business.
We expect gross margins to decline this year given an anticipated increase in outlet promotions as well as a greater reliance on off-price partners. Our margins will be further compressed due to the lingering impact of the strong U.S. dollar.
With the further reduction to expenses, we are now planning that our full year operating expenses will be flat to slightly down this year. We are planning higher marketing investments to support strategic initiatives and our wearable technology infrastructure including the addition of Misfit expenses and the related purchase accounting costs.
These increases will roughly offset a reduction in our base infrastructure costs as well as the impact of last year's restructuring charges. This will result in an overall expense rate that is higher than last year given the decline in sales of traditional watches.
Therefore, for the full year, we now expect reported operating margin in the range between 5% and 7%. This includes about a 90-basis-point decline due to the impact of currencies. Now we expect earnings per share in the range between $1.80 and $2.80 per share, and this range reflects the challenges we are facing with forward visibility.
The currency environment has not changed materially from our initial guidance, so we are still expecting significant translation and margin headwinds as well as far fewer net currency contract gains. We now estimate the net impact of those items is roughly $0.87 per share.
We continue to expect that this year's results will be negatively impacted by $0.36 per share resulting from the amortization of Misfit intangibles and contingent equity grants. And the year-over-year comparison will continue to be impacted by last year's foreign tax credit resulting in a $0.24 EPS headwind this year as well.
We continue to plan this year with a 30% tax rate. For the second quarter, we are planning a reported sales decline between 8% and 10%, including about a 160 basis point headwind due to currencies.
We are planning with lower gross margins and expect increases in our strategic marketing funding and wearables will slightly offset declines in our base infrastructure spending. We expect reported operating margin between 1.5% and 3% which includes a 120 basis point currency headwind.
And we expect EPS in the range between break-even and $0.15 per share. We continue to plan CapEx in the range between $75 million and $85 million. And now we'll open the call up to your questions. And to be fair to everyone, please ask only single part questions. If you have more questions, please re-queue after others have asked theirs..
Thank you. Good afternoon, everyone. Thank you for joining us and welcome to Fossil Group's first..
Thank you. We'll go to Omar Saad with Evercore..
Thanks. Good afternoon. Was hoping you could help us understand the back half and how you're thinking about the back half revenues guidance and the change in trend. I understand the traditional watch business has really dropped off in the first quarter, traditional wholesale watch business.
But how do you think about integrating all the new products you have coming into the market both from the wearables side and the tech side, but also from the fashion side. My understanding was you guys have a lot of new stuff coming into the market.
Are you getting feedback from your retail channels that they don't want to order into those areas strongly? Or is it really wait-and-see from the retail accounts? Like, help me understand why – I understand why maybe sales are slower now, last – in 1Q, 2Q, but with all the newness coming, why don't you expect sales to rebound in the second half, constant currency? Thanks..
Well, let me take maybe a deeper dive into guidance, and then we can fill in with some of the discussion about wearables for the back half.
But just to sort of double-click on how we're seeing the year and just to echo what we said, first, the change in guidance is virtually all related to what we saw in the wholesale watch business, which reflects both the step-down in sell-throughs that the channel reported to us in the quarter, and frankly, to reflect the further risk in a channel where our visibility is very limited right now.
And you remember back to the last fourth quarter, we guided to a pretty wide range that accommodated a big step-down at the time, even though sell-throughs had been fairly stable for the prior couple quarters, and that was principally to reflect our lack of visibility.
And fortunately, in the fourth quarter, we didn't see that step-down and our performance came in near the top of the range. So we've maintained that same approach coming into 2016, guiding to a pretty wide range with wholesale sell-throughs that then actually been pretty stable for three quarters.
So what's changed is unlike the fourth quarter, in the first quarter that just passed that reported, we did see that wholesale step-down and it was substantial, larger than we had seen before and it was pretty much across the board.
With the data we receive from partners, reported sell-through declines here in the United States and Europe, and as we mentioned earlier, Latin America where market intel is pretty challenging, that business fell well short of our sales plans. And even external sources like NPD also repeated a very significant step-down from Q4 to Q1.
So where that leaves us is the top of our guidance now generally reflects the current trends that we're seeing and the low end reflects that further step-down to account for lack of visibility. We also may be able to manage and shift some sales further to off-price.
That would impact obviously our margins and we reflected in our guidance the impact of further expense cuts that we've made. That includes cutting some marketing investments in areas of business that really aren't paying off right now.
What hasn't changed, and this is really what supports the growth in the back half, is our confidence in Fossil and our confidence in wearables. The marketing buzz and the buzz around Fossil Q, as we said just a minute ago, we've nearly eliminated traffic headwinds in our U.S. full price stores. We've got positive comps.
So we are continuing to invest behind that, and we think that can drive performance in the back half of the year. We have confidence in the products that we're bringing to market and believe that the customer is there. You heard what Kosta said just a minute ago talking about Basel and the excitement around our strategy for the category.
So we're going to continue to invest in that..
So, Omar, you're right on the product side. We are launching a lot of wearables back half of the year. Everything looks great, looks very exciting. The stores are really excited to change their departments. In addition to that, as you mentioned, we are putting into market a lot of new innovative materials, ideas, shapes, et cetera.
We're seeing a strong response to that across the platforms. We're adding more of it in the second quarter. I think when times get tough like this, innovation is always a driver, and we expect that'll be continuing.
But just you look at our entire analytics and our data right now, we seem to be in a lot of turbulence in terms of the traditional watch business, and we feel it's prudent to give the guidance we've given.
But we think the combination of wearables and all the new product that at some point this is going to turn around and be a pretty exciting prospect for us..
And our next question comes from Ike Boruchow with Wells Fargo..
Hi, everyone. Thanks for taking my question..
Sure..
I guess in terms of your own connected technology products that you plan on rolling out in the back half of the year, can you just help us understand maybe what level of commitment your department store partners have discussed with you? I mean, I'm just trying to understand at this time how are you internally planning the launch given it's a brand new category that you guys have never sold through and the fact that they seem to be buying the traditional watch business much more cautiously today? Thanks..
Well, first of all, the stores obviously have seen their watch business decline. So if you go back seven years ago, the watch department is very much larger than it was then. It's grown in multiples.
It is actually, with the decline in the watch business, probably come down a bit obviously in productivity, but still one of the most productive areas of the store. And the stores are actually very excited. There's so much consumer interest in wearables. It's very top-of-mind. It brings a younger customer in their store.
There's a bunch of excitement around it. We think that there's an opportunity to change the entire watch department from a typical watch department to a wearable technology department. Obviously, millennials overspend on technology, so it's very exciting.
So we are in the process of getting plans in place for the back half of the year in all the brands we're launching, especially Fossil and Kors, getting point-of-sale visual presentation fixturing in place, getting a lot of marketing PR. There's probably going to be TV campaigns on both brands. We're getting everything in position.
There are commitments we've made in products, but we're going to be launching in the third quarter this year. There is a potential even for us to do a reorder for holiday. We already know that probably about 50% of wearables are sold in the month of December, so it could be an additional amount of commitment there.
So to answer your question about commitments, the numbers are changing almost every week, and there's a lot of excitement. And we're putting plans in place to have a strong execution.
The one thing that's clear is, just from our launch at Basel, we got more press and page views than anything we've ever done before and we are seeing already just looking at numbers, purchase intent on Fossil smartwatches and it's still a very small business for us.
It shows to be a pretty significant number and we don't have a lot of product in the market yet. So all our analytics look strong, with the customers are excited about it and the actual commitment from them and our numbers are moving every week..
I'd add one other thing to that, which is although Founder, which is our display smartwatch for Fossil, was our number one selling SKU and has been, so we're very bullish on that category.
But one of the most exciting things coming out of Basel was the reception we got from customers from integrating technology from Misfit into the existing watch business as well. So we're getting – and we're already on generation two and three in development of these things.
But the ability to have added functionality like time that automatically changes with time zone changes or daylight savings, press a button and have a where's-my-phone feature, these are all added value to existing watches that is driving a lot of customer interest that is beyond what we even expected when we showed people at Basel.
So really bullish on all three categories, those two plus trackers..
Thank you. We'll now hear from Dorothy Lakner with Topeka Capital Markets..
Thanks, everyone, and good afternoon. Just wanted to, I mean, I don't want to beat the dead horse here but just to go back to what you're hearing from your wholesale partners, you did see the significant step-down in traditional watches.
Are they stepping up to the plate on the new watches on the wearables? Are you seeing some commitment there or is there just a lot of reticence around the entire category? How confident are you in seeing this growth in the second half of the year from all that you're doing on the wearables side?.
A couple of things. First of all, I'd say, overall, I think in the first quarter this year, there has been a step-down just in overall traffic and consumer activity. So that's one thing..
Right. Right..
In addition to that, I think especially in watches, I mean, we attribute this really to all the press and PR and excitement around wearables. I think there seems to be somewhat of a lack of interest in watches relative to last year. We actually had a pretty good quarter, first quarter last year in watches.
I think another piece of this is the stores saw in the fourth quarter relatively slower sell-throughs on watches so they didn't fill back in in the first quarter as they normally would have and typically that means, as you know, the larger doors don't get filled back in and they may impact their sales so it has a multiplier effect in there.
So I think there's just kind of a malaise in watches. Our biggest objective in all this technology stuff is really to disrupt the watch business. We think, as Greg mentioned, to put additional functionality in traditional watches.
And as we've said before, our mission is to eventually we want to put connectivity in every watch we make without adding a lot of additional to the retail price.
So we're – with the Misfit technology and all of our engineers, et cetera, the mission is really to take the existing watch business and add functionality, innovation, and connectivity and make that category more relevant to consumers that increasingly overspend on technology.
We think that's a very exciting prospect and largely Millennials have not worn watches because they grew up with smartphones.
So just taking the existing core business and all the activities we've got without smart analog movement, which is just a regular analog watch, great looking watch, that's heavily designed and branded, and it's got connectivity in it with not a lot of additional price, we think that's going to make the category very strong.
We think we'll gain share, we'll have differentiation, and we think that's a very strong prospect for the traditional watch business. Having said that, that's not going to change totally this year.
We're going to be launching in, I think, eight brands the smart analog movement that's not going to penetrate the overall assortments to a large degree until the next couple years. So this is starting off pretty small.
In addition to that traditional watch business, we're launching, of course, trackers in many brands which we think can be a new accessories business.
So imagine trackers as connected jewelry with branded storytelling and engagement with different brands we think it can be – just like a handbag business or something else, it can be a branded accessories business and we're going to add design, color, branding, emotional attachment, et cetera, to that category.
And then the third piece is the smartwatch which is a digital display Android watch. And if you just look at the wearable technology, the tracker, and the display watch, the projections are from research groups like IDC is that in 2019 that's a $54 billion business that we are going to participate in.
I think they mentioned that in 2019 there's going to be 88 million smartwatches sold and we are – we've got our toe in the sand now and we've got a lot of activities coming and we're going to participate in that in a very large way. So we feel like there's two things.
We're going to disrupt the existing watch business and take a bigger share and make it more relevant and then we're going to participate in a strong way bringing branding, design, our distribution power and all of our resources to bear on that wearable technology market and make it a fashionable business and we think it's a very exciting prospect to us to add that much more addressable market to our company, and all these are adjacent businesses.
With the Misfit technology and our capabilities now, we're in a unique position to capture a much larger market..
Thank you. Our next question will come from Oliver Chen with Cowen & Co..
Hi. This is Cecile Origenes for Oliver Chen. Thank you for taking my question. I actually wanted to just ask you a little bit more questions about your CRM and digital initiatives. It's very encouraging to see some of the – or hear some of the positive results you're seeing from your investments so far in that area.
Could you just speak to some of the opportunities that remain in FY 2016 and what you're most excited about?.
Yeah. This is Greg. So we're actually getting just in the last couple months a lot more highlights from the successes that we had in Q4.
So although Q1 this year, 2016, wasn't a big step-up in marketing for the Fossil brand, the highlights – some of the highlights that we saw in Q4 were a very, very good ROI, significant increase year-on-year, very strong Millennial response, so not to bringing a lot of new customers into the business that are not just wearables-driven, but are actually coming in and buying wearables plus other products, saw not just brand interest growing across social channels and search channels, but omni-channel traffic, and that's measured by our own e-comm channels, our own direct-to-consumer channels and what we're seeing in traffic and searches broadly.
So really in all channels, we're seeing increasing interest in Fossil brand.
So that's where, as we look for the back half of this year, we're going to continue to fine-tune the mix and continue to lean in on the vehicles that have been working to-date and then plus up a significant amount of spend against the wearables launch in particular so that we're getting the right push on the brand into the direct-to-consumer channel on the products that are working..
We'll continue on to Ed Yruma with KeyBanc Capital Markets..
Hi. Good afternoon, and thanks for taking my question. I guess on the department store front, anecdotally, it seems like some department stores are pulling out of one of your major brands.
Has that been impactful to your numbers? And are you expecting that? And then I guess as a follow-up to that, do you think that they're selling down in anticipation of wearables? Or do you think they're selling down in anticipation to lower sell-through? Thank you..
Well, I think it's a combination of factors. Traffic is off in general, and the watch category is slowing down.
And the other thing to consider, and we've talked about this before, is that during the fourth quarter, it's a relatively small time of the year for watches, so there's not a huge amount of – there's not a lot of companies out there trying to fill back into watches right away because the sell-through is relatively slow.
So all those things I think are playing into that. And then the stores are obviously very excited about wearables and there is going to be a conversion over the next couple of years from traditional watches adding more technology to them. So there may be some conservatism on inventory from that regard as well..
Thank you. Erinn Murphy with Piper Jaffray. Your line is open..
Hey. Good evening. This is Christof Fischer on for Erinn. So I was wondering if you'd speak a bit more about the Michael Kors brand and what role you see it playing in your portfolio. Maybe any type of information on kind of the performance during the quarter and what do you see as the key drivers going forward for the brand's performance. Thanks..
While we were – last year, I think in the first quarter, we had a very strong watch business and Kors was a big part of that and we had over the last couple years seen very significant growth. The business is very, very large as you can imagine so we've seen a moderation of that but we're moving forward.
I think probably the most exciting thing for Kors this year is a couple of things. One is we're going to have a huge launch. I mean we – they actually had a press conference in our Basel Fair and out of that press conference there was about 1 billion page views from it.
The consumer interest on the Kors smartwatches, very significant, there's going to be very significant amount of activities around when that launches, so we think that's going to be very exciting. We also – as we mentioned, we have been changing the product line quite a lot. It looks a lot different.
We're seeing a lot of new ideas, sell-through in there and we think that that's going to improve over time. We also still have a relatively large opportunity both in men's and in jewelry. We're continuing to build shop-in-shops.
One thing that, even though the business has come down some, it's still by far the most productive watch brand that we have and it's one of the most productive in the world just in terms of sales per square foot. And, of course, Asia is just getting started. It's still a relatively small business. The brand is getting a lot of traction there.
And in all of those markets, especially Asia, the smartwatch is going to be a big player because there's a lot of interest over there. So, all in all, I think we still have a lot of growth ahead of us long-term in the Kors brand..
Great. Thank you..
And we'll go on to Simeon Siegel with Nomura..
Thanks. Good afternoon.
Kosta, just given the wholesale commentary, any thoughts on just how large that North American business should be, in your opinion, looking further out? And then, Dennis, maybe just a similar question around margins, what is the right EBIT margin for your business? Can you talk about the moving pieces be it product, geography, channel dynamics, anything within there and then how are connected margins versus traditional watches? Thanks..
Well, I think, as we mentioned, the watch business globally is about $65 billion, wearable technologies is expected to be an additional $54 billion in 2019. We're going to – we think through this process we can gain share in the traditional watch business with all our activities.
In addition to that, we're going to capture a share in the wearables business. So, to us, there's no reason why we shouldn't have a much larger wholesale business in the United States.
There will be – with our activities with the Misfit brand and other items, there will be additional distribution for us as well and this is going to put is in the CE channel and other distribution and obviously distribution channels are changing globally.
I think the one thing that's clear is that wearable technology is very much skewed towards e-comm and this is going to open up a lot of doors for us globally. It could be, actually a catalyst for us, not only in the United States but in Asia, where it's difficult to penetrate the Asian market, especially China, with shop-in-shops and concessions.
But e-comm may be the answer and wearable technology may be the catalyst. So a lot of great stuff out there. We do think that we're going to have a much larger wholesale business in the U.S., though..
Yeah, in terms of the margin structure, last call we went through this quite a bit but nothing really fundamentally has changed. And we feel that, and said before that 2016 is an inflection.
As we go through this transition and there's headwinds in the wholesale business and we've got growth opportunities and the steepness of that inflection point is part of what's masked right now with the lack of visibility, but we still see growth drivers coming out in the back half of this year and beyond that can accelerate as we bring more brands onto the platform and even add new brands.
The biggest risk remains how we can replace any weakness in the traditional watch business with these new growth drivers.
In terms of operating margins, in gross margins we see some near-term dilution, because wearables margins right now are a little tighter than the traditional business but there's opportunities to offset those with scale and innovation.
And then as we've proven to ourselves, we think there's opportunities for additional AUR when our best-selling product in the stores right now is coming at a very substantial price tag that bodes well for our ability to add AUR as we add features into our products.
We said and our strategy remains that as we come out of this year that we would expect to moderate. We've had some headwinds as we've been investing in marketing and our goal going forward is to invest more consistently with our top line. We're getting good returns on those investments now.
The biggest opportunity for us in terms of margin expansion is on the overall structure, which we will always every year as we look at our plans, we look to see what we think revenues could be and then size that appropriately. But as we look forward, largely everything that we need to run this business is already in place to any material extent.
So that remains an opportunity for us to leverage. Probably the one big factor that remains to be solved is the impact of currencies over the last two years. Based on our numbers right now, currencies have taken about almost four full points of operating margin, and that's going to be difficult to get back quickly, absent a weakening of the U.S.
dollar..
Thank you. Our next question comes from Rick Patel with Stephens..
Thank you. Good afternoon, everyone. There seems to be a lot of excitement about the features your wearables will have thanks to Misfit.
Can you give us some examples of the types of things that will change? Are there features that can be improved upon that consumers would take notice of? And as you leverage these new capabilities, will that change your relationships with Google and Intel? Thank you..
the cloud and the cloud ecosystem and the apps, the whole app infrastructure to be able to not only bring those products to market successfully, but scale them across the breadth of our branded portfolio across most of the countries we're in and across all the languages.
So this year, it'll be eight brands, 40 countries, 20 languages, and that's what the Misfit acquisition allows us to bring to market. On smartwatches, which is effectively the Apple Watch competitive set, we are committed to the Google Android Wear operating system.
So the Michael Kors Access watch and the Fossil Q watches and the lines that are coming out this year, those will always continue to be based on the Google Android Wear operating system.
We are continuing to be very bullish around where Google is taking that operating system and have seen some of what they're bringing to market later in the year in operating system upgrades, and it's just going to continue to significantly advance in capabilities.
Google will take the lead on announcing exactly the functionality that is being enhanced there though..
Thank you. Our next question comes from Lindsay Drucker Mann..
Thanks. Good evening, guys..
Hi..
I wanted to ask again on the U.S. wholesale business, could you help us understand, first of all, your channel mix, department stores, and any other buckets? So how much of the U.S.
wholesale business is in department stores? And then, as you talked about that sort of step function change in sell-through, could you help give us some specifics on maybe order of magnitude, what sell-through was running in the preceding three quarters and what it's running now? We heard from you in mid-Feb, and did that dynamic happen sort of later in Feb and into March or was it already underway? And then just lastly, as I square your earnings guidance to back half of the year, the implied revenue guidance I think is up 1% to 2%, and I wanted to understand what sort of growth or how you were thinking about the trend for the Americas in the context of sort of the back half of the year.
Thanks..
Just quickly, the makeup of the American business, U.S. department stores is probably the largest part of that. You also have a significant number of boutiques. So some of our brands that have their own stores, they can be significant businesses and customers for us.
Latin America is a big business for us as well, all wrapped up in the Americas region, as is Canada and Mexico. So there's a lot of components that make up that business.
In terms of the second quarter, or the back second half of the year, what we've said about in the guidance is that the top, you should think about the top end of the guidance generally reflecting the current trends that we're seeing right now.
And we've stretched that to accommodate in the lower end some further deterioration just given lack of visibility that we had in terms of what we saw in the channel. The step-down in the business was fairly consistent throughout the quarter.
You get reads throughout different parts of the business, different times and there's differentiations in terms of the sophistication of the channel. So it really pulls together throughout the quarter. But in some parts of the business, the step-down was pretty quick and, significantly, there's always some choppiness to the data.
But the significant thing is that it was sustained throughout the entire quarter in a lot of places..
Thank you. Our next question comes from Anna Andreeva with Oppenheimer..
Great. Thanks. Good afternoon, and thanks for taking our questions..
Sure..
I guess we were curious on either Misfit or Fossil wearables, dollar or unit sales in 1Q, how did that number come in versus expectations? Just trying to assess the opportunity for 2016 as you have the additional launches in the back half. And we noticed you took AUR down to, I think, $95 on the activity trackers.
I guess, what drove that decision? And any additional tweaks we should expect with pricing? Thanks..
So let me just start with the numbers. I mean, we're not separately disclosing the Misfit numbers or the Fossil wearables. We can tell you, right now, the numbers are still fairly modest for both of those brands. The bigger opportunity comes as we bring more brands into the back half of the year..
Yeah. And on price point, we think the tracker business is clearly having a lot of unit sales across multiple channels with the success of some of the competitors that are out that.
We think as we bring fashion and the feature-rich functionality that Misfit brings us at a killer price point, so that $95 to $99 price point across eight brands this year, we think we have the ability to get, drive a lot of unit sales.
And then we can ladder up in average unit retail as we add accessories that are more fashion-oriented, so from sport band to leather and other products that are brands that might command a higher premium. But that under $100 killer price point with breadth of brand is what we're going for..
And we'll hear from Betty Chen with Mizuho Securities..
Oh. Good afternoon, everyone. I was just curious, as we get into the second half, is there any color you can give us on sort of the inventory commitment for the smartwatches and trackers and wearables? I know that you mentioned exiting Q1 the inventory composition is very healthy. Just thinking about how we should expect that in the back half.
And then in terms of the wearables having slightly lower margin than traditional watches for now, when should we expect the margin profile to be much more comparable? Is it going to be 2017 or perhaps even further out just because of the way the business may ramp up? Thanks..
Sure. On the margins, I mean, right now, if you look at our connected products, there is compression relative to the total. The volumes are still – certainly, right now, they're still relatively small. They'll get bigger but still relative to the total they'll be smaller.
But it's, over time, as we bring more brands onto the platform and produce more units, it's the benefits of scale as well as improved technology that we think, ultimately, can drive those costs down and provides with a feature set and provides an opportunity to add AUR..
Yeah. And the scale matters a lot in these products. More so than our traditional business that's highly depreciated asset base that supports it. So we've got to make a lot of upfront investments in engineering costs to get product to market.
That requires for each major product line over 1 million units to really reach scale, we're investing heavily on the supply side of our business to get our own captive manufacturing facilities to test, assemble, and bring these products to market.
And then we've got a large fixed cost base in the engineering resources and the software platform we've acquired with Misfit. So on all three of those dimensions, we've got to get to scale to get to fully-loaded margins, but a really good margins.
There's no reason long-term why we shouldn't be at our traditional margin structure the way that we see it..
And on the inventory commitment, we're in the middle of this right now as getting projections from our customers, doing forecasting, looking at the supply chain, really measuring all of this right now. So it's still early to tell. As I mentioned, there is a potential – potentially that we could do a reorder for holiday as well.
So it's kind of a moving target right now..
And at this time, I'd like to turn the conference back over to Dennis Secor for any additional or closing remarks..
Thank you all for participating today and we look forward to reporting on the second quarter in August. Thank you very much..
Thank you. And ladies and gentlemen, once again that does conclude today's conference. Thank you all, again, for your participation..