Apple’s launch of the Watch in April 2015 has had a profound impact on the watch business. Media attention has focused for the most part on whether Apple poses a threat to Swiss watchmakers. (Not without reason: It is affecting the high-volume, under-$1,000 segment of the Swiss industry.)
But the Apple Watch’s biggest impact, as we noted here a few months ago, has been on the watch industry’s huge fashion-watch segment, whose leader is the Texas-based Fossil Group. Fossil Group sales, which were at record highs in 2014, have been clobbered since the Apple Watch launch. So has its stock price.
So how goes Fossil’s slugfest with Apple? The release of Fossil’s 2017 financial results and its earnings call with financial analysts on Tuesday offered some insights.
In a nutshell, Fossil is still down. Total group sales fell for a third consecutive year, down 8% from 2016, to $2.8 billion. Worse, it fell deeply into the red, reporting a net loss of $478 million for the fiscal year ended Dec. 31, compared to a $78.9 million profit in 2016.
But the company is not out. Its aggressive entry into the wearable category, which began with its purchase of Misfit in December 2015, is going well, its executives say. The group’s sales of wearables nearly doubled in 2017 to $300 million and it predicts strong double-digit growth in that category this year.
Plus, its efforts to streamline the company and cut costs, an exercise it calls “New World Fossil,” are also working, the execs say. They predict that the company will return to profitability as early as this year. Sales growth will take longer: revenue will decline again this year by 6% to 14%, flatten out in 2109, and grow in 2020 and beyond, they predict.
Here are some highlights from Fossil’s results and the earnings call with the financial analysts.
A $17 Billion Market
Fossil is in the battle of its life. Apple is 82 times bigger than Fossil, measured by revenue, and its smartwatch success continues to threaten Fossil’s core watch business. Apple provides no data on watch sales, but Credit Suisse estimates that Apple sold 12 million watches in 2017, out of a total market of 22 million pieces.
“The traditional watch business in our price points is clearly being negatively affected by the significant growth in the overall smartwatch category,” Fossil CEO Kosta Kartsotis told the analysts. Fossil watch sales, which account for 80% of the group’s total revenue, fell 5.6% last year to $2.20 billion.
That’s down from an all-time high of $2.74 billion in 2014. In the three years since then, group watch sales have dropped 19.7%. That’s an erosion of more than half a billion dollars in annual watch sales.
Fossil’s response has been to fight fire with fire. It has gone all in on smartwatches. In 2016, it launched 100 new wearable products, in 8 of its 16 brands (six owned, six licensed). In 2017, it rolled out new hybrid and display (i.e., digital) smartwatches in 14 brands in the second half of the year. The sales results surprised the financial analysts. Connected watches generated $142 million in sales in the fourth quarter. Smartwatches accounted for 20% of group watch sales in the fourth quarter; the figure was even higher in the U.S. market. Smartwatches lifted total Fossil-brand watch sales in the second half of the year versus 2016.
In just two years, the Fossil Group has proven itself a player in the smartwatch field. It is now the third largest producer of smartwatches, after Apple and Samsung, according to Credit Suisse analyst, Guillaume Gauvillé.
Said Fossil’s chief financial officer Jeffrey Boyer, “Our success with wearables this past year gives us confidence that wearables will continue to be a growth driver in 2018 and beyond. We see strong double-digit growth in this category in 2018.”
“The overall wearable category is very robust and creating a significant opportunity for the company,” Kartsotis said. The wearable market is surprisingly large, he said. “Last year it was a $17 billion market and it’s expected to go to $32 billion in 2020.” Kartsotis said the market consists largely of fashion-conscious, “aspirational” females. Fossil’s opportunity, its executives said, lies in its ability to create women’s wearable watches that are more fashionable than the competition’s and that include key apps like health and fitness and voice search. “Our significant advantage in fashion traditional watches, combined with our wearable capabilities, put us in a unique position to compete in the evolving wristwear business,” Kartsotis said.
Fossil The Retail Chain
Another element in the group’s comeback strategy is to restructure and scale down what is no longer a $3.5 billion company in order to cut costs and create efficiencies. One example is store closings.
A second, often overlooked, cause of Fossil’s recent sales declines is that the group is not only a traditional watch manufacturer, but also a giant brick-and-mortar retailer. In 2016, it had 585 stores around the globe operating under the Fossil and Watch Station names: 265 in the Americas, 200 in Europe, and 120 in Asia. Fossil is dealing not only with the rise of Apple, but the equally disruptive rise of e-commerce, which has dramatically reduced traffic in retail stores. “The disruption in retail is continuing with more sales and customer engagement moving to digital,” Kartsotis told the analysts.
Last year Fossil closed 41 unprofitable stores; it will close another 60 this year. That will result in a loss of $60 million in sales, but add about $10 million to the bottom line. Along with the store closings, Fossil has pumped up its e-commerce efforts; online sales jumped 31% in the fourth quarter compared to 2016.
“In this upcoming year,” Kartsotis told the analysts, “we will become a slightly smaller but a more profitable business. Sales will contract as we exit unprofitable stores and businesses and product lines.” (One example is the loss of Burberry and Adidas fashion-watch licenses, which expired at the end of 2017.) But the cost savings will improve the bottom line. The target is low single-digit growth in operating income this year, Kartsotis said.
The Core Question
Fossil’s strategic shift toward wearables and away from brick-and-mortar stores makes sense. What is still unclear is how the company plans to revive its traditional watch business.
Kartsotis took pains in the presentation to the analysts to underscore Fossil’s commitment to its traditional fashion-watch business and to point out that smartwatches complement the core business. “We remain focused on stabilizing and growing our core watch business,” he said at one point. At another, he said, “The most important business in our company is our traditional watch business. Although this business remains difficult due to the dramatic growth of wearables in the overall wrist market, we are continuing to innovate with differentiated new ideas and materials and watches that we feel will resonate strongly with consumers this year. The business will be enhanced by the growing interest in smartwatches among our core fashion consumer.”
But Fossil brass offered little detail or guidance about how to turn around the shrinking traditional watch business. Indeed, the forecast for the core business in 2018 appears to be more turbulence. “Connected watches are expected to experience strong growth this year,” Kartsotis said, “but the absolute dollar decline in traditional watches in our wholesale channel will be greater than that growth.”
At Fossil, the core question is not about wearables. It’s about the fate of the core business.