Fossil Group's (FOSL) CEO Kosta Kartsotis on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Fossil, Inc. (FOSL)

Fossil Group (NASDAQ:FOSL)

Q2 2014 Earnings Call

August 12, 2014 4:30 pm ET

Executives

Eric Cerny -

Kosta N. Kartsotis - Chairman and Chief Executive Officer

Dennis R. Secor - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Rick B. Patel - Stephens Inc., Research Division

Irwin Bernard Boruchow - Sterne Agee & Leach Inc., Research Division

Omar Saad - ISI Group Inc., Research Division

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Oliver Chen - Citigroup Inc, Research Division

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Lizabeth Dunn - Macquarie Research

Jerry Gray - Cowen and Company, LLC, Research Division

Anna A. Andreeva - Oppenheimer & Co. Inc., Research Division

Matthew McClintock - Barclays Capital, Research Division

Operator

Good day, and welcome to the Fossil Group Q2 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Eric Cerny. Please go ahead.

Eric Cerny

Thank you. Good afternoon, everyone. Thank you for joining us, and welcome to the Fossil Group's Second Quarter 2014 Earnings Conference Call. I'd like to remind you that information made available during this 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 on 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 would like to turn the call over to the company's Chairman and CEO, Kosta Kartsotis.

Kosta N. Kartsotis

Thanks, Eric, and good afternoon, everyone. And joining us today is Dennis Secor, our Chief Financial Officer. Dennis is traveling today, but dialing in remotely, and both of us will be available for questions following our prepared remarks.

We are pleased to continue our positive momentum, delivering second quarter results consistent with our plans, with sales growth driven by the disciplined execution of our strategies and the benefit of operating a diversified business model with global reach, powerful brands and a strong innovation pipeline.

Sales grew across geographies, demonstrating the worldwide demand for our brands, with notable strength in Europe and Asia. Globally, we continue to see the strongest gains in watches and jewelry. The branded jewelry trend continues to gain traction. It's a category we can grow meaningfully, leveraging the synergies of our design, production and global distribution capabilities.

Once again, watches led our growth across brands, with the quarter seeing noteworthy progress on some of the key opportunities we highlighted at the start of the year. We are encouraged by the leathers performance within our FOSSIL brand. And while it's still early, customers have responded well to our new deliveries.

For SKAGEN, sales accelerated from the first quarter, delivering 12% growth, even as we continue to refine distribution as we align doors with the aesthetics of the brand. Overall, we look back on a solid quarter that was very much in line with our expectations and gives us confidence that we are on track for the year.

The FOSSIL brand grew during the quarter, highlighted by double-digit growth in watches, with increases across all regions, showing positive momentum in our core product category. FOSSIL's strongest growth was in Asia, where we have been investing in brand-building and also expanding our distribution.

Our goal is to continue to build the FOSSIL brand globally by building awareness with investments in expanded print and digital media and by gaining customer insights through tools like CRM. Our research shows that the brand resonates well and enjoys a large fan base that loves our categories and our products but wants the brand to tell a clearer story. Making these investments to sharpen our communication and engagement with our customers is critical, and you'll see that play out in our campaigns and communications, as we deliver a clear expression of the vintage American FOSSIL lifestyle going forward.

In leathers, we are seeing several positive signs, though we are extremely cautious given it is still early. In the quarter, we grew FOSSIL leather sales and we posted positive comps for the category in our own retail stores.

Some initial testing with our wholesale accounts, it's also been encouraging. While the category remains highly competitive and promotional in the wholesale channel, our goal is to use the improvements we've made in our designs to transfer this momentum into the department stores as we move into this fall season.

SKAGEN delivered double-digit growth in the quarter, and all regions posted increases. In Europe, we made great progress growing the brand in our own retail stores, as our 2 remodeled stores in London continued to perform extremely well. In Asia, the brand delivered strong double-digit growth, with notable strength in China and Japan, demonstrating that the brand with a unique and differentiated Danish aesthetic is resonating globally.

We continue to build out the lifestyle image for the SKAGEN brand. In addition to solid growth in watches, we delivered a strong increase in jewelry. And this fall, we are on track to continue to develop the SKAGEN lifestyle with the introduction of leathers and will continue to build awareness with flagship store openings at both New York and Frankfurt.

In our multibrand watch portfolio, we continue to gain share and delivered a solid 12% increase for the quarter, with the vast majority of our license brands delivering increases for the quarter.

As consumers continue to embrace fashion lifestyle brands, we are well positioned to take advantage of this trend now and into the future with our portfolio of highly desirable brands. Our growth in the portfolio during the quarter continued to be balanced geographically, with double-digit increases in Europe and Asia and solid growth in the Americas, despite a very challenging U.S. retail environment.

Michael Kors continue to perform very well, as the brand gained significant momentum in many of our international markets. Armani also contributed nicely to the growth of our portfolio, bolstered by the initial launch of the Armani Swiss assortment.

Today, we also announced the renewal of our partnership with the Armani brand, as we have extended our global watch license for another 10 years and look forward to continuing to grow that brand well into the future.

Looking ahead, we remain on track to launch the Tory Burch brand in the fall with a unique assortment of Swiss-made watches to a select and targeted global distribution. The brand already enjoys tremendous momentum, and we remain confident that it can be an exciting business for us in the future.

And we're very excited about the fashion Swiss opportunity overall, which can be a powerful tool to develop our international business, especially in Asia. Fashion Swiss affords us the opportunity to develop a new part of the market, where customers who already appreciates Swiss-made craftsmanship can combine that with the lifestyle brands that they connect with.

With our proven design and production capabilities, our vertically integrated Swiss manufacturing and our portfolio of fashion brands, we are uniquely positioned to bring a compelling product offering to this market.

On the wearables front, we continue to develop opportunities for our brands to participate in the wearable technology trend. Our partnership with Google combines the functionality associated with the Android Wear platform and our ability to bring premium lifestyle branded watches to market.

Things are developing very rapidly in the wearable space, and we view smart watches as a part of our broader wearable technology strategy of integrating technology into our products in ways that leverage our competitive advantages and allow us to participate in the various ecosystems emerging from the wearable tech trend. Our team continues to develop a strategy around the functionality and the experience for the fashion customer. It's still too early to speak about specific products, brands and launches, but our goal is to launch new product in 2015.

From a regional perspective, the Americas grew 3% during the quarter, with growth in watches driving the trend and again showing positive momentum in our core product category. Solid growth in watches and jewelry was partially offset by a decline in leathers, which was entirely driven by the RELIC brand. Market retail trends are still challenging, as mall traffic continues to decline and department stores remain very promotional.

We continued our outstanding trend in Europe, where we grew sales by 19%, which included a strong currency benefit. Our growth in the region was broadly based, as we grew both watches and jewelry and expanded our business in nearly all countries. Both our multibrand watch portfolio and the jewelry category delivered strong double-digit growth during the quarter.

We continue to be pleased with the trends we are seeing in our retail stores, where comps have been positive in nearly all of our European markets, despite challenging traffic.

In Asia, sales grew 12% overall. We saw strong double-digit gains in our larger markets of Japan and China. Our Korean business softened coming out of the first quarter with only modest growth, reflecting the overall market conditions.

In China, sales grew 20% with strong growth in the retail channel. Already today, the addressable watch market in China is over $6 billion and forecasted to exceed $10 billion in just 4 years. We continue to invest in this very important market and see real potential to increase our market share over time in the mid-tier price points. This is still a developing market, where traditional watch brands dominate and where the biggest challenges remain building distribution and brand awareness.

We remain focused on investing in our brands and cultivating distribution relationships that we believe can position us for sustainable growth in the region.

Beyond China, in many Asian markets, we are investing in creating brand awareness for our brands to support years of future growth. Our analysis suggests that market demographics are favorable to us. And we believe that as consumers gravitate to fashion watches, we are in the best position to take advantage of these markets with our portfolio of desirable fashion lifestyle brands.

Our team continues to be focused on deploying all of our resources to drive shareholder value. Our goal this year is to create efficiencies in our operations that will drive leverage in the more mature areas of the business and allow us to invest in profitable long-term growth.

With the great progress we've already made in developing our infrastructure, we are now targeting our investments in more direct ways to fuel our future growth. We are also allocating our resources to opportunities that yield a strong return on investment.

To that end, we've made the strategic decision to focus our full-price Watch Station concept to the many international markets where it has proven to be a great vehicle for the multibrand distribution. This decision will impact a small number of full-price stores we operate in North America, though it has no impact on our Watch Station outlet concept, which continues to perform very well. We're also refining and rightsizing some of our Fossil retail stores here in the Americas to optimize the use of our capital.

As we enter the second half of 2014, we feel we are on track for the year and remain excited about our prospects for the future. As a leader in a growing global category, our goal is to leverage our many competitive advantages, including our design and brand-building talent, our compelling portfolio of brands, a world-class supply chain and an expansive global distribution network.

These strategic advantages position us to deliver consistent top line growth and afford us many opportunities for efficiencies and profit expansion in the future. Combined with our solid financial position and our cash generation power, we feel we are poised to continue to deliver sustained growth and outstanding returns for our shareholders.

And now I'll turn it over to Dennis for more comments.

Dennis R. Secor

Thanks, Kosta, and good afternoon, everyone. Second quarter net sales grew 10% to $774 million, reflecting sales increases across all of our reported business segments. For the quarter, we slightly exceeded both our sales and earnings expectations, as we offset modest gross margin headwinds with lower expenses.

Growth during the quarter came from strong performance in Europe and Asia, with both regions delivering growth across channels, markets and brands. The FOSSIL brand grew 4%, posting strong increases in watches and a small increase in leathers. In jewelry, we continued to refine our wholesale distribution, which led to a modest decrease in the category, though performance in our retail stores was strong.

SKAGEN sales were up 12% in the quarter, with solid growth in all 3 regions, and our remodeled stores continued to perform very well. Our multibrand watch portfolio remained very strong, growing 12% in the quarter, with the vast majority of our brand posting increases. In North America wholesale, sales increased 2% to $265 million. Our North American wholesale channel delivered growth during the quarter despite a continued decline in mall traffic and a very challenging and promotional retail environment.

Our U.S. sales increase drove the region's performance and grew even while key department stores and boutiques actively pursued leaner inventories.

Sales to our off-price partners increased during the quarter, reflecting our strategy to reengage the channel to reduce the liquidation burden on our outlet stores and make room for made-for-outlet product. Our multibrand watch portfolio delivered the greatest volume improvement for the quarter, with jewelry growth in the high-teens and leathers declining primarily due to declines in the RELIC brand. In Europe wholesale, sales increased 19% to $202 million, which includes $9 million of favorable currency benefit.

Our European growth was driven by strong double-digit gains on our multibrand watch portfolio, with the majority of our brand delivering increases, as well as in our jewelry business.

For FOSSIL, double-digit watch growth was more than offset by declines in leathers and jewelry. The European wholesale decline for the brand is largely due to efforts to refine our distribution in Germany, as we are eliminating certain doors that do not align with our brand message.

Our growth continues to be balanced geographically as we posted gains in all of our major markets with the exception of Italy, which continues to be soft, and Germany, where we're adjusting distribution. We posted the strongest sales increases in the U.K. and the Middle East.

Sales from our Asia wholesale operations increased 10% to $106 million, which includes a small favorable currency translation impact. We posted gains in our proprietary brands as well as our multibrand watch portfolio.

The growth was across the majority of our markets, with particular strength in Japan, China and Taiwan, as well as in our travel retail business, while wholesale sales in Korea were down slightly, as market conditions there remain choppy.

While we continue to post strong gains in China, discussions to expand with some existing distribution partners didn't materialize as we had planned, which affected second quarter shipments. We do expect future shipments to accelerate coming out of the second quarter.

Sales growth was driven by higher sales through wholesale accounts, which is the largest channel in the region. Concession sales also grew, driven by door expansion, which more than offset a comp decline. We ended the quarter with 315 concessions in the region. In our direct-to-consumer business, second quarter sales increased 12% to $200 million.

Sales growth was driven by store expansion, as overall comps were roughly flat. Second quarter comps benefited slightly from this year's later Easter.

Positive comp store sales results in Asia and Europe were offset by a slight decline in North America, primarily driven by the U.S. stores, where conversion rates continue to improve but not enough to offset the impact of significant mall traffic decline and promotional activity.

Comp store sales in jewelry increased double-digits during the quarter, while sales of leathers increased slightly and watches were flat. During the quarter, we opened 16 stores, bringing our company-owned store count to 558 at quarter end. In the second quarter, gross profit increased 9% to $445 million compared to $409 million last year. The gross margin rate decreased 40 basis points to 57.5% compared to 57.9% last year.

The contraction of our gross margin rate was primarily driven by the impact of an unfavorable mix of sales from lower margin channels, including outlets, where we used promotions to drive traffic, and an increase in off-price sales and sales to distributors compared to last year. These headwinds were partially offset by the impact of a favorable regional distribution mix, given the growth in international markets and a greater sales mix of higher-margin products.

Our operating expenses increased $58 million or 19% to $360 million. The planned expense increase was driven by our retail and concession expansion, infrastructure investments to support growth in global initiatives, point-of-sale displays, advertising royalties and the development of our SKAGEN team and infrastructure.

We continue to expect to invest more this year in marketing and brand awareness, though some of the activities that we plan for the second quarter moved later in the year to support the business during our peak selling season.

During the quarter, we conducted a strategic review of our real estate portfolio related to our North American full-price Watch Station stores that Kosta mentioned. We also made plans to address some specific underperforming Fossil stores.

Based on our plans, which were designed to optimize the use of our capital and improve profitability going forward, we recorded a $5 million impairment charge in the quarter. Overall, as planned, our expense rate increased for the quarter from 42.8% to 46.5%, an increase of 370 basis points.

Operating income decreased 21% to $85 million for the quarter, including a benefit of roughly $2 million from foreign currency translation. Operating margin declined 410 basis points to 11%.

Interest expense increased $2 million to $4 million compared to last year, given our higher debt level. Our effective income tax rate for the second quarter was 31.2% compared to 32.5% last year.

The overall second quarter net income decreased 22% to $53 million, as expense increases and a small gross margin decline more than offset the impact of higher sales. During the second quarter, we invested $67 million to repurchase approximately 600,000 shares of our common stock at an average price of about $107 per share. We ended the quarter with $309 million remaining on our share repurchase authorization.

Second quarter earnings per share decreased to $0.98 from last year's $1.15, as our operating income decline more than offset the benefit of our lower share base.

Now turning to our cash flows and balance sheet. For the quarter, we generated operating cash flow of $59 million compared to $73 million a year ago. We ended the quarter with $273 million in cash compared to $313 million last year and debt of $547 million compared to $341 million a year ago.

Our inventories increased 14% to $664 million. The growth primarily reflects increases in watches, where we have taken strong positions in our best-performing brands, and compared to last year, we've shifted more production into our owned factories.

Additionally, our leathers inventories are higher given the category's performance. Accounts receivable increased by 18% to $305 million. Wholesale DSOs increased roughly 4 days compared to the prior year. In the quarter, we invested $22 million in CapEx, primarily to support new and remodeled stores, along with systems investments. Depreciation and amortization expense totaled $26 million for the quarter.

So now moving to our outlook. For the first half of the year, we've executed well, delivering both sales and earnings that aligned with our expectations. Generally, we feel we're on track for the year. And our overall operating expectations for the second half of the year have not changed significantly since the last time we provided guidance. We feel we have a sales plan for the second half of the year that aligns with a compelling product offering, and our inventory is well positioned to support that plan.

We have momentum in many parts of our business and plans in place to improve areas of the business where we have not executed flawlessly. We continue to expect strong growth coming from our watch and jewelry businesses, with both Europe and Asia continuing to gain share.

Our biggest challenge remains our U.S. business, where the retail environment is still challenging and where retailers continue to use promotions as a way to drive traffic. Having achieved sales expectations for the first half of the year, we do see the full year sales range narrowing from the lower end and now expect full year sales growth in the range between 8.75% and 10%. It is important to remember that we do not operate with significant sales visibility. And while we plan to operate our business in a manner that supports the long-term integrity of our brand, it is difficult to predict how others might manage their businesses, how customers will behave or how new products might affect the market.

For the third quarter, we expect sales growth in the range between 7.5% and 9%. With respect to gross margins. We do expect our margins to benefit both from the relative mix of our international businesses, as well as us from the continued strong performance of higher-margin products like watches and jewelry. Partially offsetting these benefits will be the impact of outlet promotions, which we anticipate will continue to be necessary to drive traffic into our outlet stores. Therefore, for the full year, we continue to expect gross margin expansion, though not quite to the same levels that we anticipated a quarter ago given those higher outlet promotions.

For the third quarter, we are planning gross margins to be flat to slightly down, primarily impacted, though, to a different extent by the same factors affecting the full year.

With respect to expenses, our goal for this year has been to drive efficiencies in more mature and developed parts of our structure to fuel our investments in growth. We continue to expect to operate with a higher expense rate for the year. So that higher rate will be driven by the investments we are making in brand awareness, customer engagement, marketing, demand creation, along with higher advertising royalties.

With the second quarter now complete, we do expect to see the impact of our expense efforts begin to favorably affect our expense rate. While we are planning the third quarter with a modestly higher overall expense rate, that higher rate of growth should come almost entirely from increased marketing, point-of-sale and customer engagement investments.

Also potentially affecting our expenses this year is a further charge related to changes we are making with our real estate portfolio mainly related to closing our North American full-price Watch Station stores. Our estimate is that this could result in a charge as much as $0.10 per share.

It's difficult to predict the precise timing of this, but we estimate that this charge will likely be recorded in either the fourth quarter of this year or the first half of 2015. Given a modest change in earnings distribution among jurisdictions, we're now planning with a 31% tax rate.

Therefore, for the third quarter, we expect operating margin in the range of 16.7% and 17.2%, and diluted earnings per share in the range of $1.77 to $1.84. For the full year, we now expect operating margins in the range between 16.2% and 17%, and earnings per share in the range between $6.95 and $7.35.

Both our operating margin and EPS guidance range would accommodate the potential $0.10 per share charge related to our retail stores that I just mentioned. If we were to record the entire charge in fiscal 2014, we would not expect to operate at the highest end of the EPS range. We are assuming that currencies remain roughly at prevailing rates.

Finally, we continue to plan annual CapEx in the range between $110 million and $120 million, and anticipate annual depreciation and amortization expense will be approximately $98 million.

So now I'll turn the call back over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Rick Patel with Stephens Inc.

Rick B. Patel - Stephens Inc., Research Division

Just a question on your investment spending. Can you just rank order the buckets of SG&A during the quarter just to give us some context on where the biggest focus is, and perhaps give us a little bit more detail on which expenses will be moving to later in the year and how much that will be?

Dennis R. Secor

Sure. The big drivers this year -- if you remember last year, we invested in the back half of the year in some structures, as well as we're opening stores. So for this year, up until we get to now the quarter that we're in, the third quarter, we're lapping that. So if you compare the second this year to last year, you see a greater number of stores. That also includes the $5 million impairment charge that we took. In addition to that, a lot of the increase year-over-year comes from a greater level of displays. We've been wanting to invest more at the point-of-sale. So we have a concerted effort to invest more in the customer experience at retail. So that was also a significant part of the year-over-year increase. Advertising, both advertising that we do ourselves, as well as the advertising royalties that supports the efforts of our license partners, those also were a part of the increase. And then we also had, overall, just some of the increases that we're making in the overall structure. Now the thing to think about going forward is that, as we said in the last call, now that we're in the third quarter, we feel we've reached that inflection point where you'll see a changing trajectory of that rate. We don't expect to deleverage that in the third quarter anywhere near as we guided, that we saw in the second quarter. And that's because we finally lapped a lot of those investments. So more of the expenses will come from those growth driving initiatives, like marketing and displays. In the second to third quarter, we did shift out a little bit of our marketing investments to push those investments a little bit nearer to the holiday season in the back half of the year, which is where the majority of our revenues come from.

Rick B. Patel - Stephens Inc., Research Division

Got it. And congrats on the renewal of the Armani license. Just given that seems to be doing very well, especially in international markets, are there any ramifications for royalty fees that we need to be thinking about as the new contract gets executed? I'm curious if royalty rates will stay the same.

Dennis R. Secor

No -- we were very excited. It's an important relationship for us and to have now an executed contract that gives us 10 years more partnership is a win-win for both us and for the Armani brand. So we're very excited about it. Now specifically on the economics, we don't specifically disclose that. I think the best way though to understand it is that, that relationship with Armani, and that brand fits very well within our long-term operating plans and our financial expectations. So it's a great relationship for us.

Operator

And our next question comes from Ike Boruchow with Sterne Agee.

Irwin Bernard Boruchow - Sterne Agee & Leach Inc., Research Division

I guess, Dennis, I just wanted to ask you about the inventory, how do you feel, with the level that you're at? And can you kind of let us know about how you feel about the handbags and the watches and the jewelry? And does that have anything to do with the gross margin performance in the second quarter and the gross margin you're kind of talking about to expect for the back half of the year?

Dennis R. Secor

Yes. We feel we positioned ourselves well in inventory. The biggest part of the year-over-year growth is we've taken positions in some of our best-selling, the hottest brands on watches, to make sure that we are properly inventoried for the upcoming half of the year. So we feel that we've got our best placed well with that inventory. And again, the great thing about our model is that these are long shelf life items. So that if the second half of the year doesn't improve to be as strong as we are planning, it's inventory that easily moves into the second part of next year without any significant deterioration of the margin structure. Leathers is the smaller part of the increase. Obviously, that is a category where some of the prior seasons have not met our expectations. And that's also affecting again, but to a lesser extent, than the watch growth in the inventory. And then the other aspect of inventory change year-over-year is that there's just a change in the componentry of how much inventory is running through plants or factories that we own versus a third-party. So we actually, in some cases, compared to last year, we've got whip [ph] on our balance sheet that we didn't have before. But those are the 3 components of the inventory. The change -- the slight change in our view of margins going forward is really about outlet promotions. We were a little more promotional than we had expected driving traffic into the outlet stores. That's the big driver there.

Operator

The next question comes from Omar Saad with ISI Group.

Omar Saad - ISI Group Inc., Research Division

Kosta, could you elaborate on the Watch Station comments and the decisions around the domestic business, and then the catalyst for that, and then also what you see internationally for that multibrand concept for watches?

Kosta N. Kartsotis

Yes. As you know, Omar, we started opening Watch Stations numbers of years ago. We actually have a large number of outlets, something like 34 in the U.S. We found that those are working really well. The regular priced outlet stores are doing okay. But if you look on balance, and the return on capital, and most importantly, where we need distribution the most is in Asia. So we felt it was more prudent for us to just focus on regular-priced stores where we need distribution, so Asia and the U.K. for example. And the Watch Station outlets are very successful not only in the U.S. but globally, and they obviously provide a very important function for us of liquidating and obsolescence. So we feel now we're in a better position to go-to-market in a more cohesive way. We actually have moved the operations of planning, brand-building, et cetera, for the Watch Station organization, regular-priced organization, to Hong Kong. So it's on the ground there where we need the distribution the most. And it dovetails really nicely with our concession strategy because to a certain extent, our Watch Station store that we're building is also basically a concession that we're building in Asia. So the 2 things using these shared services and going to market in a cohesive brand-building, storytelling way we think is very compelling and it's where we need it most.

Omar Saad - ISI Group Inc., Research Division

And are there Watch Stations today internationally? Or is that something that we can look forward to in the future?

Kosta N. Kartsotis

Yes, no, actually we have about 50 outside the United States. Most of those are in Asia and a few in U.K. and about half of those are actually outlets, in some markets around the world, we have Watch Station stores and outlets in the markets.

Operator

And our next question comes from Erinn Murphy with Piper Jaffray.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

I was just hoping you could speak a little bit more on the leathers business. It seems like you're seeing some green shoots within retail for that core FOSSIL brand. I mean, could you just speak about how you're planning the second half in particular, just given how promotional the space is, and how we should be thinking about that business potentially building back within wholesale?

Kosta N. Kartsotis

As you know, the handbag business was very competitive and has been a very promotional business of late. We have struggled mostly, I think, on the product side. And we had spent a lot of time over the last year or so building a more enhanced design team, looking closely at our offerings and really, I think we've gotten much better product and that we're starting to see some results of that in our own stores, where we have a positive comp increase and we're seeing -- some of the product going forward, we think, looks terrific. So we think we are in a good place for growth. And as we've always said, our stores basically were built to really showcase handbags. And we have, as I said, it's over spaced in our stores, it's an important category, it's much larger than the watch business. And we think that as we continue to do more brand-building, make the brand more aspirational, tell a clearer story, we will be able to grow the handbag business to a much larger level. So I think we're starting to see some results. We're still early in the game. And of course, all that work we're doing should manifest itself also in growth in department stores, where we're actually building shop-in-shops in some of the larger stores in the United States right now. We just started that last year, we're continuing it this year, we'll continue next year, to give a better customer experience at the point-of-sale in department stores. And we think that will enhance the brand better and enable us to sell even more. So we think we are in a pretty good position. And moving forward, we think it's a big opportunity for us.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Great, that's helpful. And then maybe just, Kosta, on the wearables business. It sounds like you are working on launching some new product for 2015. Could you just maybe share a little bit about kind of how you're thinking about the important features that kind of that smart watch category, as you reflect on your brand portfolio, should have? Is it going to be more fitness-oriented? Or what kind of functions or features do you think kind of the brands that you have could kind of take on as this category continues to gain some traction in the space?

Kosta N. Kartsotis

Okay. Well, first of all, I mean, it's pretty amazing to watch all the interest in wearables and smart watches. And we feel it's just basically good for the business. If more interest is put in wearables and wrist devices, I think, we benefit from it. So our point of view is that it's good for us long term. And we think that we can continue to gain share in the traditional watch market, we should continue to grow. There's -- all signs say that will happen, and we see estimates that it's going to grow at 5.6% the next 5 years. So we think we'll be able to gain share there. In addition, we feel like we'll be able to build a wearable technology business. But just based on all the interest and brain power and the converging technology that's going on, we feel like we're in a good space right now with Google and some other partners. We're getting a lot of good collaboration with other companies. And what we've learned basically is that not just in smart devices and smart watches, but in other wearable items that could be health and fitness-related, or just could be a communication device that helps build engagement with the community and communicates with them, there's a lot of opportunity not just in selling devices but just in the network effect of a community. So we're working on that and we're very interested in the results of that. But having said all that, it's still early. And we're working diligently with a lot of different groups to come up with something. We definitely will have something in the market starting next year. But we feel like long term, there's a pretty significant opportunity for us to be, right in the middle of this space, as the interest continues to grow and the technology gets better.

Operator

And next will be Oliver Chen with Citi.

Oliver Chen - Citigroup Inc, Research Division

Regarding North America Wholesale. What are -- how should we think about the ongoing growth rate? And could you just speak to the strategy regarding off-price? It sounded like you're embracing this channel on a more regular basis. I want to know what your thoughts are there. And you also mentioned in your prepared remarks about key department stores actively managing your inventories. If you could help us understand what you mean there and what happened there, that would be great.

Dennis R. Secor

Yes, let me start with the Americas, just the overall growth rate. Obviously, America is our most mature market. So if you want to think of it -- or understand how we think of it in terms of our long-term growth trajectory, we think there's opportunities for us to continue to grow this business. There's areas that's challenged to begin with. There's areas of the business where we think we can make improvements and drive growth. The leathers business we've talked about continues to be promotional. We're seeing, we believe, some signs of improvement in that business. So we think it's a business that we can grow. But I think the important thing is that when we look across our entire -- the expanse of our portfolio around the world, we see the biggest opportunities for growth coming from the international markets. Asia is clearly at the top of our list in terms of growth rate expectations followed by Europe and then North America. So when we look out, in order for us to achieve our goal, which is to be a double-digit grower over time, North America does not -- and we don't expect it to do, to grow at the same rate. So we go into -- as we run our business, our expectation continues to be modest in terms of the growth opportunities -- or the growth rate that we need to deliver overall in the Americas. So with respect to the off-price, over the last year, what you've heard us say is that our initial goal with off-price was to seriously reduce the volume that we were going to sell through off-price, and then allow that volume to run through our outlet stores. What we found was that, that was preventing us from bringing higher-margin made for product into the outlet. So last year, we had -- in the early part of the year, we had shut off a lot of the off-price, and then we reengaged that later on in the year in order to make sure that we had ample opportunity to put that made-for product into the outlet. So if you look at last year, the second quarter was the lowest volume of off-price. And then as we reengaged later in the year, the fourth quarter proved to be the highest off-price volumes last year. So it does create a little bit of choppiness just understanding the complexion of the margin structure this year. But fundamentally, we've reengaged with that part of distribution in order to make sure we've got an appropriate balance coming out of our outlets.

Oliver Chen - Citigroup Inc, Research Division

And what about the comment on key department stores choosing to actively manage this category?

Dennis R. Secor

What we discovered or what we experienced in the second quarter was that both with department stores and some of our boutiques, they were really focusing on managing their inventories tightly. And relative to our expectations, we saw some compression on sales because they were reducing their inventory level.

Oliver Chen - Citigroup Inc, Research Division

And Kosta, just as a follow-up regarding wearables and your experience there. Do you envision the route to market and the distribution channels to be similar? Will these products be merchandised alongside the fashion and lifestyle offerings that you have in place? How do you think that may play out?

Kosta N. Kartsotis

Well, it's still too early to tell exactly. But our idea is that we can make watches under the different brands that we have and have them be distributed in our watch distribution and potentially, other places. Obviously, online would be a big opportunity as well. And then we potentially could have some other products that would go in a different, maybe a more of, say, tacker [ph] communication channel that may not have our brands on it but it could be an opportunity for us to get some additional distribution. So it's still early to see. But we think there is an opportunity for us to really enhance, I think, and bring more interest to the watch counter just by having the technology there, and whether the customer wants to buy that specific smart watch or smart device or wearable or not, it just brings more people to watch counter and enable us to sell them some other products. So I think just the feeling that the incredible amount of interest in this idea, I think, is nothing but a positive for us. And we're looking at it from that aspect.

Operator

And the next question will come from Dorothy Lakner with Topeka Capital Markets.

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Just wanted to follow up on the question on outlets and wondered if you could just update us on where you are in made-for-outlet product and where you expect that to go. And then with what you're doing in the off-price channel plus what you're doing in outlets, kind of where -- what impact that has on overall margins? And then, lastly, just wondered if you could also just fill us -- give us a bit more color on the Swiss opportunity? Obviously, you've launched the Armani Swiss watch this year. What else is in the pipeline? And then just lastly, also on the Tory Burch initial distribution. I know you've said that's going to be small. But if you could just give us a little bit better idea of where the initial distribution will be for Tory Burch?

Kosta N. Kartsotis

Okay. Well, to start off, we have been making more merchandise for our outlet stores mostly in handbags. And it's a -- the largest percentage we have is actually in handbags. That's probably 50% of our assortment there. In our other categories, it tends to be smaller. So it has actually given us the benefit of having a better customer experience in the stores that we're managing. We have more season correct handbags when people go to our stores, and I think that's been a big plus to us. So we're continuing to watch it really closely. We have, as a company, a relatively small percentage of our entire company's sales is actually liquidation or outlet. Still -- and we were very conscious of that. And we're continuing to look at it that way and make sure that it doesn't overwhelm the company. And so we're actually thinking that it's a good opportunity for us to give, mostly in our outlets, a better customer experience. In the past, we had been somewhat of a liquidation channel. So we had fall handbags in our store during the summer and our competitors had fresh new assortments. And our brand didn't look as good as theirs. So I think that's the biggest plus for us. As far as the Swiss opportunity goes, yes, we launched Armani, it's been very, very strong as far as we're concerned globally, especially in the Asia market. And just Asia travelers, which means Europe as well. So we're very pleased with that. And we're proceeding with -- our operations in Switzerland. We're still doing really well, making our own Swiss-made automatic movements. That's progressing very nicely. And Tory Burch will be launching in just a couple of months at a very small amount of distribution globally, mostly their stores and then some other stores in the United States and around the world. The response has been terrific. The product looks great. It's -- we think it's going to be kind of a new category and a new idea. And we feel like it can bring a new customer to the watch counter as well. So off to a good start, and we'll see what happens when we start selling them in a couple of months. But so far, so good.

Operator

[Operator Instructions] And the next question comes from Liz Dunn with Macquarie.

Lizabeth Dunn - Macquarie Research

Just a point of clarification on one of the previous questions. I guess, you mentioned a larger wearable strategy beyond the Google relationship. Was that meant to encompass other operating systems? Or did you mean to suggest other sort of non-watch types of wearables? And then also, do you have developers in-house that can use the Google platform to build this watch? Or do you need to work with outside talent?

Kosta N. Kartsotis

Well, the -- in wearables, we're actually working on smart watches, and as well, smart devices, or it could be items that have sensors, for example. There's an app that you could read health fitness, sleep patterns, et cetera. So we're actually working on both. There could even be some communication devices that have to do with jewelry. So it's not just a smart watch device, it's all types of wearable technology. And there's a lot of research and development going on in all over the world on these types of items. And because we're a relatively large player in the wrist and jewelry space, we're getting a lot of attention. And we're able to use -- we have our own development team here. But we're also being able to outsource and use other companies’ developmental resources as well. So we're kind of right in the middle of a lot of discussions, a lot of different companies, and we're all working closely together on a collaboration to come up with some products that we think will be very compelling and putting us right in the middle of it, gives us a good position, so that we can bring to market some great ideas and great products in the future.

Operator

And next will be John Kernan with Cowen and Company.

Jerry Gray - Cowen and Company, LLC, Research Division

This is Jerry Gray, on for John. Just on the Michael Kors business. They guided to a significant deceleration in their licensing revenues for the second half of this year. I was just wondering if you are concerned at all about a moderation in sell-throughs for Kors, particularly in North America. And then if you could also talk about the size and potential for the Kors business in Europe and Asia?

Kosta N. Kartsotis

Well, we are seeing, as we mentioned in the past, very strong growth continue in the U.S., but also accelerating very quickly in Europe. And the potential in Asia is huge. We are seeing very high growth rates in jewelry in the U.S. and around the world, and that looks like it's going to be a much larger business. We're launching a big launch on men's watches in the next couple of months, which is, we think going to be a catalyst for us to grow another category there that we're relatively small in, in that business. And then there's also, obviously, a massive travel retail opportunity. And there could be a smart watch opportunity for Michael Kors also. So all in all, when we look at the business, both companies, us and the Kors company are working very closely to kind of be disruptive in the market, come up with new ideas and new categories and new price points, and these 2 ideas to have a much larger business over time. So we're seeing nothing but growth in the future.

Jerry Gray - Cowen and Company, LLC, Research Division

All right. Great. And Dennis, on the expense side, it seems like we should think about the SG&A rate up a little bit in Q3. I was wondering if you could talk a little bit about SG&A growth into next year and if there was anything unsustainable about the prior peak margins that you guys were able to generate a couple of years ago.

Dennis R. Secor

Yes. So it's probably too early. We're still working on our plans for '15. So it's too early to get into any specifics. But I think if you -- the commentary that we made about the second half of the year is really the way that we're thinking about the business. We've -- really starting in '14, the entire organization has been focused on really holding tight and optimizing the infrastructure that we have and doing everything we can to create capacity within that structure and to then redeploy that to growth-driving initiatives, like a lot of things we talked about, in terms of increasing our marketing and our advertising expenditures and investing in CRM and getting more intel into how the customer is motivated. That's the philosophy. That's the strategy of the company. And we've got the whole organization deployed behind it. So that's the way we're thinking about going into '15. But let us get on the other side of all the planning and we'll talk about more specifics when we specifically guide to '15.

Operator

And our next question will come from Anna Andreeva with Oppenheimer.

Anna A. Andreeva - Oppenheimer & Co. Inc., Research Division

A question on leathers. Can you guys remind us how big is RELIC and talk about some of the opportunities to turn that brand around. Obviously, it's a pretty promotional environment out there. And just looking at the new guidance for the year, embeds a pretty big improvement in the fourth quarter, I think 25% EPS growth if you back out the $0.10 charge. Talk about how should we think about gross margin versus SG&A. And I guess, what gives you confidence for that degree of earnings growth acceleration?

Dennis R. Secor

So with respect to RELIC. RELIC is still a relatively small part of our overall model. The reason we highlight is to really help people understand some of -- the dynamics in the leathers business. And it's -- that brand is isolated to 1 -- really, the change is 1 category in 1 region. So it's relatively -- the change is relatively impactful to this particular quarter. But overall, it's not that meaningful for the overall business. With respect to the fourth quarter, we were looking at the rest of the year sort of based on existing top line trends and not expecting things to get significantly better or worse. I did share some things on the prepared remarks in terms of how we think about the rest of the year. But as I just said, the organization, I think, has really done a lot of work on managing the cost structure, holding tight on those in the infrastructure investments. And I think we'll begin to see that play out in the operating margins in the fourth quarter. If the sales perform within our expectations, then that's the quarter where we could see some overall leverage. Still, under the covers, you're getting leverage from the operational and infrastructure, and we're redeploying some of that towards marketing investments and other initiatives that we think drive growth for the longer term. But in terms of the structure and how the operating margins could expand in the fourth quarter, it's largely driven by the work that we've done on the expense structure. We do see, on the gross margins, there's the lingering benefit of mix throughout the entire year. But some of the headwinds on the gross margins should abate. Most notably, it was, as I said earlier, the largest quarter last year of off-price. So if our plans maintain themselves, then we should not see that kind of headwind or certainly not to the extent that we did last year.

Operator

And next will be Matt McClintock with Barclays.

Matthew McClintock - Barclays Capital, Research Division

Kosta, I was wondering if you could focus on distribution in Asia again. As we think about the Watch Station expansion in that specific region, can you maybe remind us how -- in your current distribution in Asia, what's the mix of owned brands versus portfolio brands? And how do you think about Watch Station maybe maintaining more of a 50-50 mix that you have in the U.S. and other regions?

Kosta N. Kartsotis

Well, as we discussed earlier, we're actually moving our Watch Station operation over there. We actually have a new store design, and we actually changed the name slightly. So it's called WSI. And the new store design, which we're opening -- I think we've opened a couple of them the last month or so, look very good. They're a little more Asia-focused, more branded, look a little more luxury. They have the opportunity, I think, to really communicate the brands and storytelling better. So it's really much more tuned to that market, which we think is very helpful. And as -- if you look at our distribution over there, especially in China, there's not a lot of places where we can just automatically go and sell. We have to build concessions, our own distribution, our own stores, et cetera. So having Watch Station as a catalyst for that over there, whether it's an actual store on a street or it's a concession in a mall or in a department store, it all fits together. And it enables us to do exactly what you said. When we first go into a market, typically, the brands that are in our portfolio are much more well-known than FOSSIL. So Armani is an extremely powerful brand throughout Asia and especially in China. So it's kind of a door-opener. It enables us to get locations, then we add the other brands, and we bring our own brands along. So FOSSIL and SKAGEN will get the benefit of getting distribution in those locations. So as you said, with Watch Station, we're able to put our whole portfolio in there, tell the stories we want to tell, tell the Swiss story. And being able to scale that over across Asia long term is a very significant opportunity for us. Because it's largely pioneering a category that doesn't exist at this point. There's a huge amount of interest in luxury brands and there's a huge amount of interest in watches and there's a huge amount of interest in Swiss. And we're bringing all of that to life in one place under the WSI banner, which should be very successful for us.

Matthew McClintock - Barclays Capital, Research Division

And then, Kosta, you touched upon the Swiss opportunity in that specific region. As you think about fashion Swiss watches in global markets specifically Asia, does that make you rethink your distribution strategy in those regions for that specific product? Or do you think that -- does that open up new doors or new channels that you historically haven't operated in, in that region?

Kosta N. Kartsotis

Well, it actually opens up a whole new amount of white space for us. So all this interest in Swiss-made watches for us to put lifestyle brands in Swiss opens the doors to a very significant portion of the market that doesn't exist yet. So that's the reason we're doing it. And it should manifest itself in another additional opportunity. It's not just cannibalizing our existing businesses in price points lower than that. It enables us to break ground in a category and price point that we don't participate in largely, which we feel has a very significant potential. If you look at our company's history, starting with the FOSSIL brand, the idea of lifestyle branding, storytelling, really started displacing watch brands, starting with the FOSSIL brand. And we did that again as we added additional brands for DKNY and Michael Kors and MARC by MARC and DIESEL at higher price points somewhat displaced typical watch brands globally. So as we continue to move up the cycle in the watch business moving towards Swiss, there's a lot of Swiss watch brands that are just watch brands, and we think we can come to market with brands in a lifestyle way that customers around the world have an affinity for, that they want to own rather than just a watch brand. And we feel like being able to do that on a global scale with some of the most powerful brands in the world is a great opportunity for us. The fact is that the world is getting increasingly globally branded, and we're right in that place, and we're going to optimize it the best we can.

Operator

And that is all the time we have for questions today. I'll now turn the conference back over to you for any additional or closing remarks.

Dennis R. Secor

So thank you, everyone, for joining us today and for your continued interest in Fossil Group. We look forward to speaking with you on our next quarterly call, which will be in November. Thank you very much.

Operator

Thank you. And that does conclude today's conference. We do thank you for your participation today.

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Fossil (NASDAQ:FOSL): Q2 EPS of $0.98 beats by $0.02. Revenue of $774M (+9.6% Y/Y) beats by $2.99M.