Fossil Group, Inc.

Good afternoon, ladies and gentlemen, and welcome to the Fossil Group first quarter 2020 earnings call. At this time, all parties are in listen-only mode. This conference call is being recorded and may not be reproduced in whole or any part without written permission from the company. Now I'll turn the call over to Christine Greene of the Blue Shirt Group to begin. Hello, everyone, and thank you for joining us. With us today on the call are Kosta Kartsotis, Chairman and CEO, Jeff Boyer, Chief Operating Officer and CFO and Greg McKelvey, EVP and Chief Commercial Officer. I would 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 discussed 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 the company's Form 8K and 10Q reports filed with the SEC. In addition, Fossil 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 can find a reconciliation and other information regarding non-GAAP financial measures discussed on this call in Fossil's earnings release, which was filed today on Form 8K and is available in the Investors section of FossilGroup.com. With that, I will turn the call over to Costa to begin the formal remarks.

Good afternoon, everyone, and thank you for joining us today. We hope you're all safe and doing well. On behalf of the entire Fossil organization, We would like to extend our thoughts to all those affected by COVID-19 and express our sincere gratitude to those on the front lines that are working tirelessly on behalf of us all. Also, the events of this past week have been deeply upsetting to all of us. Our hearts go out to the many people affected by this tragic turn of events. Fossil is fortunate to have an incredible community of associates, partners and customers globally. We are using our platforms and resources to listen, learn and think critically. Thank you. Thank you. Thank you. We have acted decisively to protect our employees, partners, and communities worldwide, adapt to rapidly changing circumstances, mitigate business disruption, and to strengthen our financial position. Let me provide a summary of the actions we've taken today. In mid-March, we closed the majority of our fossil stores and implemented a work-from-home program globally. We implemented practices to safeguard workers at our distribution centers including staggered work schedules, heightened cleaning procedures, and reduced staffing. We lowered our operating expenses by reducing payroll, furloughing a portion of our employees, and cutting other areas of SG&A. We eliminated the majority of our planned capital expenditures for 2020. We proactively reduced incoming inventory to align with current demand. In March, we drew down an additional $100 million on our revolver to enhance our financial position and liquidity. We have recently completed discussions with our primary term loan lender for the amendment of our covenants. From a global business perspective, we experienced store closures at our wholesale partners and fossil loan locations as early as February in the Asia-Pacific region. This, of course, accelerated in March as the virus spread to Europe and the Americas. In January and February, Worldwide net sales were tracking above plan, reflecting improved performance in our core business, including traditional leathers and watches, as well as higher volume in our older generation connected product, driven by liquidation activity in the Americas. Our latest generation connected products, Gen 5 and Hybrid HR, continue to be well received by consumers and have strong consumer reviews. As the majority of stay-at-home mandates took effect in March, The combination of retail store closures and reduced wholesale shipments had a considerable impact on our Q1 sales and profitability. Over the past two months, Fossil has participated in the consumer shift to e-commerce, and we saw triple-digit increases on our own e-commerce sites globally, with April up 150% and May growth approaching 200% versus prior year periods. The investments we've been making in our digital capabilities prepare us well to drive these significantly higher demand levels. In fact, during Q1, we completed the implementation of our new global e-commerce platform, which provides us with a highly flexible and responsive system that integrates seamlessly with our marketing programs. We believe this has been a critical factor in our ability to drive traffic and conversion on fossil.com. I'll provide some additional color on our digital initiatives in a few minutes. In recent weeks, the reopening of wholesale doors and fossil retail stores have started to phase in across all geographies and channels. In the Americas, we recently opened our eight Texas stores, as well as 26 outlets, and plan to gradually reopen an additional 150 locations over the next several months, primarily dictated by local and state regulations. In Europe, we have opened 49 of our 155 locations, beginning with Austria, Germany, Netherlands, and Belgium. and we'll have another 46 open in the next two weeks, primarily in France and Italy. In the Asia Pacific region, where we currently have 90 stores, approximately half have reopened thus far. We have been proactively reducing incoming inventory and working closely with our wholesale partners to align on the best path forward. With closures in effect for nearly two-thirds of the quarter, we currently expect the second quarter to be the most challenging one from a top-line perspective in 2020. Where we have reopened our retail stores, traffic is running at approximately 50% of the May 2019 levels. Sales in these doors, however, are at 70% to 80% of last year's levels as conversion has been significantly higher. Our wholesale partners globally are reporting similar trends. As we look through the balance of the year and the plan for 2021, we have developed action plans against multiple scenarios to navigate anticipated headwinds and prepare the company for the future state of business. When we spoke to you on our year-end earnings call in February, we described our focus on pivoting to opportunities outside of the wholesale channel and capturing efficiencies under our New World Fossil Transformation Program. We also outlined our four strategic priorities for 2020. Those include delivering exceptional storytelling and innovation, driving commercial transformation, particularly in digital and e-commerce channels, expanding on our opportunity in China and India, and continuing to implement New World Fossil 2.0. Notwithstanding the COVID pandemic, these strategies remain highly relevant and we believe they will be important to the long-term success of fossil. That said, the current operating environment has compelled us to move faster on certain elements of our strategy, specifically driving commercial transformation and executing on our New World Fossil Transformation Program. First, I'll discuss storytelling and innovation. With the challenging environment and dramatic shift to digital businesses, we are more focused than ever, significantly reducing our product range to focus on the most iconic and innovative product in our categories with an effort to tell fewer and better stories to our consumer. We see this as an opportunity to celebrate not only our new products, but the relevance of our icons such as our dive and mechanical platforms. New introductions of critical shapes and styles will continue in traditional watches in leathers and in jewelry. Exciting developments in Gen 5 enhancements, smaller sizes in hybrid HR, and meaningful upgrades in the software experience will continue to flow through the balance of the year. These current times require that we lean into our strengths with great style, great brands, great stories, and great value. Our second strategic priority, and one of the areas where we're really putting the pedal to the floor, is in commercial transformation. Thank you very much. Collectively, we expect this DTC channel to represent nearly 60% of our worldwide sales in the second half of this year. Looking more specifically at our own e-commerce, we believe there is an opportunity to significantly increase sales penetration globally from current levels of approximately 10% in the first quarter to over 30% for the second quarter and nearly 20% for the year. As you know, secular trends have been driving a contraction in the wholesale channel for some years now. We have been leaning into that shift and preparing to support a much more robust online business through our expanded digital commerce and marketing capabilities. Moving now to our third strategic priority, expanding our opportunity in China and India. In 2019, we delivered strong double-digit growth in these markets, and this year, we are continuing to execute against a proven strategy centered around localized marketing and segmented assortments. The impacts of COVID may disrupt our growth trajectory in the short term, but we are seeing strong performance in China year-to-date and continue to view both of these markets as compelling long-term opportunities. Moving now to New World Fossil, where we're significantly expanding our current program as a result of COVID. As you know, our teams have been making good progress toward driving greater efficiency in our processes and work streams throughout the organization and right-sizing our cost structure. In 2019, operating expenses reduced by nearly $50 million. Given the current environment and our perspective on the future state of business, we have made the strategic decision to expand our New World Fossil 2.0 program. Specifically, we are shifting a portion of the immediate savings from our COVID-specific actions into permanent reductions. This is expected to generate incremental benefits of approximately $50 million this year, which increases our total savings Our teams are much leaner today than several months ago, but are functioning well, even on a remote basis, due to improved focus and efficiency throughout the organization. We believe Fossil will emerge from this crisis as a stronger, leaner, more efficient, and more digitized organization. There are notable learnings from the last three months that are guiding us forward. We can do more with less. Our employees are nimble and can adapt to a new work environment. The investments we've made in our digital capabilities make our e-commerce business highly scalable. Having fewer new product stories that are being told in a more compelling way is helping us jumpstart the fashion watch category despite the current environment. I'd like to close by acknowledging the many ways that this pandemic is impacting each and every one of us as global citizens. We are managing the business with our communities top of mind. A high level of flexibility and a focus on maintaining Fossil's solid financial position to help us navigate through these uncertain times. We greatly appreciate the dedication of our associates and the support of our stakeholders. And now I'll turn the call over to Jeff to discuss the financials.

Thanks, Costa. Before I review the first quarter financials, I'll begin by outlining the steps we're taking to manage expenses and preserve cash in response to the COVID-19 crisis. Since mid-March, we've made a number of strategic decisions that enabled us to reduce costs, increase flexibility, and strengthen our financial position. We have completed discussions to amend our credit facility to provide greater near-term flexibility, which includes financial covenant adjustments through the third quarter of 2021. We expect the amendment will be finalized and filed in the next few days. Beginning in mid-March, we implemented cost-cutting initiatives across the business. Specifically, we closed all of our North American stores and the majority of our locations in Europe. We reduced compensation costs by nearly 40% in the quarter through a combination of pay reductions, shortened work weeks, furloughs, and reductions in force. In addition, we implemented salary reductions for the executive team and reduced Board of Director compensation. We also significantly reduced expenses across several other buckets, including marketing, travel, professional fees and services, and contract labor. In addition to these cost reductions, we've also taken several actions to preserve cash and increase liquidity. First, we drew down approximately $100 million under our revolver in late March to enhance our financial position. At quarter end, we had approximately $33 million of availability remaining undrawn. Second, we eliminated the majority of our planned capital expenditures for 2020, cutting total capex spending by nearly 80%. Third, we've been managing working capital by proactively working with our vendors and reducing incoming inventory to align with anticipated demand. Lastly, we are working constructively with our landlords and licensing partners to align on the best path forward in the new operating environment. We have significantly reduced our cash outflows and expect to end the second quarter with a cash position of approximately $200 million. We anticipate that our currently quarterly cash burn rate of approximately $45 million will moderate in the second half of the year as sales productivity is expected to increase on an overall lower cost base. Moving now to the first quarter financials. Q1 net sales came in at $391 million, down 16% versus a year ago, and 15% in constant currency. Excluding the 3% incremental sales benefit from the extra week in our first quarter, our net sales contraction in the first quarter was primarily due to the impact of COVID-19. From a regional lens, Asia Pacific decreased high single digits, while the Americas and EMEA experienced double-digit declines. Although net sales in Asia decreased 7% on a constant currency basis, we saw strong double-digit growth in mainland China. Our business in China continues to expand strongly behind our brand portfolio, particularly Armani, as well as our strong digital capabilities. In the Americas and Europe, sales declined 20% and 14% respectively, primarily reflecting softness in the wholesale channel in those regions, as well as store closures in the final weeks of the quarter. Moving now to our direct-to-consumer business, first quarter 2020 included 14 weeks, while the comparative 2019 period included 13 weeks. Global retail comp sales and constant currency, based on a 14-week calendar, decreased 14% in Q1. Prior to COVID-19-related store closings, our global comp sales were trending up about 1%. with full price comps down but outlook comps positive double digits driven by more effective promotions. In the first quarter, we permanently closed a total of 10 stores, ending the quarter with 447 fossil locations. Within e-commerce, double digit comp increases internationally were offset by softness in the Americas. Turning to category performance in Q1, watches declined 14% in constant currency with traditional watch sales declining double digits. Connected watch sales, which represented 18% of total watch sales in the quarter, decreased high single digits. First quarter gross margin was 35.9%, down substantially from a 53.3% margin a year ago. The Q1 pressure can primarily be traced to the liquidation of older generation connected inventories, which we had planned for, and connected inventory valuation adjustments as well as minimum product royalties. This is partially offset by margin optimization efforts through our New World Fossil program as well as favorable regional and product mix. SG&A expense was $263 million in the first quarter, up modestly versus $258 million a year ago. We continue to make good progress against our New World Fossil 2.0 program, generating an operating expense reduction of $12 million in the first quarter. This was offset by non-cash charges of about $20 million related to operating lease right of use and intangible asset impairment, as well as minimum marketing royalties. Income tax benefits in the first quarter were approximately $64 million and included a favorable impact from a lost carryback provided under the CARES Act and the release of certain deferred tax asset valuation allowances. Moving down the P&L, Net loss of $1.69 per diluted share included newer fossil restructuring charges of $0.15. Currencies, including both the translation impact and operating earnings and the impact of foreign currency hedging contracts, had an unfavorable EPS impact of $0.12. Turning now to the balance sheet and cash flow, we ended the first quarter with $245 million of cash and cash equivalents. Thank you for joining us. We currently anticipate that second quarter net sales will decrease by approximately 60 to 70%, reflecting declines in retail and wholesale, partially offset by ongoing strength in both owned and third-party e-commerce. As economies begin to reopen, we believe challenges for retail will exist for the foreseeable future and anticipate the operating environment will be highly promotional. We are aggressively managing our cost base and have expanded our New World Fossil initiatives to deliver increased savings under our 2.0 program. In 2020, we now expect to achieve operating expense reductions totaling $100 million, approximately double our prior plan, driven by a combination of reductions in force, salary and pay reductions and lower spending levels. As we look farther ahead and consider the level of uncertainty that remains, we are taking a conservative view of future top-line performance. We believe this is prudent and assists us in establishing the right cost structure going forward. With this conservative outlook, we are prioritizing liquidity, cash preservation, and inventory management to navigate the current environment and feel confident that the measures we're taking will allow us to manage our business through the pandemic. Now I'll turn the call to Christine to take us through some questions.