Q1 2020 Fossil Group Inc Earnings Call
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Conference call is being recorded it may not be reproduced in whole or any part without written permission from the company now I'll turn the call over Christine Greenie other blue shirt group to begin.
Hello, everyone and thank you for joining us.
With us today on the call or Kosta, Kartsotis, Chairman and CEO.
Jeff Boyer, Chief operating officer, and CFO, and Greg Mckenzie, SVP 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 Companys form 8-K, and 10-Q 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 fossils earnings release, which was filed today on form 8-K and is available in the Investor section of fossil group dotcom.
With that I will turn the call over to Kosta 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 Coven 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 had 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 and do what we can to foster greater quality and fairness.
Turning now to our prepared remarks, our conversation will focus on the actions we've taken in response to the co with 19 pandemic and how we're pivoting the business for both the present and future.
We'll also review our first quarter results and provide a high level picture of current Q2 trends on reopening plans.
Since the onset of the co. The crisis, 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 that are distribution centers, including staggered work schedules heightened cleaning procedures and reduced staffing.
We lowered our operating expenses by reducing payroll furloughing portion of our employees and cutting and other areas of the best DNA.
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 five and hybrid HR continued 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 ecommerce and we saw a triple digit increases on our own ecommerce 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 prepared as well to drive these significantly higher demand levels.
In fact during Q1, we completed the implementation of our new global ecommerce 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 dot 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 the across all geographies and channels.
In the Americas, We recently opened our eight Texas stores as well as 26 outlets and plan to gradually reopened 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 in Belgium, and we'll have another 46 open in the next two weeks, primarily in France and Italy.
In 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, our at 70% to 80% of last years levels as conversion has been significantly higher our wholesale partners globally, our reporting similar trends.
As we look to the balance of the year in 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 yearend earnings call in February.
We've 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 ecommerce channels.
Expanding on our opportunity in China and India.
And continuing to implement new real fossil 2.0.
Notwithstanding the Covance pandemic. These strategies remain highly relevant and we believe they will be important 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're more focused than ever significantly reducing our product range to focus on the most iconic and innovative product in our categories with with an effort to tell fewer and better stories to our consumer.
We see this is 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 and leathers and jewelry.
Exciting developments in Gen five 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 in 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.
We have deployed substantial resources toward increasing our digital capabilities in recent years and that is helping us to serve our customers. During this time of heightened demand we've invested in a robust set of tools that can support a much larger direct to consumer business in the future today, our direct to consumer business encompasses fossil retail stores fossils.
Got calm and third party E commerce.
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 ecommerce. We believe there is an opportunity to significantly increase sales penetration globally from current levels of approximately 10% in the first quarter two 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 lean into that shift and preparing to support a much more robust online business to 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're continue to execute against a proven strategy centered around localized marketing and segmented assortments.
The impacts of Cobot may disrupt our growth trajectory in the short term, but we're 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 were significantly expanding our current program as a result of Cove it.
As you know our teams have been making good progress toward driving greater efficiency in our processes and workstreams throughout the organization and Rightsizing our cost structure.
In 2019 operating expense was 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 covance specific actions into permanent reductions.
This is expected to generate incremental benefits of approximately $50 million this year, which increases our total savings to $100 million in 2020.
Our teams are much leaner today and 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 ecommerce 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.
Hi level of flexibility and a focus on maintaining fossils 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, Kosta before I review, the first quarter financials I'll begin by outlining the steps were taken to manage expenses and preserve cash in response to the covered 19 crisis. Since mid March we've made a number of a strategic decisions that enabled us to reduce costs increased flexibility and stuff.
Within 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.
We reduced compensation costs by nearly 40% in the quarter through a combination of pay reductions shortened workweeks 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 increased 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 eliminate 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 and the new operating environment.
We have significantly reduced our cash outflows and expect to end the second quarter, but the cash position of approximately 200 million.
We anticipate that are currently quarterly cash burn rate 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 cobot 19.
From a regional lens Asia Pacific decreased high single digits, while the Americas in 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 in 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 for 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 in constant currency based on a 14 week calendar decreased 14% in Q1.
Prior to coated 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 ecommerce 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 trace to the liquidation of older generation connected inventory, 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.
SGN expense was 263 million in the first quarter up modestly versus 258 million a year ago.
We continued to make good progress against our newer Fossett 2.0 program generated operating expense reduction of 12 million in the first quarter.
This was offset by noncash charges of about 20 million related to operating lease reviews, 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 loss carry back provided under the care zac and the release of certain deferred tax asset valuation allowances.
Moving down the piano net loss of $1.69 cents per diluted share included neural fossil restructuring charges of 15 cents.
Currencies, including both the translation impact and operating earnings and the impact of foreign currency hedging contracts had an unfavorable EPS impact of 12 cents.
Turning now to the balance sheet and cash flow.
We ended the first quarter with 245 million of cash and cash equivalents.
At quarter end inventory totaled 440 million up 14% from a year ago due to lower sales volume.
Net debt was 74 million, reflecting the drawdown on a revolving credit facility as well as higher inventory levels.
Moving onto some high level color on the second quarter and full year.
But the majority of our global business effectively closed during April and May. We currently anticipate the 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 ecommerce.
As economy has begun 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 neural fossil initiatives to deliver increased savings under a 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 topline performance. We believe this is prudent and assist us in established in the right cost structure going forward.
With this conservative outlook, we are prioritized on liquidity cash preservation and inventory management to navigate the current environment and feel confident that the measures were taken will allow us to manage our business through the pandemic.
Now I'll turn the call to Christine to take us through some questions.
Thanks, Jeff.
Im going to start with a few questions that are top of mind for investors and then we'll turn the call over to Wells Fargo to continue the Q.
Comes down what are you seeing from the consumer in the initial days and weeks of reopening both in the wholesale channel and in your fossil owned retail stores.
And how are you thinking about consumer behavior traffic and conversion for the balance of year.
Well, we're obviously, Washington consumer very closely and as Weve opened some of our stores throughout Europe, and the United States, We're seeing traffic down about 50%, which is what we expected and we got that from looking at our stores that reopened in Asia. So initially they were running about 50% traffic, but the surprises benefit our conversion rate is.
Actually been much higher so were down 50% in traffic and down 20% in sales. So far so so far so good part of that it seems like there is some pent up demand in the customers are coming in the stores or moment motivated to buy on comers rates are high. We also are inspiring additional sales by having more promotional activity than normal in those stores.
So were watching that closely as well.
And we're also seeing this pattern and our wholesale partners as well and around the world. So we're hearing similar things so.
We'll see how that plays out over the next several weeks or months.
That said for the second half of the year, we're still planning very conservatively and we're expecting traffic and sales levels to remain soft.
Due to both the uncertainty of the health crisis, but also the recessionary pressures were expecting so theres still lot of unknowns and we're looking forward to a more normalized environment.
Thank you appreciate that Jeff.
Could you tell us how should we think about liquidity and cash burn for the remainder of the year.
Sure for same.
The organization has done a great job.
Reducing the cost structurally expenses in cash outflow in this quarter, which is really an unprecedented quarter in terms of how business operations have changed our net operational cash flow really the cash receipts and the cash payments from just operating the business is actually expected to be relatively flat this quarter.
For the majority of our cash outflow in Q2 is really for financing reasons as primarily for the Paydown of our revolving credit balance that's outstanding as we work inventory levels down the revolving balances coming down for paying that down.
Given the near total shutdown we've experienced in the first several months of this quarter. We believe that this quarter is going to have the most significant operational impact as I. Just told you the operational cash flow has been pretty good. So we've managed through this in pretty good shape in Q2.
As we begin to reopen stores and the second and third quarter and assuming there are there is a second away with additional closures, we do expect to see a stabilization in our cash unit utilization and usage in the second half and then we'll have net positive cash generation.
Thats happening to the fourth quarter.
Great. Thank you.
One final question for Greg what are your thoughts on E. Commerce performance. During this period them what it means for fossil digital transformation.
Thanks.
Over the last several years, we've all been witnessing the shifting consumer shopping to online channels, driven by both convenience and value.
And in response, we've been aggressively building our capabilities and developing our our digital channels for us we've been going after online sales in three distinct channels. The first is our direct to consumer ecosystem, which includes our own branded dotcom web sites and the platform capabilities to drive online sales like digital marketing.
Technology platforms CRM.
Et cetera, but but also the platform and how the platform integrates with our store network through loyalty programs by online pickup in store.
Virtual shopping experiences with our store associates endless aisle in the store all the which together create a an exceptionally strong digitally enabled direct to consumer ecosystem across online and brick and mortar environments for us. The second is one in Threepi. So first party in third party marketplaces to this includes.
Amazon T mall, and Gd Dot Dot Com and China is a londo in Europe, Flipkart in India, and many others are emerging marketplaces.
Success with these partners is more about understanding and optimizing algorithms than it is selling fashion that we've historically done. So it's taken time to really build that capability and start to scale. These businesses, but we're really hitting our stride invested heavily over the last few years and it's just at the right time, I think paid significant dividends and then.
In the third as wholesale dotcom, so we have great traditional brick and mortar partners across the world that are aggressively making the pivot to digital and we're very well positioned to help them on their journey given our capabilities.
And I think it's in total will strengthen our total online and offline relationship with them as as a result.
So now with or without as the backdrop and then the impact from co bid in the closing of our and our partner retail stores globally. This shift is just accelerated enormously as I mentioned, we've been focusing in investing heavily for several years. So we're well we've been well prepared to support and drive digital business during the crisis.
And it's showing in our results our weekly ecommerce sales globally so far.
In Q2 across the digital channels that I mentioned, so our own and our partner sites had had been increased in the range of 2% to 300% year over year, some weeks much higher than that.
While the significant triple digit level of growth is something we may not sustain.
We do expect continued outsized growth E commerce, and we're seeing this across and believe this because of the metrics across all facets of the business. So it's not just traffic that's up its conversion that's up and our ability to to convert customers effectively at the lower cost of acquisition that that's the effectiveness.
Performing mark of our marketing performance.
It's the accelerated growth that we're seeing in the file size of our our customer database and ability to drive lifetime value off that.
We're seeing everything really start to work after years of investment. So we're excited about it.
On the macro channel shift in the capabilities, we built our product categories, particularly traditional connectable watches also we're just very well suited to online sales given small product dimensions, which results in lower cost of shipping.
Accessible price points for customers and their products that don't need significant sizing or education on its use unlike some other categories.
And then the ability to translate beautiful product design and branded storytelling, which has been a brick and mortar strength of ours for for literally decades.
We've been able to replicate in the online format and are really compelling way with richer content content than you can achieve in a store. So given these attributes are online sales.
Our our natalee growing.
But give us great economics, so we've got tremendous growth opportunity online with great economics. So as a result, we're going to continue to increase our focus and investment in these in these channels.
One additional data point I'd add is that this year, 50% of our sales pitch for that of our entire company sales will go through some ecommerce site either our own E commerce.
Pure play or wholesale dot com. So it shows that we're in position for future long term growth as digital becomes more important.
Terrific. Thank you, Jeff and Greg now I'm going to ask the operator to open the line of Ike Boruchow at Wells Fargo to ask some additional questions of the team.
Hey, Thank you. So good afternoon, everyone hope everyone in your family's you're doing well.
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So I know you guys are in a tough spot from use and visibility and you're not able to offer guidance, but it's going to the 8-K. His presentation. There has got a lot of a lot of detail.
On on Threeq and Fourq you it looks like your revenue outlook is for decline as 40, 30% I guess my despite my question on that is is that based on your backlog is that based on your wholesaler conversations it's kind of curious where where those expectations kind of come from.
Yes.
First comment as important to note that that presentation has really for refinancing purposes.
As we stayed on that so that really made for.
Investment purposes, but that said what I would tell you is that's a estimate of store traffic and consumer traffic in the and the category effectively being down a bit more than that with.
Airline business and digital business being stronger.
So it's just an expectation of it in general I would tell you. It's a conservative outlook really in order to ensure we could develop.
To go through a refinancing discussion revised covenants.
Got it okay. Thanks, Jeff.
And then just.
So if somebody else in that division not met numbers or guidance, just the detail I wanted to understand.
I think you mentioned at the licensing royalties are currently under negotiation I'm talking about payment in arrears versus prepaid just can you help me understand.
Maybe a little better detail what exactly is taking place on that front, what exactly these weve negotiation bar.
Yes, we have agreements with our with our license source for different payment streams on different basis and in certain cases, there oftentimes minimum.
And as you can appreciate those minimums are out there to help drive healthy performance on our part to drive the business overall. They are established many years ago, the business really different in terms of channels and how that helped performed.
So we're in discussions with them to discuss that structure of the overall also as well as the timing in terms of the payments. So really most everything revolving around our licensing agreements, we're having discussions with our key partners.
Very constructive we've been very successful with these partners they've benefited greatly over the years. So we love the partnership and and the discussion. So we continue to have those.
Those probably for next few weeks and months.
Got it and then this big picture last question your store count today relative to where maybe you expect it to move and become a.
Year to just as retail continues to evolve very very quickly if there's any thoughts on maybe the store count in the U.S. and then globally.
Mhm.
Yes.
Yes.
Add strategic discussions that we've had conversations about moving from the brick and mortar model that we are aware and right now to a more digital model, but still stores are really important and having really productive stores around around the globe, but there would be some contraction probably getting below the 400 store more.
With the evolution, we've seen with the great growth we've had in digital it's probably force that evolution faster than a number of years down. The road. So we think that reduction wolpe just that to a 400 store chain could be at a 350.
But we're still going to have sizable number of stores around the world full price stores outlet stores, we think they're a great presence overall and we are finding that there were holistically with the online business on it from off from a.
Omnichannel perspective, yes, and the way our digital initiatives are set up as that they're not only driving E commerce, but driving traffic to our stores. So is that ecosystem approach that we think can have a smaller number of smaller stores that are highly more productive.
Driven by E Commerce, and all the other things go with it which is byline pickup store curbside everything else. So.
We're pretty interested in the future for us as we migrate to a more DTC and digital model and what the benefits could be to our entire profitability as a company not only that but our use of inventory. Our SKU counts are cash conversion cycle. I mean, there's a lot of benefits and all the one thing I would add to that just from a.
Ill portfolio standpoint, our portfolio I would say is fairly fresh in terms of expirations, meaning we have a fair amount of stores that are coming up for exploration over the next few years. So that gives us a lot of flexibility in terms of as coast to set the Navy we.
The number of stores may not change as much maybe the size and location might so it really gives us a chance to reestablish and reset the store portfolio base to be as productive as possible.
Efficient as possible with limited amount of.
Exit cost so long term.
Got it thanks guys.
Yes.
This concludes.
Okay and this concludes the question answer session I'll turn the call back over to pass does for final remarks.
While we want to thank everyone for joining US again, we'll speak again at the end of the third quarter stay safe everyone.
Thank you ladies and gentlemen. This concludes today's conference call. Thank you for participating you may now disconnect.
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