Q2 2020 Fossil Group Inc Earnings Call

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Welcome to the Q2 2020 fossil group earnings Conference call. My name is Adrian and I'll be your operator for today's call. At this time all participants are in listen only mode.

Later, we'll conduct a question answer session. During the question answer session. If your question. Please press Star then one and you touched on phone. Please note. This conference is being recorded I'll now turn the call over Christine Greenie Blueshirt Group Christine you may begin.

Hello, everyone and thank you for joining.

With us today on the call, our Kosta Kartsotis chairman and CEO.

Jeff Boyer, Chief operating officer, and CFO and Greg Mckenzie.

Okay, and Chief commercial officer.

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 discussed during this call.

Fossil group's policy on forward looking statements and additional information concerning and number factors.

That could cause actual results to differ materially from such statements.

Is readily available in the company's form 8-K and tank you report.

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 reconciliations 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 investors section of fossil group dotcom.

With that I will turn the call over to post it to begin the formal remarks.

Good afternoon, everyone and thanks for joining us today.

We hope you're all safe and doing well during these unprecedented times.

As the pandemic continues have devastating effects all over the world, we remain committed to prioritizing the health and safety our employees customers and the communities where we operate.

At the same time, where does heartened by the racial tragedies, we've seen and the underlying systemic bias that exists in our country.

As an organization, we're doing our part to foster positive change we're committed to leading by example in doing good for the planet for our communities and for our people.

Since we spoke to you in early June we remain focused on navigating the highly dynamic environment reopening our fossil stores and executing the four strategic priorities, we outlined at the beginning of this year.

Those include delivering exceptional storytelling and innovation.

Driving commercial transformation, most notably increase in our digital business.

Expanding on our opportunity in China and India.

And continuing to implement our new world fossil 2.0 program.

The current operating landscape has caused us to accelerate the expansion of our digital business and to increase the size of our new World fossil program. This year more on the strategy shortly.

In Q2 broad base store closures persisted within the wholesale channel and across our fossil retail locations throughout much of the quarter, resulting in a net sales decline a 47% on a constant currency basis.

We did see however, sequential improvement and topline trends across all regions. During the period as many economies began reopening in the latter part of May and June.

We delivered Q2 sales of 259 million, reflecting a stronger than expected peso store reopenings on wholesale order flow.

From a global business perspective, Europe, and Asia performed slightly better than the Americas, reflecting the heightened pace of their respected kobin recoveries relative to the United States.

From a channel perspective, our digital business accelerated significantly in Q2 sales were up nearly 140% on our own ecommerce sites globally and third party E Commerce increased 20%. Despite a focus on essential is among third party ecommerce players and the shift the prime day out of Q2.

We also saw stronger performance with our wholesale partners, who have strong E comp capabilities and a well developed online presence.

Core digital sales throughout our own ecommerce sites and third party marketplaces, such as Amazon and T mall shifted from 13% of our sales mix in the second quarter of last year to nearly 50% this year.

This does not include our wholesale dot com channel, which is a growing part of our wholesale business.

The reopening of wholesale doors and fossil retail stores started to phase in across all geographies and channels during the latter part of the quarter.

In the Americas, we had reopen approximately 175 stores by the end of Q2 with the remainder opened during July.

In Europe, we have opened essentially all of our 105 locations across the continent.

In the Asia Pacific Region, where we currently have 89 stores approximately 80% of reopened.

Some locations in India, and Australia remain closed pending government direction.

During the second quarter traffic and conversion trends were fairly similar across all regions with comp traffic down about 50% by the ended the quarter and conversion is up significantly.

As we look ahead to the back half of the year, we continue to expect similar traffic and conversion trends.

That said, we are facing significant uncertainly across the globe. Many regions states in countries are struggling with containing the virus, which is particularly true here in the United States.

And consumers appear slow to return to former spending levels, given the health and safety concerns.

During this time, a significant business disruption and uncertainty, we're taking steps to strengthen our operations and our financial position.

In the first half of 2020, we took actions to reduce costs manage inventory levels preserve cash and to increase our financial flexibility.

We continue to have productive discussions with our landlords and licensing partners regarding a mutually beneficial path forward.

On the real estate front, we are taking a critical lends to the portfolio.

With a significant percentage of our leases coming due and the next few years, we'll be evaluating opportunities to increase the productivity of our fleet.

Importantly, we're making progress against the four strategic priorities I mentioned earlier.

The first of storytelling in innovation.

We are leveraging our strengths to bring great style brands stories and value to the marketplace in the second half of this year will be engaging the consumer with the introduction of critical shapes and styles and traditional watches while also bringing new enhancements and upgrades to our connected category.

We continue to see dive inspired watches perform well globally, especially in the assortment of our fossil blue collection.

Our Gen five watches continue to garner excellent consumer feedback.

With a mid August rollout, our fossil smartwatch App can help you stay healthy, adding oxygen consumption and sleep tracking features to our current contact was payment function.

And we're looking forward to bringing LTE to the market and expanding into new channels of distribution later this year.

Additionally, we are expanding our digital and social marketing programs in tandem with our growing ecommerce presence as well as emerging trends in media consumption as consumers increasingly gravitate to all things digital.

Moving now to our second strategic priority commercial transformation the expansion of our digital capabilities, enabling us to leverage the fast forward them online adoption among consumers we've accelerated our investments in the digital channel for the last 12 to 18 months investing in the new E Commerce platform digital tools and online marketing program.

Which are beginning to bear fruit.

Our digital channels, which include fossil dotcom and third party E Commerce are performing well and represented nearly 50% of sales in Q2.

We are excited about the pace of Digitization and expect to continue growing the digital channel as a percentage of our overall mix.

Watches are particularly well suited to online sales and the economics within our own business model our margin accretive.

The high value small cube, and an ecommerce marketplace lends itself to great branding striking visuals and powerful economics.

As possible, we already have the infrastructure in place across systems warehousing and distribution to help us drive scale.

As we shift a greater portion of our sales toward direct to consumer touch points, particularly fossil dot com, we expect to strengthen gross margins and expand profitability in that segment over the long term.

Looking at our third strategic priority, we're continuing to focus on expanding our opportunity in China and India. In 2019, we implemented a segment assortment strategy supported by localized marketing, which drove double digit gains in these markets.

While India continues to be affected by stay at home measures mainland China has been faster to recover.

Despite the pandemic impacts we grew our mainland China business by 37% versus last year in the second quarter.

We believe both of these markets will be important growth vehicles for fossil when market conditions stabilize and began to rebound.

Turning to new World fossil we're on pace to deliver our targeted expense savings of 100 million dollar for 2020.

We will continue to look for additional opportunities as rightsizing, the cost structure and driving greater efficiency throughout the organization remain key priorities.

As we approach fall and holiday, we believe we're well positioned on several fronts. We have a focus collection of innovative products in the market and greatly enhanced digital capabilities across functionality fulfillment customer interface and marketing.

Our view of the retail marketplace remains cautious in the near term given the number of macro uncertainties.

Looking farther out as we are confident that our strategic focus and purposeful actions as we adapt to a new reality will enable us to strengthen our business model in emerged stronger with a more powerful product assortment, a more digital focus channel mix and an improved margin and cost structure over the long term.

Before turning the call over to Jeff we want to express our thanks and appreciation to the entire fossil organization. Our teams have done a tremendous job of coming together and quickly adapting to the current environment.

We also want to thank all of our stakeholders for your ongoing support during these unprecedented times and now I'll ask Jeff to discuss the financials in detail.

Thanks Kosta.

As we wrap up the first half of the year, we remain highly focused on liquidity in the near term and feel increasingly confident about our ability to navigate the impacts of co the over the longer term.

We have lowered costs across the organization.

Significantly reduce capital expenditures and proactively manage our working capital requirements, primarily through inventory reductions.

These actions coupled with the successful amendment of our credit facility have provided us with greater near term flexibility.

We ended the second quarter with a cash position of 278 million somewhat higher than anticipated due to better than expected revenue combined with aggressive management and timing of cash outflows.

Moving now to the piano.

Q2, net sales came in at 259 million down 48% versus a year ago and 47% in constant currency, reflecting the impact of ongoing store closures throughout much of the quarter.

Topline results came in better than expected, primarily due to the strong pace of story openings and wholesale order flow across all three regions during the latter part for the quarter.

From regional lands Asia Pacific and EMEA, both reported sales contractions in the mid Fortys performing slightly better than the Americas, which was down 52% year over year.

Within the Asia Pacific region, similar to what we saw in the first quarter and as Kosta mentioned mainland China continues to outperform delivering 37% growth in the quarter on a constant currency basis.

Within our direct to consumer business, our fossil owned E Commerce business delivered sales growth of nearly 140% while global comp sales in constant currency decreased 36%.

In the second quarter, we permanently closed a total of 15 stores ending the quarter with 436 fossil locations.

Turning to cut over performance total watches declined 40% in constant currency with traditional watch sales also declined 48%.

Connected watch sales, which represented 20% of total watch sales in the quarter decreased 50%.

Second quarter gross margin was 54.3% up 140 basis points from 52.9% a year ago.

The increase can primarily be tries to a higher mix of E commerce sales and partial abatement of royalty costs, which was partially offset by heightened promotional activity and increased freight costs versus a year ago.

We expect the environment to remain fairly promotional for the foreseeable future.

But we believe our initiatives around product assortment and channel shifts should help us partially offset those pressures and contribute to strengthen our margin over the long term.

SGN expense was 167 million in the second quarter down substantially versus 256 million a year ago. We continued to make good progress against our neural cost of 2.0 program generating a benefit of 39 million in the second quarter.

Total operating expenses decreased 86 million, reflecting a combination of reductions in force salary and pay reductions and lower spending levels across several buckets, including marketing travel professional fees services and contract labor.

Looking further ahead as Kosta mentioned, we'll be taking a closer look at our real estate and evaluating opportunities to capture expense savings.

We have lease expirations, representing nearly 60% of the portfolio over the next three years, which provides us with the flexibility to continue driving the direct to consumer channel, but with a strengthened mix of digital and physical touch points.

From an earnings perspective, net loss was 44 cents per diluted share and included new role fossil restructuring charges of 16 cents.

Currencies, including both the translation impact on operating earnings and the impact of foreign currency hedging contracts had a favorable EPS impact of five cents.

Looking at the balance sheet and cash flow. We ended the second quarter with 270 million of cash and cash equivalents in total debt of 269 million.

This compares to a cash position of 245 million at the end of Q1 and reflects a lower cash burn rate, which I discussed earlier.

Quarter end inventory totaling 376 million down 18% from year ago, primarily reflects our ability to continue to move through connected product and carefully manage inbound receipts.

As we consider the balance of the year, we anticipate that continued macro uncertainty in potential resurgence says are likely to create a choppy environment.

Taking these factors into account, we expect Q3 net sales to decline by approximately 35% to 45% compared to last year.

As such we're closely managing cash liquidity planning inventory is conservatively and carefully controlling our cost base Escos dimension remain on track to achieve full year operating expense reductions totaling $100 million under our new real fast at 2.0 program in 2020.

We believe the actions were taken combined with the strategic priorities that close to discuss particularly around product and channel focus will position us to deliver improved performance when macro conditions begin to stabilize.

Now I'll turn the call to Christine to take us through some questions Christine.

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 your Wells Fargo achieved continue the key money.

So first I'll start with co staff.

Should we think about the shift from wholesale to digital and thoughtful and can you walk us through the economics on your E Commerce.

Sure Christine.

First of all the watch business has changed a lot over the last four years Im a large part of that has been a shift from retail E. Commerce and pandemic is actually accelerated that process for us. This is manoj shift from wholesale towards E. Commerce four years ago, our wholesalers by 60% our sales analysis less than 40% and it's on its way to 20% pretty short order. So.

We've been increasingly investing in our digital capabilities and obscene that payoff over the past several quarters and of course more recently as a result of pandemic.

Since March our own ecommerce business has been consistently trending as a triple digit growth level and for the full year 2020, we anticipate that our total digital business, which includes our owned ecommerce and third party marketplaces. It will be about a third of our total sales it was 50% in Q2.

So the economics on E commerce are very attractive for us in our business in particular first of all the gross margin is higher than the company average, but also keep in mind or a number of advantages for Washington accessories and E. Commerce first of all this small cube size, which we mentioned earlier, which causes low freight costs, but also there is fewer skews online than in home.

Sale, so imagine we have.

30% at least fewer skews and just imagine the inventory efficiency of that so we have fewer points of sale few or.

Not as many locations at retail.

Feature to stay in stock, it's much easier to those aligned supply and demand and it's got a much better cash conversion cycle since we get paid immediately.

Theres also there is no sizes for accessories in watches like tourism and apparel and footwear. So our return rates are running 8% to 12%, which is a big advantage for US. In addition, we already have infrastructure in place in terms of systems, our new platform and our automated warehouses around the world. So the flow through to the bottom line is highly accretive in should get more so over time.

To take advantage of this we've accelerated our investments in E commerce over the last 18 months and we just implemented our new state of the our platform that is very scalable. The system is very robust and highly automated and significantly increases our ability to build larger and more engaged communities through personalization automotive automation and the use of data.

One example is the fact that our email file is up 40% year to date.

So overall, we're on a mission to build a global E commerce and marketing platform for watches and accessories as really as a combination of art and science.

Great product innovation and storytelling storytelling combined with a digitize data driven automated platform.

If I could add a couple of data points as well this further illustrate kostas points.

As you mentioned are totally calm growth includes three channels, our own dotcom site pure play in wholesale.

Give a little bit of color on each for our own direct to consumer sites, which delivered 138% growth year over year is really driven by significant increases in both traffic and conversion in fact, we had more than a two X improvement in conversion year over year largely from the benefits of our Salesforce platform implementation.

The first part of that is driven by our algorithm.

Cross sell an upsell effectiveness, that's just speeding better relevant.

Content, an automated algorithm driven way as customers are shopping the site. The second just how well weve mobile optimized the sites as easy to browse product.

We've designed a much simpler card checkout process for customers both of these combined.

I've really given us what we believe as a new level of conversion that we're going to build sustain and support future growth with.

With pure play E Com, which includes marketplaces like Amazon team, all JD, dotcom and others growth with only 21% up in the quarter.

However, it was heavily weighed down by Amazon and with the us in Europe, which was a selling.

Only essential goods for a significant portion of the quarter and Prime day was moved out of the quarter to later in the year normally in the second quarter, we received significant orders into anticipation of job of Prime day in July.

So we are expecting significant improvement to the trend in pure play as we go through the back half the year and already starting to see that in Q3, and we don't often talk about wholesale dot com, but helping our brick and traditional brick and mortar partners and license boutiques continue to drive growth online and digital sales has been a strategic.

Paradigm of ours, and we continue to double down on that and I have seen the benefits of that with.

Hi, double digit growth and wholesale dot com, we expect that to continue to is the year goes on the last thing I'd point out is just very strong performance that we had in marketing as well, although our spend year over year was down in line with a revenue declines so be roughly held rate.

As soon as the pandemic crisis hit we went into.

Implementing a plan with it that had a dramatic shifts in our mix to digital conversion driving marketing.

And we have delivered in the quarter historic highs in the returns on that investment.

One of the key enablers there as our of our marketing returns are the real time analytics platform that we've implemented.

It's just allowing us to do real time, ROI optimize decisions on a daily basis.

Another significant benefit us Kosta mentioned that bodes well for our future is a substantial uptick in our our acquisition of new customers to our filing a 40% growth year over year I'd note that that's with the majority of our stores closed so the ability to drive lifetime value customer lifetime value off a larger database is a cluster.

Energy of ours as well.

All of this is really strong performance in digital all around and I would say, great leading indicators for sustained growth growth in the channel going forward.

Terrific, Thanks, Greg and coaster.

Question for you what is your expectation for liquidity and cash burn through the remainder of the year and are there other areas of opportunity beyond the initiatives you put in place during first half.

Thanks, Chris seem good good question focus a little bit first on Q2, as we look at Q2, and where all of them from a cash standpoint, we do believe that Q2 would be the toughest most challenging one really given the extent.

The depth and extensive closures of store closures and those are both our own locations as well as wholesale doors and a closing down of the brick and mortar part of our business, which is still fairly substantial really drastically reduced our cash flow. When ended the quarter. We are pretty concerned around what that cash flow with means we got very aggressive on many other elements we did.

Forecast these sales to be down between 60 and 70%. So the overall stronger performance. We had on sales was early positive driver for us from a cash management standpoint, but equally importantly, we really manage some of the major cash outflows as well primarily the receipt of inventory as well as the rent payment structures that we had.

And lastly, the organization did a fantastic job and really quickly reduce spending to an absolute minimum and were very appreciative to all the hard work and outstanding work with the fossil teams did around the world too to manage through a tough tough quarter and we did a good job very good job and the second quarter of managing liquidity and that continues as the primary focus really.

With many of the same elements we had in Q2.

In the back half of the year, we expect to have program to continue we expect inflows and outflows to actually be fairly balanced given our sales outlook, how we manage expenses in the back half the year as well as our balance sheet management overall, the one caution or Kevin I'd have to that balanced.

Cash burn and the back half of the year is it does assume we will continue to go through a modest improvement in the overall consumer environment and if theres any major resurgence of the virus that could change, but right now we're expecting a fairly balanced.

Inflow and outflow of cash.

Roger balance that we have right now thanks.

Great. Thank you.

Last question for Greg what is your view of the connected business, Greg when do you expect to see growth category.

Yes.

We we remain confident in the category, which continues to grow and offers us substantial total addressable market opportunity. We also remain very confident in our team's ability to compete and grow this business for us everything starts with product our engineering and design teams just continue to step up our product offering in ways that.

Keep us frankly inspired about the future this business to that point not only do we continue to see strong performance in our Gen. Five smartwatches, which launched last fall, but we have substantial innovation and product roadmap, it's coming to market, including frequent software feature upgrades.

That are keeping the platform relevant and selling well later. This fact in later this month in fact, we will have another major software release that will bring significant new functionality, including upgrades in Washington Watch based designs with much more user personalization health tracking including sleep tracking and include improved battery life during work.

Battery life management, which includes streamline user controlled would allow our customers to optimize battery life around their lifestyle and feature releases and then also upgraded fossil only or fossil exclusive phone app on the watch which allows our users to seamlessly answer or may call than they're watching compared to an iPhone and much more we've.

Got initiatives underway this year that position our core smartwatch business to return to growth in 2021, as we discussed at the beginning of the year before coded crisis. We began implementing a more focused connected strategy built around of course that a brand skews and channels that perform well today. This includes emphasizing.

Tumor and online sales expanding into consumer electronics, and telecom channel, while reducing our connected presence in wholesale we're also exiting certain brands and skews to simplify and focus the business. We've been implemented this plant on the first half have accelerated during the crisis. It will end the year with a much more focused platform for growth.

At the same time, we are reshaping the business around a profitable core we've continued to keep pace with innovation. In addition to the software features on Gen. Five that I mentioned that we're launching in August.

We've also been hard at work on our first cellular LT E connected watch built on our successful Gen. Five software platform that will launch this year and we have several yet to be announced new products that will release later this year end throughout next year.

LTV version of Gen. Five is particularly interesting from a growth perspective in that it opens us up to the telco channel as a meaningful incremental distribution opportunity.

So in summary, the near term refocusing of the Wearables business, along with continuing to push on innovation is creating a path to profitable growth and connected in we think in believe 2021 is the turning point, where our teams make that happen again.

Great. Thank you appreciate that operator could you. Please go ahead and open the line of Ike Boruchow well.

Some additional question.

Thank you Sir.

Your line is now open.

Hey, Thanks, everyone a couple of questions from us.

Jeff I think I heard you allude to promotional pressures remaining will elevated here in Q3, you gave us the revenue outlook, which is really helpful. But any chance you could talk us through the margin on gross margins and the promotion the promotional environment, you're expecting and has made maybe what the revenue decline could you mean from an EBIT perspective.

It probably won't go all the way to an EBIT perspective for you, but in terms of components on Tennessee, We still believe coming out of the code crisis emit consumers back into the spending pattern on a discretionary accessory category, we will be some of promotional we really successful this quarter in terms of mark and perform.

So overall, we do think there'll be a little more pressure as we would be in the back half of the year.

We're not giving guidance, but I know you've got to put a mile together I think about it probably a couple points below where we're at this year probably in the high and the high Fortys is the way to think about that as you do some modeling and almost all of that's going to be promotional pressure as we continue to build the business and attract consumers in these.

In these times right now.

Got it.

And then on the expense line the the incremental.

Newer Pago savings I think I think you said that those are incremental to the next year. The same run rate for this year, but also kind of go through and I'm sure. If the other 50 million you added what exactly does that comprise.

As a combination of organizational savings as well as some spending.

Means that expenses.

Well as we took a look at what's going on through the crisis, we got a bit more aggressive and how we're going to organize the company and we.

We made some more reductions and adjustments. So that we also that from a spending standpoint in really focused on our learnings. We went through a neural fossil 2.0, when we expanded it went to a minimum viable organizational approach and we just expanded that and got more aggressive to get additional savings and.

And 20, and 2020 and some additional will carry into 2021 as well so mostly organizational savings with some expense savings as well.

Got it Jeff could you maybe allude to in terms of the current trends you're seeing or your current wholesale outlook.

Specifically North America. Despite by channel I know your E com business is very well, but especially on the wholesale side just department stores at the specialty stores I'm kind of curious what were your visibility is kind of the best and where you have the least amount of visibility regarding your you're North America wholesale business. If you can kind of.

I may have I may have Greg jump in these really close on the commercial side to that so Greg, yes, what you're saying that I think the way to think about as we really lack visibility to how wholesale brick and mortar is going to perform in the back half of the year. They are lean on inventory. So we may have the ability to drive a business they're both.

But we just don't know how consumers are going to respond how the next the whether the current wave that's happening with Covance can impact the business. So we're we're being conservative in our approach and just closely partner them to make sure that we're balancing supply and demand as we see the demand signals I would highlight though that as I mentioned earlier wholesale dotcom has encouraged.

Doubly healthy.

And driving our wholesale business a substantial mix within our wholesale business in ways that has not are.

And we're partnering with them on helping drive that digital growth.

In sharing.

Marketing tactics, and and specific product strategies to drive their digital businesses. So we can kind of grow that pie together.

Got it I guess my last one again I know you guys aren't giving guidance so.

I'll take my shot I mean, when we when we think about the business into Q4, I mean, I think you had a pretty challenging Q4 last year, I mean, I'm, assuming you're expecting margin expansion.

Even though sales are probably going to be down is there any color you could provide on what your best expectation is on revenue.

And potential income in the holiday quarter.

Well I'd, probably say just help you model a little bit even though we're not giving guidance I know so it's a tough thing when you're in.

In the situation, but so end of second quarter, we were down I call it roughly.

50% was 48%, but roughly 50% you're seeing for our guidance, we've given a range of between 35 in 45% being down the Midpoints 40, Susan improvement of that of about 10 full percentage points on that.

Actually if I were you want to use a similar extension on that going into Q4 that it'd be another 10% increase and improvement in contraction. So I'll give you some sense that we should go from up 50% to a 40% to something some some of further improvement in fourth quarter for a margin simply the fourth quarter last year had a fair amount of.

Liquidation of connected product will be through a great deal of that this year. So the margins should be much more and that I think we were probably mid ish fortys last year 45, 46%, maybe with what our fourth quarter was last year, which should be much more in the high and the high Fortys just for your modeling purposes, so not quite as strong as.

This quarter, which has some favorability isn't it.

We as I mentioned, but still some competitive pressures so that'll help.

Get the topline maybe on the margin structure about right just from off just a general sense of over our heads are at on that.

Yes really helpful. Thanks, Thanks got so much appreciate it.

Okay. Thanks, Ike and thanks, everyone for listening we appreciate your support and interest and we look forward to talk to you at the end of Q3. Thank you very much.

Sure. Thank.

And gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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