Q3 2021 Fossil Group Inc Earnings Call

Good afternoon, ladies and gentlemen.

2021.

At this time all parties are endless smelly mode.

Conference call is being recorded and may not be reproduced in whole or in part without written permission from the company.

Now I'll turn the call over to Christine Green or Blue shirt group to begin.

Thanks, Shannon well.

Everyone and thank you for joining up with US today on the call or close the card Covid Chairman and C E O, Jeff Boyer Chief operating officer.

<unk> <unk>, Chief Financial Officer, and Greg <unk> E V P and cheese 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.

Thoughtful group policy forward looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is.

Is readily available in the company's form 8-K, and 10-Q reports filed with the S. P C.

In addition, fossil it seems no obligation to publicly update or revise in your car was looking statements.

Whether as a result of the new information future events or otherwise, except as required by law.

During today's call, we will refer to constant currency results. Please.

You know that you can find a reconciliation of actual results and currency results 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 <unk> Dot com.

Now I'll turn the call to Kosta to begin.

Thanks for stirring good afternoon, everyone and thanks for joining us today.

We are pleased to deliver another quarter of strong performance driven by continued momentum across our key categories and regions.

R Q3, nephews grew 13% or 11% in constant currency.

Gross margins remains strong at 53% and.

And we delivered double digit adjusted operating margins, 11%.

We're proud of our teams were continuing to deliver superior execution and remaining focused on our strategic priorities and what is being a dynamic environment for nearly two years.

Our top line performance was fueled by our digital first focus.

Ongoing product innovation and favorable watch category dynamics.

And importantly over the last several years, we have become a much more efficient organization.

Actively transforming our company and positioning us to deliver profitable growth and create long term shareholder value.

Most recently, we further strengthened our financial condition with the successful completion of $150 million senior notes offering more to come on this from Sunil later.

It is great to see our digitally led mindset drive measurable results until 2021 and.

In the third quarter digital sales grew 28% and double from 2019.

Digital sales penetration remains strong at approximately 40% of our overall sales mix.

As a reminder, digital sales include sales on our own e-commerce sites.

Global third party platforms and wholesale dot com sites.

During the quarter, we completed another key element of our strategic roadmap on digital all 27 of our global websites now reside on our Salesforce platform.

These websites cover our fossil Skagen watch station, Michelle and Zodiac brands.

Specifically, having our sights on one common platform allows us to more effectively scale, our strategies to drive consumer engagement and personalization through digital means.

Longer term. This will also enable us to deliver superior customer experiences across both digital and non digital channels.

Yeah.

Looking at the business from a regional lambs, starting with the Americas consumer demand in the United States remains strong which continues to be led by our traditional watch category and jewelry.

Better inventory management reduced reliance on off price channels and an emphasis on digital channels is driving healthier more profitable performance from the region.

As we head into the holiday selling season, our inventories are in good position as we were able to pull forward some inventory buys.

For added context, we have not experienced a significant impact from shipping headwinds and watches and jewellery. We have historically ship. These buyers since they have a relatively small cube size and a low freight costs per unit and.

In leathers, we have experienced some delays and increased costs and shipping, but our plans have been calibrated accordingly.

Our EMEA region reported a strong quarter of growth with net sales up 21%, despite continuing pandemic related closures effecting brick and mortar traffic in certain locations.

By digital channels, we captured demand for traditional watches and jewellery in the region.

Looking ahead, we expect to see momentum billed as markets continue to open up and key countries, including France, Germany and Italy.

And now turning to Asia Q3 saw a notable change in sales trends between mainland China, and India is pandemic factors shifted the markets.

During the quarter mainland China was impacted by new Covid, driven restrictions and two weeks ago, China announced a new wave of closures and travel restrictions due to an increase in COVID-19 cases across several provinces and.

In mainland China sales in the quarter were down 1% compared to last year and up 55% versus 2019.

Conversely in India, and improving trend in Covid infections, and vaccination rates across key cities resulted in improved traffic and spending with.

With solid inventory positions and effective marketing campaigns are third quarter sales rebounded sharply up 95% of last year and up 24% compared to 2019.

While we navigate pandemic driven traffic disruptions in the short term, we continue to view, China, and India as attractive high growth markets with sustained long term opportunities across our categories and brands the.

The demographics in this region are very compelling with a significant middle class has a strong affinity for branded washes and accessories and.

And over many years, we have invested significant resources and build strong capabilities in both China and India. This has enabled us to deepen our understanding of the consumer and build brand equity in these markets, which we believe gives us a long term sustainable advantage.

Let me now turn to Q3 performance by brands and product categories. Importantly, the traditional watch category remains healthy and continues to show signs of strengthening consumer demand.

During the quarter, we saw broadbase strength across all three regions and achieve strong double digit growth in both our fossil and kors brands as our iconic styles resonated with consumers.

We also continue to see momentum in our jewelry category, which also delivered robust performance across all regions in the quarter.

And the connected category, although sales were down versus last year, we executed against our strategy to focused on best in class products with key brands sold primarily through DTC in our digital distribution channels.

This strategy has resonated with consumers and it's driving better economics for the category.

In September we launched Jen six which represents a meaningful step forward in our product roadmap.

With this latest generation based on Qualcomm's 4100 chipset.

Battery life continues to improve with 30 minute charging consumers now have more flexibility to leverage the full potential of the device.

In 2022 or June 6th product will bring to market advanced where OLS technology as well as Amazons, Alexa and our own companion App.

While early in its launch we are pleased with the global consumer response to Jim six as we enter the holiday season.

As we previously shared we have been investing in marketing to reignite brand heat the.

The global campaigns, we launched this year have been fueling sales growth and bring an additional customers into the fossil ecosystem.

We're focusing on storytelling with a consistent brand voice and emphasizing icons collaborations partnerships and sustainability.

We are encouraged by recent market data and strong sellout trends, which indicate that our efforts are bearing fruit and helping us gain share.

This holiday season, you can expect to see us lean into key markets brands and gift, giving options with an emphasis on digital and social marketing campaigns.

We expect a strong finish the year based on our current momentum, which is driven by the energy and focus execution of our teams around the world.

To that end, we are raising our full year outlook and now expect to deliver sales growth of 17% to 19% and adjusted EBITDA margin in the range of eight 5% to 9.5%.

As we look at the next year, we expect to achieve strong top line growth is our categories of only partially rebounded from pandemic due to their discretionary nature.

We also anticipate that our programs to improve our operations and capture efficiencies will enable us to continue driving leverage and the model.

And now I'll turn the call over to Sunil for more detail.

Thanks, Kosta and good afternoon, everyone.

Starting with our third quarter results are third quarter was strong highlighted by better than expected top line growth solid gross margins and ongoing cost discipline, which collectively drove adjusted operating margin of nearly 11% and EPS of 65.

First let me highlight that sales.

Q3, net sales for 492 million up 13% or up 11% on a constant currency basis.

From a regional perspective net sales in the Americas are up 10% in constant currency with stronger growth in the U S market driven by continued strength in consumer demand.

In Europe Q3, net sales for 21% in constant currency as the region began to emerge from pandemic restrictions are teams have a definitely navigated store closures and reduced foot traffic with strong digital execution to drive overall topline sales growth.

And our Asia region Q3, net sales increased 5% in constant currency led by strong growth in India as the country continues to recover from pandemic driven conditions that impacted demand in the first half of this year.

Conversely in mainland China sales were down 1%, reflecting a slowdown in trend from Q2 due to accelerating pandemic lockdowns in the third quarter.

Other markets like Japan, and Korea, and Australia have not seen a significant improvement in trend.

From a channel perspective, Q3 digital sales remained strong up 28% versus a year ago, and two times compared to the third quarter of 2019.

Additionally, we continue to see our digital sales mix at about 40% up significantly from 2019 levels.

Looking at sales that are DTC channels, which encompasses our own E. Commerce site. Some stores comparable TTC sales were flat versus last year.

Globally traffic and conversion trends have remained consistent with recent quarters with traffic improvement in both the America and Europe.

We ended the quarter with 374 company owned stores down 13% versus a year ago and down 18% from 2019.

Turning to category performance.

Overall global watch sales in Q3 increased 9% in constant currency led by traditional watches which grew in the high teens.

Traditional watch sales were up in all three regions and from a brand lens, our strongest performance was in fossil and Kors.

Partly offsetting that growth are connected watch business contracted versus last year.

As a reminder, and are connected watch business. This year, we are lapping a significant amount of liquidation sales from the prior year related to earlier generation products.

Net sales of our jewelry category grew 79% in the quarter with growth in all three regions in Q3 jewelry represented approximately 11% of sales.

Moving down the P&L.

Third quarter gross margin came in at 52, 8%, which was flat to last year.

Gross margins benefited from favourable currency impact on our cost of goods sold in a better channel MC after.

Offsetting this was a less favorable geographic mix product mix and one time inventory reserve reductions in the prior year period.

Turning to expenses are teams did a good job on cost control delivering improved ratios on both SG&A and total operating expenses.

SG&A dollars in Q3, total 206 million up slightly from 202 million a year ago.

G&A as a percentage of sales leveraged by 460 basis points coming in at 41.8%.

In the quarter, we did increase our marketing spending by 230 basis points versus a year ago, which was more than offset by 680 basis points of leverage and the balance of our SG&A expensive.

Total operating expense, which in addition to SG&A includes impairments and restructuring costs for $212 million or flat compared to the prior year opt.

Operating expenses a percentage of sales came in at 43% down 570, 570 basis points to last year.

Taken together our top line perform.

And expense leverage allowed us to deliver adjusted operating income of $54 million and margin of 29%.

Third quarter adjusted EBITDA came in at $63 million and adjusted EBITDA margin reached $12, 7%.

On a trailing 12 month basis are adjusted EBITDA is coming in at 150 million basically rebounding from 2020.

R Q3 income tax provision was $9 million or 22% of pretax income, reflecting higher provisions for foreign taxes that are also tax in the us.

Diluted net income per share was 60 cents and included eight cents per diluted share and restructuring charges under the company's new role thoughtful program.

Moving to the balance sheet and cash flow quarter, and inventories for 398 million pets up 11% to last year and puts us in a healthy position for Q4 and holiday.

We ended the quarter with over $300 million of liquidity that includes cash and cash equivalents of $182 million and 123 million of revolver availability.

Total debt was $139 million, including $122 million under our term loan credit agreement.

Subsequent to quarter and we successfully completed a 150 million senior notes offering and have used the proceeds to repay the borrowings under our term loan.

Now turning to our outlook.

We are raising our outlook for fiscal year 2021, and now expect to achieve net sales growth of 17% to 19% and adjusted EBITDA margin of 85% to 95%.

This reflects anticipated net sales growth of 18% to 25% in the fourth quarter.

As a reminder, our outlook of sales prevailing currency rates.

As we approach 2022 favorable category in channel dynamics continued execution of our strategic priorities and an improved capital structure provided for confidence in our ability to continue driving profitable growth.

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

Thanks, <unk>, let me run through a few questions that we've been getting from the pastures I'll start with co step we hurting the prepared remarks that traditional watch outpaced connected watches in Q3 can you share more about your outlook on both of these category.

Sure Christine.

First of all in traditional watches our analysts are showing that the overall categories healthy and growing.

We're seeing strong growth and all three of our regions with brand performance vary by market that.

Kors on fossil businesses are both of them quite well in the Americas and also surprisingly strong in Europe, considering the closures we've seen in the region.

In Asia are Emporio Armani business has been a consistent grower for us, especially in China and.

In India is a market opens up we are seeing increasing activity in the category, especially in our fossil and Emporio Armani brands.

We believe the long term market potential for traditional watches as significant in Asia, given the growing number of emerging customers, who have a strong affinity for brands watches and accessories.

Broadly speaking the traditional watch business as a growing category and we are well positioned across brands product categories and geographies.

From a near term perspective, we're approaching holiday with product innovation healthy inventory levels and increased marketing spend to drive awareness and sales.

Smartwatch is also a fast growing category.

Over the past 12, plus months, we have executed on our strategy to prioritize key brands and digital channels.

We successfully worked through our older generation product last year and brought innovation of the market in 2021, we.

We are seeing positive consumer response to the improved functionality and performance of our latest Jim six product, which was launched in September.

So we will have more features and greater functionality coming to market in 2022, when we introduced an advanced version of Google's where else in the market at.

At a high level, we've made good progress on realigning our strategy and we're well positioned to drive improved performance next year.

Thanks kind of staff, Greg how are you thinking about brick and mortar digital over the next few years.

What does the optimal mix look like and what percentage of sales G. Ultimately wanting deal in the hotel channel.

Thanks Christine.

First I believe that we've reached an important inflection point, where the watch category as strong consumer engagement again, which is providing a broad based lift across channels are digital first strategy. In particular is also now at a point, where the combination of our progress on digital sales plus positive comp performance and top brick and mortar locations has created a growth story a true.

Additional watches that we see a sustainable.

As mentioned earlier digital sales penetration is currently 40% of total revenue growing 28% year over year and doubling over the same period in 2019.

We expect digital sales represent at least 50% of sales over time as we continue to invest in our digital teams and and the technology content and analytics capability to support them.

Second when we talk about digital we aren't just referring to channels of distribution the capabilities, we built and continue to build out in digital include the disciplines needed to convert at high rates and E Commerce on global online marketplaces and in supporting our wholesale accounts with online sales.

But also includes how we build brands launch new products and create category heat online and through social and digital marketing channels with compelling content, how we use proprietary analytics to identify fashion trends and then quickly respond with new products enabled by a quick response supply chain with geared up for digital.

And how we integrate online and physical shopping tools create great customer experiences and engagement with our brands and.

The combination of these digital capabilities is driving digital sales growth, but also reinvigorating brick and mortar sales as well and together, creating a net positive growth trend, we expect to continue for the foreseeable future.

The last point I would like to make here is that the wholesale channel in our own brick and mortar locations remain kors for our growth strategies in both instances the optimization of our portfolio over the last few years has brought us to a point where the remaining stores are much more productive in in both wholesale and our own brick and mortar stores. The attention is now on creating engaging shopping.

Experiences that merge our digital capabilities with the benefits of physical shopping and store associated interactions that you can only get in store.

Thanks, Craig.

Jeff There's a significant amount of discussion these days regarding disruption to the supply chain.

Across many businesses.

Happening from Ocean container delays to court congestion and onto the lack of truckers to clear the porch and deliver product to retailers.

How has all the various supply chain issues impacting fossils.

Nikki lately as we entered the holiday season.

So we're not fully immune from the supply chain issues. You mentioned Christine we are fortunate. These issues are not nearly as serious here if possible group is the aren't many other companies as coast I mentioned earlier, we benefit greatly from the actual dimensions of our product is nearly 90%.

Our product line is relatively small in size and the vast majority of our products are shipped by year the.

The combination of relatively small dimensions and solid.

On average and retails means that our watches smartwatch as in Jewelery can be packed and shipped very efficiently via air largely avoiding much at the core and trucking disruptions you mentioned.

We have added additional time, Georgia delivery schedules and we have incurred additional costs as we've shifted to more air versus ocean freight.

But to put some dimension on a cost impact shipping disruptions actually started in 2020.

To absorb some of the shipping cost increase last year.

They're kind of freight costs for the past two year period is estimated at several million dollars a year.

While we are never happy about these types of external incremental expenses. This low level of impact is manageable for nearly 2 billion dollar business.

Our most significant challenges on delivery time for leathers, which is about 10% of our business leathers shifts primarily the ocean freight.

And even with double and the delivery times, we find ourselves getting our products just in time not ideal, but again it has been manageable so far.

Overall, we feel very good about our current inventory levels dental floss product was limited risk regarding the timing of leather deliveries.

And we feel we are very well positioned to continue to meet consumer demand during this upcoming holiday season.

Terrific that's helpful. Thanks, Jeff.

Turning now to Tinyurl.

Can you share a bit more color on the bond offering for us what was the driver behind the offering and how are you thinking about the capital structure as we go forward.

Sure thing Christine.

We issued $150 million in a public debt offering the bonds, our five year bonds that mature in 2026 and carry a coupon rate of 7%.

The proceeds of the offering have been used to pay off our term loan because balance was $122 million at the end of the third quarter.

We are pleased with the outcome of the transaction as we lowered our cost of capital increased flexibility reduced covenants and extended maturity.

Maintaining a similar leveraged profile of one to one five times gross debt to EBITDA.

Terrific. One one last question for you see Neil how should we think about the puts and takes on the increased guidance you provided today and can you comment on your thoughts around the longer term growth algorithm for us.

Yeah sure first on the guidance.

With three quarters under our belt, it's obviously about the fourth quarter for queue for our top line growth estimate of 18% to 25% is an acceleration from Q3, 13% sales growth.

Versus 2019, however, Q4 is down 10% using the midpoint of our range similar to Q3s results.

We do expect some currency headwinds in the fourth quarter relative to the third quarters tailwind based on prevailing rates.

In terms of adjusted EBITDA margins are full year guidance of eight 5% to 95% as soon as the fourth quarter range of 10% 12, 5% or 11% at the midpoint.

The mid point of slightly lower than our third quarter results as we are accounting for some seasonally driven gross margins that are historically lower in Q4 versus Q3.

As for our longer term algorithm, we expect to continue delivering net sales growth as we have not fully recovered 2019 levels.

In addition to key categories are growing in the overall global outlook appears favorable.

Also we've demonstrated our ability to achieve leveraging the model as we've right size the cost structure and continue to focus on driving efficiencies.

With this combination this will allow us to deliver expanding operating margins over time.

As we finish off Q4 and finalize our plans for 2022, we look forward to sharing more specific guidance in our next quarterly call.

Hey, Thanks, Danielle thanks, everyone for the Q&A I'm going to turn it back over to Kosta for closing comments.

Thanks for joining us for our call today and I. Appreciate your interest in fossil we'll look forward to speaking with you and our next call for the end of the year and have a good holiday. Thank you.

This concludes today's conference call. Thank you for participating you may now disconnect.

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