Welcome to the Fourth Quarter and Fiscal Year 2018 Fossil Group Incorporated Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded. I'll now turn the call over to Allison Malkin. Allison Malkin, you may begin.

Thank you. Good afternoon everyone. Thank you for joining us, and welcome to Fossil Group's fourth quarter 2018 earnings conference call. I would like to remind you that the 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 our Form 8-K and 10-Q reports filed with the SEC. In addition, the company assumes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Please note that you can find a reconciliation and other information regarding non-GAAP financial measures discussed on this call in our earnings release filed on Form 8-K and in the Investors section of our website. In addition, you may listen to a live webcast or replay of this call by visiting www.fossilgroup.com under the Investors section. Now, I would like to turn the call over to the company's Chairman and CEO, Kosta Kartsotis.

Thanks, Allison. Good afternoon, everyone, and thanks for joining our call today. I will begin with a few comments regarding last year in 2019 and then turn the call over to Jeff Boyer, our CFO, to cover our Q5 financial performance and financial outlook for next year. Following Jeff's comments we'll have Greg McKelvey, our Chief Strategy and Digital Officer, join us for the Q&A. Note that our sales comments today will be based on constant currency unless otherwise noted. As you know, we are on a multi-year journey to transform our company. The watch and accessory business is changing at a rapid pace around the globe, consumer preferences and shopping patterns continue to shift, product innovation in watches has expanded the category overall, but has caused a move away from traditional watches towards connected product. Marketing product information and consumer research on watches and fashion accessories are shifting from our traditional brick and mortar channels to online ones. To address these structural shifts and improve the long term health of our business, we identified a number of key priorities for 2018. Our most important priority this past year was to improve our profitability and our financial condition. Due to fundamental structural changes in the watch and accessory categories, we recognize the need to be highly focused on improving our financial condition to provide us the flexibility to make the necessary changes to our overall business model. One critical element was to improve our overall profitability, which meant at times walking away from less profitable parts of our business, such as unprofitable stores and businesses and product lines. This year, our sales decreased, but our actions did drive dramatic improvements in profitability, as adjusted operating income increased significantly versus last year, reaching $115 million which is nearly four times higher…

Thanks Kosta and good afternoon everyone. Overall, we're pleased with our progress this quarter as we continue to navigate a challenging environment. Every quarter this year we've improved our profitability and this continued in the fourth quarter. During the fourth quarter, we expanded gross margin to 53%, reduced expenses by $47 million and delivered a much stronger balance sheet. We reported net income of $48 million compared to a net loss of $80 million last year. Our reported earnings of $0.94 per diluted share included New World Fossil restructuring charges of $0.07 per diluted share. Last year our fourth quarter EPS was a loss of $1.65 and included tax related charges of $2.20 per diluted share mainly for the impact of the December 2017 tax legislation, combined with valuation allowances established under protect assets and a restructuring charge of $0.09 per diluted share. Excluding these items, our adjusted EPS was $1.01 this year, as compared to $0.64 last year. Currencies, including both the translation impact and operating earnings and the impact of foreign currency in hedging contracts, unfavorably impacted our EPS comparison in the fourth quarter by $0.09. Sales decreased 15% to $787 million and decreased 13% on a constant currency basis. While store closures unfavorably impact sales comparisons during the quarter, profitability in our direct business improved significantly as we exited unprofitable stores and were less promotional overall and our retail concepts. Store closures negatively impacted total year-over-year sales comparisons by 170 basis points. We have closed 67 stores since the fourth quarter of last year and ended the quarter with 484 stores. License brand and business exit unfavorably impacted total sales by 310 basis points. Excluding these items, underlying core sales decreased 8% in the quarter. Our fourth quarter underlying core sales results were negatively impacted by lower…

Thank you. We'll now begin the question answer session. [Operator Instructions]. And the first question comes from Edward Yruma from KeyBanc. Your line is open.

Hey, good afternoon guys. A couple of questions on wearables, I know you mentioned product delays or shipment delays. Help us just trying to understand kind of what the longer term growth looks around wearables? Maybe give a little bit color in some of these delays. And kind of what would wearable performance have been potentially without some of those some of those issues that you had?

This is Greg. I'll talk about the supply shortage and then maybe pass off to Jeff to talk about how we sort of view growth. Unfortunately this is the first time in four years we've had a supply chain issue or a shortage so it hasn't -- unfortunately it hasn’t happens a lot but it was unfortunately material this time. The key issue was a supplier and one of our sub assembly processes. So, it’s a little bit deep in the supply chain where we had a single source of component that caused the issue. We've already actually moved to three suppliers, so we've diversified away, have the problem solved, but it was material in Q4 and we'll continue to be material in Q1. We're confident, we'll be fully caught up though by the second quarter. Maybe pass up to Jeff talk about materiality and growth projections.

Ed, Jeff here. In the fourth quarter we estimate the amount of constrained or loss sales at probably about 200 basis points of the total company, so it's about $15 million or so. Obviously because the connected business is a smaller piece overall and that does have a bigger impact on the growth. So that would flow that from a slight decline to a growth for and connected. The other thing that you should be aware of is we are going through -- we're going to start lapping some of our liquidation from last year, so we’re kind of an abnormal event to clear through a fair amount of inventory and connected really started in earnest in the fourth quarter of 2018 on it down 2017 and as we left in 2018 because of some drag. That's going to continue on in the first and second quarter. When we strip out the liquidation pieces and supply chain piece of it, we are looking at the underlying display program that connected display product to be up about 20%. So the display product excluding some of this liquidation should be strong going into 2019.

I’d just add one other point on growth and we had a tremendous success albeit shorten supply on the launch of our fossil sport product. And really that indicates a drive still to continue with the fashion product with more traditional fashion materials, but more use of silicone and more brands targeted at the sports segment which is where a lot of the growth in the category consumption is today. So you'll see that extended as a part of our program this year.

Great. And one follow-up if I may. Obviously lots of moving pieces in the traditional launch business. I know you were impacted by comp against the liquidations in that particular within the Kors business. How do we think about the trajectory of the traditional watch business? When do you think that you could start to see some leveling off if at all? And how should we think about kind of opportunities to continue to kind of rationalize the brand portfolio? Thank you.

As you know, the traditional watch has been tough for some time and we don't have a lot of visibility on the turnaround in there. We do have. I would say this year we've identified a number of opportunities but especially for the balance of this year we have seen a response to some new trends we've put in the marketplace and our teams are working diligently on as much differentiation as possible. And I would say also we do think at some point that a game changer for traditional watches is going to be adding technology and part of our arrangement with citizen is basically to do that is to get to critical mass and scale. I have great product and lower prices which will create more awareness than to do as quickly as possible. So that's what that project was about. But we do think through a lot of innovation and differentiation some of it being technology we'll be able to reach a point where we start growing again.

Great. Thanks so much, guys.

And our next question comes from Simeon Siegel from Nomura. Your line is open. Please go ahead.

Hey, guys thanks. Good afternoon. Just within the Kors commentary what is the connected versus traditional penetration kind of I guess similar to what you'd given for you for the total? And then on the total across the brands what would you expect -- would you expect the connected watch penetration to end 2019? Thanks.

In terms across the brands it's actually relatively similar, it's not that different. Fossil and Kors are two big brands and they sit in a similar spot and it kind of sets up the basis for the entire company. In terms of where the penetration is going to be add overall, it will be climbing probably not as quite a faster paces as it has a couple of the past couple of years. We'll have some modest growth in connected in 2019 mostly because we're up against the liquidation problem that we have. But with their traditional business being down we'll gain a few share points within that penetration in connected, probably in the low 20s, I don't think we'll get 25% at this point, Simeon.

Great. Thanks. And then, obviously not material. Did you say what the new corporate revenue line item? What was that?

New corporate revenue item, we actually have had that and was embedded in the region that wasn't material, but we decided to break it up separately to have our regions line up a little bit more cleanly on overall. So there's some factory income is the biggest thing with the factories that we have -- most of the factory income at this point.

Got it. Great. Thanks a lot guys. Best luck for the year.

Thanks.

[Operator Instructions] And the next question is from Omar Saad from Evercore. Your line is open.

Hey, thanks. Thank you for taking the question. I want to ask more about the wearables category and try to understand why it's declining or not growing faster. I know the underlying asset is about plus 20. But you put so much innovation and newness across the brands into the holiday, little bit surprise it’s not growing more. Can you help us understand that there is a general issue you know that it is once reserved for the wearables category they are managing through? And also like others – the ongoing to clients in the fashion watch business. Why do you think more of those consumers aren't transitioning or switching to the wearables category? Thanks.

So I'll start, Omar. This is Greg. A few number of thing. So overall we see the category as healthy and wearables including what all the other competitors are doing. So, category is growing and we see the rate of innovation increasing and have not changed our view on where the category is going to be in 2021, 2022, so categories healthy. Short term for us, the supply shortage was pretty material to us and also caused us to be a bit more conservative in our drive to increase the business in Q4 and Q1. So we pulled back a little bit, more conservative our inventory position. Another point is we've done a nice job. Our brands are bringing fashion products. So I think metal and leather. However a lot of the demand in the category is sports. So we're as we are now pivoting to more silicone, lighter weight materials, think more like what we did with the Fossil sport and extending that across brands. We think that will open up the number of consumers we're going to be able to segment and target so we can increase our share of the category. And then we're working really hard on continuing to drive product costs down. So as we do that we should see improved margins but we should also see sharper price points to drive volume up.

And on your question on traditional watches, I mean it's clear to us that we're in a very disruptive watch market. The traditional watch brands are addressable markets about 35 billion. Smartwatches last year did about 15, it should grow to 30 over the next several years. But just the sheer number of volume that's coming going into wearables or smartwatches right now, and we already know it's largely health and wellness. It's largely female. It's a younger customer. It's really our traditional fashion watch customer that's largely buying these smart watches. So now, we think we're putting ourselves in position with brands and styling and new technology, the product is going to get better and we're going to accelerate it with our partnerships with Google and with Citizen to put ourselves in position to capture this growing market and balance out our efforts both in traditional and in smartwatches. So we're in a unique position as the market gets disrupted. We're with partners that we're working with. We're trying to do it as -- we're trying to get better product, lower costs and do it faster. So it creates scale, the create awareness to change the watch market and that's the situation we're in right now.

That's really helpful color guys. Could you also address the channel question? Is there there something unique or different or what are you learning about which channels to the wearables category overlaps best?

Well, as we said before you wearables is skewing very heavily towards online probably about 50% of the total sales is done online either through our Web sites or our retail partners Web sites or pure plays. So it's clearly that younger customer, there's a lot of you know obviously detail the customer has to learn about the product. They're doing that online rather than the point of sale and they're purchasing there. We've obviously seen a big increase in buy online pickup in store and wearables as well. So you know the channel shift which is ongoing from retail to digital is actually putting us our company in a position where as we're getting bigger and wearables we're migrating more towards digital ecom.

Got it. Thank you.

And our next question comes to Ike Boruchow, Wells Fargo. Your line is open.

Hi, good afternoon. Thanks for taking the question. First question; so Jeff I think I understand that the headwinds that are impacting the connected category. Just curious they were down about mid-single digits on a reported basis in dollars and in Q4. Is that the kind of decline we should be expecting in Q1 or should that worsen because the discounting comparisons are tougher. And then just curious should we expect a return to growth in your connected business on a reported basis once we get out of Q1 into Q2 and beyond?

Yes. That probably I'm connected because of the liquidation issue with a couple of quarters that will be Q1 and Q2. Those will both be in the rough range you know low single digit softness mostly because again of that liquidation piece. You get to the second half of the year and we've moved through most of liquidation and that growth will return again. What we like to take a look at is stripping out and looking at just the pure display product itself that's unaffected by the liquidation effects on it. That pure display of product will be up in the low 20s is what our forecast is. But we do have some noise because of the excess liquidation we went through in 2018 and that were up against now in 19 particularly in the first half of the year.

So on a reported basis small, small low single digit declines and connected in the first half and then reacceleration in the back.

Right. Right.

Okay. Thank you. And then there’s follow up. Just making sure I heard right on the guidance, is the 20 million gain from the sale to Google. Is that included in the Q1 other income line. And then the follow up to that is just the on the working capital if you could address inventory, I mean, you've taken, you've done a great job of working cap and taking inventory down in 2018. Is there more room to run there? Or it is working cap now maybe to start building up is kind of curious how we should think about that?

On the Google gain, that is an other income, it is in the guidance also. There’s a small amount that's hedging, that's in there, but most of that gain is from the net gain from the Google transaction. On the working capital piece of it, we’re still going to be very focused on inventory productivity on it. You will have not seen kind of the sizable step down you saw this year. We’re working on inventory turnover to flow the product on it, and so we're not looking at adding significant amounts of inventory overall. So I think the working capital equation would be fairly similar in 2019 until we ended 2018 out there. There's not a whole lot of opportunity on top of that. So no big changes there as we exited the year and got into 2019.

Got it. Thank you.

Sure. And this concludes the question answer session. I'd not turn the call over to Jeff Boyer for closing remarks.

I want to thank everybody for joining us today. We look forward to speaking with you on our first quarter call in the future. Thanks.

Thank you ladies and gentlemen. This concludes today's conference call. Thank you for your participation. You may now disconnect.