Welcome to the Q1 2019 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 first quarter 2019 earnings conference call. 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 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. Please note that 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.

Good afternoon, everyone, and thanks for joining our call today. I will begin with a few prepared remarks and then turn the call over to Jeff Boyer, our CFO, to cover our Q1 financial performance and financial outlook for the year. Following Jeff's comments, we'll have Greg McKelvey, our Chief Commercial and Strategy Officer join us for the Q&A. Note that our sales comments today will be based on constant currency unless otherwise noted. In the first quarter, sales performed at the higher end of our expectations, though down the last year. We're continuing to see growth in our Asia business where core sales grew 7% in the quarter with both China and India delivering double-digit growth. Our direct business also continues to see encouraging trends driven by our digital marketing and our consumer experience focus. Full price retail comps on a global basis, which include full price retail stores and our owned e-commerce sites, were roughly flat for the quarter with the modest negative impact due to Easter shifting to the second quarter. As we expected, our connected business declined for the quarter. This was due to higher liquidation levels last year, which were not repeated, our Generation 4 Smartwatch availability issue and store closures. The underlying performance of our newest generation display product however, continues to perform well and grew for the quarter. Despite these positives, our overall core sales declined 12% in the quarter with currencies, store closures and business exits negatively impacting reported sales by approximately 600 basis points. As we outlined in our February call, our core business continues to be affected by the disruptive environment. The watch and accessories business is changing at a rapid pace and consumer shopping patterns continue to shift. Product innovation in watches has expanded the category overall, but has…

Thanks, Kosta, and good afternoon, everyone. As Kosta mentioned, we continue to operate in a disruptive environment. During this period of disruption, our focus continues on improving our overall profitability while also strengthening our balance sheet. While our topline sales have been challenging, we are pleased with our progress to improve profitability through both gross margin expansion and reduced operating expenses. We expanded gross margin rate to 53.3%, an increase of nearly 300 basis points, and we reduced expenses by $48 million or 15%. We are also pleased with our progress on the balance sheet, as we improved our net-debt position by nearly $280 million with our debt balance at $230 million and our cash position expanding to $271 million by the end of the first quarter. We reported net loss of $12 million for the first quarter compared to a net loss of $48 million last year. $48 million at last year. Our reported loss of $0.25 per diluted share included New World Fossil restructuring charges of $0.16 per diluted share and included a gain on sale of intellectual property to Google of $0.33 per diluted share. Last year, our first quarter EPS was a loss of $0.99 and included a restructuring charge of $0.35 per diluted share. Excluding these items, our adjusted EPS was a loss of $0.42 this year as compared to a $0.64 last year. Currencies, including both the translation impact on operating earnings and the impact of foreign currency hedging contract had an unfavorable $0.08 impact on our EPS in the first quarter. Sales, which were within our expectations, decreased 18% to $465 million and decreased 15% on a constant currency basis. While store closures unfavorably impacted sales comparisons during the quarter, profitability in our direct business improved significantly as we exited unprofitable stores and…

[Operator Instructions] And the first question comes from Edward Yruma from KeyBanc. Your line is open.

I guess, first on traditional watch business, is there any way you could contextualize the performance of Kors ex the liquidation drop off? And I'm just trying to understand, has the trajectory changed, is the -- and in particular, as you think about kind of the lineup of fashion watches going forward, are there reasons to get more constructive or do believe at this stage we're in kind of a continued secular pressure phase? And then second is a follow-up. I know that you gave some cadence information on New World Fossil 1.0, are we expecting a benefit from 2.0 this fiscal year? Thank you.

First, on Kors, the decline we had, as we mentioned, was largely due to what we were liquidating last year, was large numbers of wearables in the category. But, I would say, overall, if you look at the health of the business in all three categories, traditional, wearables and in jewelry, we're seeing sequential improvement on sell-throughs and overall health. It's still declining but it’s not declining as much as the overall numbers. And then going forward, I think we have a lot of opportunity to change the direction. We've been working very closely with Kors on all categories. But, in traditional watches we've identified some trends that really are getting back to more of the iconic oversized look. I think in the past year or so, we tried more minimal, which was the trend, and we think that's going to change the direction. In wearables, we’ve got more platforms coming this year than last year, and one of them is a sport version, health and wellness oriented. It could be a game-changer in the wearables business, so new functions and features, and we’ll be talking more about that later in the year, it could be good. And in jewelry, we also -- we've indentified some tweaks to the model. I think we've seen some things that we can change and improve the business. But, I think we're going to see ongoing improvement in all three of those categories. The other question about the watches in general is, I would say over the last couple of years, we had a lot of initiatives and emphasis on building our wearables business and traditional business has been soft. This year, I think over the last 6 to 8 months, we've kind of taken the gloves off on innovation, design, new materials and traditional watches, we've got a lot of new ideas hitting the market this year. Our idea is to the store [ph] differentiation as much as possible in the market. As soon as possible, you will see a lot of that product flow in the second and third and fourth quarters. We're also spending a lot of time and energy on making the cases look different but do marketing. We're emphasizing more digital capabilities to broadcast this, but we definitely think that in our experience sometimes the watch business and traditional watch business is cyclical. And what changes the direction is innovation and differentiation, and we're taking the gloves off and we’re bringing as much as we can in the market as we can.

As there were couple of more financial questions that you asked about, one was the liquidation impact on Kors and how much of that decline was due to that. I'll tell you about a third of the decline year-over-year, which is the liquidation, we had the additional liquidation last year, particularly in their Bradshaw connected product. So, that made a tougher comparison and for some of that decline. You asked the question about New World Fossil 2.0 and whether we’d see benefits in the P&L this year. Yes, you will. We've incorporated those into our forecast already. They are part of underlying forecast on it. It's going to be a smaller amount as we're just getting started on the program overall, $10 million to $20 million of benefit is embedded in the forecast right now for some of the efforts they we get early start on New World Fossil 2.0.

And our next question comes from Omar Saad from Evercore. Your line is open.

Actually I just wanted to clarify first, did you give the growth rate of the wearables business excluding the impact of the smaller liquidation this year versus last year, wearables grow excluding that?

Yes, it did. We gave it on the Fossil 1, it was when we were supposed to call out growth in Fossil business, provide 10%. And that's a good portion of our business overall, and Gen 4 product, this product did grow year-over-year about 10% in the first quarter. So, we feel great about that. And that's even with the situation where we really had limited supply. We are constrained because of supply issue we have. So, we feel really good going into Q2 and the rest of the year in terms of what that product did in a constraint supply situation and what it means for the back half of the year.

So, there is a lot of noise in the numbers, last year's liquidation of werables and also high results of store closures, but we're on track this year to have a double-digit increase from wearables.

So, yes, that was my follow-up. This is a kind of -- shift towards the sport, it sounds like that business is doing well but still small. Can you maybe give us some more context around the shift towards sports, why that makes sense, an increased focus, is that what's been missing in the wearable offering shoring and this is a key kind of moment when you are adding those types of functionalities? Can you give us some more context around that please?

Omar, this is Greg. There's actually five things. I'll start with sport. That is the reason why the back half we see actually a step -- a significant step-up of the business. First, sports, as you know, sport drives the category broadly. We’ve largely been focused on fashion SKUs, metal, leather, and we’ve done really big business off that. But Fossil sport right out of the gate has done incredibly well; we couldn’t keep it in stock, and we're going to be driving that sports platform with silicone, lightweight materials, latest tech across several brands as we go through the year. So, that’s just a significant addressable market we really weren’t going after before. As we mentioned, back half, we won't be -- won’t have the liquidation in our base. So, that will be clean in terms of lapping. We had significant inventory issues, as you know; so, we couldn’t actually fulfill demand Q4 or Q1. We're actually back up and running and caught up with significant capacity expansion in the back half to take advantage of the growth that we perceived. Michael Kors in particular, the fourth point, the runway platform that we launched, we really backed everything on one platform, which is a bit minimalist and we believe moved a little bit away from the jet set and true runway appeal that Michael Kors customer knows. We’ve got multiple proven platforms coming back again that are much more consistent with what their customer expects. We just launched on April 25th the Sofie product, which was a huge success when it launched year-and-a-half ago, and we’ve got more coming in the fall. So, we expect proven platforms to play out. And then we are seeing a lot of opportunity in sharper price points during key periods that we think are going to get us good margin and drive a lot of volumes, taking advantage of key moments. Last thing is, there is going to be as Kosta mentioned, a lot of partnership with our customers and completely overhauling point of sale to make sure that we are being disruptive and communicating at point of sale, the right messaging that gets customers to stop and quickly understand what these products do for them.

And the next question comes from Dana Telsey from Telsey Advisory Group.

Hi. Good afternoon, everyone. As you think about the gross margin and SG&A, the variables going forward with obviously platform 2.0 and lesser promotion. Can you unpack what that means either as you're thinking about it by region or by channel, both on the SG&A side and the gross margin side? And just one quick thing on Tory Burch and DKNY, were those renewals under the same terms as they had been before and for the same timeframe? Thank you.

On the newer Fossil 2.0, you asked channels and regions on it, and broadly this is a broader initiative that really effects the broader base. And if you think about we had a newer Fossil 1.0, we saved about a $100 million in gross margin about $100 million in SG&A. So, from that detail piece, we can share that, so it will be a couple of hundred million dollars over a three-year period with some start this year but really the bulk of it in 2020 -- in 2021 again split in those categories. On the gross margin side, it will be things such as strategic sourcing, manufacturing, logistics efficiencies as well as revenue management, category management efforts. On the cost side of it, I would tell you it’s spending efficiencies, continue to take a look at it. We mentioned on our comments, we're doing zero-based, so take a really hard look here where our spending is at that and look at where we could do much better from a spending standpoint and from an organizational efficiency standpoint as well. And that will go - that won't be limited or focused particularly in regions and sort of channels, it will be a broader corporate program, along those dimensions, Dana.

Yes. On the licenses, they are pretty much the same terms as the license -- so we look forward to working with those brands in the future.

And lastly, just any update on tariffs, if it does go to 25%, how you're thinking about it?

We've done an analysis on that, and the good news is we have very limited exposure, most of our product categories have been exempted already. Traditional watches are exempted definitionally and connected watches have an exemption that was granted. So, it’s really on the existing products that's 10%. In year impact right now, they were anticipating without any additional efforts which obviously we do additional efforts, is under $5 million. So, it's not a very material impact to us overall. And that's kind of a worse case in year impact without any additional work. But we're working hard to continue to shift our production, our sourcing around to minimize negative impacts from the tariff growth.

The good thing is in watches, the country of origin is actually Japan because we use Japanese movements. So, there's no risk there.

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

So, congrats on the profitability improvements; that's good to see on the margins. But, I guess, I want to talk about the top line for a second. On the wearables side, I think Jeff, I think you said modest decline in the first quarter, but if I'm just going through the numbers, the decline looks like it's closer to 23%. So, is that accurate or am I looking at the wrong numbers? I'm trying to understand how much year-over-year the total wearables business looked like?

Yes. The total wearables business was down more in the mid-teens. So, your backwards math, you’re trying to triangulate on that is probably little bit high, but it was down about in teens with a fair amount of it all being driven by Bradshaw and hybrid liquidation on it, and constrained a little bit because of the supply chain issues, still with the supply chain issues we had, the display watch excluding that grew 10%.

Right. And I guess, my follow-up to that is, I mean, on the last call you had said you expect it to be down low single. So, there's clearly something that came in the quarter worse, down mid-teens, was it the supply chain constraints or was there something in point of sale. So, just trying to understand the down -- I guess mid-teens relative to down low-single.

The supply chain, we got back in the business a little later, took a little bit longer to bring the inventory back up again. We're actually just getting there now. We thought we'd be back in business a little bit faster on that. So, the vast majority of it was supply chain.

Got it. And so, when we look at the guide for the year on total topline now, there's clearly improvement baked in. I guess, just the two questions I have with that, and I'm done, would be, are you getting there, are you assuming the improvement is driven by the wearables inflecting or is it maybe a stabilization of traditional or both? Just trying to understand how you get there. And then, how Q4 weighted would that back half improvement relative to the first half be?

If you think about the timing issues we have, we have a lot of kind of structural comparison issues this year versus last year. So, it is weighted to the back half improvement. Liquidation was heavily weighted, connected and traditional business in the first half of the year. And then in the back half of the year, we also had connected supply issues. Those are the big structural things. The good news is you can kind of identify those things and look at them. I will tell you that from a traditional watch standpoint, the underlying forecast and expectation for traditional watches is really continuation of that. So, we get some benefit, decent amount of benefit just from the structural comparison changes, not going up against liquidation numbers in the back half of the year, being back in business and connected products that we feel really good about what's happening right now plus what's coming, so very excited about that. So, overall, we get into a much better year-over-year comparison by the time we get to Q4.

[Operator Instructions] Our next question comes from Simeon Siegel from Nomura. Your line is open.

Hey, guys. This is Steve McManus on for Simeon. Thanks for taking our question. So, just thinking through the store closures, can you give us some color around what you guys have been seeing in terms of any sales recapture, whether online or nearby doors? And then, maybe remind us the cadence, store closures moving through the balance of the year?

From a recapture standpoint, we don’t have a great deal of density in stores, so you can tell a good recapture when you are say a grocery chain or something that have stores within a 5-mile radius; our radius tends to be quite a bit further than that. So, we don’t get a lot of recapture in that. And it’s always a tough thing to just really capture how much we pick up online. And we know we are picking up some element in from some of our omni-channel work, but really hard to quantify that. It's an excellent question, Simeon. It’s one of the great mysterious right now in terms of the omni-channel modeling on it. In terms of the cadence of store closures, we always close most of our stores in the first quarter, that's when most of them happen. We have 30 that we anticipate closing for the full-year. And so those -- mostly in Q2, Q3 because Q4 you don’t really close any stores and Q4, it’s generally most profitable quarter. So, it tends to be first three quarters of the year with the heaviest weighting in Q1.

The other thing I would comment on, as we mentioned in the prepared remarks, we are now in the process of implementing a new e-com and marketing cloud. So, it's the latest state-of-the-art technology that’s going to enable us to do exactly what you mentioned, which is recapture customers as they migrate different places and then truly really up our game quite a lot, both on the e-com side, building e-com sites around the world where we don’t have them but also on CRM, omni-channel capabilities, use of data et cetera. So it's going to be, we think, quite a game changer for us now as well.

And this concludes our question-and-answer session. I'll now turn the call back over to Jeff Boyer for closing remarks.

I just want to thank everybody for your support and listening in on the call today, and look forward to updating you in about 90 days when we close the second quarter. Thanks again.

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