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 a listen-only mode. Later, we'll conduct a question-and-answer session. Please note this conference is being recorded. I'll now turn the call over to Christine Greany of The Blueshirt Group. Christine, you may begin.

Hello, everyone, and thank you for joining us. With us today on the call are Kosta Kartsotis, Chairman and CEO; Jeff Boyer, Chief Operating Officer and CFO; and Greg McKelvey, EVP and Chief Commercial Officer. I would like to remind you that information made available during this conference call contains forward-looking information and actual results could differ materially from those that will be discussed during this call. Fossil Group's policy on forward-looking statements and additional information concerning a number of factors that could cause actual results to differ materially from such statements is readily available in the company's Form 8-K and 10-Q reports filed with the SEC. In addition, Fossil assumes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. Please note that you can find a reconciliation and other information regarding non-GAAP financial measures discussed on this call in Fossil's earnings release, which was filed today on Form 8-K and is available in the Investors section of fossilgroup.com. With that, I will turn the call over to Kosta 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 to have devastating effects all over the world, we remain committed to prioritizing the health and safety of our employees, customers and the communities where we operate. At the same time, we are disheartened by the racial tragedies we've seen and the underlying systemic bias that exist in our country. As an organization, we are doing our part to foster positive change. We are committed to leading by example and doing good for the planet, for our communities and for our people. Since we spoke to you in early June, we have remained 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 increasing 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 these strategies shortly. In Q2, broad-based store closures persisted within the wholesale channel and across our Fossil retail locations throughout much of the quarter, resulting in a net sales decline of 47% on a constant currency basis. We did see, however, sequential improvement in top line trends across all regions during the period, as of many economies began reopening in the latter part of May and June. We delivered Q2 sales of $259 million, reflecting a stronger-than-expected pace of store re-openings and wholesale order flow. From a global business perspective, Europe and Asia…

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 of our ability to navigate the impacts of COVID over the longer term. We have lowered costs across the organization, significantly reduced capital expenditures and proactively managed 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 P&L, 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. Top line results came in better than expected, primarily due to the strong pace of store reopenings and wholesale order flow across all three regions during the latter part of the quarter. From a regional lens, Asia-Pacific, and EMEA both reported sales contractions in the mid-40s, 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 to 36%. In the second quarter, we permanently closed a total of 15 stores, ending the quarter with 436 Fossil locations. Turning to category performance, total watches declined 48% in constant currency, with traditional watch sales also declining 48%. Connected watch…

Thanks, Jeff. I'm going to start with a few questions that are top of mind for investors and then we'll turn the call over to Wells Fargo to continue the Q&A. So, first, I'll start with Kosta. How should we think about the shift from wholesale to digital at Fossil? And can you walk us through the economics on your e-commerce business?

Sure, Christine. First of all, the watch business has changed a lot over the last four years and a large part of that has been the shift from retail to e-commerce and the pandemic has actually accelerated that process. For us, this has been a shift from wholesale towards e-commerce. Four years ago, our wholesale was about 60% of our sales and now it's less 40% and it's on its way to 20% pretty short order. So, we've been increasingly investing in our digital capabilities and have seen that pay off over the past several quarters, and of course, more recently as a result of the pandemic. Since March, our owned e-commerce business has been consistently trending at a triple digit growth level. And for the full-year of 2020, we anticipate that our total digital business, which includes our owned e-commerce 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 and our business, in particular. First of all, the gross margin is higher than the company average, but also keep in mind, there a number of advantages for watches and accessories in e-commerce. First of all, the small cube size, which we mentioned earlier, which causes low freight costs, but also there's fewer SKUs online than in wholesale. So imagine we have 30% at least fewer SKUs and just imagine the inventory efficiency of that. So we have fewer points of sale, fewer – not as many as locations at retail, it's easier to stay in stock, it's much easier to align supply and demand and it's got a much better cash conversion cycle since we get paid immediately. There's also, there's no sizes for accessories and watches like there's in 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 and 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-art 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, 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. It really is a combination of art and science, great product, innovation and storytelling, combined with a digitized data-driven automated platform.

And if I could add a couple of data points as well to further illustrate Kosta's point. As he mentioned, our total e-comm growth includes three channels: our own .com sites, pure play and wholesale. I'll give you a little bit of color on each. For our own direct-to-consumer sites, which delivered 138% of growth year-over-year, is really driven by significant increases in both traffic and conversion. In fact, we had more than a 2x improvement in conversion year-over-year, largely from the benefits of our sales force platform implementation. The first part of that is driven by our algorithm, cross-sell and up-sell effectiveness. That's just feeding better and relevant content in an automated algorithm driven way, as customers are shopping the site. The second is just how well we've mobile optimized the site. So it's easier to browse products. We've designed a much simpler cart and checkout process for customers. Both of these combined have really given us what we believe is a new level of conversion that we're going to be able to sustain and support future growth with. With pure play e-comm, which includes marketplaces like Amazon, Tmall, jd.com and others, growth was only 21% up in the quarter. However, it was heavily weighed down by Amazon in both the US and Europe, which was 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. And normally in the second quarter, we received significant orders in anticipation of Prime Day in July. So, we are expecting significant improvement to the trend in pure play as we go through the back half of the year and are already starting to see that in Q3. And we don't often talk about the wholesale.com, but helping…

Terrific. Thanks Greg and Kosta. Jeff, question for you. What is your expectation for liquidity and cash burn for the remainder of the year? And are there other areas of opportunity beyond the initiatives you've put in place during the first half?

Yeah. Thanks, Christine, good question. Focus a little bit first on Q2. As we look at Q2 and what all meant from a cash standpoint, we do believe that Q2 would be the toughest and most challenging one, really given the extent – the depth and extent of closures – of store closures and those are both our own locations as well as wholesale doors, the closing down of the brick-and-mortar part of our business, which is still fairly substantial, really drastically reduced our cash flow. Going into the quarter, we were pretty conservative on what that cash flow would mean, so we got very aggressive on many other elements. We did forecast the sales would be down between 60% and 70%. So the overall stronger performance we had on sales was a really positive driver for us from a cash management standpoint. But equally importantly, we really managed some of the major cash outflows as well, primarily the receipt of inventory as well as our rent payment structures that we had. And lastly, the organization did a fantastic job in really quickly reduce spending to an absolute minimum. And we're very appreciative to all the hard work and outstanding work that the Fossil teams did around the world to manage through a tough, tough quarter. And we did a good job – a very good job in the second quarter of managing our liquidity and that continues to be the primary focus really with many of the same elements we had in Q2. In the back half of the year, we expect that program to continue. We expect inflows and outflows to actually be fairly balanced, given our sales outlook, how we're managing expenses in the back half of the year as well as our balance sheet management overall. But one caution or caveat I'd have to that balanced cash burn in the back half of the year is it does assume we'll continue to go through a modest improvement in the overall consumer environment. And if there's any major resurgence of the virus, that could change. But right now, we're expecting a fairly balanced inflow and outflow of cash around our balance that we have right now. Thanks.

Great. Thank you. Last question for Greg. What is your view of the connected business, Greg? And when do you expect to see growth in that category?

Yeah. We remain confident in the category, which continues to grow and offer 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 of this business. To that point, not only do we continue to see strong performance in our Gen 5 smartwatches, which launched last fall, but we have substantial innovation and product roadmap that's coming to the market, including frequent software feature upgrades that are keeping the platform relevant and selling well. Later this month, in fact, we will have another major software release that will bring significant new functionality, including upgrades in watch face designs with much more user personalization, health tracking, including sleep tracking, and improved battery life during work outs, battery life management, which includes streamlined user control that allow our customers to optimize battery life around their lifestyle and feature choices. And then also, upgraded Fossil only or Fossil exclusive phone app on the watch, which allows our users to seamlessly answer or make calls on their watch even if paired to an iPhone and much more. We have got initiatives under way this year that position our core smartwatch business to return to growth in 2021. As we discussed at the beginning of the year before COVID crisis, we began implementing a more focused connected strategy built around a core set of brands, SKUs and channels that perform well today. This includes emphasizing direct to consumer and online sales, expanding into consumer electronics and telecom channels, while reducing our connected presence in wholesale. We're also exiting certain brands and SKUs to simplify and focus the business. We've been implementing this plan in the first half, have accelerated it during the crisis and 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 5 that I mentioned that we're launching in August, we've also been hard at work on our first cellular LTE connected watch built on our successful Gen 5 software platform that we'll launch this year and we have several yet to be announced new products that will release later this year and throughout next year. The LTE version of Gen 5 is particularly interesting from a growth perspective and 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 in connected. And we think and 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 to ask some additional questions.

Thank you. Ike, your line is now open.

Hey. Thanks, everyone. Couple of questions from us. So, Jeff, I heard you allude to promotional pressures remaining a little elevated here in Q3. You gave us the revenue outlook, which is really helpful. But any chance you could talk us through the margins – the gross margins and the promotion, the promotional environment you're expecting and just maybe what that revenue decline could mean from an EBIT perspective?

Yeah. It probably won't go all the way to an EBIT perspective for you, but in terms of promotional intensity, we still believe coming out of the COVID crisis (00:29:34) consumers back into spending pattern and a discretionary accessory (00:29:38) category, we will be somewhat promotional. We were really successful this quarter in terms of margin performance overall. We do think that there'll be a little more pressure as we'd be in the back half of the year. We're not giving guidance, but I know you've got to put a model together, Ike. You think about it, probably a couple points below where we're at this year, probably in the high-40s 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 times right now.

Got it, and then on the expense line, the incremental New World Fossil savings. I think you said that those are incremental in next year, it's the same run rate for this year. But also kind of – is that true? And then, curious the other $50 million you added to it, what exactly does that comprise?

It's a combination of organizational savings as well as some spending savings – expenses as well. As we took a look at what's going on through the crisis, we got a bit more aggressive in how we're going to organize the company, and we made some more reductions and adjustments to that. We also did, from a spending standpoint, really focused on our learnings. We went through our New World 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 in 2020, and some additional that will carry into 2021 as well. So, mostly organizational savings with some expense savings as well.

Got it, Jeff, could you may be allude to – in terms of the current trends you're seeing – or your current wholesale outlook, specifically North America, just by channel – I know your e-comm business is doing very well, but especially on the wholesale side, just department stores, the specialty stores. I'm kind of curious where your visibility is kind of the best and where you have the least amount of visibility regarding your North America wholesale business, if you can kind of talk about it?

I may have Greg jump in. He's very close on the commercial side to that. So, Greg, you want to talk about what you're seeing?

Yeah. I think the way to think about is 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 inventories. So we may have the ability to drive a business there, but we just don't know how consumers are going to respond, how the next – the current wave that's happening with COVID is going to impact the business. So, we're being conservative in our approach and just closely partnering 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.com is incredibly healthy and driving our wholesale business with substantial mix within our wholesale business in ways it has not before. And we're partnering with them on helping drive that digital growth and sharing marketing tactics 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 you aren't giving guidance, so I mean I'll take my shot. I mean, 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'll probably say just to help you model a little bit, even though we're not giving guidance. I know it's always a tough thing like when you're in this situation. So in the second quarter, we were down, I'd call it, roughly 50%, it was 48%, but roughly 50%. You're seeing from our guidance, we've given a range of between 35% and 45% being down, the midpoint is 40. So you see then improvement of about 10 full percentage points on that. I'd actually, if I were you, I'd have used a similar extension of that going into Q4 that it'd be another 10% increase, an improvement in contraction. So that'll give you some sense that we should go from a 50% to a 40% to something, somewhat further improvement in fourth quarter. From a margin standpoint, yeah, the fourth quarter last year had a fair amount of liquidation of connected product. We'll be through a great deal of that this year. So the margin should be much more in that. I think we were probably mid-ish 40s last year, 45%, 46% maybe was what our fourth quarter was last year, which should be much more in the high 40s, just for your modeling purposes. So not quite as strong as this quarter, which had some favorabilities in it, as I mentioned, but still some competitive pressures. So that'll help you get the top line maybe and the margin structure about right just from a – just a general sense of where our heads are at on that.

Yeah, really helpful. Thanks guys so much. Appreciate it.

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

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