Fossil Group, Inc. Q1 FY2024 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to the Fossil Group First Quarter 2024 Earnings Call. This 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 Greany of The Blueshirt Group to begin.

Hello, everyone, and thank you for joining us. With us today on the call Jeff Boyer, Interim CEO; and Sunil Doshi, Chief Financial 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, 10-Q and 10-K 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. During today's call, we will refer to constant currency results. Please note that you can find a reconciliation of actual results to constant currency results 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. Now I'll turn the call over to Jeff to begin.

Good afternoon, everyone, and thank you for being here. As we announced earlier today, our first quarter net sales and operating margin met our expectations. Despite facing tough top line trends, our efforts to enhance gross margins and reduce costs allowed us to decrease our operating loss and improve our free cash flow compared to last year. The benefits from our Transform & Grow Plan are central to our enhanced gross margin and cost reductions, involving a wide-ranging program initiated in 2023. We began to see financial benefits last year, which are expected to significantly increase in 2024 and carry into 2025. About half of the initiatives within our Transform & Grow program are aimed at structurally improving our gross margins. Our first quarter gross margin increased by 300 basis points from last year, attributable to exiting the smartwatch category, better product margins in our core categories, and reduced freight costs. Our initiatives in product sourcing and supply chain are projected to yield benefits in late 2024, contributing to year-over-year improvements in gross margin. Importantly, our Transform & Grow efforts are keeping us on track to achieve historical gross margin levels in the mid-50s over the coming two years. The remainder of our initiatives is focused on reducing costs within our expense structure to enhance operational efficiency and lower fixed costs; cutting expenses in procurement; and optimizing costs in our direct channels. Our operating expenses for Q1 dropped by 20% compared to last year, thanks to savings in headcount, labor, and services initiated in 2023. We expect our initiatives to continue driving year-over-year declines in operating expenses throughout the rest of 2024. Despite the improvements we've made across our Transform & Grow initiatives, our sales are still under pressure, and we are making urgent efforts to stabilize the trend. Generally, we observe three major themes in our revenue that we expect will persist throughout 2024. Firstly, about half of our revenue is starting to stabilize. Performance in certain segments such as traditional Fossil watches and jewelry globally showed flat results compared to last year in Q1. Our value brands, sold through general merchandisers and off-price retailers, along with our premium products sold in specialty channels, are also showing stable performance. From a broader perspective, consumers are generally leaning towards value. Wholesale customers are increasingly favoring value products as sell-out remains reasonable in this price segment. Meanwhile, both sell-in and sell-out of higher-priced products have also remained resilient. The Indian market, where we've invested significantly over the years, continues to grow due to our marketing and brand-building efforts across Fossil and Armani Exchange. Lastly, we've seen improvements in our traditional Fossil watch segment thanks to our digital strategies, broad distribution, and investments in marketing and product development. Over the past several quarters, traditional Fossil watches, one of our largest categories, have demonstrated stability. The second theme addressing the challenges I mentioned earlier relates to ongoing issues in two areas of our business: our licensed fashion watch brands and our leathers category. Together, these two segments represent over 40% of our revenue and declined by about 30% in Q1. Recent industry data indicates that the fashion watch segment has contracted in the mid-price range within the wholesale channel in both the U.S. and Europe. Moreover, this segment continues to face high double-digit declines as economic factors are affecting consumer demand. We expect these challenges to persist into 2024, which we have considered in our revenue forecast. Looking ahead, we anticipate this segment of the traditional watch business will stabilize and recover through the repositioning efforts of our major licensed brands. Lastly, as highlighted earlier, we have been closing underperforming retail stores and exited the smartwatch category. Although these decisions may hinder sales in 2024, they are beneficial for our operating income. In our year-end earnings call back in March, we identified four immediate priorities essential to our turnaround, including advancing our Transform & Grow plan, strengthening our balance sheet, stabilizing our operations, and conducting a strategic review. Let me provide updates on each of these priorities. Our top priority is effectively executing our Transform & Grow Plan, which is a far-reaching restructuring program that encompasses almost all aspects of our operations. The organization has been diligently working on seven initiatives, and we are seeing significant results reflected in our financial performance in 2024. We are on track to achieve $100 million of annual benefits in 2024, in addition to the $125 million we realized last year. The primary source of improvement in gross margins is expected to come from our product sourcing and supply chain starting in the latter half of the year. Additionally, we have begun to see benefits from rationalizing our SKUs and implementing pricing and promotional strategies. Steps taken to streamline our organization in 2023 led to a notable decline in operating expenses in Q1 and will continue to positively impact SG&A throughout 2024. We made considerable workforce reductions in 2023, driving benefits into our financials this year. The commitment and resilience of our teams throughout these changes have been commendable and highly valued. Within our Transform & Grow plan, we are also addressing service provider costs through numerous requests for proposals and are striving to achieve cost reductions through efficiency improvements in our labor models across stores and concessions. We have achieved a lot under our current Transform & Grow program, and we are actively seeking additional operating efficiencies to pursue further opportunities across various channels, categories, and regions. Moving on to our second priority, we are making strides in strengthening the balance sheet and enhancing our liquidity. In the first quarter, we had minimal cash usage and, as anticipated, received a $57 million U.S. tax refund in mid-April from provisions in the CARES Act, providing us with important additional cash to implement our plans for 2024. We are also pursuing opportunities to monetize our assets, including real estate sales in Europe, which could yield $10 million to $15 million in net cash by year-end. With these initiatives and continued careful management of working capital, we expect to be free cash flow positive in fiscal 2024. Next, we are taking decisive actions to stabilize our business. We will keep redirecting resources and capital towards the more stable segments of our business that show potential for growth. This includes investing in traditional Fossil watches, jewelry, value brands, and premium-priced products. We are also collaborating closely with our licensors to manage the contraction in our fashion brands amid declines in these price segments, brand transitions, and challenging macroeconomic conditions, especially in large markets like China. We are handling these brand contractions by safeguarding the pricing and margin structure of our categories for the long-term sustainability of our business. Although we are observing some positive developments from new product launches, merchandising initiatives, and growth in emerging markets, they are not yet substantial enough to counterbalance the larger brand and category challenges in our primary markets. Finally, while our strategic moves may create headwinds for our top line, we will continue optimizing our store footprint and aim to be almost fully divested from the smartwatch business by the end of Q2. Lastly, we are working with our advisors on a strategic review of the business, examining our business model and thoroughly assessing our capital structure and allocation strategies. We are working with urgency to focus on these priorities. In the first quarter, we appointed two independent board members, which, together with recent leadership changes, brings new oversight and fresh perspectives. These individuals bring considerable value to our organization with their extensive experience in retail, consumer operations, turnarounds, and finance. We look forward to their contributions as we urgently work to stabilize the business and explore ways to maximize shareholder value. We are incredibly grateful for the dedication of our teams and the support of our shareholders during this transformative period for Fossil. We look forward to keeping you informed about our progress and enhancing value for all our stakeholders.

Thanks, Jeff. First quarter net sales totaled $255 million, down 21% in constant currency. With better gross margins and lower SG&A, both driven by our TAG program, we narrowed our adjusted operating loss by $6 million to $19 million. First quarter cash flow from operations was slightly positive, a significant improvement versus last year when we used $86 million. The improvement in cash flow was primarily due to closely managed working capital, timing of payments in the current year and lapping heavier than normal seasonal working capital needs last year. We ended the quarter with $113 million in cash and $123 million in liquidity. Diving deeper into our Q1 trends. As Jeff noted, there are 3 underlying themes that we have seen playing out across our business for several quarters now, which continued into Q1. First, about 5 points of our 21-point revenue decline in the first quarter was attributable to the year-over-year decline from closed stores and the exit of our smartwatch business. The revenue impact was roughly 4 to 6 points in each of our regions. As a reminder, the stores we are closing are at lease expiration and in aggregate, did not have a material contribution in terms of 4-wall profitability. And since announcing our exit from the smartwatch category, we've more aggressively worked to move through our remaining inventory. Second, we are seeing signs of stabilization in about half of our Q1 revenue base. Across this portion of our revenue base, net sales in the quarter were down 1%. Global net sales in fossil brands, traditional watch and jewelry categories were negative 4% on a comparable basis. This reflects comp growth in the direct channels in India and our Asia region offset by declines in the indirect channels in the Americas and Europe. Growth in India remains robust for traditional watches, where we achieved double-digit growth in the strategic market anchored by strong sellout trends and expanded distribution. In our value-priced brands and more premium priced brands were about flat to last year. However, as Jeff noted, we've experienced persistent challenges in our licensed fashion brands and leathers category that carried into the first quarter of this year. Sales across this portion of our revenue base was down approximately 30% in Q1 and reflects both challenging operating conditions in China and distribution and category headwinds in traditional wholesale channels, particularly in the Americas and in Europe. Turning to gross margins. Q1 gross margins were up 300 basis points versus last year, primarily driven by benefits from our TAG plan. Gross margin improvement versus last year can be traced to 2 factors. First, the prior year results included a onetime 170 basis point drag from a TAG-driven restructuring charge in our cost of goods related to liabilities from certain product categories. Second, the balance of the gross margin improvement or 130 basis points came from product margin improvement in our core categories, where initiatives from SKU rationalization, assortment architecture and reduced promotions in our direct-to-consumer channels drove better results. Lower freight costs also contributed to the year-over-year gross margin improvement. SG&A expenses in the first quarter were down approximately $39 million year-over-year or 20%. Productions were primarily attributable to lower store operating costs on fewer stores as well as lower compensation and administrative costs resulting from our TAG initiatives. We ended the quarter with 277 company-owned retail stores, down 15% from the prior year. Turning now to our outlook. Our first quarter results for sales and adjusted operating margin were in line with our expectations, and our full year forecast remains unchanged from our prior guidance of approximately $1.2 billion in sales an adjusted operating margin loss of 3% to 5%. Our net sales guidance of approximately $1.2 billion assumes approximately $100 million of negative impact from our store and concession closure plans and the lapping of last year's smartwatch sales. As we noted on our last earnings call, we expected Q1 to be the softest sales quarter of the year. Benefits from our TAG plan continue to be a key driver of our 2024 gross margins and SG&A forecasts. We expect to achieve over $100 million of P&L benefits in 2024, stemming from annualized savings achieved in 2023 and expected to be achieved in 2024 under the TAG plan. These benefits are expected to materialize in both gross margin and SG&A. Within gross margin, our TAG initiatives are expected to contribute to gross margin expansion, particularly in the second half of the year. The improvement is primarily expected to be driven by initiatives within our product sourcing strategy, coupled with ongoing initiatives around assortment architecture and SKU rationalization as well as product mix benefits resulting from minimal smartwatch sales in 2024. Looking at the balance of the year, we anticipate that SG&A dollars will be down in the low to mid-teens on a year-over-year basis for the remaining quarters of 2024 as we begin to recognize the annualized benefit of our TAG plan. Restructuring costs for fiscal year 2024 are estimated at $35 million. We are also laser-focused on strengthening our balance sheet. We ended the first quarter with $113 million in cash and $10 million available under our revolver. And we have a solid roadmap for generating free cash flow for full year 2024, a significant improvement versus last year's use of cash of approximately $70 million. Note that our expectation to be free cash flow positive this year includes the onetime benefit of the $57 million tax refund. It's also important to note that the seasonal nature of our business and projected sales declines will require operating cash used in Q2 and Q3. In the near term, with limited availability on our ABL facility, and as cash flows turned positive in the fourth quarter, we believe it is prudent to preserve our financial flexibility until the business strengthens. At the same time, as part of our current strategic review process, we are taking a holistic review of our capital structure, along with our strategic and operational plans in order to aggressively improve the longer-term capital structure of the company. We will share more detail on future calls as our plans and programs are developed. We appreciate the support of our shareholders and look forward to keeping you updated on our progress in future quarters.

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.