Hello, and welcome to the Fourth Quarter 2017 Fossil Group Incorporated Earnings Teleconference. My name is Michele, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Allison Malkin. Ma'am, you may begin.

Thank you. Good afternoon, everyone. Thank you for joining us, and welcome to Fossil Group's fourth quarter and full year 2017 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 projected 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.

Thanks, Allison. Good afternoon, everyone, we appreciate you joining us today. I will begin with a view prepared remarks before returning the call over to Jeff Boyer, our CFO. Following Jeff's comments, we'll have Greg McKelvey, our Chief Strategy and Digital Officer, join us for the Q&A. As we entered 2017, we embarked on making significant changes in the company to improve our business model by focusing on four key operational objectives; to advance our connected tech agenda, to leverage scale to drive cost out of our supply chain, to become more digitally enabled, and to continue the transformation of our business through New World Fossil. Although it had has been a challenging year, we have accomplished many of the goals we set out for ourselves. Our connected products nearly doubled in size reaching over $300 million in just two years. Our product cost on connected products were down nearly 20% from last year. Operationally, we have reduced our overhead expenses by $95 million versus last year. And on the digital front, we made significant progress on increasing our digital marketing investments and drove strong e-commerce growth. Lastly, we completed our credit facility refinancing to provide an appropriate near-term capital structure for our business. Within a tough environment and while executing a number of strategic initiatives, we are pleased to deliver our fourth quarter operational results with sales and earnings near the top of our expectations for the quarter. These numbers reflect the focus and outstanding education of our team as we transition our business, bringing innovative new products to the market and drive operational efficiencies that can ultimately enhance our profitability. The most important business in our company is our traditional watch business. Although this business remains difficult due to the dramatic growth of wearables in the overall risk…

Thanks, Kosta. Before I cover our financial performance for the quarter, I'd like to build on a number of Kosta's comments. Overall, 2017 was a challenging year, more challenging than we originally expected. The midprice fashion watch business and our strongest channel, wholesale, was under significant pressure from the smartwatch segment. We have put a strong foundation in place to start improving our profitability in 2018. We have a sizeable presence in fashion focused variable products, both display and hybrid. We are quickly improving the margin profile of this business. We are aggressively building out our digital capabilities to reach consumers in new ways and sell our product in a growing number of online channels. We recognize that we must make our business model more profitable and we are executing well against our New World Fossil initiative, improving our product economics and reducing expenses. That we're executing on many positive fronts across the enterprise, we are on a segment of retailers going through significant structural change in both, product and channel. However, our long-term goals remain the same, to return to a profitable high-return business. Now turning to our financial results; reported net sales for the fourth quarter decreased to 4% to $921 million, while fourth quarter constant currency net sales decreased 7%. Overall, sales were in line with expectations, driven by modest improvements in our direct channel while our wholesale business continue to contract in the low double-digits. Store closures negatively impacted total direct channel sales by roughly 450 basis points. Excluding store closures, our direct channel posted mid-single digit gains with positive store comps and solid increases in our online business driven by growth in connected sales. Our connected watch business, which represented almost 20% of total watch sales continue to contribute significantly to the overall top line…

[Operator Instructions] And the first question comes from Ed Yruma from KeyBanc Capital Markets.

I know there are lots of puts and takes around the release of wearables last year, there were the liquidation. How should we think about the shipments for wearables this year and your ability to kind of have a longer product life cycle that maybe you have last year, given some of the early schedules?

One thing I would say is, we -- through last year, through last couple of years, we learned obviously a lot about the cadence in delivery and launching on these wearables. We also learned, for example, that a huge part of that sales are in December so it's quite a different profile in terms of timing. So through last year, as you know, we were moving as aggressively as we possibly could, we wanted to get critical mass quickly so we can get awareness out there and also get our costing down, we did that; we didn't have our timing right on the styles and the way we launched in the cadence was not correct. So having gone through all that, we've taken a reserve on the inventory. We're now in possession, we are -- made a huge amount of progress on variables, we've learned a lot and we're in a position now to be more opportunistic and more balanced about how we approach it. We do not expect to have inventory issues again this year. The one thing I would add is just -- we were surprised quite a lot, and I would say, the number one thing we're surprised about is the size of the wearables market. The watch business is about $65 billion globally, our part of it that we participate is about half of that, Swiss is about half; so say, $32 billion addressable market. Last year, in wearables, it was $17 billion market and it's expected to go to $32 billion in 2020. So we are surprised that it's that large and the reason is, it's largely female; we see that in our own business, or in both Fossil and in Kors. Our analytics show clearly, largely, female aspirational customer fashion and anecdotally what we…

I'd just add one other key message, which is we spent at the last two years -- often the acquisition of misfit, building out the wearables business model. We're not launching products, we've installed the business model; that business model is in place, proven and is scaling and driving meaningful growth in the business. So we are -- we now have the flywheel going and we're going to prudently plan the business but we expect this to be a long-term growth driver and just really, we're congratulating the teams across the world that have made that happen.

The next question in the queue comes from Omar Saad from Evercore ISR.

I wanted to just ask a couple more questions on the wearables front. Could you guys talk a little bit, just a little bit more detail on the inventory reserves and where you are with that or why you're comfortable that you're done with that process? Also maybe a little bit more learning's in the categories, '17, 2017 versus '16, especially with the inventory reserve situation? And then I thought it was interesting that you mentioned the wholesale versus retail, if you're seeing a pretty different dynamic or maybe you can expand upon that and maybe what the read-through is for the strategy going forward?

This is Jeff. Omar, I'll answer the inventory reserve question and we kick it over to Greg and some of the learning's. From inventory reserve question, we did get an excess inventory position, but we have been very conservative and looking at our sell-through estimate going into FY '18. We've got good experience in the fourth quarter in moving through some products. We've got a pretty could handle at what price we did sell product through. The quantities we own, obviously, we know the generation we got a sell through. So we got a pretty solid plan to sell-through the product. I would tell you at the appropriate profitability, we could really liquidate quickly, but that's not the best way to do it so we're going to liquidate the products through the next 3 quarters. Be essentially out of it by the time we get into the fourth quarter as new products hit, but we feel very good taste on a history of what we sold at price points in the fourth quarter this year.

I just add, as you mentioned, the business models in place and that I mean, it's large, we scaled across 14 brands, we're delivering consistently on time, high-quality product with dramatically lower costs and sustainable margins are now getting nearer and the teams are over delivering. But as we look to next year, what's happening is that the product and consumer trends are now becoming very clear. We launched the Fossil this products that has fitness and health at the very end of the year. Last year, those immediately became bestsellers. We also saw tremendous response from customers on our marketing that the future Google Assistant. So the product turns of health, fitness and wellness and then voice search and voice integration experiences in to these products, are what's going to drive these categories over the next several years. So our teams tend to position ourselves in our new product innovations to deliver this across a variety of brands and product formats. And then the second is dimension. That female fashion customer, we are seeing the adoption that we need to know that this is -- that we are not only well positioned in the category, but with our core customer, and that's critical because that's where our design and branding and our distribution sets us apart.

And then the wholesale versus retail dynamic? Would you mind just addressing that, I thought that was interesting.

Yes. What we found and we mentioned this before which is as you'd expect, these product are new and there is some training that goes with it. So they're actually selling better on our own environment. So on our own website and in our own stores, they're setting better. Especially you can expect better than our typical wholesale. The other thing I would add though is that we have seen increasing knowledge and awareness and adoption on this [indiscernible]; so there's less and less training at the point of sale now. In fact, we're seeing something like 50% of the sales on wearables globally was done on e-commerce, both our e-commerce sites as well as our partners. So it's clearly becoming more understood. One other thing I would mention on the hybrid issue is we -- hybrids are actually doing very well in increasing in our stories. And when we communicate it well, it's doing very well. I think the immediate adoption of this place smartwatches, I think, is really taken some of the options out of the hybrid market, but is doing very well, it's got a lot of fans, we're going to expand it. We think long term, that's a very significant business and it will have a large impact on the overall watch business so we're continuing to do that. And as more and more awareness gets out about these products both at wholesale and at retail, we think the wearables are going to grow.

The next question comes from Simeon Siegel from Nomura.

Can you talk about what categories and I guess, the amount of storage you are planning to exit maybe what are their sales loss and expense savings you'd expect from that? And then sorry if I missed it, but just to elaborate on the product reserves, just to be clarified, sorry, are you taking reserves on product you're expecting to clear later on or is this product at that you've already cleared through this quarter?

On the reserve, that's product that we will be clearing through, it's effectively lower cost for market reserve that we paid. So we can identify what we're going to sell this product through to our wholesalers, to our retail channel and recognize what that loss is so it's future looking reserve for the economics that we're going to lose on it let's say, requirements you have from an accounting standpoint, so that's going into the future. In terms of the sales loss from store closures, we have about 60 stores or so that we're going to close this year, and it's about $1 million -- it's about $60 million of sales loss from that. When combined with the licensing terminations that we have as well as some smaller businesses that we are exiting that weren't profitable, we it's about 550 basis points of sales hit that we have headwinds that they have entered. From a profitability on the store side, these stores aren't profitable, it's about $10 million of net profitability were underwater on those stores. So we're going to be more profitable by about $10 million for those closed doors.

The next question in the queue comes from Dana Telsey from Telsey Advisory Group.

On the product you're taking reserves for, how are you get rid of that product? Any way different than you've than in the past, what are you seeing there? And then also if you think of a smaller yet more profitable company, what do you think of as a baseline revenue, base line margins for this business?

On the wearables product that we're liquidating, we have quite a lot of demand, both in our own outlets stores, which are the number of watch stations towards around the world, in addition to that other third-party liquidation companies so there's a significant demand out there that we've planned this out of the next several months, and we don't see it being a problem.

On the second question, Dana, regarding the size of the business and the margin structure. I mean, really, FY '18 is probably the major step down we had an overall sales. We've moved from a couple of years ago being north of $3 billion, you can see that range is about $2.5 billion, this is the range for next year sales. My comments are a little bit of stabilization in '19, so there could still be a bit of a drag in '19, it could be a little bit smarter, but we really think and we're hitting a little bit of inflection points as connected business starts to grow, as the traditional business starts to stabilize, somewhat. On the margin side of it, we do think from New World Fossil initiatives, we have a lot of tailwinds in that initiative in order to going back into that again into a second phase. We think there's a couple of years' worth of a couple of hundred basis points. So if you look where we're at right now, at roughly at the range we gave you at 200 basis points of operating income, hit another couple of hundred points the next few years, you can easily get to about a 600 basis points, 6% operating margin as a company. And at some point in time, those restructuring charge will start to mitigate as well. So you can get to high single digit margin structure at rough numbers of $2.4 billion to $2.6 billion in sales, small profitable and kind of grow from there. So there's a good potential here for penetration and driving the business pretty well.

The next question in the queue comes from Anna Andreeva from Oppenheimer.

Two quick questions from us. Question on the wearables. I guess, can you elaborate what drove the 4Q '17 sales mix versus what you guys laid out in November? And then secondly, on gross margins, how much of the 400 basis points of expansion is the New World Fossil? And did you say how much benefit we should expect from that in '19?

On the sales, we didn't miss sales in Q4. So I'm a little confused about that question. I think we actually came in about what we thought equity came it is a bit better. Where we missed sales was earlier in the year forecasting, way back in Q1, coming out of '17 -- no, '16, goodness, '17, with expectations that in general, be much bigger business. So that's probably where that reference is coming from. And so it was a call we had to make over a year ago on the size of the business, [indiscernible] leaves early and late in 2016 and it had some high sales expectations that proved to be a little bit too ambitious. In terms of the margin performance, 400 basis points of margin performance improvement, and you were referencing, which line item on the P&L again, Anna, on that?

On the gross margin line, the 400 basis points of improvement for the year?

Yes. probably, I think we said 200 to 400, that's about 300, overall. And it's really a combination of a number of drivers on that. The absence of those inventory reserves gets you about 150 basis points on it. Our New World Fossil initiative gets you about 150 basis points as well. So you're about that 300 basis points right there between the 200 and 400; could be some currency favorability that helps as well, if we get some continued facility [ph], be offset a little bit with the typical mix pressure we get because connected to the larger -- I'm sorry, as a lower margin business than the traditional business. So it's those -- the biggest drivers are the absence of the inventory reserve and the New World Fossil initiative to drive about 300 basis points. Then some offices for between mix and connected and currency.

The last question in the queue comes from Ike from Wells Fargo.

It's Tom for Ike, actually. I just wanted to have a clarification about the operating expense guidance. For the year, I think you said about $50 million of restructuring cost, and if you strip that out, I mean, I'm getting SG&A dollars down, let's call it down 10%, plus or minus a couple of percentage points. I mean, I just want to make sure I'm thinking about that correctly. And that seems like a pretty aggressive cost cut. And I know you mentioned wire store closures in the year before, I guess, just how do we think about what costs you're taking out of the business and how that could potentially impact your ability to sort of reinvigorate the top line?

No. A lot of the cost reduction, expense reductions, are in fact, we called them structural around things that we're doing. Store closures is almost [ph] plus $40 million, $50 million of OpEx coming up from store closures. Our New World Fossil initiative is close to $60 million of savings on it. We do get some variable benefit from the sales decline. Our marketing expense closed down because we are not paying royalties and have marketing expenses on that, and that's usually another $20 million. So your math is right but a lot of it is initiatives we have in place for the New World Fossil, store closures and just the variable sales declines that we have. Operator, we're going to be taking some additional calls after this conference call so we'd like to close the call after this point in time and thank everybody very much for joining us. We look forward to speaking with everybody when we report the Q1 results later on this year. So, operator, please close the call.

Thank you, sir. We will now end the conference. Thank you for participating, and you may now disconnect.