Welcome to the Q2 2018 Fossil Group 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. 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 second quarter 2018 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.

Thank you, Allison. Good afternoon, everyone, and thanks for joining us this afternoon. I will begin with a few prepared remarks before turning 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 Q&A. All my comments will be in constant currency. In the second quarter, the business performed better than our expectations, surpassing the high-end of our guidance on sales, gross margin, and operating expenses. In addition, we continue to make solid progress on several key goals as we reduced inventory and improved both working capital and cash generation. As you may recall from our calls earlier this year, our posture for fiscal 2018 was to plan prudently but operate aggressively. This approach continues to drive better-than-expected results despite the ongoing disruption in our categories and our distribution channels. As we look ahead, we will continue to plan carefully but take every opportunity to aggressively pursue accretive sales opportunities as we focus on becoming a more profitable company. In the second quarter, we had stronger sales performance versus our expectations on a number of dimensions. Across regions, the Americas and Asia solidly exceeded our sales plans. Asia grew 5% behind strong double-digit growth in both China and India. The rate of decline in our Americas region slowed to minus 3% and a solid improvement from the declines we experienced for most of last year. Smartwatches grew 91%, driving growth across our entire brand portfolio and across all three of our regions. With this continued growth, smartwatches represent about 25% of our total watch sales, up from about 10% in the second quarter of last year. Our direct e-Commerce business continued to build nicely with sales up 25% in the second quarter versus Q2 last year.…

Thanks, Kosta, and good afternoon, everyone. Now turning to our financial results, our reported net sales for the second quarter decreased 3% to $577 million, while second quarter constant currency net sales decreased 6%. Overall, sales exceeded expectations driven by stronger performance in the Americas and Asia, partially offset by softness in Europe. Our wholesale business, while continuing to contract, improved to a moderate single-digit decline in the Americas as compared to a double-digit decline in the first quarter, as better inventory management resulted in reduced wholesale markdowns and returns and U.S. retailers tempered recent supply reductions during the quarter. Store closures negatively impacted total direct channel year-over-year sales comparisons by roughly 500 basis points. We have closed 69 stores since the second quarter of last year and ended the quarter with 497 stores. Excluding store closures, our direct channel posted a 4% gain with flat retail comps and solid increases in our online business driven by growth in connected sales, despite a 200 basis point negative impact due to Easter shifting to Q1 this year. Flat retail comps were driven by positive comps in watches, offset by negative comps in jewelry and leathers. Our reported loss of $0.16 per share included New World Fossil restructuring charges of $0.23 and non-cash intangible asset impairment charges of $0.10 per diluted share. Last year, our second quarter EPS was a loss of $7.11 and included non-cash intangible asset impairment charges of $6.50 and a restructuring charge of $0.13 per diluted share. Excluding these items, our adjusted EPS was $0.17 this year as compared to a loss of $0.48 last year. Currencies, both the translation impact on operating earnings and the impact of foreign currency hedging contracts, favorably impacted our EPS comparison in the second quarter by $0.13. Our watch business declined 4%…

Thank you. We'll now begin the question-and-answer session. And our first question comes from Edward Yruma from KeyBanc. Please go ahead.

Hey, guys. Thanks very much for taking my question today. I guess first on some positive commentary on destocking or maybe a little bit of a slowdown in destocking in the U.S. wholesale channel. I guess, are retailers finally just hitting equilibrium with inventory levels or are they taking maybe a more offensive position and starting to build inventory in some of the wearables and maybe some of the new fashion watches? So any insight there would be helpful. And then second, I know a lot of moving parts to the FX. The adjustment at the high-end of the EBITDA guide for the year, was that solely related to FX? Or were there other pieces moving as well? Thank you.

On the destocking issue, in the United States, I would say, our stores' wholesale partners are prepared for the holiday season in a prudent manner. I think our inventories are in line with the sales trends. We do have a lot of new products hitting in the next couple of months, not just our new wearables but also there's a lot of new initiatives on the traditional watch side. There's a lot of new things, new ideas, new materials. We've identified a couple of new trends, so those are going in place. But I would say on balance, the inventories are in line with the trend. Where we have seen some destocking is Europe. It's in a very difficult situation; a lot of disruption there. Business has been tough, traffic has been off, and we've seen that our retail partners over there, a lot of them are smaller retailers, as you know, have been very conservative on the inventory, so there is some destocking going on there. But in the United States, I think we're in a pretty good position.

Excuse me, Ed. This is Jeff. On the guidance range on the adjustment that we made, you've got to think about it this way that we flowed through Q2 favorability pretty much intact on that. We also flowed through some additional sales benefit as well that we had in the second half we're forecasting, but the biggest impact has been currency. The currency did impact the top-line a couple hundred basis points and does flow through, so that does impact the bottom-line on a reported basis because the currency impact on it. We also narrowed the range a little bit as we got further through the year and looked at the ranges we had. We also narrowed it. From a sales standpoint, that narrowing actually increased the net midpoint overall but because the net flow-through on the profitability, our reported numbers were slightly different because of the currency impact. So, I hope that helps.

Great. Thanks so much, guys.

Thanks, Ed.

Thank you.

And our next question comes from Simeon Siegel from Nomura. Please go ahead.

Thanks. Good afternoon, guys. I think you mentioned overall growth in 2020. Could you speak to the timeline you expect for that growth in watches Americas and Michael Kors? And then I don't know if you said, how are watch units and pricing within that constant currency decline this quarter? Thank you.

Well, let's go to the first question and we'll come back to the second question. I was getting hung up on you because you were asking about watch revenue returning in 2020. As we look at the long-range plans out here, we can see some stabilization in the traditional level as we get through 2019. Really see continued growth in the direct channel as well as the connected business, but what happens is both of those businesses get large enough, our direct channel as well as our connected business, that that growth starts to overcome any weakness we have in traditional. So that's the basic math we're seeing on that. I'm going to have to ask you to ask the second question again on your pricing question that you had. You had a number of pieces in that, so if you can ask that second question that would be great.

Sure. So, the second one was just how is ASP versus – how are units versus pricing within this quarter's constant currency decline? And then, I guess, the other part was just thinking through when Michael Kors turns to – you'd expect that to inflect.

So I would say, over the last several quarters, if you look at traditional watches, the average unit retail has come down slightly. So, I think that's a global situation, probably not so much in Asia, but especially in Europe and the U.S. We are seeing, obviously, if you look at the whole mix, because wearables is a much higher retail, I would say, probably as a company, our average unit retail hold steady. I would say that might be the case. We do have – we have been improving our business with Kors largely through the increase in wearables and we have a lot of new things going in that market, too. We are expecting, at some point, traditional watches to level off. Don't have a lot of visibility when it's happening, but you've seen a lot of more interest in the watch business on the upper end in Swiss, et cetera. So there is some indication that there is a lot of interest in watches that hadn't been there the last couple years, so the combination of being in a position to grow our wearables business as the traditional watch business levels off, I think is a good thing. And we're pushing that as fast as we can.

Great. Thank you. And then, if I can, just one other one since it's topical. Obviously, still a lot of moving pieces, but any color you can share on what you'd expect from any potential tariff impacts?

Yeah, at this point, Simeon, it's uncertain as to exactly what the impacts are going to be. The final form hasn't been decided yet. It would affect just two parts of our business, the leathers part and the smartwatches. So the largest part of our business, traditional watches, is not impacted by the proposed tariffs. We're working hard with legislators and with lobbyists to influence the position on that. Hopefully, it's just a threat at this point, but we are anticipating there could be some impact. And with that we're working hard on all the levers we can pull from manufacturing, sourcing across our supply chain, both in locations, working with our partners on it, as well as what we can do with our wholesale partners, as well as if we need to pricing on it. So we've got many different levers we're pulling on. At this point again, it's a bit too soon to say exactly with precision how much that might impact us. We'll have a better idea in the back half of the year. Important to recognize that from a buying cycle for us, largely we're locked through most of the end of the year and there will be very little impact of inventory running through with higher tariffs. This will really be an FY 2019 issue, so we've got some time to address our purchase cycles, our sourcing, our manufacturing, and our supply chain and pricing. More to come on that.

Understood. All right. Thanks a lot. Best of luck for the rest of the year.

Thanks.

Our next question comes from Ike Boruchow from Wells Fargo. Please go ahead.

Hi. Good afternoon, everyone. Jeff, I'm sorry if I missed this. Could you update us on your wearable growth plan that's embedded in your guidance? I think in the last call you had said mid-20% growth. Is there an update you can give us?

Yeah, yeah, as you can appreciate, we had some strong growth in the second quarter on it, and we have taken that guidance up. We haven't explicitly called it out, so it's a good question, Ike. It was – 20% to 30% was our previous guidance, roughly 25% was a good midpoint. Now we're ranging really in the 30s, into the high-30s, pushing close to 40%. So think about 30% to 40% growth for the full year. A lot of that hasn't been achieved in the back half. We did mention in our comments some moderation on it. So we don't know, we'll be at that – in the first half of the year, we were at 80%, 90% growth rate overall. So you'll see some moderation in the second half. Still good solid growth on a very healthy base. So we really love the way the connected product is performing. But we have a big hill to climb covering next – the second half growth that we had last year. But the full year will be 30% to 40% growth on that. So well over $400 million for us in the connected business.

And I mean – I guess I don't mean to nitpick, I mean, is there a level of conservatism that's built into that? Because I mean that would imply I think net negative wearable revenue in the back half. So I'm just trying to understand if there is some...

Yeah, it doesn't imply negative. It's still growth. It's still strong double-digit growth in there. I will tell you the challenge we have is, obviously, we had great response to our Gen 3 product last year. And we're introducing the Gen 4 product that's just hitting right now on it. We love the product, we love the features, heart rate, GPS, near field communication, swim-proof, all the features it has. And so we're just trying to be appropriately cautious until we cycle through kind of what the response is going to be. Again, more we'll know after we get through the third quarter on it. But we still have double-digit growth in the back half of the year on smartwatches.

Got it. Thanks, Jeff.

Thanks, Ike.

And our next question comes from Omar Saad from Evercore. Please go ahead.

Hi. Good evening, guys. This is Warren Cheng on the line for Omar. I just wanted to clarify. The Gen 4 versus the Gen 3, I think if I remember correctly, heart rate and NFC payment capabilities, those are both new for Gen 4, right? And also just what other differences in either functionality or form factor can we see from the Gen 4 versus the Gen 3?

Yeah, thanks. This is Greg. You mentioned payments for sure and then the broad fitness features, so we have heart rate and GPS, untethered GPS integrated as well. Additional features that the teams have worked hard to engineer is swim-proof and then a rapid charge capability. So pretty rich feature improvement versus prior year. In addition, it's also thinner, so the teams have done a nice job continuing to improve the fashion elements, and we have many more brands and a lot of material innovation as well. So broadly, the offering this year is particularly strong. And while – I'd add one other thing, in addition to adding features, we've been able to engineer costs down as well. So we're getting much better product at lower product cost at the same time. So really, really proud of our teams and what they've accomplished this year.

Okay. And then just a follow up I had to that was how does the ASP compare year-over-year if I were to compare as like-for-like as possible? How would the ASP compare?

Yeah, comparable. So this has been the strategy all along. Last year, we priced it appropriate before we thought consumer willingness to pay was based on our insights and analytics. We drove volume to get down the cost curve, and that's played out pretty much as expected. So we've held price and brought product costs down to expand margins.

Great. Thank you.

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

Good afternoon, everyone. As you think about Puma and BMW coming into the mix, how does the volume and how you planning that relative to the exit of adidas and Burberry and how do you see that progressing? And then also on the wholesale business, Europe, the Americas, Asia, I think last time there were some headwinds on European wholesale. What are you seeing now? And how are you seeing order trends in the different regions? Thank you.

Okay. On the first one, Puma and BMW, obviously great opportunities for us, great brands. We're going to approach them somewhat asymmetrically on a different approach, largely digital, and we're going to get started on that and be shipping next year. So those businesses will start off small as we typically do in new business. Start small and get the working model right before we expand it. So there is, in this case, both those brands have strong followings, huge amounts of passionate fans for those brands, a lot of CRM capabilities, et cetera. So we think we can scale it quicker than maybe we have in the past. But in any case, we're going to start off with those. We have seen in Europe a lot of disruption over there, traffic way off, there seems to be some systemic problems there with the market that we'd seen maybe in the U.S. a couple years ago, a lot of increasing e-Comm. So we're seeing still some very difficult times over there. We've got a lot of activities in the market. We are growing e-Comm there and our own e-Comm. We've got a lot more social and digital activities going in there to turn the trend. But in our forecast for the back half of the year, we're not predicting that that business is going to change its trend. There's still a lot of work to do and we're working on it as fast as we can.

Dana, just you asked about the Puma, BMW and the adidas, Burberry impact. Think about it this way. The Burberry, adidas impact, we're largely will be through those this year and the Puma and BMW really hit next year. So really incurring all the pain with that departure this year with those businesses and we'll get the growth in BWM and Puma next year as those cycle and we get those products in the market.

Thank you.

And our next question comes from Laurent Vasilescu from Macquarie. Please go ahead. Laurent Vasilescu - Macquarie Capital (USA), Inc.: Good afternoon. Thanks for letting me on the call. For the second quarter gross margin, can you remind us how much of the liquidation provision you took last year, how much it flowed through into the second quarter gross margin?

Yeah, really from a net economic standpoint, given the fact that we had compressed margins on the sell-through, there's really no net economic impact on it. It happened similarly in the first quarter and the second quarter, so those margins are basically doing what they should be doing as reflected through the net economics on it. So it really didn't have a net impact from any liquidation impacts overall. Laurent Vasilescu - Macquarie Capital (USA), Inc.: Okay. Thank you very much. And then on the fourth quarter, the operating margin – take the midpoint of 9%, it suggests meaningful improvement year-over-year on the SG&A. Can you walk us through the drivers of that if that's marketing or if there's other components that we should consider?

Yeah, it's actually a lot of pieces, Laurent, on that. It's some marketing spending on it. We were investing pretty heavily last year in some of the connected fixturing and marketing programs. That isn't at the same level this year. We have a good base out there. I would tell you the continuation will happen with the store closures. The store closures continue to have savings on there year-over-year, that's going to be a benefit. And then our infrastructure savings as well. So it's really spread across all three of the major categories we have, marketing spend, our direct spend for mostly stores as well as our infrastructure and all of those are favorable year-over-year fairly consistently. Laurent Vasilescu - Macquarie Capital (USA), Inc.: Okay. Thank you very much, and best of luck.

Okay. Sure. Thanks.

We have no further questions. I'll turn the call back over for final remarks.

Okay. We thank everybody for joining us on the call today, and we look forward to speaking to you when we report our Q3 results in November. Thanks again.

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