Welcome to the Fourth Quarter 2019 Fossil Group Incorporated Earnings Conference Call. My name is Hilda, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Miss Christine Greany. Miss Greany, 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 Financial Officer; and Greg McKelvey, 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 and 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 From 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 From 8-K, and is available in the Investor Section of fossilgroup.com. Now, I'd like to turn the call over to the company's Chairman and CEO, Kosta Kartsotis.

Hello, everyone, and thank you for joining us today. I'll begin my remarks today with a discussion of Q4 and recap the highlights from 2019. Then, I'll provide our perspective on the current operating environment, how we plan to navigate our challenges, and where we see opportunities to drive growth as we continue to transform Fossil’s business model. Before returning to my formal remarks, I would like to briefly comment on the coronavirus. First and foremost, we want to express the collective concern of our management and board for the well-being of our Fossil team members, partners, and their local communities that are being impacted by the crisis. As it relates to our business, the 2020 outlook that Jeff will take you through reflects our current assumptions based on what we know today. As the situation unfolds, we will continue to monitor events closely and update our guidance if needed. Turning back to last year, while there were a number of strategic and operational accomplishments in 2019, we are disappointed to close the year with a particularly challenging quarter. The underperformance primarily reflects lower than expected sales of our older generation connected product, as well as ongoing softness in traditional wholesale, principally in the United States. Going into the holiday season, we anticipated that our previous generation connected product would be a significant growth driver as a strong value offering with a lower price point. However, consumer response was negatively impacted by the combination of competitive pricing in the marketplace for value-oriented product, and to the strong response to our Gen 5 offering, which has much improved functionality. To that end, Gen 5, our latest generation display product, and our new Hybrid HR product, both performed very well in the quarter. In fact, we are pleased to note that we're…

Thanks, Kosta. At a high level, sales came in at the low end of our expectations, principally due to ongoing challenges in U.S. wholesale, as well as soft performance of our older generation connected product. We continued to improve our cost structure, but gross margin was impacted by promotional intensity and charges related to the write down of inventory, which puts substantial pressure on profitability in the quarter. Q4 sales came in at $712 million. That's down 10% versus a year ago and 9% in constant currency. The top line was negatively impacted by continued challenges in traditional wholesale, store closures, license brand exits and weaker than expected performance in older generation connected product. Excluding store closures and business exits, which were roughly a 150 basis point headwind, underlying core sales declined high single digits consistent with performance in both the second and third quarters. Looking at performance by region, strong growth in Asia was more than offset by double-digit declines in the Americas and EMEA. On a constant currency basis, net sales in Asia increased 11% reflecting growth of 61% in mainland China and double-digit increases in India and Korea. Our exceptional growth in China is attributable to ongoing strength in the Emporio Armani brand and the success our integrated wholesale and e-commerce marketplace approach. In the Americas, sales declined 16% driven primarily by the wholesale channel. Within the wholesale, department stores have been the most challenged with sell in and sell out performance declining more than 20% in Q4. We are able to partially offset these declines with strong growth in e-commerce marketplaces in the U.S. In Europe sales declined 9% in constant currency, reflecting softness in the wholesale channel. Similar to the U.S. department stores independent within EMEA continue to face headwinds, while our e-commerce marketplace business…

[Operator Instructions] We have a question from Ike Boruchow from Wells.

Hey, good morning, everyone. I guess my first question is to start with the first quarter. Could you elaborate on? I know your Asia guide for the year, I think it's double digits you said. What are you planning Asia in Q1 given the headwinds from the virus? I was curious.

We are expecting the APAC region should be down double digit, just low double digits overall. We got off to a very good start in January, and had anticipated the typical slowdown during Chinese New Year. Obviously, the virus situation has had an impact on the business. So for the remainder of the quarter, we forecasted that down fairly significantly, and it puts us down low double digits in the first quarter for APAC.

Got it. A few more if it's okay. I think you gave some color, but can you give a little bit more explicit guidance on the wearable's outlook. I know it's declined the last two quarters but what are you planning wearable's in Q1? And then how do you expect that to progress through the year?

Yes, we are expecting to be down on the full year overall. On this [indiscernible] contraction, both in assortment rationalization as we focused on some of the key brands and skews and also on a distribution, rationalization as well. We focused on channels of our business that can drive the business overall. Don't have the specifics right in front of me on the Q1 call on it, but I tell you be down probably for the year roughly about 10% on it, so some contraction for the contraction.

The one thing I would add icon the wearable's is, as we mentioned, we're seeing very strong reviews and sell through on Gen 5. And when you stand back and look at where we are wearable's right now, especially with a new product out there. Do we obviously have a product issue last year, but our capabilities, our software, our programs, our roadmap, just our overall capability is much greater than it was last couple years and the reviews and sell through we're getting just leads to believe that we have a much bigger opportunity going forward. So that's something for us to be excited about.

I mean to stick with that. I mean it sounds like the new generation product keeps working. And I think this is the second inventory. Right down, I think in the last as many years just is there anything you guys are working on to do better at kind of managing the lifecycle of your wearable business and trying to understand like at what point do you kind of get more comfortable with managing the inventory after that category?

Let me -- let me provide a little bit more color. You know, as we position the business for Q4, it was clear that the market was developing into two distinct tiers of product. The first is just the latest tech, which is largely full price with a high consumer willingness to pay. And then the older generation or less featured products at sharper price points. And what we're hearing from a lot of our channel partners was the focus on the opening price point sharp price point business to be able to drive a unit volume and traffic to the stores. So we actually positioned our inventory as such. So we had 70% of our inventory, roughly in Gen 4 in sport, and only 30% in our latest tech offering, which was Gen 5 and our hybrid HR thinking that that mix represented the channels desire, but we found out the consumer responded very differently than channel expectations. So our Gen 5 and hybrid HR products, both of which have 4.3, 4.4 stars, really, really well done by our engineering teams across the world. Forex exceeded expectations than any channel that carry those was very happy with the results, but the price competition in the lower tier was much greater than we had expected, or frankly, any of the channel partners had had expected. And that drove not only in our lower unit volume overall, but lower margin than we expected. So that's why we took the charge. So although we're disappointed though, in the commercial outcome for Q4, we proved and our teams proved with the success and the seller reviews of Gen 5 and how to reach out that we belong in the category. We're a leader in the business, and we just need to keep pivoting…

Got it. Thanks, Greg. Last on the balance sheet if I can have one more, Jeff to understand few things, just the term loan amendment details and also, I think in that 8K [ph] there is potential leverage, covenant violation that would come up in Q2. I'm just kind of curious, what exactly is going on with the amendment and what's going on there. And then just quickly, can you give us. Sorry, go ahead, Jeff.

Yes, like the amendments complete. So we have that in place right now, with a broader net leverage ratio metric. So it's 2.7 times for the next four quarters all of this year, net debt over EBIT up. And some of those drawn by the inventory levels that we have. Also we get into the conversation given some of the business issues out there right now, with the coronavirus. I want to make sure I have some protection on that. And it continues on into next year at 2.25 for the first three quarters of the year and reverts back to the 1.5 times net debt leverage for Q4 of 2021. So, we're in a good position with that. So, that's all done and behind us at this point, Ike. So, there’s not a leverage issue.

Got it. Thank you, Jeff. And then lastly, can you help us with CapEx, G&A? And then based on your guidance on getting to a negative free cash flow number for this year, can you can you correct me there or help me out with free cash number you provided under guidance?

You should have some modest free cash flow, overall on it. CapEx is about $25 million overall on it. The depreciation number is roughly $50 million or so, $45 million, $50 million on depreciation. And as you can appreciate with a bit of extra inventory ending fiscal ’19, that will be reduced and will drive some working capital benefits. Personally work with you a little closer to get the specifics on that EBITDA calculation.

Thank you very much, guys.

Okay, thanks, Ike.

[Operator Instructions] Our next question comes from Dana Telsey from Telsey Advisory.

Good morning. Can you unpack a little bit about wholesale channel, what you're seeing there, how it's impacted globally, and what changes you foresee for your product assortment? And then can you give us any update on the license brand, and any timing of expiration, and particularly what's happening with the Kors brand? Thank you.

Under the channel discussion, I think we've commented that we're largely expecting the trends to continue in both Europe and Americas, which means we quoted the sell through issue in Americas, and selling itself out issues being down about 20%. So, we're still forecasting that for most of this year in Americas wholesale. And then on AMEA, AMEA isn't impacted quite as much. It’s more in the mid-teens contraction we have. So, those are both still in our forecasts and in the underlying numbers. Those numbers largely are what's impacting our overall contraction as we make the change and the pivot to a more direct business model, both to third-party marketplaces, as well as websites on it. So, that's the kind of channel discussion. Strengthened in those channels, the DTC channel, as well as geographically, the strengthen in APAC, we expect will rebound in that in the second half of the year. On licensed brands, I would tell you there's not a lot new report. We continue to work closely with our licensed brands, have great relationships there. Continue to work with our Kors partners on the opportunity for watches and jewelry, both in the wholesale channel, as well as in the boutiques, and that relationship continues to be very strong. From an expiration standpoint, those no major expirations coming up at this point in time, and no major issues that we see in our licensed planning portfolio as we move through some of these transformation efforts that we're going through.

I would just add, Jeff, that we -- just like we have historically, we still have great relationships with both our wholesale accounts and our licensing partners. So, and we're focused across the board with them on driving growth across channels. Within traditional wholesale, especially in the U.S., is definitely more promotional and trends are challenging, but we do see a lot opportunity to continue to stabilize the business with just better product and better storytelling. And so, we've challenged our teams to create excitement for consumers in both brick and mortar and online. And then especially online, we see tremendous growth opportunities globally in the marketplace businesses that we're in, and frankly now with our digital transformation, that's accelerating with our sales force platform. So, you're going to, both in wholesale, online marketplaces, and DTC, see digital bring to life the right product and the right storytelling this year, but also as we go into future years.

And I would add also we continue to look at the marketplace as it evolves, and we probably, over the next couple years, will be adding additional licenses and change some of our portfolio as we continue to evolve the business.

And then, just on the coronavirus; where are you in terms of fast factories, component parts, given diversification and manufacturing? How do you see that playing out as this very fluid situation is still underway?

Actually, our factories are coming back online nicely, slower than we had anticipated. We estimate right now that the capacity right now is about 50%. Expect to have the factories and the underlying component suppliers up to full speed by the end of March on it. We've been prioritizing key products on it. As you can tell from our inventory position, we're actually in a very good inventory position to manage through this process. We pulled some inventory ahead because of Chinese New Year's anyway. And the inventory that we have is good quality. And we're prioritizing production for cheap products that continue to sell. So, we feel pretty good about our factories coming up to speed in China and being at full speed by the end of the first quarter.

Thank you.

Thanks, Dana.

Thank you. I will now like to turn the call back to management for closing remarks.

Before we sign-off, we wish to again express our concern for all those affected by the coronavirus. Despite this near-term issue, we want to emphasize that we have every confidence that our transformation initiative will be successful over the long term. We have innovative products, talented people, and great partners. We have a capital light business that generates good cash flow with no net debt at the year end. We're planning 2020 based on current market trends, but we will be driving our three major growth engines of connected, Asia, and DTC to achieve top line stabilization as quickly as possible. We appreciate your continued support and look forward to updating you in the next quarter. Thank you very much.

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