Fossil Group, Inc. (NASDAQ:FOSL) Q4 2023 Earnings Call Transcript

Fossil Group, Inc. (NASDAQ:FOSL) Q4 2023 Earnings Call Transcript March 13, 2024

FOSL isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, ladies and gentlemen, and welcome to the Fossil Group Fourth Quarter and Full Year 2023 Earnings Call. At this time, all parties are in a listen-only mode. 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.

Christine Greany: Hello, everyone, and thank you for joining us. With us today on the call are 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. With that, I will now turn the call over to Jeff Boyer to begin.

Jeff Boyer: Thanks, Christine. I’m pleased to be taking on the role of interim CEO, having spent nearly 17 years with Fossil on both the Board of Directors and the executive leadership team, I have a deep working knowledge of the operating model, the organization and our underlying profitability potential. As Chief Operating Officer, I was one of the key architects of our Transform and Grow Plan and have played a critical role in driving execution of those initiatives, which remain on track. Importantly, I’ve worked side-by-side with Kosta for nearly two decades, which will make for a seamless transition in the coming months. Together with our experienced leadership team, we’re going to ensure continuity as we continue to advance our tag plan in order to lay the foundation for a profitable business model.

In connection with the earnings release today, we also announced that the Company is conducting a strategic review of its business model, considering additional debt and equity financing options and pursuing actions to strengthen the balance sheet. What we want to make clear today is that we’re taking steps to maximize shareholder value, and we have sufficient liquidity to operate the business for the foreseeable future. This past year has been more challenging than we anticipated, reflecting three key factors: one, macro-driven economic conditions globally; two, wholesale channel dynamics; and three, persistent pressure on consumer spending in China, one of our most important markets. Against this difficult backdrop, we took aggressive actions to rationalize unprofitable segments of our business.

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Q&A Session

This included exiting our smartwatch business and closing underperforming stores. Excluding these actions, we ended 2023 with core top line trends contracting approximately 10%. The most important thing we want you to hear from us today is we’re committed to improving performance and we’re all hands-on deck to further advance our TAG plan and strengthen liquidity. As Interim CEO, I’m prioritizing the following: Stabilizing the business, advancing our TAG plan, strengthening our balance sheet and conducting a broader strategic review of our operating model. I’ll discuss each of these in greater detail. First and foremost, we’re taking steps to stabilize the business and improve our financial position. In 2023, we closed 45 underperforming stores, and in Q4, we made the strategic decision to exit the smartwatch category.

While these actions contributed to our top line headwinds, they did not materially contribute to operating margins. More importantly, these actions help us refocus the Company on our most profitable and productive core categories, enable us to further streamline our operations. In 2024, we expect to close approximately 50 retail doors as we exit underperforming locations through natural lease expirations, and we expect to fully exit our smartwatch inventory in the first half of 2024. These actions will also enable us to refocus our inventory investments into higher-margin, faster-turning categories, like traditional watches and jewelry. Regarding this reinvestment in core categories, note that the fourth quarter execution of our Revitalization Strategy for Fossil brand drove some of the best results within our portfolio.

Global traditional watch sales for the Fossil brand grew in Q4 of last year and our direct-to-consumer channels, comp sales in traditional watch and jewelry grew mid-single digits. Additionally, we’re seeing gross margin growth in the Fossil brand continue thus far in 2024 in our core watch and jewelry categories. Our second priority is our TAG plan, which remains on track to capture $300 million of annualized benefits by 2025. As a reminder, our plan to achieve these benefits is anchored by three core objectives; driving sales productivity, reengineering end-to-end operations and streamlining overhead costs and improving capital efficiency. Our teams delivered solid execution in 2023, and we captured approximately $125 million in annualized benefits.

This was driven primarily by company-wide headcount reductions where we streamlined our regional and corporate functions to be more centrally led and dramatically reduced our smartwatch cost structure. Additionally, our initiatives on SKU management, inventory management and price management, drove improvements to inventory productivity and traditional watch product margins. We ended 2023 with inventory down 33%, better overall inventory composition and improved product margin architecture heading into 2024. In 2024, we expect to capture another $100 million potentially more in annualized benefits from our TAG plan. The largest area of savings is expected to come from our supply chain activities where we have successfully renegotiated a number of significant sourcing contracts.

Cash benefits begin in the first quarter this year, with P&L benefits materializing in the second half. These actions are expected to drive gross margin expansion this year and help us return to historical gross margin levels, which were in the mid-50s over the next two years. Our third priority we are focused on is strengthening our balance sheet. We are pursuing opportunities to better leverage and monetize the Company’s assets through additional financing and the sale of our European facilities. In addition, we’re expecting to receive a U.S. tax refund of approximately $56 million associated with NOL carryback provisions from the CARES Act, more on these efforts from Sunil shortly. Lastly, as we outlined in our earnings press release today, we announced a strategic review of our current business model and capital structure.

This review will include efforts to further optimize our business model with appropriate changes to our overall operations as well as additional structural cost reductions. We expect this effort will further expand on our current TAG plan and could include additional debt and equity financing options including monetization of various assets. Our action plan for 2024 is focused with a high sense of urgency on top line stabilization and improved profitability. The guidance we’re providing for 2024 is based on the underlying trends we saw exiting 2023 as well as the strategic actions we’re taking to stabilize the business. Our outlook calls for worldwide net sales of approximately $1.2 billion, which includes about $100 million in year-over-year negative sales impact resulting from store closures and our exit from the smartwatch category.

We expect that underlying business trends will continue to be challenged by macro-driven pressures affecting consumer spending, category and channel softness and brand dynamics among some of our key licensing partners. We’re acting quickly to leverage our core strengths in people, implement our TAG plans and improve our financial condition to make Fossil a leaner, stronger and more durable business. We are fortunate to have incredible teams across the organization who are passionate about the Company, committed to our purpose and dedicated to winning as we continue to execute our TAG plan. We appreciate the support of our shareholders and look forward to updating you on our progress throughout the year. Now I’ll turn the call over to Sunil to discuss Q4 results and provide more granularity around our financial objectives and outlook.

Sunil Doshi: Thanks, Jeff. Fourth quarter net sales totaled $421 million, down 16% versus last year or down 17% in constant currency. Adjusted operating margin was negative 2% for the quarter and negative 6.5% for the fiscal year. Fourth quarter cash flow from operations was $49 million, and we ended the year with $117 million in cash and $181 million in liquidity. For the full year, cash flow used in operations was $59 million and improved versus the prior year as we manage working capital levels down during the year. Diving deeper into our Q4 sales trends. In the fourth quarter, approximately 7 points of the overall 17-point constant currency sales decline came from store closures and lower smartwatch sales. As Jeff noted, in the fourth quarter, we exited the smartwatch category and began to more aggressively move through our inventory.

We also completed the rationalization of our smartwatch infrastructure costs in Q4. With the decision to exit the category, we have pivoted our future inventory purchases to drive better ROI and faster turn categories like traditional watch and jewelry. Heading into 2024, we will lap approximately $60 million in smartwatch sales from 2023 with minimal expected liquidation sales in 2024. While this will be a top line headwind to our fiscal year 2024 sales, we believe the reduced infrastructure costs and placing more inventory and higher-margin sales in traditional watch and jewelry will drive better longer-term financial outcomes for the Company. Excluding the 7-point impact that primarily came from store closures and smartwatches, fourth quarter net sales declined about 10 points versus last year.

The majority of that 10-point sales headwind came from our largest license brands, where sales in traditional watch and jewelry were down versus the year ago period in both our wholesale and direct channels. In the wholesale channel, particularly in the Americas and Europe, Q4 sales declines did moderate from the very steep sales declines we saw earlier in the year, consistent with our retail customers reporting more balanced stock levels. Underlying sell-out trends, however, remained negative in the quarter. As inventory levels appear to be more balanced, we anticipate that retailers will maintain conservative inventory purchasing behavior to limit overstocking risk. In Asia, licensed brand revenue in the wholesale channel was down modestly with declines in Mainland China and other distributor markets, offsetting double-digit growth in India, Japan and Korea.