Kontoor Brands, Inc.

Good day, ladies and gentlemen, and welcome to the Contour Brands Q2 2022 Earnings Call. All lines have been placed on a listen-only mode, and the floor will be open for questions and comments following the presentation. If you should require assistance throughout the conference, please press star zero on your telephone keypad to reach a live operator. At this time, it is my pleasure to turn the floor over to your host, Eric Tracy. Vice President of Corporate Finance and Investor Relations. Sir, the floor is yours.

Thank you, operator, and welcome to Contour Brand's second quarter 2022 earnings conference call. Participants on today's call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to materially differ. These uncertainties are detailed in documents filed with the SEC. We urge you to read our risk factors, cautionary language, and other disclosures contained in those reports. Second quarter 2022 results are on a gap basis. Select comparisons to 2021 results will be on an adjusted dollar basis. And in certain cases, we will make comparisons to 2019 results, which we clearly define in the news release that was issued earlier this morning and is available on our website at contourbrands.com. Reconciliations of gap measures to adjusted amounts can be found on the supplemental financial tables included in today's news release. These tables identify and quantify excluded items and provide management's view of why this information is useful to investors. Comparisons will be in constant currency unless otherwise stated. Joining me on today's call are Contour Brands Chief Executive Officer and Chair Scott Baxter and Chief Financial Officer Rustin Welton. We anticipate this call will last about an hour. Scott?

Thanks, Eric, and thanks, everyone, for joining us today. I want to start today's call by sincerely thanking our colleagues around the world. I have been greatly humbled by our team's agility, collaboration, and resolve to not only persevere through these dynamic times, but deliver on our near-term operational results and drive industry-leading TSR since our spend. all while continuing to position Contour for greater long-term success. And let's be clear, to say the macroeconomic environment has been dynamic simply isn't enough. Let's call it like it is. It's been downright difficult. From the COVID pandemic and lockdowns, to the war, to supply chain disruptions, to inflation, the pressures that companies, consumers, and people around the world have and continue to face are unprecedented. And as we've discussed on many of our recent quarterly calls, Contour has not been immune to these obstacles. In addition to, and in the face of, these challenging times, we at Contour have executed a spinoff, stood up an independent company, implemented a new global ERP system, and set the foundation for our catalyzing growth strategy. And as you'll hear more about today, we are further globalizing our operating model, including relocating our European headquarters. We're really excited about these initiatives as they better position us to attract world-class talent in the region, unlock significant benefits for our organization, and further support the transition to a growth-oriented model. We knew our journey would not be easy. We knew it wouldn't be linear. But as we sit here today, and even with near-term macro challenges, Our strategies to further strengthen our brands, operating model, and organization over the last three years have been tremendous. But they can't and don't transform our business and some of the legacy challenges overnight. This requires time and sustained execution. I will provide greater insights on how we intend to do this in a bit. But first, let me touch on our second quarter results. Despite the uneven operating environment, we were able to expand share TOS and AURs to drive top-line strength in our core U.S. business, and we're still able to deliver on our profitability goals with operating income up over 50% year-over-year and earnings up 57%, coming in at the midpoint of our guidance range. Now, this bottom-line strength didn't come without some incremental headwinds, including inflationary pressures and the much-discussed retailer inventory rebalancing that caused the supply-demand pendulum to aggressively swing as the second quarter progressed. While we had anticipated these factors would more fully weigh on second half results, they somewhat tempered our strong underlying brand momentum, impacting our top line sooner than we expected. That said, global growth was still strong, up 27% in constant currency. The expected declines in our international business owing to China lockdowns and timing shifts impacted compares in Europe, were more than offset by strength in the U.S., with both the Wrangler and Lee brands up at least 40% domestically. These gains in our largest market were supported by the breadth and development of our product portfolio in Q2. Highlights in Wrangler included the women's modern collection, augmented by the workwear in Western categories. In fact, Western summer seasonal bookings were up double digits. In addition, the brand's product evolution once again saw strength in outdoor ATG and growing momentum of its fishing sports specialty line, Wrangler Angler. At Lee, men saw really strong performance within core denim, casuals, and seasonals, with the brand driving share gains across all male categories in the quarter. Women, too, experienced solid double-digit growth as innovation platforms FlexMotion and Ultralux supported the gains. Stepping back a bit from just our second quarter results versus last year, I think it's important perspective to look at the first half performance compared to pre-pandemic first half 2019, providing a more normalized assessment of the business. It also gives a better indication of how we believe our strategies have and should continue to drive diversified accretive growth across our core channels, categories, and geographies. Compared to the first half of 2019, first half 22 global revenue increased 5%, but more importantly, increased 13%, excluding our proactive actions taken with DFO in India. In terms of our core U.S. business, Wrangler and Lee increased 19% and 14%, respectively, over first half 2019 levels. In our largest market, both brands have driven significant share gains. in the core men's denim casual bottoms business over first half 19, with Wrangler up 80 points and Lee up 60 points, and would be even greater if not for our proactive quality of sales actions to exit certain points of distribution. Importantly, AURs driven by MIX have also increased over this time period, up double digits in the US for both brands, supported by innovation digital and expansion of the brands to more premium points of distribution. Turning to our channel diversification, with a focus on digital, our first half 22 global owned.com increased 111% and our US owned.com increased 140% compared to 2019. How have we been able to deliver this performance despite the multitude of macro challenges? By making the long overdue investments to support these brands like never before in key growth enablers such as talent, demand creation, and innovation. From a demand creation perspective, both Lee and Wrangler continue to amplify brand heat in Q2 and have exciting plans for the balance of the year. First with Lee, the team continues to enhance marketing efforts to elevate brand positioning, particularly within digital spend, integrated seasonal demand creation, including the streaming summer campaign Free Your Originality by Lee Originals drove holistic digital experiences across consumer touchpoints, supporting 61 million digital media impressions and a 103% year-over-year increase in social media traffic during the quarter. Authentic. Brand-right partnerships also remain key in Lee's premiumization strategies, including the second drop of the highly successful collab with the hundreds that launched in May. And perhaps the most exciting moment in Q2, and reflective of how different the brand is showing up in the market compared to years past, Lee sponsored the Bonnaroo Music Festival in June, celebrating American culture in the spirit of originality. Brand activation events were highlighted by the original Lee tree, not only a one-of-a-kind piece of art made of 900 square feet of Lee denim scraps, but an interactive brand experience that allowed music goers and brand aficionados, old and importantly new, to make their mark by decorating the tree with additional leaves throughout the festival. It is exactly these types of demand creation investments that have helped support Lee's elevated brand health, reflected in Q2 domestic men's denim casual bottom share gains, which increased 50 points over last year, and AURs that increased 22% over 2019 levels. With Wrangler, the brand's 75th anniversary celebration continued in the second quarter, with demand creation efforts through our For the Ride of Life campaign and elevated social media platforms, allowing the brand to reach new consumers like never before. Similarly, Distorted investments in digital drove meaningful growth, including 73 million additional media impressions and significant year-over-year growth in traffic to Wrangler.com. Authentic collaborations, such as our recent partnership with iconic music brand Fender, highlight how the Wrangler brand plays at the heart of cultural influence. Augmenting the Fender collab, Wrangler has further leaned into its brand connection with music to catalyze consumer engagement. Acting as the exclusive denim sponsor of the two Lollapalooza music festivals in Chicago and Berlin, as well as Austin City Limits, a collaboration with these three iconic music festivals, celebrating self-expression and shared passion through music, fashion, and culture, kicked off with our 75 Days of Summer, a sweepstakes offering 75 days of prizes to destination music festivals. In the Wrangler booth, an interactive customer space Brand enthusiasts are able to buy exclusive Denim Festival merchandise and personalize it with free laser customization specific to the event. A complete line of Lollapalooza by Wrangler Apparel, including tees and denim, is available on Wrangler.com. Finally, we are really excited to amplify Wrangler's 75th anniversary with an upcoming New York City event, including a preview of our Wrangler Leon Bridges Collection followed by a performance by the Grammy Award winner himself. I know some of you on this call will be joining us for that event. We can't wait to share this with folks. As you can see, we have an incredible amount of brand elevating activation with both brands. And we will continue to invest behind these demand creation efforts to drive brand equity, consumer reach, and top-line growth in 22 and beyond. So let me now close with how we think about the go-forward. As you've seen, we lowered our outlook today, not necessarily an indication of the healthy momentum we are experiencing in our own business. Recall from our initial guide back in March, we anticipated the back half to be more greatly impacted by these factors, but to reflect an even more conservative view of the macro backdrop, particularly retailer inventory rebalancing and ongoing lockdowns in China. Despite the macro headwinds, we remain focused on executing our strategies, As we've stated frequently, we anticipate that future revenue will be driven by outsized growth in category, channel, and geographic expansion. This is important as we look to diversify our portfolio beyond US wholesale. As I said earlier, this doesn't happen overnight. We are absolutely investing in those creative areas. First, channel diversification in enhancing our digital platform. While leveraging our global brick-and-mortar learnings to further develop a holistic, full-price D2C omni-channel experience for our consumers. While we have established a target of 10% digital penetration by 2023, our opportunities to vertically integrate our D2C model, showcase pinnacle product, and more directly connect with our consumer are much greater and, importantly, at accretive margins. From a category perspective, you have already seen the tremendous strides we have made to evolve our product portfolio beyond denim bottoms. but we remain in the early days. And what we love is the breadth of this category growth across Western, outdoor, workwear, tees, female, and really importantly, it's authentic, natural extensions that leverage each of the brand's ethos. And finally, turning to international expansion, we remain highly under-indexed in markets outside of the U.S., as most of our peers do nearly 50% of their business internationally. So a significant opportunity for us to nearly double the size of our business over time. As we've discussed, we expect macro pressures to weigh on international, particularly China, over the near term. But we continue to aggressively invest in positioning ourselves for substantial long-term growth across both Asia and Europe. Highlighting this investment to enhance growth, I'm excited to announce today that in Q3, we made the decision to further globalize our operating model, including the relocation of our EMEA headquarters to Geneva, Switzerland. With the implementation of our global ERP infrastructure and foundation now complete, it's the ideal time for us to further drive global operating efficiencies and accelerate our transition to a growth-oriented organization. For long-term benefits, these actions are significant, including providing greater capital efficiency, improving go-to-market capabilities, enhancing access to best-in-class talent, and driving skew rationalization. The announcement reflects our commitment, even when macro conditions remain difficult, to continue to strategically invest for long-term, sustained, profitable growth. We also recognize the need to be agile in this environment, and we will accordingly look to tighten non-strategic expenses. Further, the significant actions we've taken over the last several years to fortify our balance sheet and optimize our capital structure afford us increased flexibility to navigate the choppy waters. These moves, coupled with our proven strong cash flow generation, even in periods of macro uncertainty, gives me great confidence that Contra will continue to accelerate our competitive separation. Rustin? Thank you, Scott, and thank you all for joining us today. I know you all have questions on a number of macro topics, including consumer demand, inflationary pressures, and retailer inventory rebalancing. So I'll begin by discussing some of these key external factors before reviewing our second quarter performance and closing with how both are incorporated in our updated 2022 outlook. Let's begin in the U.S. As Scott mentioned, many retailers began to rebalance inventory levels during the quarter to better reflect supply and demand signals in the marketplace. While retail apparel inventory levels have been well chronicled at a macro level, I want to dig a little more into specifically our core categories and how our brands performed at point of sale. Over the past three months, the U.S. total measured market for denim bottoms, casual pants, and seasonals grew in the low to mid single digits across both men's and women's segments, with men's categories performing a bit better than women's. In men's bottoms, our largest core segment, Wrangler and Lee significantly outperformed the market in our key categories of denim and casual pants. As we have stated previously, we believe consumers migrate to trusted brands in times of uncertainty. With the investments made in product, innovation, and demand creation that Scott outlined, the value proposition of Wrangler and Lee is as high as ever, and we saw this resonate with consumers during the quarter at point of sale. In women's, There was disparity across the portfolio with strength in casual pants and softness in seasonals. But Wrangler and Lee outperformed the market in the majority of categories. And while market softness in the seasonal category is noteworthy, as it is a key rebalancing focus for retailers with discounting taking place prior to end of season, our seasonal business has outperformed the market to date. On a broader level, Retail inventory challenges have led to more restrictive open to buy dollars that adversely impacted our second quarter shipments and are expected to continue into the back half. But stepping back, we are very pleased with how Wrangler and Lee performed at point of sale in the US. We are clearly winning on a relative basis and how consumers continue to embrace our brands and offerings in our core categories. In the international markets, the quarter generally played out as anticipated. In China, Shanghai reopened in line with our expectations during the quarter, but citywide lockdowns and restrictions on movement in a number of jurisdictions, such as Chengdu, Shenzhen, and most recently Wuhan, remain. These restrictions are impacting consumer behavior and brick-and-mortar traffic and are contributing to a more conservative outlook for contour in the back half. In Europe, FX pressures accelerated in the quarter with the Euro and U.S. dollar at parity for the first time in two decades, and we expect currency headwinds to continue to temper results. Turning to supply chain, inflation on key input costs such as cotton and crude oil, which affects freight surcharges, spiked during the quarter to year-to-date highs before moderating to end Q2. We are not assuming a significant benefit from recent commodity reductions in the second half of 22, given the six to nine month lag time on impacting our P&L on many of these inputs. With this backdrop, let's review the second quarter results. Beginning with revenue. Global revenue increased 27% compared to the prior year. Growth was driven by strength in the U.S. across both the digital and wholesale channels. On a regional basis, U.S. revenues increased 40%, driven by continued broad-based momentum. In addition to strengthening our core, we are encouraged by the progress we are making in diversifying the business into new categories, such as outdoor, workwear, and tees, all of which delivered strong growth in the quarter. And in our digital business, usown.com increased 24% compared to the prior year, supported by our distorted investments in digital, which are driving improved traffic and AURs. International revenues decreased 11%. As expected, COVID-related lockdowns in China and compares to the EMEA ERP implementation in 2021 weighed on the quarter. Turning to our brands, global revenue of our Wrangler brand increased 36%. Growth was driven by continued momentum in the U.S., including strong contributions from Western outdoor and workwear. In addition, we saw strong growth in tees, which increased triple digits compared to the prior year. In Wrangler's digital business, USown.com increased 28% in the quarter. Wrangler international revenue increased 8%, with gains in non-U.S. America's partially offset by timing shifts related to the 2021 ERP implementation in Europe. Turning to Lee, global revenue increased 12%. Lee U.S. revenue increased 40%, driven by momentum in performance and comfort styles, as well as new product platforms. We also saw strength in digital, with usown.com increasing 14%. and U.S. digital wholesale up 97%. We international revenue decreased 22%. As discussed, COVID-related lockdowns in China had a significant impact on the quarter, particularly in April and May. We did see a sequential improvement as lockdowns eased, particularly with our digital business, which saw double-digit increases in June. And finally, from a channel perspective, U.S. wholesale increased 44%, non-U.S. wholesale decreased 10%, and globalowned.com increased 10%. Now on to gross margin. Gross margin decreased 260 basis points compared to adjusted gross margin last year. As we discussed last quarter, we continue to see elevated transitory costs, including air freight. These factors resulted in 170 basis point headwind in the quarter. In addition, unfavorable geographic mix shifts resulting from China lockdowns and ERP-related timing shifts in Europe resulted in a further 150 basis point decline. Partially offsetting these headwinds were the benefits from strategic pricing, which more than offset product cost pressures in the quarter. SG&A expense was $178 million for an $11 million increase versus first quarter 2021 adjusted SG&A. As a percent of revenue, SG&A leveraged by 510 basis points in the quarter, demonstrating the benefits of our highly efficient model and multiple levers to support profitability while still investing behind key growth enablers such as demand creation, digital, and IT. Earnings per share was $1.09 compared to $0.70 in the same period in the prior year on an adjusted basis. Now turning to our balance sheet, second quarter inventory increased 33% compared to last year. Compared to pre-pandemic 2019 levels, inventories were flat, We finished the second quarter with net debt or long-term debt, less cash, of $647 million and $145 million in cash and equivalents. Our net leverage ratio or net debt divided by trailing 12-month adjusted EBITDA at the end of the second quarter was 1.6 times, within our targeted range of one to two times. Finally, during the quarter, we repurchased $40 million in common stock And at the end of the quarter, we had approximately $62 million remaining under our share repurchase authorization. When combined with a strong dividend, we returned a total of $65 million to shareholders during Q2. Before we review key assumptions regarding the outlook for the balance of the year, I'd like to take a moment to reflect on our first half results. In March, prior to COVID lockdowns in China, retailer inventory rebalancing efforts in the U.S., and incremental inflationary pressures, we provided a supplemental breakdown on our first half outlook given our ERP implementation in 2021. Specifically, we indicated that we expected global revenue in the first half of 1.29 to 1.31 billion, or a 13 to 15 percent increase compared to 2021. Although the quarters unfolded differently than expected due to macro factors, our first half revenue grew 14% in constant currency compared to 2021. Similarly, on the bottom line, we indicated in March that we expected first half GAAP EPS of $2.40 to $2.60 per share, or a 13% to 22% increase compared to 2021 adjusted EPS. we delivered GAAP EPS of $2.49 in the first half, an 18% increase in constant currency compared to 2021 adjusted EPS. Despite the many factors we have discussed, we were able to deliver top and bottom line results right in the middle of our expectations. Our agility and focus on execution combined with our brand momentum in the marketplace clearly gives us confidence to navigate future uncertainty. So, how are we thinking about the second half in light of everything I just covered? Let's begin with revenue. In our previous outlook from last quarter, we mentioned that we expected the first half global revenue to increase in the mid-teens range, with full-year global revenue to increase at approximately 10% compared to 2021. This guidance implied a mid-single-digit increase in the second half. Notably, we were already incorporating anticipated consumer demand softening due to inflationary pressures. Our updated outlook now assumes second half global revenue to be relatively flat compared to 2021, driven by two primary factors. We anticipate open to buy dollars to be somewhat restricted as actions to rebalance retailer inventory levels are implemented. We expect these issues will weigh on our top line more than originally anticipated, with the third quarter more pressured than the fourth quarter. Second, given the ongoing COVID restrictions and lockdowns, we believe China will remain a challenging market. and now believe it is prudent to take a more conservative approach to our second half outlook. In sum, we delivered global revenue growth in the first half of 14% in constant currency, driven by U.S. growth of 19% compared to 2021. With our more cautious, updated outlook, we now expect second half global revenue to be relatively flat compared to 2021. In terms of gross margin, a few items to call out. Inflationary pressures that peak during the second quarter will continue to pressure gross margins, as will the retailer inventory rebalancing and adverse geographic mix from a more conservative approach to China. We expect these headwinds will be somewhat offset by lower transitory expenses such as air freight and continued structural mix shifts to accretive channels and strategic pricing. Last, I want to spend a moment on SG&A. Importantly, first and foremost, we will continue to make thoughtful strategic investments, as Scott highlighted, including digital, international, and the globalization of our operating model to accelerate diversified accretive growth over the long run. However, in light of the uncertain macroeconomic environment, we expect tighter expense controls on non-strategic and discretionary items. Additional details on our outlook can be found in today's earnings release, but to summarize, revenue is now expected to increase approximately 6% for the full year, with second half relatively flat compared to 2021. The third quarter is expected to experience greater pressure relative to the fourth quarter. Gross margin is now expected to approximately 43.5% compared to adjusted gross margin of 44.6% achieved in 2021. We expect gross margin year-over-year headwinds to moderate in the second half, with the third quarter experiencing greater pressure relative to the fourth quarter. Adjusted SG&A, excluding an estimated one-time charge of $18 million associated with our globalization efforts and European headquarter relocation, is now expected to increase at a mid-single-digit rate compared to adjusted SG&A in 2021. relatively consistent with revenue growth. Adjusted EPS, excluding an estimated one-time charge of 25 cents per share associated with our globalization efforts in European headquarter relocation, is expected to be in the range of $4.40 to $4.50 per share. Finally, I want to briefly provide some comments regarding inventory, cash flow, and capital allocations. Since the spend, we have discussed actions to improve our inventory metrics. Looking back to 2019, our inventory levels are flat despite higher 2022 projected revenues. Given the U.S. retail inventory rebalancing efforts during the quarter, our inventory levels did finish higher than expected. But importantly, we feel good about the quality as the majority is in poor evergreen styles. and we will be working to sequentially improve from these levels in the second half. Additionally, Q4 is historically the highest generating quarter from cash from operating activities, and we expect this to continue in 2022. As we have discussed, we remain confident in our capital allocation optionality, which provides us with tremendous flexibility in times like these. We are clearly operating in a highly dynamic environment, But I want to be clear. We remain laser focused on executing our Horizon 2 strategies, investing behind profitable growth initiatives to transform the model, while delivering long-term sustainable shareholder returns. This concludes our prepared remarks, and I will now turn the call back to our operator. Operator?