Kontoor Brands, Inc.

Greetings and welcome to the Contour Brands third quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Eric Tracy, Vice President of Corporate Finance and Investor Relations. Thank you. You may begin.

Thank you, Operator, and welcome to Contour Brand's third 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. Select comparisons to 2021 results will be on an adjusted dollar basis, and in certain cases we will make comparisons to 2019 adjusted results, which we clearly define in the news release that was issued earlier this morning and is available at 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 President, 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 for joining us today. We continue to operate in unprecedented times, so it's really important for me to start my comments today by thanking our contour teams around the world. I'm so grateful to partner with them each and every day and proud of how our colleagues remain agile, resilient, and execute on our strategies, even in the face of ongoing macroeconomic challenges. We have a lot to cover, so let's get to it. There are three primary topics I want to address. First, As I know it is on everyone's mind, I'd like to offer some thoughts on the macro environment from our perspective, specifically acknowledging four key factors that are having the biggest near-term impact on our business at Contour. Second, I'll take you through key highlights from our third quarter and provide some select proof points of how our strategic investments in brand enhancement initiatives are paying off. And finally, I'll touch on our outlook, including what we are doing to address the implications of the broader trends and how our strategies will continue to help improve the model going forward. I started my comments on the second quarter call with a sobering description of the macro backdrop, and we continue to see a dynamic landscape during the third quarter. As I said, we think about four areas that are impacting us in varying degrees. Clearly, the first challenge we are seeing is the impact of inflation on underlying consumer demand and input costs. In the U.S., consumers are experiencing inflation levels that haven't been seen in nearly half a century, with elevated prices on everything from food to housing to apparel. And in Europe, consumers are facing similar inflationary pressures, including severe energy crisis as we begin to move into the winter months. The second factor is the ongoing lockdowns in China. The zero COVID policy has weighed on consumer traffic in the world's second largest economy. And candidly, the pace of reopening has been slower than we've expected. Third, while we anticipated significant inventory rebalancing across countries, U.S. retailers would adversely impact shipments as open-to-buy dollars were restricted, this dynamic had a bit more of an impact on our third quarter revenue in subsequent inventory build. Finally, the global supply chain challenges that have plagued the industry for the last year plus have begun to show signs of moderating from historic highs. Specifically, we have seen lead times from Asia moving closer to pre-pandemic levels, and ocean freight, while still well above historic levels, has begun to moderate. As we've stated consistently, Contour is not immune to these factors, and we attempt to accurately reflect these impacts into our outlook, which I will cover in a bit. But I also know our company is better positioned than we have ever been to continue to drive competitive separation. And I am extremely proud of the organization's overall ability to once again deliver profitability and earnings above our internal expectations while also positioning the company for more sustained, profitable long-term growth. So let me now turn to addressing some of the key takeaways from our third quarter results. We anticipated third quarter revenue, particularly within our U.S. wholesale business, would be challenged by reduced shipments at key retail partners as they aggressively rebalanced their inventory positioning. And this played out, as I said, a bit more than we planned, with overall revenue down 5% in constant currency as U.S. wholesale declined 9%. However, we believe it is important to note that while sell-in for traditional product was impacted by lower overall retailer open-to-buy dollars, our Wrangler and Lee brands once again were able to outpace the market, expanding share, POS, and AURs during the quarter. Further, when compared to the pre-pandemic levels, U.S. revenue year-to-date has increased 7% versus 2019. And beyond core product, we once again experienced broad-based strength across categories, including outdoor, workwear, and t-shirts, collectively up 9% in the quarter. This category expansion has been and will continue to be a critical piece of our growth strategy. Authentic brand extensions into areas such as outdoor, workwear, and tees afford us meaningful white space opportunities in large, growing addressable markets representing nearly $150 billion in aggregate, while also diversifying our product portfolio beyond denim bottoms. These new categories also provide permission to play in new channels of distribution when combined with elevated product design and enhanced demand creation, The Lee and Wrangler brands are increasingly showing up in premium specialty, western, sporting goods, and outdoor specialty, further diversifying from the core distribution. And as we drive closer connections with our consumers, there's no more important channel than the continued evolution of our own D2C in digital platforms. As you all know, we remain in the early days here. Well below our competition in terms of penetration within digital, our global own.com increased 14% over 21 and 111% over 2019. While our US own.com experienced mid-teens year-over-year growth in the quarter, great proof points that our investments, including digital demand creation in this highly accretive growth channel, are paying off. And within our brick and mortar stores, we have some exciting developments to share. First, in Europe, we recently opened a dual Lee Wrangler branded premium retail concept in Berlin with plans to opportunistically roll out the format in select markets across the European region. The expertly crafted retail destinations will offer consumers a unique, immersive experience with products from both brands. The stores will maintain separate frontages for each brand, unified by a design concept that underscores the brand's combined 200-plus years of denim expertise. I actually just spent time with the team in Europe last week, including a trip to Antwerp and my first visit to our new EMEA headquarters in Geneva. It was fantastic to see folks in our new environment, and I was able to commend them on their really strong quarter as Europe revenue increased 27% year over year. But we also spent a great deal of time on the go-forward strategy, understanding that the near term will be confronted by the inflationary pressures I discussed earlier. I have no doubt that our teams will come together to support one another through these challenging times while positioning our great brands for long-term success. Within our APEC region, we knew the ongoing lockdowns in China would continue to challenge results. We did see sequential improvement from Q2 in China, with third quarter revenue down 20%. In areas that have reopened, we have seen really great performance. So while we continue to be cautious with respect to reopening in the region, we continue to build on momentum when conditions normalize, and the long-term opportunities remain significant. Similar to Europe, our APEC team is pushing forward despite the near-term backdrop to strategically enhance the global KTB model. This includes the recent launch of our Retail Excellence Initiative, a program aimed at transforming Contour Asia into a world-class retailer. A reformatted store footprint, improved POS technologies, and enhanced product assortments will amplify the consumer experience. Based on the success of early testing, we are rolling out the Retail Excellence Initiative across the region now, and over the next 12 to 18 months, we will look to do so globally. The opportunities to leverage our learnings in Asia as we more fully develop our brick and mortar strategy globally are tremendous. More to come on this in the coming quarters. These retail developments in Europe and Asia will be critical as we seek to navigate the respective challenges in each market while also continuing to build our globalized platform. And these opportunities for growth across categories, channels, and geographies don't happen without the significant investments we continue to make in brand building, Some of you were able to join us during Fashion Week as our Lee and Wrangler brands took over lower Manhattan and Brooklyn for a night. We were able to see how these investments in product design, innovation, and demand creation come to life as our teams collaborate with iconic leaders such as photographer Mark Seliger and brand ambassador and Grammy Award winner Leon Bridges. The Lee brand is thrilled to once again partner with the preeminent creative director, Seliger, in launching our second global brand equity campaign, Lee Originals. Inspired by those who don't just stand the test of time, but define it. The campaign highlights the new Sam Tanez song aptly entitled, New Wave. Lee's celebration of individuals who approach small and big moments of their lives with one part boldness, two parts optimism. From the newly originals campaign to sponsoring this year's Bonnaroo Festival to the innovative X-Line collaboration with 7-Up in China or Brooklyn Circus here in the U.S., the Lee brand continues to embark on amplified demand creation efforts in support of its enhanced global brand repositioning. And similar to Lee, the Wrangler brand continued to drive greater connection with consumers during Q3 and its 75th anniversary. using creative brand activation events, unique collabs, and authentic brand partnerships to extend its reach to younger, more diverse consumers. In addition to the launch of the Leon Bridges collection I mentioned earlier, Wrangler continues to build world-class partnerships with cultural influencers and iconic brands. Importantly, these partnerships are highly authentic to the brand's Western ethos. While organically taking the brand to new heights, Collabs, such as our college program with Coliseum, brings the Wrangler brand to university ambassadors all across the South and Midwest. Teaming up with the iconic Gantt brand, we were able to bring our cowboy culture to fashion-forward signature pieces while staying true to our roots. Anecdotally, during my trip to Europe, I saw firsthand how this Gantt collaboration with shirts selling for over 900 euros supports the premiumization of the Wrangler brand. And finally, our ongoing partnership with Yellowstone continues this fall. With the much-anticipated fifth season premier hitting in a few weeks, expect Wrangler to show up in a big way. The multitude of these great demand creation initiatives, when coupled with ongoing investments in talent, innovation, and supply chain, hopefully demonstrate our commitment even with the challenging macro environment. to strategically invest behind our brands in powerful ways that support our improved long-term position. Which takes me to my final comments as it relates to the go forward. As you've seen, we tweaked our revenue and earnings guidance down a bit here today with incremental currency headwinds impacting top line by about a point, as well as our acknowledgement of the four challenges I touched on earlier. From a high level, while we don't have a crystal ball in the macro, as I stated earlier, we are assuming that inflation and subsequent tight monetary policy weighs on demand, resulting in economic conditions remaining challenged over the near term. So given that assumption, why are we planning revenue to essentially accelerate in Q4? A few points here. First, we base our outlook on the combination of still strong domestic POS, share gains, and new business developments. Second, while certain U.S. retailer inventory levels remain challenged, the significant rebalancing efforts from select retailers has materially improved with aggressive actions taken early from many of our key retail partners, with open-to-buy dollars opening back up and accelerating into Q4. Based on this second point, our quarter-to-date U.S. orders and shipments have been strong, but we want to be prudently conservative given the uncertainty in the current environment. With respect to our own inventory, Rustin will take you through more detail in a bit, but let's be clear. We exited Q3 heavier than we would have ideally wanted, but we have and will continue to productively address, particularly in utilizing planned capacity downtime in our plants. This downtime, coupled with the fact that roughly 90% of our current inventory is in core product, significantly mitigates markdown or brand health risks facing many of our competitors. Most of our key customers have seen meaningful adjustments to contour-specific inventory as sell-through of our brands has outpaced shipments, affording us a relatively advantageous position to navigate through the holiday even into next year. And regarding full year 23, I know all of you would like some color. While we are not going to guide specifically, rest assured that we are well into our planning process already. As I've stated, we assume ongoing challenges on the macro front with operational headwinds to be more pronounced in the first half on both the top and bottom line and the opportunity to accelerate fundamentals in the second half of 23 as inflationary pressures both on demand and input costs are more likely to begin to ease. We also recognize the need to be more flexible in this fluid environment and will accordingly look to tighten discretionary expenses as we did in the third quarter. The substantial actions we've taken over the last several years to bolster our balance sheet and enhance our capital structure provide us increased agility to navigate the uneven landscape. This is evidenced in the recent 4% increase in our quarterly dividend, reflecting the confidence of our board that our fundamental improvements coupled with our proven strong cash flow generation, even in challenging times, support our unique competitive position in the marketplace and ability to continue to drive industry-leading returns for all our stakeholders. Rustin?