Wolverine World Wide, Inc.

Greetings and welcome to the Wolverine Worldwide Inc. Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A brief 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. It is now my pleasure to introduce your host, Alex Wiseman, Vice President of Science. Please go ahead, sir.

Good morning and welcome to our fourth quarter 2022 conference call. On the call today are Brendan Hoffman, our President and Chief Executive Officer, and Mike Starnit, our Executive Vice President and Chief Financial Officer. Earlier this morning, we issued our press release and announced our financial results for the fourth quarter and full year 2022 and guidance for fiscal 2023. The press release is available on many news sites and can be viewed on our corporate website at wolverineworldwide.com. This morning's earnings press release and comments made during today's earnings call include non-GAAP disclosures, which adjust, for example, for the impacts of non-cash impairment of Sperry and Sweaty Betty Intangible Assets, environmental and other related costs, net of cost recoveries, reorganization costs, costs associated with the integration of Sweaty Betty, receivable securitization transaction costs, gain on the sale of the Champion trademark, and foreign exchange rate changes. Prior year non-GAAP disclosures include additional adjustments for debt extinguishment costs, non-cash impairment related to one of the company's joint ventures, and costs associated with the acquisition of the Sweaty Betty brand. On February 8, 2023, we announced the sale of the Keds business to Designer Brands Incorporated, the parent company of footwear retailer DSW. At the same time, we announced the intention to grant an exclusive license to Designer Brands for Hush Puppies Footwear in the United States and Canada. Additionally, as previously announced on December 8, 2022, We have started a formal process to divest our Wolverine Leathers business. As such, our guidance for 2023 reflects future financial expectations and comparable results from 2022 that exclude the full year impact of Keds and Wolverine Leathers and include an adjustment for the second half 2023 transition of our United States and Canada Hush Puppies business to a licensing model. References to our ongoing business reflect these adjustments. These disclosures will reconcile and attach tables within the body of the release. I'd also like to remind you that statements describing the company's expectations, plans, predictions, and projections, such as those regarding the company's outlook for fiscal year 2023, growth opportunities, and trends expected to affect the company's future performance made during today's conference call, are forward-looking statements under U.S. securities laws. As a result, we must caution you that there are a number of factors that could cause actual results to differ materially from those described in forward-looking statements. These important risk factors are identified in the company's SEC filings and in our press releases. With that being said, I'd now like to turn the call over to Brendan Hoffman.

Thank you, Alex. Good morning, everyone, and thank you for joining today's call. For the fourth quarter, we reported revenue and adjusted earnings per share in line with our expectations. Our gross margin performance in the quarter was impacted by our efforts to more swiftly clear inventory to position the company for improved performance in the year ahead. Our GAAP results, as Mike will comment on, include a large non-cash impairment charge that was greatly impacted by the discount rate applied to certain acquired brands. This month marks my one-year anniversary as CEO. As I look back on my first year, 2022 was certainly a challenging period for us and our industry as the environment shifted quickly midway through. While our company, like many others, underperformed against our initial expectations, the year was also a pivotal time for our company as it shed light on key areas where we must improve. We recognized that our business was too complex, which limited our ability to quickly course correct when faced with sudden changes in consumer spending. So we set a path to simplify our business and improve our supply chain. Agility is essential in any environment, but especially important today. In December, I shared four key priorities that are integral to the 100-day plan we put in place in Q4 as part of our course correction efforts. Let me review these priorities and update you on the early progress we have made. First, the change in our brand group structure announced in November, where brands with similar attributes are now grouped together, enabling them to more easily collaborate and share best practices. Second, improving efficiency while removing costs. We established a profit improvement office that has identified $150 million in annual run rate profit improvements, with at least $65 million expected to be achieved in 2023. In addition to reducing costs, the PIO is also focused on continuous process improvement initiatives, including redesigning our supply chain planning process. We are also benchmarking our global cost structure and operating model against our best-in-class peers in the industry. Third, the strategic review of our portfolio. On February 8th, we announced the successful sale of Keds and licensing of Hush Puppies for North America. We are also moving forward with our plan to divest our Wolverine leather business. We continue to evaluate our portfolio to focus resources on the businesses and brands that will drive the highest return for our shareholders. This includes further investments in Merrill and Saucony's lifestyle businesses and expanding Sweaty Betty's global business. Fourth, improving working capital and reducing leverage. Year-end inventory was down approximately $93 million versus Q3 and lower than our November guidance by $50 million. Q4 operating free cash flow was nearly $300 million and the company's bank-defined leverage ratio of 2.7 compared to 3.4 at the end of Q3. The meaningful progress we made over the last 100 days sets a foundation for further improvements in 2023. We expect to reduce inventory to normal levels in the third quarter of the year and drive significant operating free cash flow. We also have accomplishments to share across our brands. Starting with the active group, consisting of Merrill, Saucony, Sweaty Betty, and Chaco. We are very pleased with the active group performance in the fourth quarter, including 17% growth on a reported basis and 23% in constant currency. For the full year, active group revenue increased 19% on a reported basis and 24% in constant currency, including a 7% percentage point benefit from lapping a partial year of Sweaty Betty in 2021. Merrill finished the year strong. Constant currency revenue increased 31% in the fourth quarter and rose 22% for the year to $194 million and $764 million, respectively. The fourth quarter performance was driven by global brand strength across categories and a relatively easy comparison to the prior year when Vietnam factory closures resulted in a lack of inventory. We successfully repositioned the Moab franchise with one of the best innovation pipelines in years. Our purpose-led brand messaging amplified by Merrill's Inclusivity in the Outdoors study published in 2022 and the company's global impact report continues to introduce Merrill to more customers and increased the cadence of our communication with existing customers. We were also encouraged by the strength in our own direct-to-consumer business, which was up 16% in the quarter and now accounts for over 40% of Merrill's sales in the U.S. Beginning in the first half of 22, we began to strategically shift our marketing investments in Merrill, moving more dollars up the funnel to expand the reach of the brand to both existing and new consumers. This shift was rewarded with many positive results, including increases in brand awareness, attracting new consumers, both younger and, importantly, women, sequential improvement in our year-over-year comparisons at Merrill.com, along with meaningful increases in market share in the second half of the year. We are beginning to transfer these successful marketing and direct-to-consumer strategies to the rest of the brand portfolio. As we look ahead, we are confident that Merrill will continue to leverage its leading positioning in its core hike business, along with increased traction and trail running. We believe that our highest growth opportunity for Merrill is to expand our lifestyle business. Our lifestyle product line, 1TRL, continues to expand the brand's reach with retail partners and customers. Most recently, Merrill's 1TRL partnered with Reese Cooper's RCI Reserve and earlier this month had a New York City pop-up experience featuring the limited edition collaboration. Looking ahead, we expect Merrill's revenue to grow mid-single digits in fiscal 23 with high teens growth in Q1 versus an easier comparison in the prior year. Moving to Saucony, constant currency revenues increased 30% in the fourth quarter and 10% for the year, to $121 million and $505 million, respectively. Like Merrill, Saucony's fourth quarter performance was driven by updated core franchises, including the Endorphin and Triumph. Saucony's e-commerce performance was strong in Q4, up 31%, as the brand integrated a centralized e-commerce commercial team directly into the brand team. Recall, we piloted this initiative with Merrill in early 2022 before rolling it out to the other brands. Saucony continues to drive innovation and received product accolades in 22, including the Endorphin Pro 3, which GQ rated as best road running shoes and its best in fitness awards. And the Ride 15 won best cushion shoe in runner's world. Saucony's China JV once again had a very strong quarter, as sales tripled in 2022. Our multi-channel strategy is working well, including the addition of eight new stores during the quarter. We expect revenue from our China JV to double in 23. Our highest priority for Saucony is to extend its reach beyond the core runner to everyday active and lifestyle consumers. We have several product and marketing initiatives to reach this compelling segment of the market. Also within Saucony, a high priority and opportunity for the corporation is the global expansion of our originals business, which remains robust in Italy, the global hub for international expansion. Looking ahead, we expect Saucony revenue to grow mid-single digits in fiscal 23, with high single-digit growth in Q1. Moving on to Sweaty Betty, constant currency revenue increased 5% in the fourth quarter. On a pro forma basis, if we had acquired Sweaty Betty at the beginning of 2021, full-year constant currency revenue declined 4% to $212 million. The retail environment in the UK remains challenging, but Sweaty Betty navigated the holiday quarter well. Store comps in the UK were positive, driven by new customer acquisition initiatives, as well as head-to-toe merchandising efforts that increased units per transaction. Through effective marketing tactics, the brand acquired 12% more new customers in the UK and 33% more new customers in the U.S. in the fourth quarter, a change in the negative trend we had been seeing. Encouragingly, our U.S. wholesale channel has begun to stabilize with improvements in logistical operations and robust reorder activity, showing the continued demand from our key partners. Brand margins were negatively affected by increased discounting to compete in a highly promotional UK market. However, we are encouraged that the brand ended the quarter with an improved inventory position. In 2022, we opened 18 new standalone stores and concessions in the UK, Northern Ireland, Hong Kong, and Singapore. We opened one pop-up in China. We plan to open 10 new stores in 2023, primarily in the UK and Ireland. The Sweaty Betty team has been collaborating with Wolverine's broader EMEA team to exchange best practices. This includes leveraging Sweaty Betty's direct-to-consumer and apparel expertise and further supporting Sweaty Betty with Wolverine's Centers of Excellence. As we look into 2023, our number one priority is to stabilize Sweaty Betty's home market in the UK and Ireland, while improving profitability through synergies from stronger integration within the rest of the portfolio. Looking ahead, we expect Sweaty Betty to grow low single digits in fiscal 23, with low teen declines in Q1. Workgroup revenue increased 4% and 8% in the fourth quarter and fiscal 2022 respectively in constant currency. This growth reflects strength across its key specialty retail customers, increases across the farm and fleet channel and e-commerce revenue growth with Wolverine and Cat leading the way and maintaining their number one and three positions for trade work footwear in 2022. Looking ahead, we continue to capitalize on the growing trends within the category, including the increase in work participation from the Hispanic population. We believe we are uniquely suited to meet the needs of the growing Hispanic participation rate with a relevant range of products and price points. In addition, The year will see us test Bates to Walmart as part of its private label program. Marketing will also be a focus as we look to engage with existing customers and expand our customer reach. The year will see us introduce a second collaboration with Halo following a successful launch that drove high email capture rate. Lifestyle group revenue declined 20% in the fourth quarter and 5% in fiscal 2022 in constant currency. The Lifestyle Group 2022 results discussed today include Sperry, Keds, and the Hush Puppy brands. Sperry revenues decreased 28% in the fourth quarter and 10% in fiscal 2022 in constant currency. Lower sell-throughs of certain boot styles as well as slowdown in the boat category resulted in wholesale partner cancellations. Sperry continues to experience headwinds in the U.S. marketplace across all channels. In 2022, the root cause of our underperformance was product. Customers loved Sperry for its core franchises, but we did not proactively modernize quickly enough based on trend. Between 2018 and 2022, more focus was placed on categories not as relevant to Sperry's DNA, and core declined from 70% of styles to less than 50%. As we look into 2023, our goal is to stabilize and generate consumer affection for Sperry. Our objective is to make both cool again through increased collaborations with designers that are relevant to our nautical theme and capitalize on the increasing consumer preference for spending on vacations and casual footwear for everyday use. We know Sperry can be top of mind for that vacation mindset with its classic and timeless styling. We expect Sperry revenue to decline high single digits in fiscal 23, the similar decline in the first quarter. Now, I will briefly touch on our international business. International revenue grew 32% in the fourth quarter and 42% for the full year in constant currency. Our brands continue to resonate well in international markets, and we see significant opportunities in both owned and JV-operated markets. The fourth quarter performance was driven by our top three brands, which account for over 50% of international revenues. In the quarter, Merrill and Saucony each saw international revenue growth of nearly 50%. EMEA business has also been a key contributor of the international growth, with Q4 revenue growth of plus 21%. Caterpillar also continued its strong performance with growth of 40% in EMEA. As we transition to 2023, we're focused on igniting growth across our active group, continuing our positive momentum in work, and quickly addressing our underperforming brands, all while increasing the efficiency of our business model. The retail environment remains volatile, and we continue to see some wholesale partners delay orders to allow more time to assess consumer demand trends. However, with our improving inventory position and a more responsive supply chain, we are better positioned to service the business. We expect to deliver 1% to 3% revenue growth for our ongoing businesses in 2023. Profitability is expected to improve sequentially as we right-size inventory and as savings from our profit improvement plan builds. We also expect to benefit as we introduce more newness and innovation across brands and continue our storytelling and full funnel marketing journey. We are now a leaner and more agile organization, better positioned to accelerate our profit growth and invest behind our core brands to enable them to reach their full potential. While we are disappointed that our performance in 2022 fell short of our original expectations, we believe we now have the organizational structure, the team and the strategy in place to deliver improved performance in 2023 and return to 12% operating margins in fiscal year 2024. I will now turn the call over to Mike to discuss more details about our fourth quarter financial results in our 2023 outlook. Mike?

Thanks, Brendan, and thank you all for joining the call. The last 100 days have been critical for the company. Our team has executed well against the short-term priorities we set to improve the health of the business while building a stronger foundation for the future. We beat our inventory and debt leverage goals, significantly reduced bottlenecks in our supply chain, and secured further cost savings that will benefit 2023 and beyond. The sale of KEDS was a major win, and we are especially pleased to have that transaction already completed, as this will allow for a quick transition and minimum disruption to the go-forward business. The fourth quarter revenue of $665 million was slightly above the midpoint of our guidance and represented 8.4% constant currency growth. During the quarter, our top five brands, Merrill, Saucony, Sweaty Betty, Wolverine, and Sperry, accounted for nearly 80% of our revenue. The performance footwear category drove the highest growth, and the work category remained consistent. We expect these product categories to be the best performing in 2023. During the quarter, We were pleased to ship or secure future orders for approximately 4.5 million pair or 75% of end of life inventory. Much of this will ship in the first half of this year. This critical execution will allow us to accelerate the reduction of inventory to more normal levels, enhance future cash flow, and further improve the performance of our warehouse and logistics operations. Despite this progress, we incurred higher transitory handling and inventory liquidation costs that negatively impacted our Q4 gross margin of 33.7% by 700 basis points. Higher promotions in our global D2C business and a higher mix of international distributor sales in the quarter also suppressed gross margin. Selling general and administrative expenses were $679 million including $429 million for the non-cash impairment of Sperry and Sweaty Betty intangible assets. The Sweaty Betty valuation was primarily impacted by a significant higher discount rate assumption. The Sperry valuation was impacted by a higher discount rate and a slower recovery than previously anticipated. In addition to the impairment, we also incurred approximately $10 million of severance and other separation costs related to the workforce reduction completed in December. Adjusted selling general and administrative expenses of $238 million were 35.8% of revenue, which is 50 basis points higher than last year. The new leverage was mainly due to elevated warehousing and offsite storage costs related to higher inventory levels. Adjusted operating margin was a negative 2% and below our outlook for the quarter, due to higher liquidation costs previously mentioned. The reported operating margin of a negative 68.4% includes the negative impact of the non-cash impairment and separation costs recorded in the quarter. Adjusted diluted loss per share for the quarter was 15 cents at the low end of our guidance and a 10 cent loss on a constant currency basis. The reported diluted loss per share of $4.59 includes the non-cash impairment and separation costs recorded in the quarter. Now let me provide further information about working capital and liquidity. Year-end inventory, including $43 million from CADS and Wolverine Leathers, was $788 million, which was down $50 million compared to our guidance in November. We have classified the inventory and other assets of CADS and Wolverine Leathers as held for sale on the balance sheet. Inventory for our ongoing business of $745 million was down $93 million compared to Q3. As mentioned, we have secured orders for nearly 75% of end-of-life inventory. As a result, the quality of inventory continues to improve. We ended the year with net debt of $1.02 billion and liquidity of approximately $685 million. Our bank defined leverage ratio was 2.7 times, down from 3.4 times at Q3 and slightly better than expected. Operating free cash flow was nearly $300 million in line with our guidance. Overall, we are pleased with the progress made to reduce inventory and improve liquidity in the fourth quarter. Importantly, supply chain operations have stabilized, and we expect continued working capital and cash flow improvement throughout 2023. Now let me transition to our outlook for 2023. Our guidance reflects the expected performance of our ongoing business, which excludes the full-year projections for Keds and Wolverine Leathers and adjusts for the licensing transition for Hush Puppies expected on July 1st. For reference, these businesses had revenue of $150 million and a diluted EPS contribution of 4 cents in fiscal 2022. Revenue is expected in the range of $2.53 billion to $2.58 billion in 2023. This compares to 2022 revenue of $2.53 billion from our ongoing business. and represents constant currency growth of approximately one to 3%. We expect the strongest performance from our active group with mid single digit growth. Our work group is expected to deliver consistent low single digit performance. And finally, our lifestyle group is expected to decline high single digits. Gross margin is expected to be approximately 42% compared to 39.9% in 2022. Certain transitory costs related to higher inventory are expected to have a 370 basis point negative impact on gross margin and will be most prominent in the first half of the year. More specifically, $45 million of transitory supply chain costs from 2022 that will be expensed in 2023, approximately $20 million of ongoing handling costs, and approximately $30 million from a higher mix of closeout sales. To offset these incremental transitory costs, our Profit Improvement Office has secured product and logistics cost savings of approximately $20 million that will benefit gross margin more heavily in the second half of the year. During 2023, our supply chain team will continue to drive improvement in operational planning, product engineering, SKU optimization, and speed to market. These actions will set a stronger foundation for future cost savings and more reliable performance. Adjusted selling general and administrative expenses are expected to be approximately 33.5%, or essentially flat with 2022. Higher incentive compensation costs and offsite storage costs for inventory will be offset by the benefits from profit improvement office initiatives, including $30 million from the December workforce reduction and $15 million from other indirect expense reductions. Adjusted operating margin is expected to be approximately 8.5% compared to 6.6% in 2022. Interest and other expenses are projected to be $59 million, and the effective tax rate is projected to be approximately 21%. As a result of these key assumptions, adjusted diluted earnings per share is expected to be in the range of $1.40 to $1.60. This compares to $1.37 in 2022 for our ongoing business. As you will recall, we sold the champion footwear trademark last year for $90 million and also recognized 12 cents per share of royalty earnings in 22 that will not reoccur in 2023. We remain keenly focused on working capital and cashflow optimization in 2023. We expect inventory to improve by approximately $225 million during the year due to the accelerated sale of end-of-life inventory and much lower intake of well inventory core styles. In addition, cash from divestitures and tight expense control should allow us to generate operating free cash flow in the range of $200 to $250 million. As a result, we expect year-end net debt of approximately $750 million and bank-defined leverage of approximately two times. Our outlook for the first quarter reflects the performance of our ongoing business and excludes Keds and Wolverine Leathers. For reference, the first quarter 2022 revenue for these businesses was approximately $40 million, and the 2022 EPS contribution was 3 cents. We expect Q1 revenue of approximately $580 million, constant currency growth of approximately 4%, and reported growth of approximately 1%. We expect Q1 growth margin of approximately 40% and operating margin of approximately 4%, including $17 million of transitory inventory costs from 2022 and $8 million of incremental holding and liquidation costs related to elevated inventory. The Q1 projected tax expense of approximately $5 million is unusually high due to the timing of a $3.5 million or 4 cent per share stock compensation true-up required for tax purposes. We expect adjusted diluted earnings per share of approximately 5 cents for the first quarter, which includes a negative 6 cents impact from foreign currency exchange rates. In conclusion, The strong work executed by our teams in 2022 will allow us to navigate 2023 with clear priorities and fewer supply chain and working capital obstacles. Changes made to our sourcing, logistics, and warehousing operations and systems will make us more nimble in the future. We expect profit and cash flow performance to improve sequentially throughout the year. Profit performance in the first half will be more challenging due to cost and inventory hangover from 2022. However, we should move beyond these headwinds by Q3 at the same time that profit improvement initiatives kick in. We have added a supplemental table to this morning's earnings press release to show the quarterly timing of transitory costs and profit improvement savings initiatives. Finally, we have strong line of sight to $150 million of annual cost savings for 2024, giving us future capacity to invest strategically in our growth brands while expanding our operating margin to our target of 12%. I'll now turn the call back to the operator.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Star keys. We kindly ask that questioners limit themselves to one question and one follow-up. Should you have any additional questions, please re-enter the question queue.

One moment, please, while we poll for questions.

Our first question comes from Denna Telsey with Telsey Advisory Group.

Good morning. A lot to unpack there. As you think about 2023, both Brendan and Mike, the cadence of the business and obviously the comparison the first half of the year versus the second half of the year, what are you seeing from your wholesale account and order trends? How is that looking? How are you planning promotions? And is the gross margin reduction in the first quarter Is more of it due to the businesses that are going away or how you're seeing the promotional levels? And any color there would be helpful. Thank you.

Yeah, thanks, Dana. Good morning. You know, I think like others with the wholesale business around the world, it's a little bit choppy. It's a little bit inconsistent as retailers get their inventories in line. They're certainly not placing orders in the out months like we've seen over the last couple of years, but those orders, a lot of them didn't materialize anyway. So I think they're, you know, looking for brands who are going to be able to chase the business with them as they see the trends. And, you know, I think given our inventory situation, that's one of the positives we have is the ability to do that. So. We're seeing more at-once orders than we have over the last couple of years. But we've taken a cautious outlook to the way wholesale is going to look as we think through the year. I think on the gross margin, I mean, we certainly saw a lot of promotions through holiday and into January, but that's not atypical of this time of year. As we get past President's Day, we start to – focus on more regular price. One real-time anecdote was yesterday we launched the Endorphin Elite on Saucony, full price, and had a gangbusters day in response to it. It's only in one color. So I think when we have newness and innovation, customers are still going to respond to that. And I think as we get into the main selling season, we'll see more and more regular price. And certainly as we get to the back half of the year, far less promotional than than what we just came out of. And for us, our gross margin is not only impacted positively as we go throughout the year on less promotions, but also just as we sell through this inventory. And as Mike said, on the first half of the year, we still have the low margin inventory that's burdened on the balance sheet. And as we get to this back half of the year, That's behind us, and we start to take advantage of the input costs like freight and containers that have come way down that will dramatically benefit gross margin in the back half of the year. Did I miss anything?

No, you got it. And just on the new product introductions and the mid-single-digit growth, for example, from Merrill and Wolverine and Saucony, how are you thinking about pricing the new products compared to maybe what you're pricing this past year for new products, the AURs?

Yeah, I mean, you know, I don't think you're going to see too much of a change there. I think over the last year and a half, we've tried to price more as merchants and really try to understand what the product attributes are and what we think the customer can pay for it, rather than just do a strict IMU calculation. That's going to be even more valuable for us with the Profit Improvement Office and the the costs we're taking out of our input margins and making sure we still price what we think the goods are worth. More of my concern is just what we alluded to, is just getting the promotions out of there that have taken whatever price we started at and discounted it. So, you know, I think all those brands are in a much better shape and using more analytics to help price the, figure out what the initial price should be.

Thank you.

Thanks, Dana. Our next question comes from J. Sol with UBS.

Hi, good morning. This is Mauricio Serna on behalf of J. Sol. Thanks for taking our questions. I guess I wanted to ask about the gross margin outlook. It just seems like to get to that 42% guidance that you provided, how should we think about the you know, the gross margin by half, you know, implying like maybe we should talk about like a 40% in the, around the 40% in the first quarter. Like how should we think about the cadence second quarter and like what does that imply actually for the second half gross margin? And then specifically on the Sperry brand, how should we think about the brand's turnaround plan given, you know, high single digit decline guidance for, you know, for fiscal year 23? Thank you.

Yeah, I'll start with the gross margin, let Mike top off, and then come back to Sperry. But, you know, I think it was a lot of what I just said to the previous question was the first half is burdened with all of these high costs from last year that we paid for but didn't recognize in the P&L when containers were over $20,000 and we were air freighting everything in and et cetera, et cetera, and the storage costs we're dealing with now. So as we get to the back half of the year, we see double opportunity. One, as I just mentioned, all of those are gone and have really flipped the other way. But plus, we're also going to start to get the benefit of the work the Profit Improvement Office is doing the last six months as we really work on input costs on materials and other margin components. So I feel good about the opportunity to not only recapture what we have given away over the last 12 months, but really set ourselves up for the future with a new improved margin base. Mike, you want to talk about that?

Sure. Importantly, too, I mentioned it in the script, but in the press release in the last section, we added a supplemental table that helps, I think, explain the flow of these costs as well as the benefits that we're seeing from the supply chain improvements, the cost reductions from the profit improvement office. So I think it really helps to guide you both to the expected improvements from cycling away from the transitory costs in the back half of the year and seeing those profit improvement savings start to benefit in Q3. But the margin rates kind of in the back half of the year would start to be in the, certainly in that 43 to 44% range. given that timing. And really important to emphasize that a large amount of the costs that we're expensing in 2023, especially in the first part of the year, nearly $50 million is related to costs that are on the balance sheet and are coming through in 2022, or I'm sorry, in 2023. costs that we have great visibility to. We know the timing of those expenses, and we'll be behind us by the middle of the year. So that's one of the major issues that's suppressing gross margin in the first half of the year. I think the second part of your question is on Sperry and the trajectory there. I'll let Brendan start.

Yeah, I mean, with Sperry, I mean, we've really done a lot of work over the last three or four months to be – introspective on what's wrong with the business, what we've done wrong, what we need to do differently, and really focusing on Sperry's recovery. And we realized over the last few years we've taken some missteps in product. We've been chasing product that others had success in but really weren't relevant to our customer. We need to refocus on Boat and making Boat cool again, and that includes focusing our collabs and marketing around Boat with some new updated styles that really resonate to the core. We were late to recognize that the duck boat trend was declining and replacing it with more fashion boots like the Torrent that provide function, as well as updating our marketing to focus on what our core is looking for. We took some big bets with people like John Legend, and one, we didn't have enough money to then go ahead and amplify the collaboration. But also, it wasn't core to what we were trying to do. So, You know, I think we've uncovered a lot about getting back to the core. We let fashion go historically core with 70% of our business focused around boat, boot, and vault. That dropped to 50% over the last couple years and just did not work out there in the marketplace. So I think the team's done a great job now understanding that better and using 2023 to reset the mix. And one very positive thing, if you saw the New York fashion shows, there was a lot around prep, and that's a big pillar for Sperry. In fact, they were showcased in the Foo & Foo show, which is Elizabeth Hilfiger's product line. She really leaned into prep and nautical and styled everything with Sperry. There's some real opportunities out there that we need to take advantage of, but I think the biggest thing for us is recovering some of the missteps we've made.

Great, great. And if I may add just a very quick one on, you know, capital allocation, you know, you mentioned that the plan is to get to, you know, have a, you know, healthier balance sheet by the end of the year, you know, focus on still leveraging. But how should we think about that in terms of the, you know, buybacks, you know, seeing like hasn't been really, they haven't really been taking place, you know, since I think second half of 2022. So how should we think about that in 2023 and beyond 2023? Thank you.

No, our primary, our priority now is to continue to pay down debt for the balance of the coming year here. And as we see opportunities, certainly we'll consider those other opportunities, but the primary focus will be on deleverage.

Thank you so much. Thank you.

Our next question comes from Jim Dusty with Cecil.

Thank you, guys. Good morning. Hey, some very helpful details in the release on the quarterly cadence of transitory costs and planned savings. Thank you for that. I'm trying to get a handle on the expected revenue cadence across the year. It sounds like good growth from Merrill and Saucony in the first quarter. I'm curious what's the revenue contribution of the 4.5 million pairs of end-of-life inventory I pencil out like 100 million plus. How much is that flattering the first quarter and the Merrill and Saucony growth in the first quarter? And then related to that, the active segment guide implies deceleration for the balance of the year. Are there promotional and clearance revenues to consider in the second half of 22 base that keep you conservative on the revenue outlook for the balance of the year?

I'll take the first part. Some of that product, that $4.5 million we referenced, some of that was shipped in Q4, a little more than we expected, so it's not quite the impact that you estimated, Jim. The product that we have on order now, which is a great development for us to be able to secure those orders and have good visibility to when we can move those goods out of the warehouse, those are spread over Q1 and Q2, so not especially impactful to Q1, actually, a little bit more so in Q2. And for the phasing of revenue, just remember that with Maryland Saucony having the biggest impact in 2022 from the closure of the Vietnam factories, they were coming into the year with very low inventories and sort of chasing business and kind of delivered suppressed results in the first quarter of last year. So the growth rates for Sperry and Saucony in the first quarter are probably going to outpace the rest of the year just based on that. So I think in terms of phasing in the first half versus the second half of the year, our outlook for constant currency growth at the high end is 3% growth and very similar growth in the first quarter. It ebbs and flows a little bit differently by brand. Because of the supply chain disruption and some of the inventory issues that we saw in 22, it's not a normal year from that standpoint, and the comparisons are a little bit different by brand. But I think overall, similar growth rates in the first half versus the second half of the year. And again, in 2022, our performance in the back half was certainly under our expectations, right? we had come into the back half of the year with a more optimistic view, and then the market changed quite a bit. And so our outlook in the back half of 23 is, I think, very cautious, given some of the volatility in retail inconsistencies that we're seeing out there, but very practical given the visibility to the business and the trends that we're seeing, especially in the performance brands, Merrill Saucony in our work business, which continues to be consistent. So we're comfortable with that kind of view of the back half of the year.

Thanks, Mike.

What was the second part of your question, Jim? I'm sorry, I missed that.

No, I think you covered it. It was just directionally around cadence of revenue over the course of the year and how to factor in the pairs of end-of-life inventory and the impact to that. I did also want to ask one on cost savings, and then I'll pass it along. I really appreciate the detail outlined in the release. You've got $30 million of cost savings planned in the fourth quarter. Mike, should we think about that as kind of a quarterly run rate that continues off the fiscal 22 baseline into fiscal 24?

Yeah, I think that's a fair, obviously the numbers ebb and flow a little bit in terms of of some of the one-time benefits that we'll get that kind of get pushed into the fourth quarter based on the flow of inventory. But for the most part, I think that's a safe assumption.

Great. Thanks so much. Thanks, Jim. Our next question comes from Jonathan Komp with Baird.

Thank you. Hi, good morning. Thank you. I want to just ask, can you give any more color on the D2C and wholesale assumptions that you're embedding for the year? And then maybe just to ask directly, if I go back to August, you were back then still projecting 2022 to be above $2 a share in earnings and operating margin above 9%. So could you maybe just address more directly, you know, what's changed today that's given you more visibility than maybe you had six months ago, and how you're thinking about overall visibility for both 2023 and in the comments on 2024 margin?

Yeah, well, I'll start with that second part first. I think because we've really taken control of the, through the Profit Improvement Office, of taking out costs and improving our margin through the input costs. I mean, I feel like the team over the last four months has made so much progress on this that we do have line of sight and more confidence in those being real and attainable. I think the 100-day action plan I talked about in December has really galvanized the organization to really move together and row in the same direction, understanding what needs to get done, and so the progress we've made in such a short period of time. gives us tremendous confidence that we'll be able to achieve that. And we need to for the long-term health of the business and to be able to not only provide a more profitable business, but also to free up investments to be able to expand our reach. Michael.

On your D2C question, John, or channel question, I guess, we would expect D2C to be a positive contributor to growth this year, probably in the low single-digit range. Um, you know, we are on a cop basis. We are adding some stores for sweaty Betty in, uh, 2023 in their home markets. So that'll also help drive a little bit of growth in the DTC channels. Uh, wholesales planned, uh, low single digits as well. Um, probably the area of pressure on the, on the, from a channel standpoint is in our, in our distributor business, which was up, as you know, was up tremendously in 2022. We caught up on some timing of sell-in in the first part of 2022, and that helped drive some up-paced growth for that channel. Overall, that's going to kind of correct itself. And even though our own businesses in Europe and Canada are expected to grow nicely, the third-party distributor business will be down a little bit on a year-over-year basis.

Okay, appreciate that, Collier. Maybe just one follow-up looking at the lifestyle brands. Could you just comment, Sperry and Sweaty Betty, are you expecting both to deliver positive operating profit this year? And just given the actions you took for Keds and Leathers, what are the criteria you're using for all of the brands looking across the portfolio? Thanks again.

Yeah, well, I mean, just to be clear, Sperry is in the lifestyle group, Sweaty Betty's in the active group. You know, I mentioned before some of the thoughts around Sperry. It will be positive in terms of operating profit. It won't be as positive as it has been in the past, and that's part of the recovery we need to do. You know, in terms of Sweaty Betty, you know, a lot of their headwinds are market-related in the U.K., Um, so they're working hard to, um, utilize different tools and levers to, to combat that. Um, you know, as I mentioned in my remarks, they, uh, acquired new customers, uh, for the first time in, in Q4 all year. So that was showing that some of the things we're doing are, uh, are paying off. The nice thing for them is, uh, The stores, which is a big part of their business, are all four-wall positive, and so as they see opportunities to open up some more stores in the U.K. market, that helps their overall profitability. A lot of their bottom line will depend on currency and how that moves, but we have a three-year plan to get them to much more profitable than they are today. Part of that's just utilizing some of the Wolverines opportunities and synergies, and some of it is just some of the new tactics they're putting in place.

Last part of your question, John, was just on kind of criteria. We still, as we said, right, Sperry is in that turnaround mode and that recovery mode right now, and the focus is to get first to a more stable and healthy business from a contribution, profit contribution standpoint. And then the future is about, you know, the credibility, viability of the growth potential of the brand. So I think the moves we made with Keds and Hush Puppies were certainly the step in the right direction as we were focusing on those types of improvements in the portfolio. And we're going to continue to use similar criteria for the future.

Okay. Thanks again.

Our next question comes from Sam Bolzer with Williams Trading.

Good morning. Thank you for taking my questions. I have a handful. I'll just read them off.

Prioritize the top two, Sam.

All right. So you mentioned that you would return to normal inventory levels in the third quarter. Can you define what you're going to regard as normal? Number one.

Sure. No, I think that by Q3, we would expect inventories to improve by another $150 million in that regard. Obviously, part of that's from the end-of-life product that we're moving through in the first half of the year. A big portion of that is the reduction in just intake of core franchises that we've reduced in the supply chain, the sourcing network this year. So I think good visibility to being able to achieve that, Sam, and get the inventories down to a level where we are supporting direct-to-consumer as that grows more prominently in the mix of our revenue and in our channels and supporting the forward coverage growth of our brands. So are we down to an optimal level by the end of Q3? Probably not, but I think normalized level. Certainly as it relates to end-of-life product, we'll be in a much healthier and more normal positioned by the end of Q3.

Yeah, the other thing I just want to say, you know, we talked about last time one of the big goals of the 100-day action plan was to reduce the gridlock in our warehouses given all this excess inventory. And the team has done an unbelievable job putting in new processes and procedures that have allowed us to, despite the inventory levels, get close to a normal flow to service our customer. And I think that's going to pay huge dividends when we do get the inventory down to be much more leaner and efficient in the way we're able to service the customer. Go ahead, Sam. What's next?

Well, okay. I just, well, I don't know which one to use here. Would you consider, I mean, I think you alluded to the fact that ICR that, that I think somebody asked you, you know, if given an appropriate offer, would you, would you sell Sperry? And two, What forward weeks of supply would be optimum for you from an inventory perspective, just as a follow-up to the other thing?

Well, it's different by brand. We have some brands like our work business where forward coverage can be very tight because it's very tight assortment. And in other brands, it needs to be a little bit longer. Lead times impact that. We try to be in that 100-day to 120-day range is optimal range. But I don't think we'll be to that level until the end of the year.

And as far as the other question... As far as Sperry goes, as I mentioned, I think we've uncovered some stuff that can help us recover some of what we've lost over the last few years, and that will just make the business healthier for whatever track we decide to take it. You know, right now I don't think would be a prudent time to do anything. We're still working through the... the KEDS transition, which we were thrilled with that outcome, and feel like there's some opportunities in Sperry that, given the macro conditions, we should focus on and then reassess. All right, thanks.

I'll jump back in. Thanks, Sam.

Thank you. Our next question comes from Mitch Cummins with Seaport Research.

Yeah, thanks for taking my questions. I guess starting on the gross margin, I just want to better understand the 42% because you're starting at 39.9. In the supplemental tables, if you kind of net the two pieces together, it looks like it's a negative 45 million to gross margin. So obviously there's an offset there, and I'm trying to better understand that. Is it really that in Q4 – you should see a big year-over-year pickup, maybe some reversal of kind of Q4 22 transitory expenses and maybe get back to a gross margin in Q4 that's, you know, maybe more similar to Q4 of 21. Is that kind of the way you get to the 42?

I think the biggest piece that's not represented in those tables is, frankly, you know, the – the higher, whether it's promotion or just sale of closeout end-of-life inventory, and the mix impact that has on the gross margin, Mitch, it's at least 100 basis points alone, and we see that improving sequentially through the year, again, as we work through the end-of-life product. We know that there will be a more quote-unquote promotional environment to contend with out there throughout the year through all of our channels, but We took an especially hard hit in Q3 and Q4, just selling off the excess inventory. So that's not reflected in the table, and that's going to be a major source of margin improvement as we work through, especially in the back half of the year.

Okay. And then, Mike, from a freight standpoint on the gross margin, year over year, adding in containers and air freight and all of that, is there any way to – to quantify the impact there. Is that, is that better in 23 than 22?

It's better for sure. However, we had in the first half of 22, we had a lot of air freight. So there's some puts and takes there, but I would say, you know, again, continue, continue to see improvements there. We actually are finalizing our contract with our ocean carriers in the next month or so. And so we'll have more information exactly how much better that could be, but we're seeing a, a strong improvement on the ocean freight. And then certainly as we get through the year here, hope to see even more improvements as we solidify those contracts. And it's certainly part of the savings that we're counting in our table there as it relates to supply chain costs, but potentially some upside to that number.

Okay. And maybe the last thing real quick, I might have missed in your prepared comments, but Did you guys provide a cash flow from operations target for the year? And if so, what is that?

Yeah, the target was between $2 and $250 million of operating free cash flow for 23. And then driving inventories down to $225 million or so, kind of at the middle of that range.

Okay, great.

Thanks and good luck. Thank you. Thank you.

Our next question comes from Abby with Piper Sandler.

Great. Thanks for taking my question. How are you navigating fueling growth in the active group as the space becomes increasingly competitive? And particularly on Sweaty Betty, do you see the same strategic benefits that you did at the time of the acquisition? And how are you planning a bigger expansion there into the US?

Well, I think that's One of the growth levers we have with Sweaty Betty when we bought it and certainly feel now, I mean, our main focus right now is stabilizing the U.K. market. That's where we're opening up the stores. I mean, that's where their foundation is. A year ago, I would have expected to have opened up a few Sweaty Betty stores in the U.S., but just given the climate, we decided to focus on the U.K. market while we focus here in the U.S. on our wholesale business. You know, I think I mentioned last time the nice relationship they have with Nordstrom's as well as some other specialty stores. And we moved them into our U.S. warehouse. Previously, they had been servicing it from the U.K. And while we had some hiccups in the fourth quarter, we think that's going to, in 2023, allow them to be much more agile in terms of servicing the U.S. wholesale market, which we also believe will give them exposure. to drive more U.S. e-commerce business while we contemplate what a store rollout looks like there. I think in terms of the broader question, the active group, in terms of the market trends you talked about, as we mentioned, as I mentioned in my remarks, two of our biggest priorities for the company are Merrill expanding into Lifestyle, and Sweaty Betty moving beyond the core. And so I think that, you know, and by the way, the overall trends in these categories are still very strong, you know, when you think about where we were a few years back. So we feel like there's ample room for us to continue to grow these growth brands. And, you know, ultimately it'll come down to product and innovation, as I mentioned earlier. Abby, I know you're a Saucony fan. We just had a tremendous launch last night with the Endorphin Elite. So I think that gives us even more confidence, quite frankly, that despite the environment still being a little bit too promotional, that when you do bring in newness and innovation, which Merrill does, of course, a great deal of as well, the customer is going to respond.

Great. And maybe just to follow up on that, on that bringing in new products such as Endorphin Elite that, you know, drive that consumer demand, like while working through inventory, how do you balance that? And do you think that limits top line growth or are you just prioritizing that on like a brand by brand perspective?

Yeah, well, I think for sure in a brand-by-brand perspective, you know, making sure that where we see the growth is where we're, you know, where we're flowing the goods more aggressively. But as we said, you know, even three months ago, a lot of the overage in the shoes and our inventory is in core product. I mean, that was when we made the decision a year and a half ago to try and chase sourcing when Vietnam was shut down, we for the most part did it in core product. So, That's where we don't have to bring in product. The newness, you know, is still able to flow. We have some newness and collaborations across the brands that we didn't get here in time last year. So a couple of the brands are actually chock full of great collaborations. So we recognize that newness and innovation is what's needed to help drive the core. So I think that hasn't been as challenging as maybe it sounds, given the approach we took.

Got it. Thank you. Thank you.

Our next question comes from Carla Casella with JP Morgan.

Hi, good morning. This is Mike for Carla, and thanks for taking our questions. I'll be quick as I can. Quick question, did you guys say how much of your inventory was currently in transit? I know you just go to that last quarter, but I'm wondering if there was an update for 4Q.

We didn't add that, but it's come down quite substantially from a quarter ago. I think it's down over $100 million. It's still elevated as we continue to work through some of the logistics, bottlenecks and container storage, but has improved tremendously in the last three months. And we'd expect the in-transit to normalize, you know, sequentially throughout the year.

Great. Thank you. And then did you guys –

ever give a disclosure on the timing of kind of the leathers divestiture sale and you know how much of that how that bakes into the guidance sure yeah well we've taken we've taken the leathers business kind of as a held for sale operation we've taken it out of our guidance um that we shared today um but it's a very active process we have a couple of interested uh strategic um parties that are evaluating the opportunity we did not give it a specific time frame because we don't have one yet but we'd expect some resolution you know by the middle of the year great thank you that's all from us thank you thank you ladies and gentlemen there are no further questions at this time I would like to turn the floor back over to Brendan Hoffman for closing comments

Thank you, everyone, for joining us today and your continued interest in Wolverine. We look forward to providing you another update at our earnings call in early May.

Thanks very much. That does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.