Third Quarter 2022 Earnings
November 3, 2022
Eric Tracy - VP, Corporate Finance and IR
Scott Baxter -President, CEO & Chair of the Board
Rustin Welton - EVP, Chief Financial Officer
Bob Drbul - Guggenheim Securities
Mauricio Serna - UBS
Will Gaertner - Wells Fargo
Brooke Roach - Goldman Sachs
Paul Kearney - Barclays
Greeting and welcome to the Kontoor 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 Kontoor Brands' 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 defined in the news release that was issued earlier this morning and is available at our website at kontoorbrands.com.
Reconciliations of GAAP measures to adjusted amounts can be found in 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.
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Joining me on today's call are Kontoor 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 Kontoor 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 Kontoor. Second, I'll take you through key highlights from our third quarter and provide some select proof points of how our strategic investments and 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 continued 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 in input costs. In the US, 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 US retailers would inversely 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, Kontoor 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
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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 US 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 US wholesale declined 9%.
However, we believe it is important to note that, while selling for traditional product was impacted by lower overall retailer opened by 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, US revenue year-to-date has increased 7% versus 2019.
And beyond core product, we once again experience 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 globalown.com increased 14% over '21 and 111% over 2019 while our USown.com experienced mid-teensyear-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 brands' combined 200-plus years of denim expertise.
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I actually just spent time with the team in Europe last week, including a trip to Antwerp and my first visit to our new AMEA headquarters in Geneva. It was fantastic to see folks in our new environment, and I was able to commend them on their really storm 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 APAC region, we knew the ongoing lockdowns in China will 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 APAC 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 of program aimed at transforming Kontoor 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 and 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 Tinnesz 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.
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From the new Lee Originals campaign to sponsoring this year's Bonnaroo Festival to the innovative X-line collaboration with Seven Up in China or Brooklyn Circus here in the US, 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 in 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 Gant 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 Gant 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 a 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've 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 on the macro, as I stated earlier, we are assuming that inflation in 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 sequentially 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 development. Second, while certain US 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.
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