Greetings, and welcome to the Kontoor Brands First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] 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 first quarter 2023 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. On today's call, we will make comparisons to prior year results. Comparisons will be in constant currency unless otherwise stated. Joining me on today's call are Kontoor Brands President, Chief Executive Officer, and Chair, Scott Baxter; and Chief Financial Officer, Rustin Welton. Following our prepared remarks, we will open the call for questions. We anticipate this call will last about an hour. Scott?

Thanks, Eric, and thanks for all those joining us on today's call. I'm going to focus my comments today on three areas. First, I'll walk through a few select Q1 highlights, including our continued strength in POS, ongoing share gains, and momentum in the D2C, which we believe most accurately reflect our brand health and relative performance in the marketplace. Second, I'd like to provide an update on how our strategic investments in key enablers, including demand creation should support more diversified and accretive growth across categories, channels, and geographies over time. And finally, before I turn it over to Rustin, I'll share some thoughts on why I'm confident about the go-forward for Kontoor despite the uneven macro backdrop allowing us to reaffirm our 2023 guidance here today. Turning to the first quarter. I'm pleased to share that we delivered Q1 results consistent with both our expectations and commentary we provided on our fourth quarter call. Global Kontoor revenue decreased 1% in line with our prior outlook as increases domestically were tempered by expected softness internationally, particularly in the China region. Within the U.S. market, we continue to see strong POS outpaced shipments as retailers remain working through various inventory rebalancing efforts, muting domestic wholesale and top line upside for the quarter. But let me be clear, the Wrangler and Lee brands are winning and driving competitive separation in a challenging macro backdrop as evidenced by the solid momentum in POS, as well as share gains and robust D2C performance during Q1. So let me further dimensionalize the great positives around share gains and D2C both within the U.S. and international markets that reflect improving brand equity on a global basis. From a share perspective, according to NPD, which focuses on the U.S. total measured market both of Wrangler and…

Thank you, Scott. And thank you all for joining us today. As you saw in this morning's release, we delivered Q1 results consistent with our commentary from last quarter. While the macro environment remains uneven, as you just heard, we have a tremendous number of Kontoor-specific drivers supporting our brands in the marketplace. For the balance of the call, I'm going to cover three areas. First, I will discuss key financial highlights from the first quarter. Second, I will provide an update to our full year outlook including near-term and back-half drivers. And finally, I'll close with what gives us confidence to reiterate our full year expectations and the resiliency of our operating model in an uncertain environment. Starting with the first quarter, global revenue decreased 1% compared to the prior year and consistent with the expectations previously provided. Growth in U.S. and International D2C, as well as gains in U.S. wholesale were offset by softness in Greater China wholesale due to impacts from COVID policy changes. On a regional basis, U.S. revenues increased 2% driven by continued momentum in D2C and owned.com, which increased 13% and 15% respectively. In wholesale, we continue to see sell-through outpaced shipments, resulting in a modest revenue increase in the quarter. International revenues decreased 9%, driven by the previously mentioned impacts in China, more than offsetting 17% growth in D2C. A few additional points on China. First, our retail partners made meaningful progress improving inventories in the quarter. While this had a near-term impact on revenue, we believe this best positions our brands for long-term success. Furthermore, consistent with our expectations from last quarter, we continue to anticipate Q1 to mark the most significant year-over-year declines with trends significantly improving in the second quarter, and notably stronger than we previously anticipated. In EMEA, revenues…

Thank you [Operator Instructions] Our first question comes from the line of Mauricio Serna with UBS. Please proceed with your questions.

Hi, good morning. Thanks for taking our questions. Yes, well, first I would like to know about the first quarter it seems it came consistent with your expectations, maybe you could discuss the gross margin piece a little bit more as I know like maybe there were some expectations there that were not accurately capturing - what you were discussing about the pressure in the first quarter? Maybe, Scott, for you. It looks like the brands remain quite healthy and the market, given the strong share gains and D2C growth, maybe could you elaborate more on these dynamics. And then on inventory looks like you guys are choosing to be a bit more aggressive with internal production to manage it down and be clean by Q3, is that the correct way to think about it? And then that means that most of the gross margin pressure will be concentrated in Q2, it seems like there is like a lot of headwinds in the second half, supporting that full year gross margin expansion? Thanks.

Great. Thanks, Mauricio. It’s Rustin. Good morning. I'll go ahead and start with the question around our first quarter results. On our fourth quarter call, we said we expected revs to be flat to down low single digits, and we finished down one in constant currency. As anticipated, you mentioned a little bit about gross margin. On gross margin on that call, we indicated that Q1 would be significantly pressured by higher input costs, geographic mix due to China and production actions including downtime, which were all consistent with our expectations and what we saw in the quarter. I know there were perhaps a few analysts that didn't fully capture this commentary in the Q1 gross margin and subsequently the EPS estimates, which is why we tried to be even more prescriptive in today's prepared remarks and kind of shaping the remaining quarters with particular emphasis to the fact that Q2 would be the most pressured year-on-year due to the production actions in peak inflation that we're seeing. And then we expect gross margin to inflect positive in the second half, Mauricio, with Q4 having the greatest gross margin gains, and that's really due to lower input costs. The favorable geographic mix as China continues to recover the higher production efficiencies and ongoing structurally accretive shifts to D2C. So the EPS in the first quarter was in line with our expectations as well. So in summary, yes, we were in line with what we were expecting in the first quarter and hopefully, the additional color on the out quarters helps shape gross margin expectations as we kind of go forward. Scott, you want to take the second one?

Got it. So, Hi, Mauricio, thanks for the question. And, Mauricio, for us, it's incredibly important because it's our scoreboard. So every day we come in, we look at the scoreboard and we say, “Hey share gains are the thing that makes it work here.” It's why we do. This is why we have a lot of fun running this business. And I'll tell you, the other thing that's really important here is, it's the consumer is making the choice and that is the single most important equation that we're talking about here. When they walk into one of our big customers, they've got a choice across the board. But at the end of the day for the last couple of years that choice has been Wrangler and that choice has been Lee and it's been significant. And here is the key. It's been in male, it's been in female and it's been globally, which is really, really important in an incredibly important part of our strategy. I know we dimensionalized a little bit more today in which I thought was really important that we do. So that everyone could understand how and why our brands are winning. It's like a virtuous circle of success, right? So we think about the brand and our people in the middle. And then all the things that we're doing around it to expand that distribution. You think about the elevated design that we have right now. The category extensions that churn naturally fitting in with our company and our people and the culture that we're building. And then we're bringing new consumers into these franchises like we never had before, we're doing it with a really purposeful sense from a demand creation efforts. It's holistic like it's never been before, you think about…

Yes, yes. So I'll close out the questions, Mauricio, and talk a little bit about inventory. As you saw in our prepared remarks, inventory finished up 52% in the quarter versus last year, which was sequential improvement as we had expected from the Q4 results. Just a few comments kind of shaping it and then talk a little bit about your question about gross margins and the actions we're taking first. First off, I would say that the quality is good with approximately 90% in core styles, we really feel good about the quality of the inventory. The majority of that inventory is in North America, as you would expect, with our business and that's where we're seeing the strongest brand heat and the POS strength that Scott talked about in his prepared remarks. So what are we doing to address the inventory? A couple of things. First, we're flexing our internal manufacturing and adjusting receipts on sourced goods to right-size the inventory. And what I would say, Mauricio, is a prudent and profitable manner as we move through the year. These actions certainly, particularly around the production actions are going to weigh on the near-term gross margin, but taking downtime in the facilities reduces markdown in brand equity risks and relative to liquidation in off-price channels. And I think that's a really important point. We're working this down in a way that is right for the brands and it is relatively confined to the second quarter with the actions that we're taking. We do not have any downtime planned in the second half. So, we are going to aggressively get after this in the second quarter and we're going to do it in a way that needs to continue to balance servicing the domestic growth that we're seeing in the business, while also driving the inventory reduction. So in closing, we expect the inventory growth to be in line with the revenue growth by the end of Q3, '23 and certainly see significant inventory improvement in the back half of the year. So hopefully that that answers your question, Mauricio. Thanks for the time this morning.

Yes very helpful. And if I may just follow-up very quickly with another question, could you provide some commentary on your wholesale partners. I know like there has been some concerns about, why or maybe like Wrangler and Lee Jeans no longer available at customer like Target. Maybe if you could provide some commentary around that? Thanks.

So, Mauricio yes let me go ahead and talk about Target, because that's been a question that's come up before. So we want to go ahead and address that today and you know in the past, we've indicated that we don't typically like to talk about our specific customers. Unless it's financially material, but since that question has come couple of times, we'll go ahead and talk about it. Target's been a long-standing retail Kontoor for decades and as you know, there's an ebb and flow. And if you just go back 10 years ago. So let's just dial back to the mid-teens 2000, we were well above 90% denim supplier to Target only. And then as Target has evolved and as the consumers involved we've evolved with them. So our offering has evolved greatly with them. So as you think about back in 2017. We went ahead and rolled out our outdoor initiative and Target was one of the first customers that got very excited about that and has been behind that in a pretty significant way since then. It's a great example of our category diversification and how we can continue to work with our big partners in a different way and how we can go ahead and capture more consumers as they come in the door, because obviously the consumers are looking for different things to and if you think from 2019. And I'm going to dimensionalize this for you in a pretty specific way since 2019. Our non-denim assortment in Target has grown nearly 25% annually. And in 2022, it started to represent the overwhelming part and the majority of our business. Now, I'm not going to comment on the specific strategies, but I'm going to share, not a data point, but a specific point with you that I think is really relevant to how we're discussing and how we're thinking about the future consumer and how we work with our wholesale partners, our real estate. So the amount of real estate that we have on the pad at Target, we will not change in '23 compared to what it was in '22, but it will look different relative to the assortment and the offering, but I'm going to say that again and make it real clear, it will not change. What we have on the pad from '22 to '23. Rustin anything you'd like to add?

No, I think that I think that was great. And I know there was a question to you about kind of the wholesale partners, a little bit and I think we talked about that. Mauricio, certainly in our prepared remarks, you saw that that wholesale, whether it's domestic wholesale or the international wholesale certainly is the more challenged portion of the business, but again I would go back to sort of Scott's remarks. Our brands are resonating. I think the POS and the share gains in the example Scott shared in the prepared remarks really talks about the strength of the brands and over time, the supply and demand will find equilibrium. As we move forward. So again, we focus on sell-out as opposed to sell-in and certainly our offering is resonating with consumers in a way that we would like it to, so. Thanks, Mauricio for the questions.

Thank you. Our next questions come from the line of Will Gardner with Wells Fargo. Please proceed with your questions.

Hey guys, thanks for taking my question. Just a couple here so for Scott, great to get your thoughts around the health of the U.S. consumer I mean you're baking into guidance consumer demand worsening in the second half, but you're gaining share in DTC seems to reflect some resiliency - in the business. So I just wanted to square those two competing factors what's your confidence in reaffirming the top-line for the year? And then on China, it sounds like the recovery is happening faster than you expected. Maybe just talk about what you're seeing differently in the region. How you're seeing 2Q shape out quarter-to-date and implications for gross margin going forward? Thanks.

Well, let me go ahead and I'll start with the consumer question first. I think the thing, if you just think about our business and we've talked about this. We probably haven’t - talk about it for a few quarters ago, but I always think about our brands and our company is being a company that offers incredible value at an incredible price and the product is fantastic, right. So you think about these great brands that we really amplified over the last two years. Consumers really come back to them in a significant way, but they're really at a great price, and they are available and a lot of different places. So for the consumer that's under pressure. And I think we all can agree that the consumer with the record setting inflation that we've had is under more pressure than they've been before. They're going to go ahead and they're going to migrate to a brand that they trust and know a brand that's been resilient for them before in a brand that they can afford do we fit all those categories. But there is something much different about this company that hasn't been here for years. We are creating excitement around this company and these brands with our demand creation platforms that I've shared before the things that we're doing now that we've just never done before. And if you think about it from the time that we spun all the difference that we've made from a demand creation standpoint for both brands and how we still kept our brands forefront with that key consumer that we worked with through the years in addition to the fact that we now have a really strong digital platform. But now we're going ahead and offering that same brand in…

Yes. Thanks, Scott. Good morning, Will. I'd just add a couple of points I think Scott summarized it well. On the Q4 call, we spoke a little bit about with the reopening retailer inventory levels were elevated and we talked about expecting the first quarter in China to be a little tougher than what we saw in the fourth quarter and that certainly came through when you look at wholesale. When you look at the business in China, decreased 31% in constant currency in the quarter. Certainly in line with the expectations we've laid out, I think a couple of data points that are really relevant as you think about the go forward here. First, we were super encouraged with the direct to consumer business increasing 11% in the quarter in constant currency. Because we really believe that provides an important proof point as conditions continue to normalize over the next few quarters about how the brands are resonating with consumers, as Scott talked a little bit about we have seen that recovery happen a bit faster than originally expected. As you've heard us comment, but I would also sort of say that we expect that the reopening will not necessarily be linear by quarter and/or uniform across the country and you've heard us talk a little bit about that Will, we are certainly cautiously optimistic, but we will continue to play the long game with our brands in the region, as we've always done. So again - feel real optimistic about kind of how things are opening up at this point in the long-term potential in the market. So thanks for the question.

Thank you. Our next question comes from the line of Bob Drbul with Guggenheim. Please proceed with your questions.

Good morning. I just have a couple of questions as well. The first one Scott, you talked a lot about the demand creation pipeline, I think you call it robust. It does look really strong between Lainey Wilson and the Collabs that you talked about. Can you just talk a little bit more just how you see this easing the business. And then Rustin, can you talk about the cadence of the impact of all this SG&A throughout the year? And then the second question that I have is around the inventory rationalization normalization. I think, Rustin can you talk a little bit about optionality, can you just expand a bit more in terms of how you're thinking about it as you do free up a lot of this cash for the rest of the year. And then my third question is around you talked a lot about sell-in versus sell-through. Can you quantify U.S., North American wholesale POS, like what did you see really at retail this quarter I think that'll be very helpful? Thank you.

Hey Bob, how are you. Scott I'll go ahead and talk about creation.

Good thank you.

Nice to hear your voice, I often think back about what we did before and not to spend too much time into all in the past, but if you think about when we spun-off we did two or three things only and our demand creation platforms and didn't have big teams doing it either, but we had George Street as a spokesperson for a long time and that was successful. And then we had some football right. We advertised on football and those are really the only two things that we did with really big significance. And then Lee was kind of spotty it was on TV, off TV one year, so it didn't have traction and gain traction like that. So, I always thought about it from a consistency standpoint. So from a consumer standpoint one you're touching a really small audience with just Country Music and football and you're not touching enough from a female standpoint. And then with Lee, you're not touching everybody on a consistent basis. I think the thing that I'm most impressed with our organization right now is if you think about this as I do from a holistic standpoint. So you think about the fact that we now have brand investors and we've talked a lot about those brand investors in the past, and we've now added Lainey Wilson of and I mentioned it in my prepared remarks of Yellowstone and also her recordings and then we have strategic partnerships. So, and I didn't talk about this that much, but with Whalebone with Lee and with Yellowstone the TV show with Wrangler. And then we've talked a lot about the collaborations there another component of this, but we also have the event sponsorships that we've never done before. So the American Academy of Music Awards that we're sponsoring now Live Nation that we've been a sponsor over the last couple of years Rock the Bells. So I think about the fact that like never before we're touching all those aspects and they're all coming together. And we're seeing a different consumer, we're seeing a stronger, better consumer one that wants to engage with the brands, it's showing up differently everywhere. And just - I just love the way the teams doing it and I would leave you with this. I'm always impressed every time I talk to the team, because they are bringing newness and ideas to the table that we've never seen before as a company.

Yes and on your follow-up question, Bob. Dovetailing off of that, just the cadence of the impacts of SG&A as Scott said we're going to continue to invest in demand creation D2C geographic expansion. As you've heard us talk about for many quarters. Bob, keeping the brands really strong is incredibly important component of our success as you think about SG&A kind of flowing through the year. Now, we expect it to be more relatively balanced I'll say between H1 and H2 with some of that amplified demand creation in Q2 that we talked about in the prepared remarks. In the back half, we expect greater second half benefits from reductions in nonstrategic spend and tight cost controls that's an area of focus for us. Bob, it always will be. And certainly frees up opportunities to either continue to improve the bottom line or invest back into the business to drive that top line growth. Maybe I'll shift over to a couple of your other questions you talked a little bit about inventory and optionality. So let me hit that one, Bob. And then maybe I'll close with a data point about sell-in versus sell-through that might help kind of resonate there. So as we think about sort of capital allocation. You've heard us talk a lot Bob over time about optionality and we really think that's critical particularly in an uncertain operating environment like we're in at the moment. Our near-term priority is going to remain on cash generation and conversion, as we worked down the inventory levels and enhance our operating cash flow. As I said a few minutes ago, we do expect significant improvement in the inventory levels as we get through the back half of the year. And certainly that increases the cash flow and gives…

Thank you. Our next question comes from the line of Jim Duffy with Stifel. Please proceed with your questions.

Hi, good morning, this is Peter McGoldrick on for Jim. Thanks for taking our question. I was curious about the inventory at domestic wholesale, as you looking at the channel, the inventory. What visibility do you have to the inventory they have on hand, and given the higher rate of sell through could you anticipate a return to strength in the U.S. market?

Yes, I'll go ahead and take that one. Peter. So as we think about retailer inventories, certainly in the back half of last year. I think pretty well chronicled you know about the rebalancing efforts that took place in the back half of last year. As we think about the wholesale channel. Certainly, it's in a much healthier spot. I would say than where it was middle part of last year. But with that being said, I think, certain certainly retailers are being cautious as they think about the outlook moving forward and the open to buy dollars remain restricted. So again I think the inventory levels are and healthier spots and that's why we focus a little bit more on the POS and how our brands are doing in terms of sell through, because certainly over time that supply and demand will find equilibrium. As we move forward in the markets. So again, I think continuing to improve, but still a tight environment out there. So hopefully that answers your question. Peter. Thank you.

Thank you. Our next question comes from the line of Brooke Roach with Goldman Sachs. Please proceed with your question.

Good morning and thank you so much for taking our question, Scott, I was hoping that you could help us quantify the level of demand creation that you guys are embedding in your outlook as you lean into brand investments and marketing. And then for Rustin I was hoping that you could help us understand, how the conversations that you're having with wholesale partners now versus a few months ago and what's really changed and perhaps as you think about the second half. How are you thinking about your units versus price opportunity in the U.S. market? Thank you.

Look, I'll go ahead and start and then hand it over to Rustin what we've done here is that after having several years of experience and also bringing in Bridget and Holly some true professionals that know how to run these categories in this business. We're actually spending a lot of time on the ROI. And what we've done is in addition to what we have from a core standpoint we're reallocating dollars to the higher opportunities from an ROI standpoint. And having that data available to us now and looking at it differently, but also in addition to that, just having different programs and doing different things that we can evaluate and look at and see how sticky it is and how the consumers just answering our questions that we're asking and how they're carrying on a conversation with us. So for us it's really about an allocation to higher ROI and the things that bring the consumers in. Rustin?

Yes and Brooke. Good morning, thanks for the question. In terms of the wholesale partner conversations, I would say that similar to our comments on the call here. We certainly in conversations with our partners, focused on the fact that the brands are resonating with consumers that sell-through is really strong and the brands are gaining momentum and gaining share. Certainly I just mentioned that, I think many wholesale partners are cautious about the back half outlook and you've heard that - heard us reflect that as well in our outlook taking that into consideration in the back half, with the U.S. And certainly continuing to sort of work through that, but won't get into dimensionalize in units versus price assumptions. But again, keeping the brand, strong making sure that they're resonate and offering a compelling value to consumers when they come on the floor, really important for us. Key piece of our strategy and we're going to continue to do that in the back half and make sure that the brands are strong by investing in demand creation. So thanks for the questions Brooke

Thank you. Our next question comes from the line of Sam Poser with Williams Trading. Please proceed with your question.

Good morning and thank you for taking my questions. I have handful number one - since there was some misunderstanding about how the gross margin was going to fall in the first quarter. And could you give us a better direction for what's happening with how much the gross margin is going to be down. Are we looking at a 40% or I mean can be done 200 bps in Q2. Are we looking at 600 bps in Q2, so that's number one. Just give us and on the SG&A as well. Give us some help here, because there was some misunderstandings in Q1 and I hope, there's not as many misunderstandings going forward. Number two, on Target the discussion that you had – due to the prior question was that involving Wrangler. And can you give us a status of both brands Lee and Wrangler at Target. And thirdly, inventory levels in the third quarter should be in line with sales growth. So call that low to mid-single-digit sales growth in the quarter. In Q3, that would put inventory above where it is today even though it's not as much on a year-over-year basis and it would mean that your forward weeks of supply, would be quite high. So what is the accurate like sort of inventory turns that you want and what should normalized inventories look like?

Sure. Good morning, Sam. It's Rustin I'll go ahead and start with the question on gross margin and then flip over to Scott on Target and then come back on your inventory question. So in Q1, our gross margin was down 180 basis points. We were down 200 basis points in the fourth quarter. Sam, as you well know and we talked about in that fourth quarter call that we expected higher inflation geographic mix and production downtime to be partially offset by strategic pricing and moderating transitory costs like air freight. So as I mentioned earlier, certainly came in line with our expectations. With shipments lagging POS, the Q1, '23 inventory finished higher than expected. So, we're really getting after taking action here in the second quarter, as we've talked a little bit about and that includes incremental proactive actions in managing that internal production, that's planned here in Q2. Further based on those more elevated inventory levels Sam, the highest cost goods are now expected to flow through the P&L in Q2. So, we will be at peak inflation of what's flowing through the P&L. I'm not going to get into specific guidance around the gross margin number, but I will draw you to the fact again that we said we expect in Q2 that the greatest year-on-year gross margin pressure will come during the quarter because of those two factors. Certainly gives us confidence in holding the full year rate though because we're going to get greater efficiency in the back half, because those production actions as I indicated are behind us. Certainly peak inflation is easing significantly in Q3, Sam Before inflecting to a tailwind in Q4, and then certainly then you layer in the geographic mix from China. That's going to further support that second half margins with the greatest year-on-year gains again expect gross margin gains in both Q3 and Q4, but the greatest year-on-year gross margin gains in that fourth quarter. Scott, you want to take the Target piece.

Hey, Sam just a quick comment on your question on Target, Lee has not in is not in Target so there haven't been there. So hopefully that answers your question. Rustin from an inventory standpoint?

Yes, so on the inventory side and Sam you know this, from this business, typically we build inventory in the first three quarters in preparation for holiday. And then certainly, you see a big decrease in the fourth quarter as you think about kind of how the inventory flows, through the year. So certainly, to your point, inventory in building for that holiday season will continue out there. As we said, we do expect at the end of Q3 to have that inventory growth to be in line with revenue growth. And then certainly in that fourth quarter as you normally would with ours cadence of our inventory to see further reductions from there so, again some significant opportunities to generate cash in the back half of the year Sam, with some of the actions that we're taking here. So thanks for the question. Appreciate it. Sam.

Thank you. That is all the time, we have for questions today. I would now like to turn the call back over to Scott Baxter for any closing remarks.

So folks, just a quick couple of comments first I wanted to thank everyone that participated on the call today we here at Kontoor Brands certainly appreciate all the support that you gave us each and every day. So thank you very much and we look forward to our call. Again in a few short months, but I did also want to mention that I know we ran a bit long today. So I'm sorry if we didn't get to everyone's questions, but please follow up with Eric and Rustin as you usually do. So again, sorry, that we ran a bit long. And then just one quick note to finish today and that is that you saw in our prepared remarks where I mentioned that we would be have any Investor Day coming up so, please watch for those details in the next few months and we'll let you know, but we'll look forward to that too. So, thanks everyone. Thanks for your participation and have a great rest of your day.

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.