Greetings and welcome to the Kontoor Brands' Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Eric Tracy, VP, Corporate Finance and Investor Relations. Thank you. Please go ahead.

Thank you, operator, and welcome to Kontoor Brands' third 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. Amounts referred to on today's call will often be on an adjusted dollar basis, which we clearly defined in the news release that was issued earlier this morning. Reconciliations of GAAP measures to adjusted amounts can be found in the supplemental financial tables included in today's news release, which is available on our website at kontoorbrands.com. These tables identify and quantify excluded items and provide management's view of why this information is useful to investors. Unless otherwise noted, amounts referred to on today's call will be in constant currency, which exclude the translation impact of changes in foreign currency exchange rates. Joining me on today's call are Kontoor Brands' President, Chief Executive Officer and Chair; Scott Baxter; and newly Chief Financial Officer, Joe Alkire. Following our prepared remarks, we will open the call for your questions. We anticipate the call will last about an hour. Scott?

Thanks Eric and thanks for all of those joining us on our call. I'm pleased to share that we delivered Q3 results above our expectations, most notably with upside to our topline. Our strategic playbook is working and is why I'm so confident in the next phase of Kontoor's evolution, even as we assume a more challenging macroeconomic backdrop. And on the bottom-line, it excluding the duty charge, which Joe will provide more detail on in a bit, operating results also exceeded our plan. Global Kontoor revenue increased 8%, including about a point of FX benefit, with particular strengths in the US across both wholesale and D2C. Within the US market, ongoing strong POS and share gains were driven by accelerating shipments during the quarter. From a share perspective, according to Circana, which focuses on the US total measured market, we continued to outpace the market in our US wholesale and core denim business during the third quarter and here to start Q4. A few notable call outs. For the last three months, Kontoor Brands outperformed the market by approximately 140 basis points and in men's bottoms, we outperformed the market and our largest competitor by 170 and over 250 basis points respectively. And in women's, our lead business gained over 60 points of share to the market, outpacing our closest competitor by 30 basis points. Importantly, even after aggressive price pricing actions taken by select peers, we've continued to see market share gains. For example, over the last month, our Wrangler men's bottoms business outpaced our largest competitor by over 250 points, while Lee's men's outperformed by roughly 150 points. Our share gains in the core are in large part due to the strategic investments in our brand across innovation, design, and demand creation. That drives competitive separation. I'll…

Thank you, Scott and thank you all for joining us today. Before I review the third quarter, let me say how honored and appreciative I am to have the opportunity to serve as CFO of Kontoor Brands. I am thrilled to reunite with the Kontoor family and I want to express my gratitude to Scott, the Board, and the organization for the support as I transition back into the business. I feel a tremendous amount of responsibility and stewardship to all Kontoor employees around the globe as well as those that have come before me and built the strong foundation that is in place today. I'd also like to extend a special thank you to Rustin, who has been a strong resource for me during the transition. He will be missed, and we wish him and his family all the best in retirement. With that, let's review the third quarter. Global revenue increased 7% compared to the prior year as broad based growth in the US in both wholesale and DTC was partially offset by a decline in international. Our third quarter results again reflected the strong momentum of our brands, as evidenced by continued market share gains and POS strength across key accounts and distribution channels. On a regional basis, US revenue increased 12%. Direct-to-consumer increased 7%, including 11% growth in digital. In the wholesale channel, revenue increased 12%, with strong performance from both brands. In addition to strength in our core categories, we also drove growth in outdoor and non-denim bottoms, as category expansion remains a top strategic priority. And while retailers remain cautious, inventory levels in the channel continue to improve and are more balanced as POS and shipments work towards equilibrium as we enter the holiday period. As expected, international revenue decreased 8%, driven mainly by…

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Today's first question is coming from Mauricio Serna of UBS. Please go ahead.

Thanks. Good morning and thanks for taking my questions. Maybe just to start with the duty expense, can you give us more color around it? Should we think about the fiscal year 2023 EPS guide now at $4.50, really? And then on the gross margin and inventory actions, it's great to see the sequential improvement there. Could you talk more about the amplified inventory actions taken? Still seems that you want to be proactive and make sure you come out in a clean position out of 2023. Is that the way to really think about it? Thank you.

Hey, Mauricio. Good morning. It's Joe. Maybe I'll start with the duty and I'll let Scott kick off the inventory conversation. So, yeah, on the duty, the issue primarily relates to prior periods, 2021 and 2022 specifically. As we stated in the prepared remarks, we identified the issue late in the quarter, and it really dates back to the ERP implementation. And so, perspective here I think may be helpful. The duty charge was $13 million over a two and a half year period on total cost of goods sold over that same timeframe of, several billion dollars. So, we won't get into the accounting technicalities as to as to why the charge is presented as gap versus adjusted, but the charge was a prior period adjustment, really a correction of an error and just out of period. So, clearly this charge was not contemplated in our prior outlook. And as you think about the appropriate baseline for underlying earnings in 2023, we view $1.22 and $4.50 of adjusted EPS respectively as more representative going forward.

Fantastic. Thanks, Joe. Mauricio, thanks for the question. We thought about what we wanted to do to position ourselves for 2024 and put our teams in the A position. And we started this process a little bit, Mauricio, with our manufacturing downtime in the beginning of the year. And then we had such broad-based strength in our business that we knew we could do this. We knew we could be aggressive and we could clean everything up. It was the right thing to do from a hygiene standpoint for our business. And as it frees up a tremendous amount of cash that we can invest back in the brands and back in our people, which is really great. We're investing back in the business because of this. It optimizes our distribution centers and our supply chain, which is great. And, when you think about an action like this, what it does is it has benefits in almost every aspect of our business. So we're really excited about where we stand from an inventory standpoint heading into 2024. And it's been difficult for a lot of people the last couple of years, but right now we are in a fantastic position. Joe, any additional comments there?

Yeah, maybe just a few. These actions, as Scott said, were proactive. These were the right decisions for the business. We're clearing through non-core inventory. The majority of our inventory remains core, over 85% or so. And, in terms of these actions, our inventory levels continue to normalize. We're almost there. In some respects, these actions are evergreen. But in terms of the more elevated impact, we'll be through that pretty much by the end of this year.

Got it. Congratulations. And thanks for answering the questions.

Thank you. The next question is coming from Bob Drbul of Guggenheim. Please go ahead.

Hi. Good morning, guys. And Joe, welcome back. Congratulations. I guess, I have two questions I'd like to really focus on. The first one, Scott, from your perspective, when you look at the macro, you touch a lot of different price points now and distribution channels. Can you just give us maybe your perspective on a high level around the consumer, around the macro, sort of even more recent and in the sort of the next few weeks as you think about the holiday season? And then the second question I have is, you talked a lot about, the share gains and some of the, point of sale strength that you've seen in the third quarter. It seems like, you're seeing it in the fourth quarter. Can you just talk a little bit more about sort of the dynamics, maybe, pricing, competition, anything more around what you see unfolding around these share gains and the sort of categories that you're competing in? Thanks.

Sure, you bet. Good to hear your voice, Bob. Thanks for the question. I'll start and then I'll toss it over to Joe. We'll kind of do a little bit of both on this one. But from a macro standpoint, we've talked a little bit about the fact that we thought the consumer was going to be a little stressed here as the year went on. And hopefully that'll start to mitigate here going into 2024. But I actually think that we're going to have a good holiday season. The consumer always shows up around the holiday season. And why I think that for us is that we've taken a lot of share here in the last couple of years, which has been really important for our brands. So what that means is you see our brands in a more elevated way. And you also see our brands in a bigger distribution from a real estate standpoint. And what's happening for us is you talk about our brands are priced right. You get a tremendous amount of value at a really good price. But there's two other components that have been really important for us. One, we've taken our demand creation to another level. So people are walking into our big customers and our big consumers are walking in and saying, hey, where are Wrangler and Lee? I have to have them. I'm seeing them everywhere. I'm seeing them if I go to a Dallas Cowboys game. I'm seeing them if I go to Austin City Limits. We see these big Barbie kickoff and collection. So we're seeing some really interesting things and people are migrating to our brands at a really good price. So I think we've positioned ourselves really well as we've thought about how we distance ourselves from everybody else. But there's one other little piece here that's really interesting for us as a company as we move forward. And that's that from a D to C standpoint. And Bob, you've been with us on this journey. And you remember we talked a lot about leading with digital, leading with digital, leading with digital, because we never invested in digital in the old world five years ago. And so we did that and we've got that platform up and running. But now we're really spending some of this extra cash that we have and the investment dollars that we have on building our D to C network globally. In addition to that, really building out our international platforms too. And the key for us is that it's pretty evergreen because we're fairly new in both of those. And we have a lot ahead of us versus some of our competition. So that's why I feel really good about our consumer and how we're going to control our own destiny from this moment here going forward. I'm pretty excited about our future here. Joe, any comments about share gains and pricing?

Just a few on pricing, Bob. So pricing for us has been a tailwind this year. There's really nothing fundamentally different compared to the prior outlook on the pricing front. As Scott said, our market share gains remain strong. Performance at POS remains strong. These brands are performing at retail. And we were very strategic with pricing over the past couple of years. And pricing is a conversation with retailers as it always is. But it's just one factor in terms of the number of levers we have to pull on the gross margin front.

Thank you very much.

Thanks, Bob.

Thank you. The next question is coming from Brooke Roach of Goldman Sachs. Please go ahead.

Good morning, and thank you for taking our question. Scott, I wanted to follow-up on Bob's question and just get a little bit more sense of what's changing in the macro outlook that's caused you to be a little bit more cautious on the year. And it sounds like a little more caution into the first half of next year, despite the ongoing strength of your brands and the share gains. Is there any one particular region, channel, or type of product that's causing this incremental conservatism?

So, Brooke, not cautious really at all. Still feel great about the business. From the standpoint of our POS, our POS is still strong and continues to be positive. Now, our customer might be a little bit more cautious in their ordering patterns and what have you. But let me be really clear here. This is a really interesting point. Because our gains are so strong, share gains, our POS is so good, and our demand creation right now is hitting on all cylinders, it creates an atmosphere where you have to go ahead and order our products. So I feel really good about what's happening in our business right now. I mean, I've been here now as the CEO for five years, and I've told the team here recently, I have never felt better than I feel right now. This team, this business, these brands, the product that we're creating, the decisions we're making, I feel really confident. So not from me. Joe, anything to add there?

No, I think you covered it.

Great. And then maybe a follow-up for Joe. Can you elaborate on the incremental changes in your outlook for gross margin beyond the duty charge? How much additional margin headwind are you seeing this year from inventory clearance actions? And then can you contextualize the level of transitory headwinds that are still weighing on gross margin in 4Q, where we might see some better visibility on those returning to normalized levels into 2024? Thank you.

Sure, Brooke. So for the quarter, excluding the duty charge, the gross margin was flat. That included the inventory management actions that we took. That was about 30 basis points. So excluding those, the gross margin increased year-over-year pretty much as we expected, and the main drivers of that were really price mix and lower transitory costs, such as air freight offset by still higher input costs, moderating as we expected versus Q2, but still higher. So for the full year, we were at 42.5 or 42.9 when you exclude the duty charge. That's about 60 basis points off of the low end of our prior outlook, and the biggest driver of that really is the inventory actions that we took. There's a little bit of mix-related impact in there as we tightened up the revenue range, and you've got ongoing strength from U.S. wholesale. But I think importantly for Q4, we've got about 300 basis points of expansion embedded in the outlook. Again, the drivers are really the same pricing mix, but as we've said all year, we have input costs flipping to a tailwind in the fourth quarter, and that will really continue into next year.

Thank you so much. I will pass it on.

Thank you. The next question is coming from Will Gaertner of Wells Fargo. Please go ahead.

Hey, guys. Thanks for taking my question. So just to start off, so cash generation, you're improving your inventory significantly here. Could you just discuss your capital allocation optionality here? I noticed you didn't have any share purchases this quarter. Just can you maybe discuss how you're thinking about that going forward?

Yes, so go ahead, Joe, and then maybe I'll jump in at the end.

Yes, maybe I'll start here, Will. So on the capital allocation front, the priorities are unchanged. Organic reinvestment in the business, given the performance we have across both brands, maintaining that superior dividend, which you saw what we did this quarter, and then we've got share repurchases in M&A. So I think near term, we're continuing to focus on working capital improvement. We're really pleased with the progress on the inventory front, and I think we're almost there on the inventory side. Leverage is in good shape. It'll come down further next year, as we expect an increase in cash generation and gross margin recovers and our inventory normalizes further. So we've got a lot of optionality. We're going to remain really disciplined here, but certainly an opportunity to more actively deploy capital in a TSR creative manner.

So just a quick comment. I agree with everything Joe said, obviously, right? But if you think about how we think about this as a company and how pleased we are with the position that we're in, and if you think about the industry and the world that we operate in right now, to have a balance sheet like this, to be in the position that we're in, to be able to do what we need to do to drive this business. And I think the other thing that makes me more excited about anything, or anything that we've talked about, is the fact that we can do multiple things. We aren't tied to just one thing by any. You saw in my prepared remarks and Joe's remarks, we increased our dividend. That was just one thing we did recently. But we have the ability to do multiple things at the same time. And I think being in that position in this day and age and the time and the environment right now really puts us at a big, big distinctive advantage, especially with these brands and how they're operating right now.

And maybe just one follow-up. So on SG&A, you're cutting from mid-single-digit growth to low single-digit growth. Can you just discuss where you're taking costs out and maybe if there's opportunity in the next year to continue to do so?

Yes, I'll take that. So really no change to the investments in the strategic priorities, DTC, demand creation, and innovation. The reduction is really on the discretionary expense side, and we're just being a little bit more cautious, given our outlook on the overall environment.

Great. I'll pass it on. Thank you.

Thank you. The next question is coming from Jim Duffy of Stifel. Please go ahead.

Hi, this is Peter McGoldrick on for Jim. Thanks for taking our question, and welcome, Joe. First, on free cash flow, can you talk about the puts and takes of the operating cash flow guidance? I recognize this is a new guidance slide item, but with inventory managed more tightly than previously anticipated, I was curious to get a sense of the working capital items and other drivers of the $335 million operating cash flow guide.

Yes, so I'll take that, Peter. How are you doing? Yes, so we've got a pretty strong fourth quarter in terms of cash generation. That's really two things, margin recovery in the business, mainly driven by gross margin, and then further unwinding of the net working capital, mainly inventory. So we've got about $335 million for the year. I think we're somewhere around $175 million or $180 million in the fourth quarter, and roughly $100 million of that will be a further reduction in overall inventory levels.

Okay. And one follow-up. As we zoom out and think of the long-term financial capacity of the business, can you discuss the structural gross margin potential and any updated assessment you might have of a bridge towards the prior 46% gross margin potential outlook?

Yes, I'll start. So nothing fundamentally different, Peter. I think we still see that algorithm largely intact. You'll have the structural margin drivers in DTC and international as input costs normalize. Here, we're going to recover a lot of what we lost over the past couple of years from inflation and supply chain disruption. And then we've got a handful of other initiatives that I talked about in my prepared remarks that are more mid- to longer-term in nature on the supply chain front that are significant. These are gross margin and networking capital related. We'll share more details on those, but those will unfold over a multi-year period, and we may start to see some of those bear fruit in the second half of next year.

And I'd reiterate what Joe said here. I think there's one really important point that we've talked a lot about as a team. We went through a spin. Obviously, everybody knows that. Then a very difficult ERP. As everyone knows, when you do an ERP, it takes up a lot of mind space for your entire organization. Now, you've got a lot of bright people, a really talented team that are going to focus their energies on this back-end supply chain that Joe has now talked about a couple of times, and we're going to put a lot of effort and energy into that. One of the things that's great about here is that we already do it really well, and we're going to enhance that going forward. So we see opportunity there, as Joe has mentioned, and we've got a lot of people that are going to be focused on that now that we've freed up some of their time.

Thank you.

Thank you. The next question is coming from Paul Kearney of Barclays. Please go ahead.

Hey, good morning. Thanks for taking my question. And Joe, good to hear from you again. First, can you talk about the margin performance by brand? It looks like the operating margin fell almost 350 basis points versus Wrangler down 25. What was the driver of the differential between the two? And then I have a follow-up.

Yes, Paul, if you're looking at the reported numbers, you've got the duty charge embedded in there. So there's some noise in there related to that.

Is that primarily pulling on lead?

No, it would be both brands.

Okay. Second, I guess, as we look into next year and we think about SG&A, how should we think about SG&A growth relative to the low single digits this year, especially given the investments that you're making into the business? Thanks.

Yes, I think we'll hold on any specific guidance for next year. But I would say just from a construct standpoint, we'll continue to look to distort investment toward the areas we talked about, DTC, demand creation and innovation, while we hold the line on discretionary expenses and look to leverage those pretty aggressively. We do continue to have opportunities to drive further efficiency in the business. I talked about that a little bit in my prepared remarks. And we'll talk about where and how that's going to come to life in the context of our plan for next year.

All right. Thank you.

Thank you. The next question is coming from Bob Drbul of Guggenheim. Please go ahead.

I wanted to jump back in just and follow up on, I mean, the SG&A and the spend, but the demand creation, you're talking about just the brand doing as much as it's ever done sort of this current quarter. The Cowboys and Laney Wilson. Can you just talk about sort of the level sort of where you are today? And as you think about that dollar spend or percentage spend, how that might proceed into next year and beyond? Thanks.

Yes, yes. Thanks, Bob. I'll start on the numbers and Scott may want to jump in here. So, so for the quarter, as an example, we increased our demand creation spend at a double digit rate in the quarter. Right. And you've seen the impact that that's had and some of the things we're doing, which we're really excited about. That's something we'll continue to do over time. So I would expect, demand creation as a percent total to continue to increase and we'll look to grow that investment at a rate slightly above our overall revenue growth.

And Bob, I'm going to jump in here because I really want to, because I would be remiss if I didn't give a big shout out to Holly and Bridget globally from Wrangler and Lee, the two folks that lead our demand creation platforms across the globe for our brands. And that, in my point of view is that you can spend any amount of money you want, but if you don't spend it intelligently, it really doesn't matter. And we used to spend a lot of money and not get a lot of return from that investment. And like anything in life, you want to increase that investment return in our teams. And those leaders have done an outstanding job. And I won't go through all the things that we talked about like the Laney Wilson, the Cowboys and all their, collabs and everything again. But it's a real tribute to how the teams are thinking about our brands, how we're culturally right in the center of everything that's going on around the globe. And every day I'm astounded when I hear about the things that we're working on. And I shared this one other time, we used to make outbound calls for people to partner with us. We got a lot of calls that come in now, everybody wants to partner with us. So it's a really fun position to be in and we're really driving forward. And I think that we're doing some things that I think, people would think about us from the standpoint of our size as a company and our spend. I think people would think that we're much larger than we are and spend a lot more than we do because we're having such an impact on the things that we're doing culturally. And you can see it, the brands are really, really, benefiting from it greatly. So I just wanted to make sure that, that was stated. So thanks, Bob.

Thanks, Scott.

Thank you. The next question is a follow-up coming from Mauricio Serna of UBS. Please go ahead.

Great. Thanks for taking the follow up. I just want to follow-up on two things. First, on DTC, maybe you could talk a little bit more about the momentum you're seeing there on the own.com business. How much actually does that represent of your sales at the point? And then another follow up on inventory. Do you have any exposure to the PFAs chemicals? Just wondering if that increases any risk on the inventory age as some retailers with a national footprint would likely try to reduce that exposure starting the spring of 24, as other brands have commented recently. Just wondering how that could affect your approach to discounting, too. Thank you.

Yes, so let me start with the dotcom. And yes, we're really pleased with our dotcom business right now. I think the thing that I'm most pleased with from the standpoint of certainly the growth, but we put a lot of investment behind our dotcom and we're actually seeing the benefit of that. Now, we built out a team. We've done some really good advertising and marketing within their capabilities. And now you're marrying our new ERP system that we've put in globally and you're matching that up and marrying that up to our dotcom business. And the teams are working really exceptionally well together and we see a pretty bright future. So I guess I want to make sure everyone knows that we're still focused on that digital aspect. It's super important to us. It's still front and center, of course, going forward and really like, what Chris and team are doing there. So, so really pleased. And on the other one, let us get back to you and we'll look into that. We'll make sure that we have the exactly correct information. So we'll get back to you.

Thank you.

Thanks. You bet. Thank you.

Thank you. The next question is coming from Will Gaertner of Wells Fargo. Please go ahead with your follow up.

Hey, hey, guys, thanks for let me come back in here. Just a question on the US wholesale. You have a big, you're lapping a big number next quarter. Just how are you thinking about that? As far as growth in the next quarter as you're lapping this sort of big spike last year?

Yes, I think will the most important thing is a freshness of your product, making sure that you're enhancing your core product at all times, which we've done, making sure you've heard us talk a lot about our category extension. So we've done a really nice job in our T-shirt business done a really nice job in our, for instance, our ATG business, our Wrangler for Angler business. So all of those ancillary lines and also categories are helping us grow that business. We're gaining real estate because of our strong POS. We're gaining share because of our strong POS. And then you enhance that with all the demand creation that I talked about. We feel really confident in the next quarter and we really like our big customers. They're terrific partners. We've been with them for a long time. We work really well together. They're winning in the marketplace. And I think that's a pretty powerful combination. And I will say this once again, our inventory is in a really good spot. So, from an inventory standpoint, with our customers, we've got, A plus inventory heading over there. And that's what we're focused on going forward. I like what I'm seeing quite a bit.

Thank you. At this time, I'd like to turn it back over to Scott for closing comments.

Well, thank you, everyone. Really appreciate all the thoughtful questions today and look forward to spending time with you again next quarter. Wanted to wish all of you a happy, healthy and safe holiday season. And thanks for your interest and care about our company. We are working really hard to make sure that we're doing all the right things. And we've got a terrific team here. And I'm glad you have a lot of confidence in us. And I know I have a lot of confidence in our team going forward. And we'll look forward to sharing more with you in the future. So thanks, everyone.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or walk off the webcast at this time and enjoy the rest of your day.