Kontoor Brands, Inc. Q3 FY2022 Earnings Call

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. As a reminder, this conference is being recorded. I'd 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 on our website. Reconciliations of GAAP measures to adjusted amounts can be found on the supplemental financial tables included in today’s news release. These tables identify and quantify excluded items and provide management’s view of why this information is useful to investors. Comparisons will be in constant currency unless otherwise stated. Joining me on today’s call are 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 everyone 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 am 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 in brand enhancement initiatives are paying off. And finally, I will touch on our outlook, including what we are doing to address the implications of the broader trends and how our strategies will continue to help improve the model going forward. I started my comments on the second quarter call with a sobering description of the macro backdrop, and we continue to see a dynamic landscape during the third quarter. As I said, we think about four areas that are impacting us in varying degrees. Clearly, the first challenge we are seeing is the impact of inflation on underlying consumer demand and input costs. In the 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. In Europe, consumers are facing similar inflationary pressures, including a 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 than we planned. Finally, the global supply chain challenges that have plagued the industry for the last year have begun to show signs of moderating from historic highs. We have seen lead times from Asia moving closer to pre-pandemic levels, and although ocean freight remains above historic levels, it has begun to moderate. As we've stated consistently, Kontoor is not immune to these factors, and we attempt to accurately reflect these impacts in our outlook. However, I also know our company is better positioned than we have ever been to continue to drive competitive separation, and I am extremely proud of the organization's ability to deliver profitability and earnings above our internal expectations while positioning the company for sustainable, profitable long-term growth. Now let me address 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. 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%. It is important to note that while sales of traditional products were impacted by lower overall retailer open-to-buy dollars, our Wrangler and Lee brands were able to outpace the market, expanding share, point-of-sale and average unit retail during the quarter. Furthermore, compared to pre-pandemic levels, US revenue year-to-date has increased 7% versus 2019. Beyond core products, we again experienced broad-based strength across categories, including outdoor, workwear, and t-shirts, collectively up 9% in the quarter. This category expansion continues to be a critical piece of our growth strategy. Authentic brand extensions into areas such as outdoor, workwear, and t-shirts provide meaningful opportunities in large growing markets representing nearly $150 billion in aggregate, while also diversifying our product portfolio beyond denim bottoms. These new categories also allow us to enter new channels of distribution. When combined with elevated product design and enhanced demand creation, the Lee and Wrangler brands are increasingly appearing in premium specialty, western, sporting goods, and outdoor specialty, further diversifying from core distribution. As we drive closer connections with our consumers, there's no more important channel than the continued evolution of our own direct-to-consumer and digital platforms. As you know, we remain in the early days here, well below our competition in terms of penetration. Within digital, our global own.com increased 14% over 2021 and 111% over 2019, while our USown.com experienced mid-teens year-over-year growth in the quarter, which is proof that our investments—including digital demand creation in this highly lucrative growth channel—are paying off. 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 region. These expertly crafted retail destinations provide consumers a unique immersive experience with products from both brands. The stores maintain separate frontages for each brand, unified by a design concept that underscores the combined 200-plus years of denim expertise. I recently 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 exceptional quarter as Europe revenue increased 27% year-over-year. We also spent considerable time discussing our go-forward strategy, understanding that the near term will continue to be confronted by the inflationary pressures I previously discussed. I have no doubt that our teams will support one another through these challenging times while positioning our great brands for long-term success. In the APAC region, we are aware that ongoing lockdowns in China will continue to challenge results. However, we did see sequential improvement from Q2, with third-quarter revenue down 20%. In areas that have reopened, we have seen strong performance. While remaining cautious with respect to reopening in the region, we continue to build momentum when conditions normalize, and the long-term opportunities remain significant. Moving to Europe, our APAC team continues to enhance the global Kontoor Brands model strategically. This includes the recent launch of our Retail Excellence initiative, aimed at transforming Kontoor Asia into a world-class retailer. A reformatted store footprint, improved point-of-sale technologies, and enhanced product assortments will amplify the consumer experience. Based on early testing success, we are rolling out the Retail Excellence initiative across the region and will look to do so globally over the next 12 to 18 months. The opportunities to leverage our learnings in Asia as we develop our brick-and-mortar strategy globally are tremendous. These retail developments in Europe and Asia will be crucial as we navigate the respective challenges in each market while also continuing to build our global platform, ensuring these opportunities for growth don't happen without significant investments in brand building. Some of you joined us during Fashion Week, where our Lee and Wrangler brands took over lower Manhattan and Brooklyn for a night, showcasing how our investments in product design, innovation, and demand creation come to life as our teams collaborate with iconic leaders such as Photographer Mark Seliger and Grammy Award winner, Leon Bridges. The Lee brand is excited to once again partner with the preeminent Creative Director Seliger in launching our second global brand equity campaign, Lee Originals, inspired by individuals who not only stand the test of time but define it. The campaign highlights the new Sam Tinnesz song titled New Wave, celebrating individuals who approach both small and big moments of their lives with one part boldness and two parts optimism. From the 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 amplify demand creation efforts supporting its enhanced global brand repositioning. Similar to Lee, the Wrangler brand has strengthened connections with consumers during Q3 in its 75th anniversary, utilizing creative brand activation events, unique collaborations, and authentic brand partnerships to extend its reach to younger and more diverse audiences. In addition to launching the Leon Bridges collection I previously mentioned, Wrangler continues to build world-class partnerships with cultural influencers and iconic brands. Notably, these partnerships resonate with the brand's Western ethos while organically elevating its status. Collaborations like our college program with Coliseum extend the Wrangler brand to university ambassadors across the South and Midwest, and teaming up with the iconic Gant brand allows us to merge cowboy culture with fashion-forward signature pieces while staying true to our roots. Anecdotally, during my trip to Europe, I saw firsthand how a Gant collaboration sold shirts for over €900, supporting the premiumization of the Wrangler brand. Finally, our ongoing partnership with Yellowstone continues this fall, with a much-anticipated season premiere approaching, where you can expect Wrangler to make a significant appearance. These great demand creation initiatives, coupled with ongoing investments in talent, innovation, and supply chain, demonstrate our commitment to strategically invest behind our brands in impactful ways, even amidst a challenging macro environment. This leads me to my final comments regarding our go-forward strategy. As you've seen, we have adjusted our revenue and earnings guidance down slightly today, factoring in incremental currency headwinds impacting the top line by about a point, along with recognizing the four challenges I previously addressed. From a high level, while we don't have a crystal ball concerning the macroeconomy, as I previously mentioned, we are assuming inflation and subsequent tight monetary policies will weigh on demand, resulting in persistently challenging economic conditions in the near term. With that premise, why are we planning for revenue to sequentially accelerate in Q4? A few points here. First, our outlook is based on a combination of still strong domestic point-of-sale share gains and new business development. Second, while certain US retailer inventory levels remain challenged, significant rebalancing efforts from selective retailers have shown improvement, with aggressive actions taken early on and open-to-buy dollars opening back up and accelerating into Q4. Based on this second point, our quarter-to-date US orders and shipments have been strong, but we want to proceed with prudent conservatism given the uncertainty in the current environment. Regarding our inventory, Rustin will provide more detail shortly, but let’s be clear: we exited Q3 heavier than we ideally wanted. However, we have and will continue to productively address this, particularly by utilizing planned capacity downtime in our plants. This downtime, coupled with the fact that roughly 90% of our current inventory is in core products, significantly mitigates markdown or brand health risks faced by many of our competitors. Most of our key customers have made meaningful adjustments to Kontoor-specific inventory, as sell-through of our brands has outpaced shipments, providing us an advantageous position to navigate through the holiday season and into next year. Regarding full year 2023, I know all of you would like some insights. While we will not guide specifically, we are well into our planning process already. As stated, we anticipate ongoing macro challenges and operational headwinds to be more pronounced in the first half of both the top and bottom line, with opportunities to accelerate fundamentals in the second half of 2023 as inflationary pressures on demand and input costs are more likely to begin to ease. Additionally, we recognize the necessity of being more flexible in the current environment and will accordingly look to tighten discretionary expenses as we did in the third quarter. The significant actions we have taken over the last several years to bolster our balance sheet and enhance our capital structure provide us increased agility to navigate the uneven landscape. This is evidenced by the recent 4% increase in our quarterly dividend, reflecting the board's confidence in our fundamental improvements, coupled with our proven strong cash flow generation, even in challenging times, support our unique competitive position in the marketplace, along with our ability to continue to drive industry-leading returns for all stakeholders. Rustin?

Thank you, Scott, and thank you all for joining us today. As Scott stated, these are indeed unprecedented macroeconomic times. Inflation, consumer spending and confidence, interest rates, inventory rebalancing, and global geopolitical events create a cross-section of factors. However, the strength and positioning of our brands and the resiliency of our operating model provide a competitive advantage during times of uncertainty, allowing us to drive competitive separation in the marketplace. For the balance of the call, I'm going to cover a number of these topics and discuss how we are thinking about their impacts on our business and what actions we are taking to best position Kontoor for success, not only over the near term but also long-term as we execute on our Horizon 2 strategies to deliver superior total shareholder return. Finally, I will provide an update on our full-year guidance in light of these considerations before opening up the call to your questions. First, let me start with a review of our third-quarter results. Global revenue decreased by 5% compared to the prior year. Growth in our global direct-to-consumer business was offset by US retailer rebalancing and ongoing lockdowns in China. On a regional basis, US revenues decreased by 8%, driven by reduced shipments as retailers took significant actions to reduce inventory in the quarter. Partial offset came from the reported softness in wholesale, along with ongoing strength in our digital business, which increased by 14%. We are encouraged by progress we are making in key non-denim categories such as workwear and t-shirts, which delivered solid growth in the quarter. International revenues increased by 7%. COVID-related lockdowns in China continue to weigh on that region, while AMEA increased by 27% driven by strength in digital and timing related to the ERP implementation in 2021. Turning to our brands, global revenue for our Wrangler brand decreased by 2%. In the US, it was down by 5%, significantly impacted by the inventory rebalancing actions taken by retailers during the quarter. That said, we continue to drive growth in the categories such as Western and female, each of which posted double-digit increases while t-shirts showcased even stronger momentum with a triple-digit increase during the quarter. Our own digital channel's revenue increased by 16%, driven by increases across traffic, conversion, average order values, and average unit retail reflecting the strong returns from investments made in our digital platform. Wrangler's international revenue increased by 15%, driven by gains in China and Europe, as well as timing shifts related to the 2021 ERP implementation. Turning to Lee, global revenue decreased by 9%. Lee's US revenue decreased by 19%, driven by the retailer inventory balancing actions, partially offset by a 10% increase in our digital channel. Lee's international revenue increased by 3% in China, where COVID-related lockdowns significantly impacted the quarter, though we noted sequential improvement from the second quarter, and our eCommerce business revenue grew by 11%, building strong momentum into the important 11.11 shopping holiday. In EMEA, revenue increased by 34%, with our own.com growing by 27%, fueled by brand investments yielding favorable results. Looking at the wholesale channel, US wholesale decreased by 9%. Non-US wholesale increased by 8%, while global own.com increased by 14%. Gross margin decreased by 60 basis points compared to adjusted gross margin last year. The inflationary pressures and elevated ocean freight and foreign currency weighed on the margin rates, somewhat offsetting the headwinds, with a sequential improvement in transitory impacts like air freight in addition to ongoing structural benefits from accretive channels. The channel and product mix improved, contributing approximately 70 basis points of benefit. In the quarter, adjusted SG&A expense was $174 million, a $12 million decrease versus the third quarter of 2021. Adjusted SG&A reflected tight discretionary expense controls and lower compensation costs, offset by higher distribution expenses and continued strategic investments in digital and IT. As a percent of revenue, SG&A deleveraged by 20 basis points in the quarter. Adjusted earnings per share was $1.11 compared to $1.28 for the same period in the prior year. Regarding our balance sheet, third-quarter inventories increased 66% compared to last year and increased 24% compared to 2019. I will touch more on inventory in a bit. We finished the third quarter with net debt of $774 million and $58 million in cash equivalents. Our net leverage ratio, defined as net debt divided by trailing 12-month adjusted EBITDA, at the end of the third quarter was two times, which is within our targeted range of one to two times. Our board of directors has declared a regular quarterly cash dividend of $0.48 per share, a 4% increase. This reflects our confidence in the business and our resilient operating model, even amid a challenging macro environment, along with our commitment to deliver superior cash returns to our shareholders. Finally, at the end of the third quarter, we had $62 million remaining under our share repurchase authorization. Before discussing the specifics of our updated outlook, I want to touch on the key factors impacting the global operating environment and how we have incorporated these elements into our updated guidance. Starting with the top line, as Scott discussed, several themes are impacting the global demand environment, including US retailer inventory rebalancing, consumer spending and confidence under inflation, and China lockdowns. With respect to inventory rebalancing, following a prolonged period of supply chain disruptions and chasing demand, channel inventories across multiple consumer products became elevated in the marketplace. The subsequent retailer rebalancing actions, combined with cost inflation, and improved lead times led to third-quarter inventory levels higher than we would ideally want. But let's be clear: we are taking action. First, the quality of our inventory is good, with approximately 90% in core styles. Furthermore, while we expect a relatively promotional environment in the near term, we will be thoughtful and balanced in light of this, adjusting our internal manufacturing and modifying receipts of sourced goods to right-size our inventory position in a profitable and brand-appropriate manner. This will continue over the next few quarters, but we anticipate more normalized inventory levels by mid-2023. Second, while we expect the fourth quarter to be impacted by uncertain consumer trends amid inflationary pressures, we are encouraged by the healthy underlying demand for our brands. The investments and value we deliver to consumers resonate in the current environment. Despite shipment impacts seen in the third quarter, we continue to gain share in the US, with healthy point-of-sale performance. When combined with the improving Kontoor-specific inventory position, we are seeing signs of progress, reflected in significant revenue trends following a slower start in July and August. Revenue trends have accelerated notably in September and quarter-to-date, with both US shipments for September and October outpacing 2021. Concerning China, we continue to take a long-term view for both brands. As Scott stated, the reopening has been slower than anticipated, and this is reflected in our outlook as I will discuss soon. While this also impacts our gross margins, we believe it is prudent given the current uncertainty. Moving to gross margin, inflationary and supply chain impacts from commodities, wages, and ocean freight are the largest contributors to year-over-year declines this quarter, offsetting benefits we see from strategic pricing and product mix shifts. While costs such as cotton and freight remain elevated relative to historical levels, we note some sequential improvement in commodity prices and moderating lead times. Although we expect these headwinds to influence us in the near term, as stated, structural margin drivers remain very much intact. Shifts to accretive channels, categories, and geographies will support long-term gross margin expansion. Lastly, for SG&A, we have made substantial progress in improving our brand health over the last three years, which will continue as we prioritize investments that support both long-term momentum and superior total shareholder return potential. As illustrated in the third quarter, we have a strong cost discipline mindset in the current macro environment and will remain prudent, particularly concerning non-strategic spend. We have adjusted our full-year SG&A guidance accordingly to reflect our Q3 performance and updated plan. Moving on to our outlook, additional details can be found in today’s release, but in summary, revenue is now expected to increase approximately 4% on a reported basis and approximately 6% in constant currency compared to 2021. The updated revenue guidance includes an incremental one-point negative impact from foreign currency. Gross margin is now anticipated to approximate 43%, compared to adjusted gross margin of 44.6% achieved in 2021. The updated gross margin guidance includes incremental impacts from capacity downtime, geographic mix, and foreign currency. Benefits from continued structural shifts toward accretive channels, ongoing cost-saving initiatives, and strategic pricing are expected to help offset these higher costs. Adjusted SG&A, excluding an estimated one-time charge of $16 million associated with our globalization efforts and European headquarters relocation, is expected to increase at a low single-digit rate compared to adjusted SG&A in 2021. Adjusted earnings per share, excluding an estimated one-time charge of $0.23 per share associated with globalization efforts and European headquarters relocation, is anticipated to be in the range of $4.35 to $4.40 per share, compared to prior guidance of $4.40 to $4.50 per share. To close, as I discussed earlier, we are operating in a dynamic environment, but we couldn't be more proud of the steadfast execution and agility of our global team. We remain confident in our business's resiliency to drive competitive separation while delivering superior returns for all stakeholders. This concludes our prepared remarks, and I will now turn the call back to our operator.

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Bob Drbul with Guggenheim. Please proceed with your questions.

Hi guys. Good morning. A couple of questions. I guess the first one really, when you talk about the acceleration in trends that you're expecting in the fourth quarter, you talked a little bit about it. Can you just elaborate some more in terms of exactly what you're seeing? And I think you talked about your Q4 trends, the call out, so if you could spend a little more time on that, I think sort of ties together would be pretty helpful for us. Thanks.

Sure. Bob, it’s Scott. I'll go ahead and take that one. You saw that we tweaked down the top line a little bit here from a currency standpoint and some of the things that are happening in China. The lockdowns have occurred, and they aren't opening as quickly as we wanted. However, we are seeing some acceleration in Q4, and it's truly due to a multitude of different factors we've been working on for a long time. The continued strength in our point-of-sale gives us visibility and confidence. Furthermore, we've seen nice share gains from both brands, which contributes to our optimism. We are confident that we're going to retain these consumers because we have learned how to communicate effectively with them. Our demand creation teams are performing well. Additionally, our new business development team is also doing great work because our brands have gained significant relevance in the market. So, we do have visibility to the new business development, but I'll tell you the other thing: many of our retail partners are much cleaner than they were from an inventory standpoint, so open-to-buy dollars are improving, which is critical. We are pleased with the quarter-to-date trends across our business. This includes our core US business and is complemented by growth in our international channels and, of course, digitally. We are particularly excited about our newer categories like ATG work and t-shirts where we have made substantial progress. Ultimately, the essence is that our brands are becoming more relevant, gaining share, and the POS trends look promising. The work from our design and demand creation teams is synchronizing beautifully. Therefore, we feel optimistic as the economy improves, and we will be right there to capitalize on those opportunities. Thanks, Bob, for your question.

Thank you. Our next question comes from the line of Jay Sole with UBS. Please proceed with your questions.

Hi, good morning. This is Mauricio Serna on behalf of Jay Sole. Thanks for taking our questions. I guess I wanted to ask you if you could please talk a bit more about the puts and takes baked into Q4 gross margin guidance. I'm interested in hearing more about the impact of the capacity down. And maybe on the wholesale side, I'd like to know how the Wrangler brand is positioned in the channel primarily with key partners like Target.

Okay, Mauricio, good morning. It's Rustin. I'll take the first part, and Scott will take the second if that's okay. As we look at our Q4 gross margin outlook, as we indicated in our release this morning, there are three primary drivers expected to incrementally affect the Q4 gross margin. The most significant will be the impact of downtime in our plants. Clearly, Scott and I both spoke about the elevated inventory levels in our prepared remarks, and we are taking proactive actions here in the quarter to begin working that down, addressing these elevated inventory levels caused by retailer inventory rebalancing efforts amid softer consumer demand that we spoke of. Additionally, we anticipate an adverse geographic mix impact from lower sales in China due to the COVID-related lockdowns. Lastly, weaker sales in AMEA are also due to the inflationary impacts on consumer demand. The final impact we anticipate in Q4 is the FX impact, which will continue to be a headwind for our margins. Again, those are the three primary drivers that are incremental to what we've seen to date, with downtime being the most pronounced. Scott?

Hi Mauricio, how are you? Thanks for the question. I'll go ahead and address that for you. As a general practice, we don’t specifically discuss individual customers unless it’s material, and this isn't material to us. However, since there's some speculation in the marketplace, I can confirm that Target is one of our top accounts and a great partner for Kontoor with the Wrangler brand. We'll continue to optimize our denim assortment there, working closely with their teams. We have a solid relationship and aim to achieve outsized growth while rather also enhancing other categories. It's a comprehensive approach, and we’ll pursue our direct-to-consumer efforts, as well as international expansion simultaneously. Thank you, Mauricio.

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

Hey guys. Thanks for taking my questions. Maybe we could start with the cost controls; they have been quite impressive. You've reduced SG&A from high single digits to low single-digit guidance. Can you discuss what has been cut from those costs, particularly in terms of strategic versus non-strategic spend?

Good morning, Will. Rustin, I will go ahead and take that. As we indicated on the second-quarter call, we anticipated tighter expense control in the second half of 2022. Certainly, we were aware of the softer macro backdrop and wanted to ensure we were evaluating non-strategic and discretionary items, making cuts where necessary, and deploying savings to fund ongoing investments in strategic areas like digital demand creation. That is a crucial distinction. We will continue to invest behind our brands and capabilities. The third quarter played out as we expected, and we continue to use a total shareholder return (TSR) lens when assessing all investment opportunities. You can expect us to maintain strong cost discipline but, as you also know, we will continue to invest in our brands and capabilities.

If I could just follow up on the brick-and-mortar side, it sounds like you're making a substantial push in Europe and Asia. How many stores do you currently have in those regions, globally, and how will you leverage these new stores in Europe and Asia, potentially in the US?

Sure, Will. We have regularly discussed our strategic roadmap in Horizon 1 and Horizon 2. From the beginning, we emphasized a digital-first approach, making significant investments that have yielded positive results. However, we believe an omni-channel presence is essential, so we are also focusing on enhancing our brick-and-mortar strategy to complement our digital efforts. In Asia, we have a strong presence with over 700 stores via various partners, primarily in a franchise model. Notably, we have developed a Retail Excellence Initiative, which has seen enthusiastic adoption within our partners and will be rolled out globally. We believe there is a strong opportunity in Europe as well. I visited some of our stores in Europe recently, and we are eager to see how these initiatives come to life as we further develop our product offerings, including ATG, workwear, and t-shirts. This will enhance the consumer experience significantly. We appreciate your support, Will, and look forward to providing more updates in the future.

Absolutely. Can you discuss, and I know you’re not guiding for 2023, but share your thoughts on FX for next year, average unit costs (AUCs), and average unit retail prices (AURs)?

Absolutely, we will not guide for specific figures for 2023. However, we acknowledge that the first half of the year will continue to see pressures on both the top and bottom line from rising inflation. We anticipate a lag in the impact of input costs that emerged during Q2. It's fair to assess that Q4 will be most impacted by the capacity downtime we are taking. Therefore, we expect to see continued pressures into Q1, improving in Q2. Simultaneously, inflation and downtime will be mitigated by lower transitory costs driven by airfreight, structural mix improvements, strategic pricing, and cost reduction initiatives. I hope this context is helpful.

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

Good morning, and thank you for taking my questions, Scott. I was wondering if you could provide a bit more context on the relative outperformance in share gains that you’ve seen in some of your emerging categories, which have helped offset some of the macro pressures. Looking ahead, how much incremental opportunity is there to continue driving that outsized growth over the next few quarters against the current macro? Also, how are you planning for share gains in the US specifically? For Rustin, regarding the rebalance of inventory, thank you for the clarity on plant downtime. Can you share more on your expectations for the cadence of inventory growth as you work through that level? How are you managing to achieve that, whether through clearance or slow sell-through?

Thanks for your questions, Brooke! It's wonderful to hear from you. I believe it's vital to highlight that, as we embarked on spinning off this company, we recognized our two strong brands were somewhat limited geographically and category-wise. We understood that we could expand on that foundation, and since our focus on the outdoor segment, we have progressively moved into work, where we already had a footprint, and into t-shirts. With each quarter and seasonal product reveal, it strikes me how much we've evolved in those categories. We are making our presence felt in outdoor, workwear, and t-shirts, and both consumers and customers have been confident in our offerings in these categories. We continue to evolve our product lines and expand new distribution channels, which fuels our confidence moving forward. Therefore, yes, we are seeing a positive acceleration in consumer acceptance. Importantly, our value proposition in these categories resonates with consumers in a tight economic climate, which is evident in our pricing strategy. Our price points are positioned favorably compared to other players while still boasting the quality associated with our brands. This has resulted in consumers gravitating towards us, even in tough times. It strengthens my belief that we have significant growth potential ahead. The addressable market remains enormous. We have just established a small foothold in the t-shirt, outdoor, and workwear categories. We have plans to continue expanding beyond it, and our teams are excited about these prospects. We, of course, keep you updated on our progress in future meetings. Thank you for your inquiry and interest, and I'll pass it on to Rustin.

Great, good morning Brooke, thanks for your question and for joining us. To cover inventory quickly, we closed the quarter with approximately $678 million in inventory, which reflects a 66% increase compared to last year and a 24% increase compared to pre-pandemic levels. Scott and I discussed the reasons behind this inflow, which are influenced by factors such as inflationary pressures, retailer inventory rebalancing, and rising consumer demand. Increased quantities were also necessary to meet our growth initiatives in categories we mentioned earlier. With continuing improvements in lead times, we experienced heavier receipts this quarter than we originally anticipated. As noted, we will proactively implement downtimes in our plants and adjust future orders and sourced goods to right-size our inventory in a more profitable and brand-resilient manner. It is essential to emphasize that the quality of our inventory is strong, with around 90% in core styles. As we adjust our inventory, we expect normalized levels by the middle of 2023. While we plan to improve our inventory levels sequentially, we will adopt an approach that allows for excess clearance without diluting our brand health. Thank you, Brooke.

Thank you. Our next question comes from the line of Paul Kearney with Barclays. Please proceed with your questions.

Hi everyone. Good morning, and thanks for taking my questions. Regarding US wholesale, is it fair to assume that Q3 will be a low point in terms of retailers right-sizing, with improvement expected beyond this point? Or should we expect more pressure heading into 2023?

From our standpoint, pressure was significant in Q2 and the beginning of Q3. We now see signs of mitigation; our retail partners are sophisticated and have worked hard to address their inventories. Importantly, our brands have become crucial to these partners, helping us maintain visibility on the shelf. Our point-of-sale performance is trending positively, and we’re experiencing good share gains. Therefore, we believe we are well positioned for the latter half of Q3 and beyond, as we maintain relationships with our top customers. This optimistic outlook stems from our brand strength and the efforts we have undertaken to elevate their status in the retail landscape. Thank you!

Thank you. Can I ask a quick follow-up regarding private label competition? Are you observing any changes from retailers leaning more heavily into private labels, and how do you view your pricing position compared to those brands over the past year?

Yes, no problem, Paul. We have a long history of competing against private label brands, and we have consistently succeeded in differentiating ourselves. We offer excitement and energy around our national brands through global marketing campaigns. This distinction has grown stronger in the past few years, effectively elevating our positioning compared to private labels. Historically, there was closer proximity due to marketing spend and recognition; however, our significant investment has widened the gap significantly. Most crucially, we maintain competitive price points and have strategically priced our products lower than some competitors. This approach resonates with consumers, and when given a choice between a recognized global brand at an attractive price or a private label, they choose us. We're confident in our positioning and are committed to this strategic path. Sure, Paul, to address your question on capital allocation strategy, we really emphasize cash generation. Our board recently approved a 4% quarterly dividend increase, which is a strong indicator regarding our confidence in the business's state and our anticipated cash generation moving forward. For now, our priority remains on cash generation as we work to bring down inventory levels. Please note that we did not repurchase any shares in Q3 but have invested $62 million in shares this year. Share repurchase remains crucial within our capital allocation strategy, with $62 million still available under our authorization. Of course, we will prioritize investments in our brand and demand creation abilities alongside share repurchases, ensuring we maintain a balanced capital allocation model moving forward.

Thank you. There are no further questions at this time. I would now like to turn the call back over to CEO, Scott Baxter, for any closing comments.

Thanks, everybody, for joining us today. I hope you know how much we appreciate your interest in our company and your support, and we all enjoy this time that we spend together. Before we conclude, since we won't have a chance to chat before the holidays, I want to wish everyone a happy, healthy, and safe holiday season. We look forward to your continued support. Thanks again, and have a nice day, everyone.

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