Earnings Call Transcript - WWW Q1 2023

Operator, Operator

Greetings, and welcome to the Wolverine Worldwide Inc. First Quarter 2023 Earnings Call. A brief question-and-answer session will follow the formal presentation. It is now my pleasure to introduce your host, Alex Wiseman, Vice President of Finance. Thank you. Please go ahead, sir.

Alex Wiseman, Vice President of Finance

Good morning, and welcome to our first quarter 2023 conference call. On the call today are Brendan Hoffman, our President and Chief Executive Officer; and Mike Stornant, our Executive Vice President and Chief Financial Officer. Earlier this morning, we issued our earnings press release and announced our financial results for the first quarter 2023. The press release is available on many news sites and can be viewed on our corporate website at wolverineworldwide.com. This morning's earnings press release and comments made during today's earnings call include non-GAAP disclosures, which adjust for certain items such as environmental and other related costs, net of cost recoveries, reorganization costs, foreign exchange rate changes and a gain on the divestiture of the Keds business. Financial results and guidance for 2023 and comparable results for 2022 where our ongoing business exclude the impact of Keds, which was sold in February 2023, and Wolverine Leathers which is subject of a sale process and reflect an adjustment for the transition of our Hushpuppy North America business to a licensing model in the second half of 2023. These disclosures were reconciled in attached tables within the body of the release. I'd also like to remind you that statements describing the company's expectations, plans, predictions and projections such as those regarding the company's outlook for fiscal year 2023, growth opportunities and trends expected to affect the company's future performance made during today's conference call are forward-looking statements under U.S. securities laws. As a result, we must caution you that there are a number of factors that could cause actual results to differ materially from those described in the forward-looking statements. These important risk factors are identified in the company's SEC filings and in our press releases. With that being said, I'd now like to turn the call over to Brendan Hoffman.

Brendan Hoffman, President and CEO

Thank you, Alex. Good morning, everyone, and thank you for joining today's call. We delivered first quarter results in line with our guidance and despite industry headwinds, we are reaffirming our full year guidance. Our active group delivered 12% revenue growth on a reported basis and 15% revenue growth in constant currency, led by Merrell and Saucony with the strongest revenue increases coming from our international markets. As expected, our actions to expedite the sale of end-of-life inventory pressured gross margin that have left us better positioned for future performance. We are encouraged by the progress we have made to execute on our strategy for long-term revenue growth and profitability increases. As laid out in prior calls, the strategy includes building stronger brands that resonate more powerfully with our consumers, distorting investment to our growth brands and extending our brands from their core businesses into large, fast-growing adjacent markets and categories. Additionally, we have continued to make progress against our operational goals to remove cost and complexity while we increase our speed, efficiency and agility. First quarter financial highlights include: reported revenue from the ongoing business, in line with our expectations of $580 million, up 1% on a reported basis and increasing 3% in constant currency from the first quarter of 2022. Adjusted diluted earnings per share of $0.09 above our expectations for adjusted diluted EPS of $0.05. Net inventory for our ongoing business declined nearly $20 million sequentially from fourth quarter of 2022 and is on track to end 2023 down approximately $225 million versus the prior year. During the quarter, we further improved our operational capabilities and our ability to execute against our financial and strategic goals. The highlights include: the refinement of our operating structure, specifically the new brand group structure now enables our teams to more easily collaborate and share best practices across common categories and markets. We are also making great strides to modernize our supply chain and operations planning processes, including the investment in a new product life cycle management tool set that will be operational later this year. In March, we integrated Sweaty Betty into our London-based international team to align them more closely with the company's global centers of excellence. We expect this change will allow us to better leverage the company's logistics, technology and operational expertise to harvest savings that can be reinvested in growth opportunities for Sweaty Betty. The profit improvement office remains on track to deliver $65 million of cost savings in 2023. I'm especially pleased to see the collaboration across all areas of the business to secure these benefits and make them sustainable going forward. We have begun to see earlier-than-expected flow-through of some of the supply chain savings. We continue to expect $150 million of annual savings from the profit improvement office in 2024. The optimization of our portfolio continues, allowing us to focus resources on the businesses and brands that we believe will drive the highest return for our shareholders. The recent sale of Keds and pending licensing of Hush Puppies will enable this focus and these transitions are well underway. We also continue to work towards an exit for the Wolverine leather business. As we evaluate opportunities ahead for the company, we need to focus our future efforts and investments on our growth brands, Merrell, Saucony and Sweaty Betty. Therefore, we have decided to explore strategic alternatives for Sperry over the coming months while we continue the foundational work needed to position the brand for long-term success. Sperry is a special brand with unique authenticity and heritage. It is the brand I was most familiar with when I joined the company. I'm convinced that with the right focus and investment, this brand has a very bright future. This decision will allow us to put more resources behind building Merrell's lifestyle business, extending Saucony's reach beyond the core everyday active and lifestyle consumers, global expansion of Saucony's original business, which remains robust in Europe and has great potential elsewhere in the world, particularly in the U.S. Stabilizing Sweaty Betty's home market in the U.K. and Ireland, while looking for opportunities globally, including the U.S. and China, investing in technology, specifically around our e-commerce platform and user experience. Moving on to brand results, starting with the active group consisting of Merrell, Saucony, Sweaty Betty and Chaco. We are pleased with the group's performance in the first quarter, including 12% growth on a reported basis and 15% in constant currency. However, some of this was due to timing given last year's recovery from the Vietnam shutdown that changed the order flow throughout the first half of the year. As expected, this benefited Q1 and will pressure Q2. Merrell's revenue increased 18% on a reported basis and 20% in constant currency to $180 million in the first quarter. This performance was in line with our expectations for high teens growth in the quarter. Notably, Merrell gained market share based on NPD data due to strength in core products and extensions and new franchises. Most notably, the strength of our core Moab franchise, which we refreshed with the launch of the Moab I reinforced our product leadership while demonstrating our ability to drive relevance and consumer love through technological innovation. As a result, Merrell showed the biggest share gains of all brands in the high category for the quarter. In trail running, Merrell returned to share gains in the first quarter. We are excited about Merrell's expansion of its lifestyle product line and believe this is our highest growth opportunity for Merrell. Our lifestyle product line, OneTRL, continues to expand the brand's reach with retail partners and customers. In the quarter, we opened the first OneTRL store in Tokyo and plan to selectively open more OneTRL stores, which provide the brand's most elevated expression around the world. Looking ahead, we continue to expect Merrell's revenue to grow mid-single digits in fiscal 2023. However, we expect Q2 revenues to decline mid-teens versus 2022 caused both by difficult macroeconomic headwinds as well as year-over-year product flow shifts that I mentioned earlier. Revenue for the first half of 2023 is expected to be flat. Before I discuss Saucony's results, I wanted to make you aware of a change in leadership. Anne Cavassa, previously Saucony's brand President, has left the company. We thank her for her contributions and wish her well. The process of naming a successor is well underway. In the interim, Chris Hufnagel, President of our active group, will be working more closely with our strong Saucony team. We believe having Chris more involved in the day-to-day operations of Saucony will allow for greater collaboration and synergies with Merrell as we look to solidify Saucony as a preeminent leader in core running and leverage the brand's strength in technology and innovation to build out a lifestyle offering to broaden its wear occasions and consumer reach. In the first quarter, Saucony's revenue grew 21% on a reported basis and 25% in constant currency to $133 million. Revenue surpassed our expectations for high single-digit growth in the quarter, driven by increases in the performance core run category and early progress on our initiative to broaden our reach to an active and lifestyle consumer, along with the change in receipt flow I mentioned earlier. In the quarter, we also launched Endorphin Elite with a very positive consumer reaction and saw a 74% sell-through on Saucony.com in the first week of the launch. Despite being new to the market, of the 25,000 runners who competed at the Boston Marathon, it was in the top 10 most worn styles. Overall, Saucony was the second highest-worn shoe brand in the sub-3-hour category at the Boston Marathon. Now touching on our Saucony Originals business, which is approaching 20% of the brand's global revenue. In the U.S. wholesale channel, we opened new accounts, including fashion lifestyle platform, Shopbop and Evereve, leveraging on our classic franchises to expand reach to more lifestyle consumers. In Europe, we featured the Rod Dixon campaign to launch the DX N trainer, putting the style in the number one spot for multiple weeks post-launch on Saucony.EU. Looking ahead, we expect Saucony revenue to decline mid-single digits in Q2, grow mid-single digits in H1, and grow high single digits in fiscal 2023. Moving on to Sweaty Betty. First quarter revenue decreased 3% in constant currency and 11% on a reported basis to $47 million. These results, while disappointing, were better than our expectations for a mid-teens decline. Sweaty Betty's results continue to be impacted by a challenging retail environment in the U.K. The recent launch of the Zero Gravity running bra, along with other product innovations, has led to improved sales trends in April, higher units per transaction and less promotional activity. We continue to stabilize Sweaty Betty in its home market in the U.K. and Ireland, while improving profitability through synergies from stronger integration within the rest of the portfolio. Looking ahead for Q2, we expect a low teens decline in Sweaty Betty revenue. For fiscal 2023, we expect Sweaty Betty to decline low single digits on a reported basis and increase low single digits on a constant currency basis. The Work Group revenue declined 17% on a reported and constant currency basis to $115 million. The revenue decline in the quarter was primarily due to normalized phasing of Caterpillar International spring product flow as well as pressure from consumers trading down to lower price point products. Our brand teams have already responded with great offerings in the under $100 price category. Our highly anticipated collaborations continue to resonate well with customers, generating further brand awareness and loyalty. Following the first launch in 2022, Wolverine continued its journey in the Halo universe with the launch of our 4 Boot Limited Edition Wolverine and Halo Master Chief boot collaboration, which sold out in less than one minute. Within the last week, Wolverine won Collaboration of the Year from Fashion Group International for its Pappy Van Winkle boots, and they were honored as Brand of the Year by the Accessories Council. Finally, we are very excited about Bates' test launch at Walmart in over 200 stores in the second half of the year. This expansion could be very meaningful to the brand given the runway Walmart offers. Looking ahead, we expect work group revenues to be roughly flat in fiscal 2023, with high single-digit declines in Q2. The Lifestyle group, which includes Sperry and Hushpuppy, saw a revenue decline of 8% both on a reported basis and constant currency. Sperry first quarter revenue declined 13% to $63 million, which was softer than our expected high single-digit decline due to lower sell-throughs of certain styles caused in part by the unfavorable weather during the spring season. We are focused on stabilizing Sperry with initiatives to introduce styles that more closely resemble the brand's DNA. We remain optimistic about the growing prep fashion trend that is emerging in the market. We expect Sperry revenue to decline high single digits in fiscal 2023, with a low teens decline in the second quarter. Now I will briefly touch on our international business. Revenue grew 13% on a reported basis and 18% in constant currency in the first quarter. Our brands continue to resonate well in global markets, and we see significant opportunities in both owned and JV operated markets. Merrell and Saucony across regions were the key drivers of performance with 29% and 37% growth, respectively. Saucony's China JV once again had a very strong quarter as sales grew over 100%, exhibiting the strength of our multichannel strategy. In Q1, the brand launched the Endorphin Elite in China, which sold through 60% in 30 days and provided invaluable activation and media opportunities for the brand. The growth also includes the addition of 12 new stores during the quarter, bringing our total store count to 81. We continue to expect Saucony revenue from our China JV to double in 2023. In conclusion, as we move through the year, we remain focused on driving growth across our active group, leveraging our leading position in work and addressing our underperforming brands, all while increasing the efficiency of our business model. We are excited about newness and marketing initiatives planned for the back half of the year across our brands. We are fully on track to return to high single-digit growth in the second half of 2023 as we lap supply chain disruptions from last year. Finally, we expect to continue to reduce inventory and take costs out of the business to free up investment for 2024 and beyond. I will now turn the call over to Mike to discuss more details about our first quarter financial results and our 2023 outlook.

Mike Stornant, Executive Vice President and CFO

Thanks, Brendan, and thank you all for joining the call. Let me briefly recap certain financial highlights primarily from our ongoing business for the first quarter, and then I will cover our outlook for the second quarter and full year. First quarter revenue for our ongoing business of $580 million was in line with our outlook and represented approximately 3% constant currency growth. Our most important brands, Merrell, Saucony, Sweaty Betty, and Wolverine accounted for over 70% of our revenue during the quarter. Reported revenue was $599.4 million. Adjusted gross margin of 40% was in line with our expectations. Adjusted operating margin was 5.1% and included the impact of $25 million of incremental transitory supply chain costs. The reported operating margin of 7.6% included the gain from the sale of Keds, partially offset by reorganization costs. Adjusted diluted earnings per share for the quarter were $0.09 and $0.12 on a constant currency basis. The reported diluted earnings per share of $0.23 reflects a gain on the sale of the Keds brand. Inventory for the ongoing business was $726 million and improved $19 million compared to Q4 2022. The first quarter was a good start to the year, and we achieved nearly all of our short-term objectives. We fully appreciate the importance of operational discipline, cost control, and cash flow in this volatile environment, and we have made important improvements in all areas. Brendan mentioned some of the benefits being driven by the profit improvement office, but I want to emphasize the great work this team is doing to accelerate and crystallize cost savings as a fundamental part of strengthening the foundation of the company. We remain confident in our ability to deliver $150 million in profit improvements in 2024 in support of our 12% operating margin target. Let me transition to our 2023 outlook for the full year. Our guidance reflects the expected performance of our ongoing business, which excludes the full year projections for Keds and Wolverine Leathers and adjusts for the licensing transition for Hush Puppies expected in July. Like many other companies in our industry, we have seen some deterioration in market trends since the start of the year and especially since early March. Macroeconomic concerns and a cold spring selling season have impacted consumer demand. Despite this added pressure, we believe the diversity of our portfolio and global reach will help to mitigate the risks ahead of us. As a result, we are reaffirming our outlook for revenue, earnings, and year-end inventory. Revenue from our ongoing business is expected in the range of $2.53 billion to $2.58 billion, constant currency growth of approximately 1% to 3%. Adjusted gross margin is expected to be approximately 42%. Adjusted operating margin is expected to be approximately 8.5%. Adjusted diluted earnings per share is expected in the range of $1.40 to $1.60 compared to $1.37 in 2022. Year-end inventory is expected to improve by approximately $225 million. Operating free cash flow is expected to be at least $200 million, and year-end debt leverage is expected to be approximately 2 times. Now let me provide our outlook for the second quarter, which reflects the performance of our ongoing business and excludes Keds and Wolverine Leathers. For reference, the second quarter 2022 revenue for these businesses was approximately $40 million, and the EPS contribution was $0.02. We expect Q2 revenue of approximately $580 million, a decline of approximately 13.7%. This estimate reflects the challenging trading conditions that persist in the market, both at wholesale and in our DTC channels. Some retailers are still working through elevated inventory levels, and most are managing the flow of goods conservatively. In addition, it's worth noting that Q2 2022 was a record revenue quarter for the company that benefited from a shift in sales out of Q1 due to significant Vietnam factory closures and delays experienced last year. We expect Q2 gross margin of approximately 41% and operating margin of approximately 6%, including $23 million of transitory inventory costs. We expect adjusted diluted earnings per share of approximately $0.20 for the second quarter, which includes a negative $0.02 impact from foreign currency exchange rates. Briefly looking beyond the second quarter, let me share some insights related to the back half of the year. Given the revenue performance now expected for the first half of the year, revenue for the second half is estimated to approach 55% of the annual total, which is consistent with more normal pre-pandemic phasing. As we discussed in February, gross margin and operating margin improved significantly in the back half of the year as transitory inventory costs recede and the benefits of our profit improvement efforts increase sequentially. We also expect our inventory levels to continue to improve each quarter in the second half. In conclusion, we are successfully navigating a tough environment and making fundamental improvements to the business along the way. While difficult, the choices we are making to simplify and clarify our brand portfolio, including the recent Sperry announcement will allow us to lean into our brand and category strength. Ongoing changes to our supply chain processes and technology platforms are making us more nimble and accurate. Profit improvement and inventory initiatives are on track, and we are creating capacity to invest in our highest priorities in 2024. Thank you to the entire Wolverine team for their ongoing commitment to the changes we are driving at the company. I'll now turn the call back to the operator.

Operator, Operator

The first question we have is from Abbie Zvejnieks from Piper Sandler. Please go ahead.

Abbie Zvejnieks, Analyst

Great. Thanks so much for taking my question. So can you just talk about, first, your decision to pursue a sale of the Sperry business? I think the previous philosophy was kind of to get the brand in a better position before you sold it. So are we there yet? And obviously, the Sperry decline has been a drag on top line. But is there any color you can give us on the profitability of the business and the potential impact on the P&L? Thanks.

Brendan Hoffman, President and CEO

Thanks, Abby. We're exploring all options. So it could be a sale, it could be a joint venture or licensing. I mean, we're just starting this process. But I think that fundamentally, it goes back to the corporate strategy work that we've been doing for over 1.5 years, including the segmenting of our businesses and active work in lifestyle and really focusing on the active brands like Merrell, Saucony, and Sweaty Betty to be our growth engines and work to support that. And as we look towards 2024 and the great work the profit improvement office is doing to free up investment dollars while hitting our profit margins, it just became apparent that Sperry was going to continue to require investment that would take away from where we think the upside is. And so it's certainly a very difficult decision because, as I've said, it's the brand that most resonated with me when I joined here, but I think it just became apparent to all of us that we should start this process and much like Keds look for a result that's best for the company and also best for the brand.

Mike Stornant, Executive Vice President and CFO

On the sort of impact to the business, I'm certainly correct in saying it's been a drag on revenue growth over the last couple of years. At the same time, given those challenges in the market and the distribution profile of that business, the operating margin for this business is below what we would require of a brand like this. So it's also been dilutive to that operating margin performance over time. Last thing I'll say is, and Brendan mentioned it, we've made such great progress and quick work on Keds and that transition, being able to get that behind us in such a quick timeframe, really allowed us to move on to this important next step. So the timing of this work in respect to that because of our success on the Keds transaction.

Abbie Zvejnieks, Analyst

Got it. That makes sense. Just one more. Can you just talk about the wholesale partner behavior that you're seeing in the current environment? I mean, you gave some Q2 guidance. But I guess, what level of caution are you seeing? And then in turn, what gives you confidence in returning to that growth in the second half? Thanks.

Brendan Hoffman, President and CEO

Yes. I mean we're certainly seeing tremendous caution right now, real-time. Although our at-once orders are up, as we know, they're chasing business. But I think everybody has seen business soften since early March with the weather trends. So there is definite apprehension that we factored into our guidance, but also starting to see some orders pick up in the back half of the year. Our order book and order coverage is in a very good position to support our back half of the year goals and guidance. And also, it gets us to a penetration that's a little more historical in terms of a little bit more back-half weighted. But right now, having been out in the market the last few weeks at various industry events, and it seems pretty consistent that people are very cautious at the moment.

Operator, Operator

The next question we have is from Laurent from BNP Paribas. Please go ahead.

Unidentified Analyst, Analyst

I wanted to follow up on Abby's question regarding Sperry. I understand you might be considering different options. If you were to sell this business, what would be the EPS contribution for this year? Although it’s not excluded, I believe it might be around $1.40 to $1.60. To estimate the EBITDA implications, is the contribution from Sperry included in this year’s guidance approximately $0.07 to $0.10? Does that sound correct? Additionally, if you were to sell it, how would you use the proceeds? Would they be reinvested in the business, or would you consider paying down debt?

Brendan Hoffman, President and CEO

The last part of that question is easy. We'll be using any proceeds from any monetization of the business to pay down our debt and continue to drive that leverage down to the levels that we are targeting. As far as the contribution to overall performance, it's a little more than $0.10. But again, on an operating margin basis, the contribution is dilutive to that operating margin rate. So it's also just important to know that as we move forward with these different options, we'll just be evaluating how the simpler portfolio is going to allow us to simplify the infrastructure of the company as well. And we've got now two important brands that we are addressing here in Keds and Sperry. We're still moving forward with our Wolverine Leathers divestiture. So at the end of the day, we're going to be left with a really strong portfolio of active and work brands and a much simpler infrastructure supporting those businesses, which will make the cost structure more efficient.

Unidentified Analyst, Analyst

Very helpful, Mike. And then my second question, following up is on Merrell stocking. It sounds like you're still reiterating the mid-single-digit growth for both brands for the year. 2Q is a little bit lighter. Is there a shift between quarters, between 1Q, 2Q, or into 3Q? And can you maybe just talk a little bit about the state of inventories in the athletic space, what you're seeing? Are they starting to normalize at your retail partners?

Brendan Hoffman, President and CEO

Yes. I think as I said in my remarks, we definitely saw some cadence shifts from last year with Vietnam being shut down that the comps in Q1 were soft, and we took advantage of that, but a lot of that business shifted to Q2 last year. And so that combined with the weaker wholesale environment we just talked about is pressure in Q2. I think out of retail, our inventories are in good shape. They've really moderated. So I don't see that as a problem for us. I think a lot of retailers are still dealing with their own private brands that is clogging up some of the open to buy. But I think specifically for our brands, we feel like based on how much flow has slowed down in Q4 of last year that we are not over-inventoried. I think that's why we're starting to see some orders pick up in the back half of the year. And also, I think in the value channel, starting to get some phone calls as they have needs again, so at healthier margins than we would have seen a few months back.

Operator, Operator

Next question we have is from Mitch Kummetz from Seaport Research. Please go ahead.

Mitch Kummetz, Analyst

Yes. Mike, on the inventory, you mentioned that you had expected to improve each quarter through the year. Could you be a little bit more specific on that? Is there any way you can kind of give us sort of where you think the inventory kind of goes by quarter on a year-over-year basis? And also, can you give us an update on the $150 million of end-of-life inventory? I think that was the number at the end of the year? Like where is that now? And I think you basically had orders against that. I'm just hoping maybe a sort of a status update on that. And I have a follow-up.

Mike Stornant, Executive Vice President and CFO

Yes. We actually added a table in the press release, Mitch, that kind of gives some of those quarterly inventory numbers, which should help you answer that question. But you'll see nice sequential improvement every quarter, the biggest improvement in Q3. On the end-of-life inventory, we did a large shipment or tranche of shipments in the first quarter and some additional here yet in the second quarter. There'll be a little bit of that that will ship out in Q3. But I would say the vast majority of that end-of-life product will be kind of out of the inventory and out of the warehouses by the end of the second quarter.

Mitch Kummetz, Analyst

Okay. And then my follow-up, I apologize for missing that table in the press release. But the table that I did see were the ones on the transitory expenses and then the profit improvement savings. It looks like some of the timing there has shifted, particularly on the gross profit side and the transitory expense. It looks like some of that is getting pushed out a little bit from Q2 to Q3? And then also on the profit improvement side, it looks like maybe some of the benefits on gross profit are accelerating or at least moving forward. So can you talk a little bit about some of those shifts?

Mike Stornant, Executive Vice President and CFO

Sure. Regarding the transitory costs, we started the year with those expenses, which are related to inventory. They affect our profit and loss statement as inventory is shipped. Because some shipments are being delayed from Q2 to Q3, the transitory cost expense is also being postponed. However, our overall outlook for the benefits and their timing remains unchanged, as the estimates have not really altered, only the timing has shifted. As for the profit improvement initiatives, we're able to secure those benefits a bit sooner than we initially anticipated. This doesn’t necessarily mean greater benefits for the entire year, but rather that we can realize them earlier, leading to the benefits you've mentioned. Next quarter, we may observe another slight adjustment in timing as various factors influencing timing, expense, and benefits come into play.

Operator, Operator

Thank you. The next question we have is from Dana Telsey from Telsey Group. Please go ahead.

Dana Telsey, Analyst

As you think about the second quarter and maintaining the guidance, the back half of the year, when you think about the profit improvement initiatives that are taking effect, how do you parse out the revenue expectation versus the margin expectation? Any more color you can put to that? And then, Brendan, any updates on Sweaty Betty and what you're seeing there, given leadership changes where you are on that state and how that business is doing?

Mike Stornant, Executive Vice President and CFO

Yes, thanks, Dana. I'll begin with Sweaty Betty. We've noticed a significant improvement in their performance over the past four to five weeks, which is quite encouraging as they have received new product deliveries. This also highlights how controlling the presentation in stores and online allows us to immediately benefit from new products. It's been gratifying to observe the progress at Sweaty Betty during these past weeks. Regarding the leadership change, Julie remains in her position for about another month before moving back to the U.S. with her family. Shanisabell Soriano, our Head of International, is collaborating closely with her. I've mentioned previously that having them report to international has been a very positive shift. They seemed somewhat isolated when integrated into Wolverine without direct connections. This change has been beneficial and is enabling us to identify synergies and improve efficiencies by leveraging our international team, which we can reinvest in Sweaty Betty. There are encouraging signs, and we are in the final stages of appointing a new brand leader who will report to Isabel. We are looking forward to that. Mike, feel free to add your insights.

Brendan Hoffman, President and CEO

Yes. I think the question was just on the sequencing or the phasing of the gross margin getting slightly better in the second quarter as we guided to. A lot of that has to do with both the timing of the transitory costs, but the amount of end-of-life product that we're shipping in the mix. In the back half of the year, Dana, we'd expect gross margins to approach 43% really in both quarters. So really strong improvement from all the factors we've talked about leading into the year, not the least of which is the profit improvement, timing and improved cost structure, freight cost improvements, and then just a better mix of business, healthier mix of business in the back half of the year. So all of those things are still on track and gave us confidence to keep our margin outlook intact.

Dana Telsey, Analyst

Got it. And any more color on the DTC channel?

Brendan Hoffman, President and CEO

Yes. I mean the DTC channel has been tough. It's definitely slowed down since early March. So that's influencing our Q2 guidance. That being said, we know last year, business slowed down around the end of May, early June. And so we have some softer comps that we start to anniversary across the business. So along with some of the new product launches that we'll be launching, I think the trends will get better. But certainly, the last 4 or 5 weeks have been challenging.

Operator, Operator

Next question is from Sam Poser at Williams Trading.

Sam Poser, Analyst

I have two questions. First, you mentioned the year-over-year increases you anticipate by brand for the quarter and the year. However, we only have the yearly data, not the quarterly breakdown by brand from last year. Could you provide that information or explain your outlook for the second quarter by segment, particularly regarding active work lifestyle and similar areas?

Alex Wiseman, Vice President of Finance

Yes. Sam, this is Alex. We have those stats in the IR deck. I can send that to you real quickly, so it's right at hand. But we laid that all out for 2020 and 2021 by quarter by the brands that we disclosed. So it's all there.

Sam Poser, Analyst

I was looking forward to the Q. Sorry about that. Okay. And then, Mike, do you expect that the gross margin has generally been higher in Q4 due to mix compared to Q3? Based on your guidance for Q2, do you think this trend will continue, and that we will see a significant year-over-year increase in gross margin? Not only do you anticipate it being higher in the fourth quarter, but that the gross margin figure will be substantially elevated in the fourth quarter. You mentioned it approaching 43%, but it likely needs to be higher than that.

Mike Stornant, Executive Vice President and CFO

In the fourth quarter, it will be a little bit stronger. A lot of moving parts, as you know, though. This is just not a normal year because of the timing of the some of these incremental benefits that are flowing through. So we're getting some of those more prominently in the third quarter, but the mix is better in the fourth quarter, so it balances things out a little bit. Directionally, what you're saying is right, Sam. We would expect fourth quarter to be a strong gross margin quarter because it's a quarter where our direct-to-consumer business is heaviest in the mix. And obviously, Sweaty Betty has a big impact on that mix in Q4.

Sam Poser, Analyst

Just one last thing. You mentioned around 43%, but based on the guidance for Q2, it seems like it should be close to 44. Do you have a minimum expectation for either quarter? Do you anticipate that, or is it just high 43?

Mike Stornant, Executive Vice President and CFO

Yes. It's in the range that I disclosed.

Operator, Operator

Next question we have is from Jim Duffy from Stifel. Please go ahead.

Jim Duffy, Analyst

Well, thank you. I'm going to start with an observation. I'm just shocked that Sam and Mitch aren't reviewing the releases more carefully. Those two, in particular, are always so good at that. It's really out of character for them. I have a few questions on Sperry for me. Sirs, is this an easy lift from the portfolio? Or are there dissynergies that we should be considering with respect to the financials?

Mike Stornant, Executive Vice President and CFO

I wouldn't say it's easy. This was mostly a difficult decision. However, along with Keds, it gives us more clarity on how we can optimize expenses. Hush Puppies is now fully licensed, which is a very profitable model. We're learning from the Keds divestiture about how this process works. As we mentioned earlier, we don't know what form this will take, whether it will be a sale, a joint venture, or licensing. Much of that will depend on our final decisions.

Brendan Hoffman, President and CEO

But you know this very well, Jim, knowing how we've operated the business. And we've said for a year now, our ability to focus, prioritize and invest on the right things beyond the cost structure and sort of the direct margin implications to the P&L. It's the ability to really emphasize our resources on those opportunities. To me, that's an important unlock for this decision, and Brandon mentioned it before, but I think it's worth repeating that.

Jim Duffy, Analyst

I find it helpful. It may be challenging to provide specifics, but considering the Sperry infrastructure, if Sperry were to go, would a Boston headquarters still be necessary? That seems like a clear opportunity for cost savings. As I understand it, the Saucony brand operates from that location if Sperry is no longer there.

Brendan Hoffman, President and CEO

All of the options that we have to look at yet and consider will be driven off of the ultimate choice that we make. So it's premature to make that conclusion. But I mean, there are examples like that across the global infrastructure for the company where depending on the alternative that we choose, I think we're going to be able to create a much more efficient and much more streamlined cost structure and support system.

Jim Duffy, Analyst

Fair enough. And Mike, you mentioned the second half, 55% of the revenue guide, which is more typical seasonality. Historically, earnings weighting has been more aligned with revenue in the fiscal '23 guide in place the second half more like 80% of the annual earnings power. Clearly, there's some impediment to margin in the first half of the year. But is the right way to think about that, that your run rate in the second half of the year is representative of your annual earnings power on a go-forward basis?

Mike Stornant, Executive Vice President and CFO

I think the back half of 2023 is going to be representative of how the business will cycle into 2024. We're going to sequentially see those improvements each quarter. But as we've discussed here, the timing of some of these extra costs and the phasing of some of the profit improvements makes the quarterly phasing of earnings very distorted. But as we get into the back half of the year, I think you're going to see a much more normalized cost structure, a much more normalized operating margin performance and with still opportunities, obviously, as we go into '24 to get the incremental benefits that we talked about from the profit improvement office. This year, we're going to get $65 million of savings that are all embedded in the '23 guidance. And next year, the full year run rate for that will be $150 million. So a meaningful incremental amount of savings that will support next year's operating margin target.

Brendan Hoffman, President and CEO

Yes. I find it exciting for both myself and the team that these temporary costs will diminish as we move into the latter part of the year and into 2024. As Mike mentioned, all the work from the profit improvement office is complete, and I'm thrilled about the progress we've achieved, which allows us to meet the targets we've outlined while also providing real investment funds to reinvest in our brands as we focus our business.

Jim Duffy, Analyst

Thank you, guys. Good luck.

Brendan Hoffman, President and CEO

Thanks, Jim.

Operator, Operator

The next question we have is from an unidentified analyst from UBS.

Unidentified Analyst, Analyst

I wanted to ask about the first quarter. If you could talk about the exit rate on the direct-to-consumer channel. And what do you expect, like in terms of the guidance, the sales cadence for the year, what does that imply for growth across both channels for the second half of the year? And then on inventories, could you talk maybe a little bit more about any pockets where you believe there's more work to be done than others in terms of bringing it to more normalized levels? Should we expect 3Q inventory growth to be in line with sales growth based on the commentary you provided previously?

Brendan Hoffman, President and CEO

Regarding DTC, as I said, we've seen a slowdown over the last few weeks. But as we get later on into the quarter and really into Q3, that's when we start to anniversary the slowdown from last year when some of these macro headwinds started to show themselves where inventory really started to pile up and the promotions happen. So we certainly feel like the back half of the year provides more potential upside in terms of trends in our direct-to-consumer business. Last year, at this time, we were working through and planning for inventory flow-through, and we didn't have a lot of new products in the back half of the year to drive our DTC business. So that's another important variable and a positive for 2023. On the inventory side, I'd say in terms of where we're a little heavier on inventory, it's in the areas where the business has been the softest. So with Sperry, we have a little more inventory in that business than we would like. But overall, we're working through the inventory right on schedule. Our inventories at the end of the third quarter will actually be down over 30% year-over-year. And so obviously, much different than what we expect our growth rates to be, but obviously working off of elevated inventory. So that's the progress that we're seeing not only as we sell through the core inventory that we own today, work through the end-of-life inventory, but we've obviously adjusted our supply chain and the inflow of new products on core merchandise in the back half of the year to get the inventories rightsized by the end of the year.

Operator, Operator

There are no further questions at this time. I would now like to turn the floor back over to Brendan Hoffman for closing comments. Please go ahead.

Brendan Hoffman, President and CEO

Well, thank you, everyone, for joining us today. We look forward to discussing our Q2 results with you in August. Have a good day.

Operator, Operator

Thank you, sir. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.