Kontoor Brands, Inc.
Q4 2020 Earnings Call Transcript

Published: 2 Mar 2021

[Operator:]

Greetings. Welcome to Kontoor Brand’s Fourth Quarter Earnings Call. At this time, all participants will be in listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I'll turn the conference over to Eric Tracy, Senior Director of Investor Relations. Mr. Tracy you may begin.

[Eric Tracy:]

Thank you, operator, and welcome to Kontoor Brands' fourth quarter and fiscal 2020 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.

[Scott Baxter:]

Thanks Eric, and thank you all for joining us today. On behalf of Kontoor, I hope you and your families continue to be healthy and safe. As Eric mentioned, our global brand President, Tom Waldron and Chris Waldeck will be joining us for this year-end review. We believe these year-end calls provide a great opportunity to have them share insights from the past year, as well as go forward strategies for each of their respective brands. You'll hear more from each of them in a bit. We are pleased to share our fourth quarter and full year results with you today results that came in ahead of our expectations, driven by broad-based improving performance across the business. Let me start by thanking our colleagues around the world. As the strong fourth quarter results and momentum we are seeing into 2021 are a direct reflection of our team's tremendous efforts over the last year. Their resiliency, agility and focus on execution during these unprecedented times has been truly inspirational. Like most companies during 2020, we experienced challenges never seen before as the impacts of COVID-19 were far reaching. However, we were nimble and we quickly focused on supporting the safety and well-being of our associates, while also strengthening our financial and liquidity positions.

[Tom Waldron:]

Thanks, Scott and good day, everyone. As Scott mentioned, while the past year has brought significant challenges with impacts from the pandemic, the Wrangler brand is better positioned now than it's ever been greatly benefiting from focused investments in people, product and processes. And as proud as I am of our team's incredible efforts in 2020, I am even more excited about the great momentum the Wrangler brand has going into 2021 and beyond. So I'd like to take you first through some highlights of the year and the quarter and then I'll provide some insights on a few key areas where prioritized investments have and should continue to yield more sustained profitable growth for the brand. Wrangler saw accelerating trends throughout the year with global revenues inflecting positive increasing 7% in the fourth quarter. We experienced balanced strength across the globe with both U.S. and European businesses increasing 8% on a reported basis in the quarter. In the US, our wholesale business has increasingly benefited from our optimized distribution strategy. Our partnerships with best-in-class retailers such as Walmart, Amazon and Target have strengthened during the pandemic as we saw increased share gains in our core denim business throughout the year, including substantial market share outperformance during the fourth quarter as measured by NPD. These share gains are highly correlated to the strategic investments we are making across design, innovation and demand creation. We are also seeing the increased ROI in our western and work businesses. Both of which sequentially improved throughout the year ending Q4 particularly strong. Given that Western business is truly the most authentic expression and ethos of the Wrangler brand this performance is really great to see and we augmented this improving US core and elevated wholesale distribution including Nordstrom's and Free People. These premium price points of distribution coupled with focused demand creation spend such as our pop-up store in Fort Worth during the Wrangler National Finals Rodeo Championship in December provided a nice halo that cascades back to the core.

[Chris Waldeck:]

Thank you, Tom. Firstly, let me also convey my appreciation to all of you for joining us today. Similar to Tom, I'm thrilled with what the Lee brand accomplished in 2020 and I'm even more excited as we turn the page into 2021. These achievements over the last year were significant and my sincere thanks to the team for not just weathering the storm with the great execution on our strategies including brand elevating initiatives, material new business development wins, and perhaps most important delivering substantial profitability gains for the business. First, I will walk you through some of the key takeaways from 2020 and the fourth quarter and then I will hit on the many exciting opportunities that lie ahead for Lee. As most of you know since the spin one of our points of focus has been in repositioning Lee for healthy long-term growth and the COVID pandemic has only validated our strategy. Given Lee's historic exposure to more challenged points of distribution within the US and select international markets one of the biggest investments we've made has been within our quality of sales initiatives. During last year, we accelerated these quality of sales measures which impacted near-term topline, but will support sustained TSR accretive growth. This is a game-changing cultural shift relative to how the Lee business was historically run. A great proof point this was the brand's seventh consecutive quarter of adjusted gross margin expansion in our largest market. While we have prioritized profitability in brand health, let me be clear, we have remained on offense, investments in innovation and design demand creation and new business development are delivering significant opportunities across categories, channels, and geographies. Overall, revenue increased 1% on a reported basis in the fourth quarter. Revenue in the US was relatively flat on a reported basis with a focus on quality of sales, while we achieved sequential improvement in our China and Europe business, which increased 11% and 5%, respectively during the quarter on a reported basis. Diving further into the US business, while more temporary nonstrategic headwinds impacted the quarter, we are really encouraged by the gains within structural areas of the business. According to NPD during, the fourth quarter the Lee brand realized strong share gains across both men's and women's categories in the US. Let me now turn to new program wins. Consistent with our TSR lens, we continue to develop new distribution opportunities with a focus on select premium and value channels. As you know we launched the Lee Master brand with Walmart in Q3 and I'm excited to share that its in-store point-of-sale became fully set. We saw a strong correlation with sell-through and these trends have only accelerated as we start the New Year, a testament to how our investments in demand creation are paying off. This is just the beginning, as we look to expand the program into new categories and doors over time. Additionally, we entered premium points of distribution such as Anthropology, Nordstrom and Free People. When we invest in design, innovation and demand creation the Lee brand has increasing permission to play in these elevated channels. To further highlight new business development wins during the fourth quarter, we announced a significant new licensing collaboration with H&M, with focus on iconic legendary looks bolstered by the brand sustainability platform for a world that works, this partnership brings the lead brand into over 1,000 doors across 61 countries, reaching a new and younger consumer. Additional powerful collaborations with key tearing AppHarvest and Alife provide perspective that we are clearly investing in elevated demand creation platforms that will continue to transform the Lee brand. We're only scratching the surface on our long-term opportunity. Rest assured our pipeline is robust. I'm here going to share more detail at the Investor Day in a few months. Another important element at Lee's evolution is our increasing efforts on transforming our digital platforms. Globally, on a reported basis, our lee.com business increased 28% in the fourth quarter while digital wholesale increased 32%. We will continue to start investment in digital capabilities to drive further brand, elevation and our closer connection with our consumer. Finally, let me touch on our business in China. As I mentioned, we saw solid growth in the region during the quarter but more importantly, as Scott discussed, we believe the Lee brand extended its overall leading denim share position in the quarter outpacing the overall market and our next closest competitor. And the momentum continues as we start the year. China will remain a focus for strategic investment with a spotlight on highly successful partnerships with key influencers such as Eddie Peng and our Stand Tall campaign. This campaign generated 340 million views on our social media platforms during the quarter. Our investment in these demand creation efforts are expected to support further share increases in existing channels and measured expansion into Tier 4 and 5 cities and further diversification of our digital platforms. There will be more to come on the building blocks of our growth plans for this region at the upcoming Investor Day. Let me summarize by thanking my colleagues throughout the Lee team for the amazing work done over the past year. In the face of incredibly difficult macro conditions, we didn't just persevere, we were able to deliver outstanding profitability improvements and market share gains, all while keeping our foot on the gas pedal driving new incremental growth aligned with our TSR accretive principles. The future is bright for the Lee brand and we really look forward to sharing this transformation with all KTB stakeholders. Rustin?

[Rustin Welton:]

Thank you, Chris, and good day, everyone. Hopefully, it's come through loud and clear with the team's remarks so far, but let me reiterate, despite a highly dynamic environment solid execution of strategic initiatives, is yielding improving fundamentals as evidenced by our fourth quarter results. We have consistently stated that sequencing of our story matters with the focus in the first few years post-spin on the optimization of the model. And even with the global pandemic, I am proud to say, we have done just that. I am confident we are entering 2021 as a stronger more profitable company. For the balance of the call, I will touch on a few key areas

[Operator:]

Our first question is from the line of Adrienne Yih with Barclays. Please state your question.

[Adrienne Yih:]

Yes good morning and let me congratulate you. We have made it to Horizon 2, are growing sales. So congratulations, I know it's a hard lift. So I guess I -- Rustin my first question is going to be for you. The prepared remarks were great in the detail. We've been hearing disruption on kind of port congestion etcetera. And I know that your DCs are primarily on the East Coast. So I'm just wondering if you could talk to us about the inventory being down 26%. You seem very comfortable with that. Obviously, I'm assuming that most of the stuff is coming to you on the East Coast. So if you can talk to us a little bit about that? Tom, if you can talk to us about the Wrangler launch in China, specifically the brand positioning the brand awareness and then kind of the digital aspect of that? And then finally for Chris if you can talk to us also about the investments in Lee product design and development and what that has borne out in 2020? Thank you so much. Scott I'm giving you a rest today.

[Scott Baxter:]

Thanks, Adrienne.

[Rustin Welton:]

Thanks, Adrienne. It's Rustin. Good morning. Appreciate the questions. I will answer your questions around port congestion and inventory and then turn it over to Tom about the Wrangler launch in China. Certainly, as we think about port congestions, we're not immune to the challenges that are taking place in the operating environment, whether that's port congestions, higher freight rates or labor shortages. And rest assured, we're aggressively working to minimize those impacts including intentional port diversification. As you're well aware, Adrienne, certainly select ports, primarily on the West Coast with L.A. and Long Beach are more impacted than other ports. And as you talked a little bit about, we really believe our diversified supply chain affords - benefits for us as we manage through this time. With approximately a third of our production in this hemisphere and two-thirds of our source production coming from 225 facilities in over 20 countries around the world, we can be a little more creative I'll say in navigating some of the challenges. Our outlook has considered kind of prolonged headwinds through the better part of 2021 based on some of these measures but we're continuing to work our way through that. As it relates to inventory, you talked a little bit about being down 26% in the fourth quarter. You know this has been a focal point for us since the spin. For the second quarter of this year we were down 20%. The third quarter we were down 21%, we're down 26% in the fourth quarter, but that also takes into consideration the model changes that we've made at DFO. So if you exclude the VF outlet stores and really the discontinuation of the third-party goods, we're down more like 20%, which is really in line with prior quarters. We continue to manage this. We feel good about the quality of the inventory heading into 2021. It's clean. And we really believe the levels are appropriate given the uncertainty but also support the momentum we're seeing in 2021. We continue to work closer than ever with our customers to align those supply and demand signals to maximize the in-stocks and certainly leveraging that diversified supply chain that I talked about earlier to minimize those important logistics disruptions. So that's a little bit around inventory. And with that I'll turn it over to Tom to talk about Wrangler in China.

[Tom Waldron:]

Hi, Adrienne, really excited about the soft launch in China. It went very well, exceeded all our KPI expectations. We will have a more robustful launch on track for this spring when the consumer environment will be healthier. We will be measured test and learn through this initiative, but what I'm really excited about is the team on the ground. They've been driving the China brand for well over 20 years. They understand how to emotionally connect with the Chinese consumer and certainly they couldn't be more excited about the Wrangler brand going after. You talked about the brand position, it's younger, it's male, female fashion-oriented. So really excited about this initiative.

[Chris Waldeck:]

Adrienne, it's Chris.

[Adrienne Yih:]

Hey, Chris.

[Chris Waldeck:]

You're right. It's really all about product and delivering that consumer low cost product and we have made significant investments on the Lee side and the Wrangler side around product design, innovation and when we look at this we talk internally about style crafted with purpose. And when we think about that it's that elevated styling, leveraging innovation, so we can deliver the consumer exceptional fit, comfort, quality, but again, at that style push that they truly need. So we're excited about the investments we've made. We're seeing that come through in our sell-through right now. If it's at Walmart, if it's the – our partnership with H&M and the share that we're gaining over in China. So we're excited about these investments. More to come with that as we get into it though. Thank you for the question.

[Operator:]

Thank you. Our next question is from the line of Bob Drbul with Guggenheim Securities.

[Bob Drbul:]

Good morning. Just a couple of questions. The first one is can you elaborate a little bit more just on the Wrangler strength and the Lee deceleration in the US, really sort of how you think that's playing out and sort of where we are going in next few quarters with both of those brands, specifically here in the US? And then the second question is Rustin, if you could spend maybe as you look at the year the gross margin expectations are pretty healthy. I was just wondering if you might be able to just walk us through a little bit more quarterly expectations throughout the year that would be helpful? Thanks.

[Scott Baxter:]

Hey, Bob. How are you? This is Scott. I'll go ahead and start and then Tom and Chris will help me out, but we're really pleased with the arc of the Wrangler and Lee brands. As you know for many years under-invested in, but I think what you're seeing now in the marketplace is just the investment in the brand and the consumer response. One of the most significant pieces of that is that we're building and designing really good products. So our consumer is loving what we're doing, and now you're seeing us go ahead and get to a better position financially which we've talked a lot about. We talked a lot about capital allocation. We talked a lot about investing back in these brands at the appropriate levels, because they've been under-invested in and what we're seeing is we're seeing an acceptance in the broad global marketplace relative to the brands around categories, channels, geographies and both brands are able to go up and down the value scale. So we really like what we're seeing. And I'll tell you one of the things that I think you can measure which is really important. And I think Tom and Chris will have a comment is that we're fielding a lot of incoming calls about people that want to do collaborations with our brands and with our people because they're seeing in the marketplace the strength of these two brands globally. Tom, Chris?

[Tom Waldron:]

Yeah. Thanks. Super excited about the momentum. Wrangler is hitting on all cylinders right now. It's a combination of really great product fuelled by design and innovation and then really great storytelling. We mentioned Rick and Morty, we mentioned Stranger Things making sure that we're connecting with younger consumers. And that's just pulling through from a consumer demand standpoint. And as Scott mentioned, we're able to invest behind the brand like we never had before. So really excited about Wrangler's trajectory. I'll hand off to Chris.

[Chris Waldeck:]

Hey, Bob it's Chris. Horizon one for Lee was really all about focusing on a cultural shift and I talked about that in our remarks and we really brought that to life and focused on TSR accretive growth for the Lee brand. And we've set ourselves up nicely for that. We're starting to see that come through you know seven consecutive quarters of sequential margin expansion in our biggest market. So we feel good about how we're positioned. And as Scott said, our investment behind design and innovation are starting to really come through for us. So we're excited about what the future holds and look forward to talking to you more during our Investor Day.

[Rustin Welton:]

And Bob, it's Rustin. Good morning. Thanks for joining. Let me provide a little more kind of shaping around the quarters. I know that's certainly top of mind as you're looking to build your model for the year. Although, I won't provide specific quarterly guidance given the macroeconomic uncertainty, let me just give a little bit of additional color as you're thinking about it. So as we mentioned in our prepared remarks, we really see strong top line momentum coming into the first quarter supported by that amplified demand creation investments we made during Q4. Actually, we would anticipate Q2 growth rates to accelerate sequentially. Certainly, the Q2 of 2019 was most impacted by COVID as you're well aware and we would expect those Q2 growth rate again actually ahead of the Q1 growth rates. We would however just remind you Bob as you're thinking about this that Q2 is typically our lowest volume quarter. And with the US ERP plan in the second quarter that certainly will have some implications as well as we talked about. So we really view kind of the top line growth rate as a bit more balanced both on a one year and two year stack basis. And so that is kind of how we're thinking about the top line. As we think about gross margin, certainly, we're pleased with the progress we've seen over the last two quarters. Gross margins have topped 43% both in Q3 and Q4 up 230 and 240 basis points. So we're pleased with the progress we've seen again confidence in talking about that expansion of 150 to 200 basis points off of that 41.2% we delivered on an adjusted basis in 2020. So as you think a little bit about the cadence of profitability Bob and earnings, again I would expect strong momentum into Q1. And as you would expect the ERP go live is going to cause some timing shifts helping Q1 even more as well as Q3, while tempering Q2 a bit more again on our lowest volume quarter. So as we said to in the prepared remarks, given the typical seasonality and some of these timing shifts, we would expect EPS on a dollar basis to be modestly higher in the second half of the year. So hopefully that provides a little more color Bob, as you're thinking about constructing the models. Thanks for the question.

[Operator:]

The next question is from the line of Erinn Murphy with Piper Sandler. Please proceed with your question.

[Erinn Murphy:]

Great. Thanks. Good morning. I guess, a first question is just on the Lee and H&M partnership. I was curious you could speak to if the shelf space games you're capturing right now, is that temporary, is it more permanent? And then just bigger picture Scott for you as you think about being a leader in sustainability, can you talk about how you're prioritizing some of your consumer facing efforts whether it's the recycled denim partnership, with H&M waterless dying sustainability -- or sustainably sourced cotton, et cetera? Just curious on that?

[Scott Baxter:]

You know what why don't I go ahead and start and I'll handle the sustainability piece. Thanks for the question Erinn. And then I turn it over to Chris, but we're really proud of our efforts in sustainability. We published year two of our company so early on in our history our first ever sustainability report early on. So, I'd encourage everyone to go out on our website and take a look at that. I think it's a really, really good piece, but we are focused on three pillars; the next people, product and planet. And those are the key pillars that we're going to focus on going forward and we're going to be. We have stated and we're very serious about that, being a leader in sustainability going forward. So I can give you a couple of examples from a product standpoint or a planet standpoint. We've got a goal by the year 2025 to save 10 billion liters of water and also a goal by 2025 to have all of our operating facilities using renewable energy, but we take all components in all pieces of the value chain within sustainability very serious. So, look for more from us. You mentioned our foam dyeing process is a very important part of our water savings initiative, but there will be much more going forward. Thanks for the question. Chris?

[Chris Waldeck:]

Hey, Erinn, it's Chris. It's interesting about the H&M partnership and you talked about sustainability. So it's really all based around sustainability and Lee's platform for a world that works. And your question about is this a one-time thing with H&M. This is a collaboration. So by definition it is one-time from that standpoint, but what I will say is that we really had a great partnership with H&M, and we're really encouraged by that. Our teams albeit had to do everything virtually, because of COVID really got along well. So I think there's high likelihood that there will be additional partnerships between Kontoor Brands if it's Lee and/or Wrangler, but then also with other vertical retailers as we think about the different opportunities out there.

[Operator:]

Thank you. Our next question is from the line of Sam Poser with Susquehanna. Please proceed with your question.

[Sam Poser:]

Williams Trading, but thank you. Just a quick one on the impact of India where that comes from and did any of that impact the fourth quarter or is that going to flow through? I mean, I would assume that it's going to impact Lee more than your -- well, India is going to impact Lee, but can you give us sort of -- can you spell it out and flow it for us a little bit?

[Rustin Welton:]

Yes, Sam, it's Rustin. I'll go ahead and take that. Appreciate the question. Certainly, as we think about the India market, we do have both brands there. It is Wrangler and Lee. And as we talked about sort of on our outlook for 2021, we said a low double-digit top line growth for Kontoor, including a mid-single-digit impact from both the VFO actions that we took this morning as well as India Sam. So while I won't get into sort of the specific impacts of each of those, I will sort of emphasize for you that we do expect both to be accretive for us from a margin perspective in that first year. And importantly, we're really confident these are the right things to do from a brand perspective, and is really aligned to our TSR focused approach. So, hopefully that helps understand things. In terms of the Q4 impact, as we talked about we'll be transitioning to that new model in the first quarter. So, certainly there were some Q4 impact associated with those actions in advance of moving from a direct to a license model.

[Sam Poser:]

All right. So let me reask the question. With an absolute revenue dollars, can you give us or as a percent of that 5%, how much is coming out of the VF Outlets and how much of it is coming out of India? Can you give us some idea in dollar terms?

[Rustin Welton:]

Sam, we’re not going to…

[Sam Poser:]

I understand the profitability situation -- I'm just trying to be able to run the model -- to be able just to break it out properly or how much of the revenue are you eliminating from VF Outlet with the store closures? I assume those stores that you're closing weren't great stores to begin with? So that….

[Rustin Welton:]

Yes. What I would say, Sam again, we won't break it out but it is collectively a mid-single-digit impact from both VFO and India. The VFO piece certainly has two components to it. It's not only the 38 door closures that we talked about in the quarter, but it's also the discontinuation of the third-party goods that are sold through that chain. And again those were a little less than half of the overall sales in the chain. So that's a little bit more color on the breakout.

[Operator:]

Our next question is from the line of Jay Sole with UBS. Please proceed with your question.

[Jay Sole:]

Great. Thank you so much. I have three questions. One is on share gains, the other on digital and the third on capital allocation. Maybe first it sounds like both brands saw nice share gains in US wholesale. Can you speak to what's driving this? And who you're taking share from whether it's other brands or private label? And then secondly on digital, the digital growth in 4Q seemed really strong. Can you walk through the digital wholesale piece versus the company's own.com? And what inning are we in with respect to development of the company's own.com channel? And then lastly it was another quarter of significant debt paydown. I think you're now below 3 times leverage. I'm sure you'll provide more detail at the Investor Day, but I was curious about how you are thinking about the capital allocation strategy at this point? Thank you.

[Scott Baxter:]

All right. So Jay we'll go ahead and I kind of have that as four questions and we're going to go ahead and dig those up a little bit, but let's go ahead and start with the share gains and you're absolutely right. We are gaining share both from a national branded and also private label. And we're driving that through our first quality goods. I think Tom and Chris both mentioned it. We are designing and building and this is a credit to our team better products across the globe and also here in North America too and we're gaining share across the wholesale channel. And we really like where we stand right now with our core partnerships and the people that we do business with. So we're really excited about the future in all of our categories. From a digital standpoint, we've talked a lot about the investment that we've made there but there's a couple of things that I think are really important from a digital standpoint we've been investing behind that. We've been investing in the platforms. You saw the gain that we had both on the own.com. We replatformed wrangler.com and lee.com, but I think the thing that's not talked about enough in these types of calls is the fact that you can have a really good platform which we do. We've hired an incredible team, but we are now starting to put really exceptional product on the sites and you're seeing that take out accelerate. That is the critical component. So we put the whole team together, great team, great site, great products really helping us go forward. So really pleased with that. In addition to that, our digital wholesale business is strong and getting stronger. Again, it goes back to our partnerships that we have with the winning retailers. It goes back to great products. So really pleased with that, looking forward to the future there. I will tell you this, if you want to talk about what inning it is, I would tell you it's very, very early stages. And the reason I say that is that we came out of the gate from a spin standpoint really at ground zero, no investment in our platform, very few people that were asked to do a lot too much actually until we got a team built around them. A lot of things have happened from an investment standpoint globally in our .coms and our own .com and those are just now starting to pay off and I think that we're really starting to learn what the consumer wants there and we're advertising in a significant way digitally and it's hitting specifically from a consumer standpoint. Before I hit capital allocation, I'll just ask if anybody has a comment from Tom or Chris or Rustin on digital.

[Chris Waldeck:]

I think the only thing, Jay, this is Chris. The only thing I'd add in there is, this is also happening outside of the US, that's happening for us in China and we're really seeing acceleration around our digital platforms in China and leveraging those key influencers I talked about 340 million views on our social media platforms in the quarter. That's driving us to new consumers, younger consumers and it's helping us capture share.

[Scott Baxter:]

So let me go ahead. I'm going to start on capital allocation then I'll flip it over to Rustin for any comments, but you've just talked before multiple times about the fact that we really liked our physicians coming in the Horizon 2 relative to we can go ahead, we can increase our dividend. We could pay down additional debt, we can invest more in these brands and we're seeing the response out in the marketplace when we do invest in these brands and we can also embark upon M&A activity, if we choose. So having the ability to have all those options and decide what's best for our stakeholders over time puts us in an enviable position. And we look forward to talking about these things in our coming Investor Day in May. Rustin anything to add?

[Rustin Welton:]

Yes. I would just highlight Jay that we have been on an aggressive debt paydown piece. We paid $300 million in discretionary payments in the last three quarters. I talked a little bit about $75 million paid in the first quarter as well. So that will continue to be a focal point for us as we're sort of exiting out of Horizon 1 and transitioning into Horizon 2 as Scott talked a little bit about. The net leverage ratio is less than 3 times. Gross is a little north of that still. So again, we'll continue to be a focal point for us, but really like the optionality as we head into Horizon 2 that Scott talked about.

[Operator:]

Thank you. At this time, we've reached the end of our question-and-answer session and I'll turn the call back to Scott Baxter to make closing remarks.

[Scott Baxter:]

No. I just wanted to thank everybody for joining us today. We really appreciate your support of Kontoor Brands and we look forward to speaking with you at our upcoming first quarter call in May and we're especially excited to spend time with you at our upcoming Investor Day on May 24th. So thanks again for your time today. Really appreciate it and we'll talk to you soon. Take care.

[Operator:]

This will conclude today's conference. Thank you for your participation. You may now disconnect your lines at this time.