Kontoor Brands, Inc KTB CEO Scott Baxter on Q1 2020 Results

Thank you, Eric. Good morning everyone. Thanks for joining us. We at Kontoor Brands sincerely hope you and your families are safe and healthy. We're navigating unprecedented times. I'll share perspective on the current environment, the impact of the COVID-19 crisis, the decisive actions we've taken, and why our model is advantaged. In Asia, the impact was most pronounced in China where demand softened starting in late January. At the peak, about 90% of our owned and partner stores were closed. China recovery continues to build momentum, led by digital. In Europe, demand declines accelerated in mid-March as stay-at-home orders were implemented. In North America, softening began in March, but many large retail customers remain operational. We have not experienced significant service disruptions due to our global diversified supply chain. We took several strategic actions: closing stores, implementing remote work, deep cleaning protocols, temporary salary reductions for senior management, and unfortunately, headcount reductions and furloughs. We also started producing Level 1 patient isolation gowns to help hospitals. Financially, we drew down $475 million from our revolving credit facility as a precautionary measure. We amended our credit facility for covenant relief, temporarily suspended the dividend, and reduced variable and discretionary expenses. We continue to invest in high-ROI areas like digital and our new ERP system. The dividend suspension is temporary; we are committed to reestablishing it as soon as appropriate, possibly as early as the fourth quarter of 2020. We believe cash is king in this environment. Our portfolio consists of two iconic global denim brands, Wrangler and Lee, with over 200 years of collective history. They have weathered many crises. We have a long track record of generating strong cash flow, even during economic cycles. We partner with winning retailers like Walmart, Amazon, Target, and Kohl's. We are excited to announce significant distribution program wins for Lee in over 2,000 doors in North America and Wrangler ATG in more than 400 doors with a European retailer in the second half of 2020. Our digital wholesale business increased 15% globally and 41% in the US in the first quarter. We recently added a new VP of Global Digital with over 20 years of experience. Our owned manufacturing in the Western Hemisphere allows us to manage inventory flexibly. Despite these challenging times, we are confident in our strategies and actions, and we believe Kontoor will emerge from this crisis well positioned. With that, I turn it over to Rustin.

Revenue was down 13 percent. The decline was primarily driven by COVID-19 impact. As mentioned, U.S. digital wholesale remains a bright spot, increasing 41%. This performance is a reflection of long-standing partnerships with leading digital wholesale platforms and the investment we've made into this important area. Our branded direct-to-consumer channel, which represented 10% of our revenues, declined 17% due in large part to owned brick-and-mortar door closures. Our owned digital business increased 1%, driven by 7% growth in the U.S. While the impacts of COVID-19 have been far-reaching, we continue to see positive results from our investments in our digital platform. The implementation of our global ERP system will be a significant enabler in developing our digital ecosystem. Given the accretive, under-indexed nature of this channel, we will continue to direct investments to grow in this area. Finally, let's turn to our brands. Global revenue of our Wrangler brand declined 17%, including one point of headwind from foreign currency. Wrangler U.S. revenue declined 14% in the period. Impacts from COVID-19, planned lower distressed sales, and the planned exit or reduction of select non-core programs were the primary drivers of the U.S. decline. These declines were partially offset by growth in digital, both owned and wholesale. Wrangler International revenue was down 27% reported during the quarter, driven by COVID-19 impacts, the actions taken in India, and business model changes in Europe. Lee brand global revenue declined 24%, including a point of headwind from foreign currency. Lee U.S. revenue decreased 9%, driven by the previously mentioned COVID-19 impacts and the transformational factors. We remain encouraged by the underlying progress of the Lee U.S. business, including the previously mentioned new program wins. Through February, our Lee U.S. business was up high single digits. Lee international revenue was down 38% with a point from FX. Nearly half the decline was driven by China, as much of the country was placed on lockdown for the majority of February and March. Now on to gross margin. Total adjusted gross margin decreased 320 basis points to 38%. The decline was primarily driven by the following factors: first, inventory provisions based upon higher levels of excess and distressed goods and lower anticipated recovery rates represented a 340 basis point headwind in the quarter. Next, lower international revenue led by China also adversely impacted geographic mix by 210 basis points. Finally, the cost of downtime in our plants as we reduced production to align supply and demand and tightly managed inventory represented a 40 basis point headwind in the quarter. These declines more than offset the underlying structurally accretive mix shifts and proactive measures we have discussed as an important part of our business model and TSR drivers. During the first quarter, the favorable impacts of restructuring and quality of sales initiatives, pricing and product cost improvements, as well as improving channel mix, positively impacted gross margin by 270 basis points. Adjusted SG&A as a percent of sales increased 310 basis points to 33.6%. The year-over-year increase was driven primarily by increased allowances for credit losses due to COVID-19 and fixed cost deleverage due to revenue declines. These increases were partially offset by tight expense control and restructuring benefits. We delivered adjusted earnings per share of 27 cents in the first quarter. Now turning to our balance sheet and cash flow. We ended the quarter with $479 million in cash and cash equivalents, which was a $373 million increase from year-end. As mentioned, we drew $475 million on a revolver during the period, which drove the increase. Excluding the revolver, cash decreased $102 million in the period, driven by working capital, global ERP and IT infrastructure investments, and our dividend payment on March 20th. Approximately half of the decrease was due to working capital, so I want to provide a little additional context here. Our business has historically experienced seasonality in our working capital needs. Specifically, we tend to have higher AR balances in our first and third quarter of the year due in part to elevated international shipments as product for new seasons are introduced. Further, inventory in the U.S. tends to peak during the third quarter as we prepare for holiday shipments and moderates in the fourth quarter as shipments occur. Thus, the first and third quarter tend to be the largest uses of working capital, while the fourth quarter tends to be the largest source. In the first quarter of 2020, our working capital use was $49 million compared to a use of $71 million in the first quarter of 2019. Finally, I will close with some shaping for the balance of the year. As we previously announced, and as a result of the uncertainty and significant business impacts caused by COVID-19, we have withdrawn our 2020 guidance provided on our fourth quarter call in March and will not be providing an updated outlook at this time. While we are not providing formal guidance, additional perspective and assumptions are as follows. We believe we are continuing to take the necessary proactive steps to accommodate a proactive to the COVID-19 environment. We anticipate negative impacts on revenue, operating income, and EPS will be most pronounced in the second quarter of 2020. As we think about the second half of 2020, we are not guiding the impact COVID-19 will have on our results. However, we do anticipate and would highlight that, outside of COVID-19, underlying revenue and gross margins in the second half are expected to benefit from new programs and distribution gains, moderating top-line headwinds as actions taken in 2019 are anniversaried, and increasing realization of proactive restructuring cost savings and quality of sales actions taken in 2019. Finally, due to predictions of a prolonged economic downturn, we have performed stress testing for a variety of financial demand scenarios during 2020 and believe the actions taken are expected to support liquidity requirements and provide operating flexibility. Although it has only been a little over 60 days since our last earnings, we had much to cover on today's call and appreciate the opportunity to walk through the many actions we have taken. In closing, I just want to reinforce how confident we are that these are the right steps at this time to position Kontoor for continued success in the new environment. This concludes our prepared remarks, and I will now turn the call back to our operator.

Sure, Bob. I'll take those and Russ will add in some color as we go along. But I think it's important to know the dividend this was temporary, it's part of our covenant amendment, and it's still absolutely foundational to our investment thesis and our TSR model, so that hasn't changed at all going forward. And I think everybody is in the same situation that cash is really important right now in the business, but as we've said we're committed to at the appropriate time reinstating that dividend, and we can do it as early as Q4. And obviously I think the thing that most want to see in this industry and the world and the sector is continued improvement and for the world to migrate into a better place and just move forward past what we're all going through right now. But I do think there's one other component that's critically important to the whole dividend discussion, and that is that we take our culture real serious here at Kontoor Brands. And we unfortunately, and I made mention of it in my comments, had to furlough some folks and we don't take that lightly at all, and give some pay reductions and do some really tough things to make sure that our business is sound and moves forward in a really constructive way. And we didn't feel as though it was right to go ahead and pay a dividend as we were taking some of those actions. Rustin, anything to add to that?

Thanks. And then in your second question, Bob, I think that one of the things that as a CEO that I'm most proud of is how the team has managed through this process. But also, if I just step back in time and think about when we transitioned our business and spun off just a year ago — the date is coming up here real quickly in a couple of weeks — we were a maintenance business for the company that owned us, and at that point in time we had to start a lot of things from fresh, from scratch I guess. And one of those things was putting together a comprehensive strategy for our business going forward. We thought really long and hard about how this world is going to change and what's going to happen, and obviously we never thought that something like this was going to happen. But when we sat back and talked a lot about our strategy here recently, and when we thought about what we did as a team in developing that strategy and how it's played into a benefit for us through this period of time, we feel very fortunate. I'd like to talk about a couple of those things because I think they're really important. One of the things that we talked a lot about was winning with the winners. If you think about going through this period that we've gone through, we've spent a lot of time with the investment community talking about the quality of sales initiatives. Now we've really cleaned up our sales throughout the globe. That looks like a really smart move right now because we've lined ourselves, as I mentioned in my script, with Walmart, Amazon, Target, Kohl's — and I could name several others — but the highest quality retailers in the world, and we feel really good about that position right now. In addition to that, we talked a lot at that time about category expansion, and one of the categories that we extended was outdoor with our all-terrain gear. I did mention earlier that we just landed a significant new account in Europe because this is going to be a global expansion for us. It's taken off really nicely, as we've talked about before in North America, but now it's going to expand globally, and we've gone ahead and done that and had a nice little program here for the second half of the year. But one of the things that I talked a lot about earlier was new business development. It is so important for us because again, we were a maintenance business. We spent a lot of time on that. I think everybody knows that just because you talk about new business development on day one, it takes a long time to develop that with a customer, create product, gain trust, and do all the things that you need to do to build relationships. And one of the reasons that we needed to do that was because Lee was underpenetrated here in the United States, under-distributed. So fortunately for us, we've done a lot of work. I want to go ahead and send a shout-out to the team that's done all that work — our Lee team and also the new business development team that works on behalf of all of Kontoor Brands. They've done an outstanding job. In the second half of this year, we do have a couple of programs coming in, but one really big program coming in that we're pretty proud of. So again, a lot of work on that. And I would tell you that one of the reasons why that's worked really well, and you heard mention of this from Rustin, and I think this is really important for everybody to think about long term: we pulled Lee into Greensboro this past year and now we have a collective team working together. Lee developing strengths they learn from Wrangler, Wrangler developing strengths that they learn from Lee, collaborating together, working as a team, with a healthy competition for the company, which we love. And then Rustin mentioned earlier about us now bringing in our direct-to-consumer team, so all of our forward-facing businesses now will be headquartered together, which we think is critically important. And I'll tell you two other things that are really important because this is playing out for us a little bit with Lee and China too: the emphasis that we've had in our strategy on digital a long time ago, and how that through this situation obviously has been critically important. We talked a lot about it and we had questions from people about why aren't we building more stores. Well, we focused on building out our digital, and we think that has been a really accretive part of our strategy. I'll leave you with this: at this point in time, we have two really great brands, but those brands also offer a great value. I mentioned a little bit in my script about how our business is pretty strong right now. We've started to see strengthening in our business the end of April, and here in the beginning of May it's really picked up. That has to do with the strategy we put in place, the strategy we're implementing now. Listen, our strategy is going to evolve over time and we're going to continue to do things that we need to do to grow this business going forward, but right now we're pleased with where we are. We're going through a really difficult time with the rest of the world, but we like how we are aligned — our strategy and our people — and we're really pleased with how the second half is shaping up. So thanks for the questions, Bob, and I hope you and your family are doing well.

Sure, so Aaron, let me start with China. It's a very important market for us. We've seen nice progression — I would call it moderate progression every week — which to me is the most important thing. I don't think any of us thought that this thing was going to go back to normal in a 30, 60, 90 day period of time. But what happened is, and what we're monitoring and what we're pleased with, is that we've seen week-to-week progression in the business. So at some point in time we'll get back to normal, and then we'll get back to growth. But for us, not taking a step back has been really critical. Seeing the consumer come back, seeing our digital business come back, and the consumer re-engaging with our brand, having all of our stores open — our partner stores are really critical and important to our strategy over there. So pleased with what's happening from a recovery in China, but again, I'm more pleased with the fact that it's been steady and not something that's been spiking or anything like that. So pleased with that. I'll take you through a little bit of how I've been thinking about how we've been talking about the quarters as we go here. Things got really difficult for a lot of folks at the end of March, last two weeks, and we weren't different than anybody. But we were very fortunate in that some of our retailers — and we weren't a priority for them at that point in time — but what's happened over time is people have started to come back to apparel, people have started to think about what's next, and people have been holding off on some purchases. We've seen a nice progression through the month of April, and then towards the end of April we saw some increased orders and just started to see it pick up. We're pleasantly surprised about the strength, and I attribute that again to the health of our partners, winning with winners. And May has started off, like I mentioned in my script, very well, and we're pleased with how it's coming along and feel really good about how we're positioned going forward. Now what I would say, and this is really important, as one country is starting to open up. We've got a lot of states opening up this weekend, a lot of states that have already opened up, and many more coming in the very near future. So it's going to be really important to see how others do because not only is a significant part of our business with current retailers that are already open, but we do have a significant part of our business that is with people that are starting to open. So it'll be really important to watch, and we want to make sure we do all the right things for our associates and for all of our customers and continue this progression moving forward. But what's really important is we're continuing to invest in the brand, we're investing in our digital space, we're investing in both Wrangler and Lee, we're continuing the investment in the ERP, which is going to help position us going forward, it helps us with our platform from a digital standpoint. So got a lot of good things going on in the business right now, got a lot of good things that we've talked about for the second half. I think one of the things that I'm most proud of with this team is that we went through a tough time. We've got some experience on this team. If you come visit us, a lot of you folks know us, a lot of us have been in this industry for a long time and we've been through some bad times before. And I think the one thing is we all know we're going to come out of these bad times, that's just how it works. It's pretty tough when you're in it, but for those of us who have been through it before, we can see the potential on the other side. We stuck to our strategy and it's paying off right now. So pleased. Rustin?

So, Alex, I'll start at this, and Rustin will share the answer with me. So we think of it as our owned, our partner, and our wholesale digital. We're really pleased with how our business has transpired there. Obviously it's been a core tenant of our strategy, and it's been a piece of the business that during this time the consumer has migrated to. We do think that migration is going to continue and it's going to pick up a little bit as things go forward. We've done some things to make sure that we're going to be there for the consumer. We recently just put a new platform in Europe, and in the next month we'll be putting a new platform in North America. So we're really excited about that because it's going to make the experience all that much better. In our own piece, our partner business is really good, and then our wholesale digital consumer business is exceptionally strong too. But we've invested a lot of time and energy in that. We saw that a long time ago, and we've been very direct about the fact that we've spent more time in the digital space and more money in the digital space than we have in building physical stores. We just think that's where the consumer is going to long term play out. It's actually turned out to be a really good decision. And then I think the last thing for me before I turn it over to Rustin is we've really thought long and hard about needing to have the right leadership there too. So we recently hired a new leader, a global leader for our digital piece, someone with a tremendous amount of experience that's coming in and making a very nice change immediately in how we think about it. And we love to bring in new talent that can help us all think differently, and it can be a game changer for us going forward. So we're very pleased with that. With that, I'll turn it over to Rustin.

Wanted to say thank you to everybody for participating today. Certainly appreciate your support of Kontoor Brands and all of our folks. Wishing all of you safety and health for you and your extended families. We are all in this together, we're going to get through it together, and we look forward to spending time with you on our next quarterly call and talking to some of you folks in between them. So thank you, everyone. Appreciate it. Please stay safe. Thank you.