Q2 2023 Kontoor Brands Inc Earnings Call
Greetings and welcome to the <unk> Brands' Q2 earnings conference call.
At this time all participants are in a listen only mode.
A brief question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Eric Tracy VP, corporate finance and Investor Relations.
Thank you you may begin sir.
Thank you operator, and welcome to contour brands second quarter 2023 earnings Conference call.
On today's call will make forward looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to materially differ.
These uncertainties are detailed in documents filed with the SEC.
We urge you to read our risk factors cautionary language and other disclosures contained in those reports.
Amounts referred to on today's call will be on an adjusted dollar basis, which we clearly defined in the news release that was issued earlier this morning adjusted.
Adjusted amounts exclude the impact of restructuring costs.
Conciliations of GAAP measures to adjusted amounts can be found in the supplemental financial tables included in today's news release, which is available on our website at <unk> Dot com.
Unless otherwise noted amounts referred to on today's call will be in constant currency, which exclude the translation impact of changes in foreign currency exchange rates.
Joining me on today's call are contour Brands', President Chief Executive Officer, and Chair, Scott Baxter, and Chief Financial Officer Rustin Welton.
Following our prepared remarks, we will open the call for your questions, which dissipate the call will last about an hour Scott Thanks, Eric and thanks for all of those joining us on today's call I'm going to focus my comments today on three areas first I'll discuss key highlights from the second quarter, including our continued share gains in the U S.
Momentum in D C, which we believe provides the best indication of brand health and the strong results of our international business led by APAC. Most importantly, I'll touch on why we believe the K TB investment thesis is so uniquely positioned given how under index. We are in D C and <unk>.
International.
Second I'd like to share how strategic investments in key growth pillars, including demand creation half and are expected to support our market outperformance in the near term, but also drive increasingly diversified and accretive growth across categories channels and geographies over time and how we.
It took amplified action here in the second quarter to reduce non strategic spend and improved operating efficiencies both of which helped fund these critical growth enablers.
And lastly, before I pass it to Rustin I will provide perspective on why im confident and calm towards glide path. Despite the uneven macro environment. This is evidenced in not only our reaffirmed twenty-three guidance, excluding the restructuring charges, but in our accelerating top line, we anticipate here in the third quarter.
Let me start with highlights from our second quarter I am pleased to share that we delivered Q2 results largely consistent with both our expectations and commentary we provided on our first quarter call.
Contour revenue was essentially flat year over year as strength internationally, particularly in the China region was offset by a low single digit decrease in U S wholesale.
Within the U S market continued strong Pos and share gains were tempered by challenges in seasonal product and softer shipments during the quarter as retailers remain cautious with their open to buys I'll touch on this a bit later, but fortunately this dynamic has begun to turn more positive here in the third quarter from.
Share perspective, according to <unk>, which focuses on the U S. Total measured market, we continued to outpace the market and our U S. Wholesale in core denim business during the second quarter, a few key callouts.
For the last three months contour brands outperformed the market by approximately 100 basis points and in men's bottoms contour outperformed the market and our largest competitor by over 160, and 200 basis points, respectively are share gains in the core are a direct function of a few key factors first.
It reflects the incremental investments in our brands across innovation design and demand creation that drives competitive separation and second we were very mindful with strategic pricing, including both where we priced and how much we priced understanding the elasticity of our consumer with a focus on using innovation and newness.
To support incremental pricing.
In terms of pricing I. Appreciate why this may be top of mind for the investment community and I will expand in more detail when I discuss our outlook. However, I want to highlight that the full year guidance. We provided in March of this year already assumed a more aggressive pricing and promotional environment in the second half of 'twenty three.
Beyond share gains in the core we also saw nice category expansion during the second quarter as we continued to diversify the product portfolio and extend our reach to new points of distribution global highlights on a reported basis include a non denim long bottoms and T shirts, increasing 12% and 24% respectively, while outdoor.
<unk> was up high single digits.
Further indication of our brand's health and consumer wallet share our D to C business once again delivered broad based strength in the quarter.
Globally contoured D to C increased 15% with own dot com and owned retail both growing mid teens.
In the U S D to C grew 9% balanced across brands with wrangler, increasing 10% and Lee increasing 8% versus last year.
And international DTC accelerated in Q2, increasing 25% with a wrangler, increasing 14% and Lee increasing 28%.
And speaking of our international business. The second quarter saw a return to growth overall up 13% as continued choppiness in Europe in wholesale was offset by DTC as well as broad gains in APAC, China in particular saw significant recovery, increasing 93% compared to last year.
We will touch on this a bit later, but while growth rates in the quarter and in future periods will be impacted by prior year Lockdowns and restrictions. We are encouraged by the overall healthier marketplace and ongoing investments that will support material improvements in both our wholesale and retail businesses overtime.
As you all note D to C and international are key areas of growth for contour going forward and given the significant white space that still remains a head DTC and international make up only 12 and 21% of our last 12 month mix, respectively. Our contour investment thesis is uniquely positioned relative.
Too many in our competitive set we have more mature DTC and international operations, the diversified and accretive growth that DTC and international affords is still very much ahead of us. This supports a more profitable growth algorithm over time.
And we will continue to use ongoing structural gross margin accretion to help fund amplified investments in critical growth enablers, such as talent technology innovation and demand creation, creating a virtuous cycle for the sustained top line growth long term, we see opportunities to lean into these.
Areas in the third quarter.
The upcoming holiday and into 'twenty four.
We also will be proactive with strategic actions that help evolve our operating model for the go forward, including the restructuring measures taken during the second quarter Rustin will provide more detail, but I want to be clear. The steps. We've taken are not in reaction to a challenging market, but because we are in a different stage of growth relative to.
Where we were at the spin with our global operating model and ERP implementation complete we are increasingly focused on driving efficiencies and reducing non strategic spend augmenting the gross margin accretion to reallocate capital towards GSR bolstering investments.
With respect to demand creation I'd like to share. Some examples of our brand elevating activations from the second quarter and future pipeline.
First with the Lee brand the team continues to build momentum with pacemakers and Trendsetters, attracting younger new to final consumers into the brand our la based stylus showroom continues to yield strong engagement with some of the world's leading celebrities and Influencers and later this month Lee is preparing its first ever women's focused partner.
Ship with Daydreamer, a female founded brand that celebrates American made graphic storytelling.
Product will be offered at premium points of distribution as well as D to C, including select product made in Los Angeles.
He is also leading into its history of innovation by expanding key platforms, including extreme motion by yearend, we expect extreme motion will grow to over half our men's denim sales in the U S. As consumers look to fit the fit and comfort. It provides and we plan to build on this momentum next year with leaves 100 years of denim anniversary.
Stay tuned as we shared exciting details over the coming quarters.
Pivoting to Asia, Lee is partnering with leading celebrities and artists in countries, such as India, and South Korea to amplify our local voice in these important growth markets and our upcoming collaboration with the rising China based streetwear brand Warring Wild is slated to be featured during Shanghai fashion week and taken globally.
Great example of <unk> ability to leverage its platform to bring differentiated product to markets around the world.
Turning to Wrangler as you know in May we kicked off our inaugural sponsorship with the Academy of country Music Awards with three incredible days of denim customization.
Artist interviews and music performances, leading up to the award show the Wrangler brand was in the heart of artist activity with prominent placement on media ROE and the Red carpet as well as musical performances from Wrangler country music endorses Cody Johnson in female brand Ambassador leaning Wilson, and we were thrilled to see Laney take home.
Four awards, including album over the year and female artist of the year Wranglers momentum only continues in the back half of the year I'm, particularly excited about our new female and kids' initiatives, including partnerships with start and many rodine. These platforms further advanced wranglers diversification strategies to attract new and younger <unk>.
<unk>, while staying true to the brand.
And as you saw earlier this week, we announced wrangler is.
<unk> denim brand of the Dallas Cowboys of sponsorship will be featured throughout the upcoming season and will include Activations throughout AT&T Stadium, social media and our monthly concert series I recently had a chance to see what is planned on and around the Cowboys Stadium and it is truly incredible this authentic connection is a night.
<unk> fit for two American icon, and we couldnt be more excited for launch in the coming weeks and.
And finally, let me provide some perspective on our unique positioning going forward during the second quarter, we took proactive strategic actions to enhance our operating model drive greater efficiencies and improve our inventory levels.
For the balance of 'twenty, three we have reaffirmed our guidance excluding the restructuring actions taken in Q2, despite our continued.
Assumption for a more challenging macro backdrop, particularly here in the U S.
In the face of these macro headwinds our strategic investments are helping drive competitive separation as evidenced by our solid share gains and improving shipments.
Given these factors and strong proof points from quarter to date trends, we expect Q3 revenue growth to accelerate driven by the U S up mid single digits and above our full year algorithms.
Along with the improving top line or gross margin drivers are intact.
<unk> moderating input cost pressures reduced production downtime unhealthier inventory and ongoing structurally accretive mix shifts to DTC and international.
Combined this provides optionality to lean into strategic investments to support both near and long term opportunities.
Rustin will provide greater detail on our assumptions, but as I stated earlier this outlook assumes a more deflationary and more promotional landscape and importantly, we intend to exit 'twenty, three clean well positioned to capitalize more sustained and profitable growth long term, we will remain laser focused on working down inventory, which coupled.
With improving fundamentals should support significant cash generation and increasing capital allocation optionality as we move through the balance of the year and into 2024.
Finally in closing our results and go forward performance always depends on our incredible colleagues around the globe I want to especially thank our teams efforts to drive strategic actions during the quarter that help position <unk> for future success I am confident that their continued commitment to the execution of our strategic playbook will help drive.
Superior turns all <unk> stakeholders, we look forward to sharing the next phase of our long term strategic vision at our Investor Day, which is tentatively target early 2020 for Boston. Thank.
Thank you Scott and thank you all for joining us today.
As Scott stated we are pleased with our second quarter results that were largely consistent with our expectations. Despite the uneven environment for.
For the balance of the call I'm going to discuss highlights from the quarter as well as our outlook, but I would like to begin by touching on the actions we took during Q2.
First on inventory.
As you saw in this morning's release, we made meaningful progress in improving the health of our inventory position during the quarter, which allowed us to generate cash and further delever the balance sheet.
As we have discussed owned manufacturing is a competitive advantage in times like these.
It allows for the proactive actions, we took in managing internal production, including downtime that we discussed last quarter to more effectively rightsize inventories.
In addition, it allows for nimble optimization of our manufacturing footprint.
During the second quarter, we took steps to streamline and transfer of select production and our network as part of an ongoing comprehensive analysis of our supply chain.
This will not only aid in normalizing inventories, but we will have ongoing benefits to our operational efficiency. In fact, we now see incremental opportunities in the back half of the year to further improve our inventory position, which I will discuss later in my remarks.
Second as we discussed last quarter, we remain highly focused on driving efficiency gains and reducing areas of non strategic spend taking this measure. This long term view combined with disciplined expense controls is foundational to our operating playbook.
I will discuss the impact of these actions during my prepared remarks, but during the quarter, we executed targeted restructuring initiatives, primarily in corporate functions to create greater efficiencies and enable additional strategic investments combined these actions increase optionality.
<unk> to further invest in the business as we will do in the third quarter as well as enhance capital allocation options that help support superior tsi.
With that let's review the second quarter Global revenue was flat compared to the prior year growth in DTC and international were offset by a slight decline in U S wholesale.
On a regional basis U S revenues decreased 2%.
<unk> in the wholesale channel was primarily driven by declines in seasonal which more than offset increases in strategic growth categories, including outdoor and non denim long bottoms.
And while improving we continue to see Pos outpaced shipments as the channel works towards equilibrium.
In the U S D to C momentum continued with growth across both brands, including 13% growth in own dot com.
International revenues increased 13% driven by strong increases in China somewhat tempered by softness in EMEA.
On China as we discussed last quarter, we expected Q1 to mark the most significant year over year declines with trends improving significantly in the second quarter.
We are pleased to share this is precisely what happened with China, increasing 93%.
And while the China recovery will not be linear as prior year, lockdowns and restrictions impacted the quarter and we will continue to impact comparisons in the back half. We are encouraged by the progress we made in Q2, including improving retailer inventories and supporting our brands for long term.
Growth in the region.
In EMEA revenues decreased 5% driven by softness in wholesale more than offsetting double digit growth in DTC tight.
Tight retailer inventory controls driven by ongoing macro and inflationary headwinds continue to weigh on the region.
Turning to our brands.
Mobile revenue of our Wrangler brand increased 2% driven by strength in DTC and ongoing diversification into non denim categories.
Once again, non denim penetration increased accounting for 48% of global Wrangler revenue.
In the U S revenues increased 2% driven by 10% growth indirect to consumer as well as gains in denim and non denim longs tops and outdoor.
Wrangler International revenue decreased 5% driven by softness in European wholesale more than offsetting double digit gains in DTC.
Turning to lead global revenue decreased 3%.
Softness in wholesale more than offset 19% growth in DTC.
U S revenue declined 15% as decreases in seasonal has had a relatively outsized impact on the quarter.
Partially offsetting wholesale declines was continued growth in DTC, including 25% growth in own dot com.
Lee International revenue increased 27%.
APAC increased strong double digits, including broad based increases in China and.
EMEA revenues decreased 1% driven by double digit growth in DTC offset by declines in wholesale.
And finally from a channel perspective U S wholesale decreased 3% non U S wholesale increased 9% and global direct to consumer increased 15%, including a 15% increase in own dot com and a 16%.
Greece and brick and mortar.
Now on to gross margin gross.
Gross margin decreased 250 basis points on an adjusted basis to 41%.
As discussed last quarter, we increased proactive actions in managing internal production, including downtime.
Support the normalization of inventory.
Max assets associated with the relocation of our European headquarters.
Now turning to our balance sheet second quarter inventories increased 17% compared to last year and sequentially improved from the 52 per cent increase in the first quarter.
Compared to Q2 2019 inventories were 16%.
As discussed while the plan production actions and downtime were completed in the second quarter. We will continue to be proactive we feel good about the quality of our inventory, which remains primarily in core styles and now see greater opportunity to optimize inventory levels and.
Expect an additional $75 million of inventory reinfection by the end of the year.
I will touch on in our outlet, we remain focused on actively managing or working capital to drive cash conversion.
<unk> finished second quarter with net debt or a longterm that less cache of $706 million and $82 million in cash and equivalents are net leverage ratio or net debt divided by trailing 12 month adjusted EBITDA at the end of the first quarter was 1.9 times with.
<unk> targeted range of one to two times and as previously announced our board of directors declared a regular quarterly cash dividend a 48 cents per share.
Finally at the end of the second quarter, we had $62 million remaining under our share repurchase authorization.
Now onto our outlook.
Revenue is still anticipated increase at a low single digit percentage over 2022 with second half revenue now expect it to be above first half our guidance in bed. The following expectations first we can he need to anticipate a more chat.
<unk> U S macroenvironment in the back half, particularly in the fourth quarter.
That said compared to our prior outlook, we now see relatively stronger Q3 trends in the U S with growth across both brands set.
Second.
As I mentioned previously the recovery in China will not be linear given 20 twenty-two lockdowns in Reopenings S.
<unk>, we expect it third quarter revenue decline to be more than offset by growth in the fourth quarter.
For the year, we continue to expect second half revenue growth in China and above the first half performance.
And finally based on continued U S share gains improving shipments M. P O S as well as strong quarter to date trends, we expect third quarter revenue to increase at a mid single digit rate.
Gross margin is expected to be in the range of 43.5% to 44% on a adjusted basis.
<unk>, 43.1% in 2022, we continue to anticipate favorable mix to support margin rates, driven by increasing DDC penetration and improving international growth rates broadly in the back half.
Easily as discuss last quarter, we saw peak inflation's lowing through the P&L in the second quarter.
Anticipate input cost pressures will ease significantly in the third quarter before inflicting to a tailwind in the fourth quarter.
As a result, we continue to expect gross margin expansion in the second half with the greatest year over year gains in the fourth quarter.
S. G N. A is expected to increase at a mid single digit right on and adjusted basis compared to adjusted SG&A in 2022.
We are planning growth rates, most pronounced in the third quarter as we distort investments and supportive upcoming holiday and 2024 to continue to support separation and a choppy environment.
As we have discussed we will continue to make investments and our brands and capabilities to drive longterm profitable growth.
He's focused initiatives will support demand creation D to see an international expansion.
This will be partially offset by tight cost controls.
E. P. S is still expected to be in the range of $4.55 to $4.75, an adjusted basis consistent with the prior outlook, excluding 13 cents associated with the restructuring charges in the second quarter.
We continue to anticipate adjusted E. B S year over year growth to be the strongest in the fourth quarter driven by the gross margin dynamics discussed and the amplified SG&A investments in the third quarter.
Finally, I want to Echo Scott Thomas and thank our colleagues around the globe.
Despite the uneven environment, our team strong execution against our strategic initiatives Grove, another quarter, consistent with our expectations and gives us confidence and R for your guidance.
We answered the back half of the year, we remain laser focused on driving profitable growth.
Improving cash generation, while expanding capital allocation optionality and supporting our brands through strategic investments.
As Scott mentioned, we look forward to sharing more on our long term opportunities at our Investor day, which is tentatively targeted the early 2024.
This concludes our prepared remarks, and I will now turn the call back to her operator operator.
Thank you.
We will now be.
<unk> a question and answer profession.
<unk>.
If you would like to ask a question. Please press one on your telephone keypad a confirmation tone was indicate your line is in question Q give.
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<unk> before pressing the stocky.
One moment, please while <unk> questions.
Okay.
Thank you.
Our first question is from <unk> <unk> <unk> <unk> hi.
<unk>.
Good morning, and.
Thanks for the questions I have a few actually.
The first one is you know when you when you look at what's happening sort of and you know in the industry and the space.
Reiterating guidance and.
Third quarter is actually accelerating could you just talk a little more around your confidence you know why you're so confident in the outlook.
And then I guess the second question is just on demand creation.
Could you talk a little bit more about the investments and the demand creation that seems to be you know, there's a pretty significant pipeline it seems to be.
A key driver of the share games that you've talked about are we thinking about this correctly and I have one more but I'll call back after these too thanks.
Hey, Bob how are Ya Scott I'll go ahead and take that I.
I guess I would start Bob with the second quarter in that we really started to <unk> momentum through the quarter. So we started to see some really nice sure needs, which as everybody knows in a in a more sluggish environment like we've experienced here for sure games become really important but share gains done strategically or even more important than our share of games are happening because of that second <unk>.
<unk> Ah really intelligent demand creation, they're making great product the pricing it right, we're really thinking about our pricing from a strategic standpoint, we've got it at the light retailers will also now expanding our D to see and that brings momentum right into the third quarter, where our shipments are starting to align with our P. O S.
Think about the third quarter and I think about some of the demand creation aspects you know our new Dallas Cowboys initiative I think about Lady Wilson, joining our team is our Brandon Bachelor and all the work. She has done and these colette that our team are coming up with it I think I've said this before that we're now receiving a lot of calls in and we used to make the calls outbound, but now we get an inbound.
And working with people like start you know really great brand on the West coast in Buffalo trace in Dragon Ball Z and sponsoring events like the American Academy of Country Music Awards, which we hadn't done before but it's a really nice fit for us in Austin City limits those things along with really good product like extreme motion and that platform that we're now taken globally, they give us really good.
Confidence going into the third quarter and the rest of the year, so feeling feeling pretty positive and as you see with taken out our guidance up a little bit from a rep standpoint.
Really happy with the moment of the protection.
Got it.
I just have one more question demand.
Yeah go ahead sorry.
Oh I was just gonna say from a demand creation standpoint, I know he's got one more question that you wanted to ask.
Yeah, I mean, it sort of ties in with demand creation, a little bit, but I guess, the steelers weren't available, but the the Cowboys you know it seems like.
Sounds like a pretty good you know it was like the perfect authentic partnership for Wrangler, but can you just talk to how this will be structured and how you're gonna execute it.
Yeah, Yeah for sure. So so no the Steelers certainly loved the Steelers, but the Cowboys were really good fit for US I know I know, we've done something really well Bob when my phone blows up like it has been a cowboys when I get a lot of messages from folks and basically the messages I get some folks are you know that was a really smart move makes a lotta sense, Texas is a really big market for us in a really important.
And market for us and and sports is a great activation platform for us in that respect and the way that we thought about this partnership you know related to you know whether it's gonna be on social media is going to be in stadium, it's going to be a concert series.
We've got it kind of from every single angle. When you think about it. So we're really happy about it and really can't wait to bring it to life as the rest of the year and the football season kicks off. So you know again I go back to I'm really proud of the team and some of the different thinking that we're now experiencing here after our spinoff versus what we did before but I think one of the <unk>.
Really baked into the business and we're seeing the acceleration of the business because of that really really smart gross so thanks Bob.
Thanks Scott.
Thank you.
Next question <unk> now with Wells Fargo. Please proceed.
Hey, Hey, guys. Thanks for taking my question.
Could just talk a little bit about pricing and the dynamics there you know.
We've heard competitors, they're so they're sort of walking back pricing I guess number one how much price have you taken over the last 18 to 24 months.
The number two are you picking on a more promotional environment and in the back to school and and the holiday.
One more follow up after that.
Well I'll start that and then I'll turn it over to rest and to go ahead and finish but you know like I made that comment a little bit earlier, we've been really smart about our pricing were taken pricing, where we can we know our consumer really well and understand the elasticity around our consumer really liked the approach and we're really thinking about the marketplace. We don't just blank at the marketplace, we put a lot of thought into.
Of this and we've been very consistent and that over the last few years.
Yeah. Thanks got good morning will you know as as Scott said, we we we kind of continue to remain focus just on offering consumers a compelling value. So as you think will about benefits received for price charged on all of our products. So certainly approach pricing from a very strategic perspective, you know.
As as Scott said, you know in the prepared remarks and the last question. We've been pleased with P. O S strength, we've seen in the U S. The share gains and really how our brands are resonating with consumers. So as we think about our outlook, we intend to dial up that demand creation in the third quarter in support of holiday in 2024.
Or you know.
Keeping your brands strong <unk>.
He is really important aspect of maintaining that price as Scott did indicate though will we certainly do assume a more challenging environment in the back half that's been consistent in our outlook you know throughout the year and it has been embedded in in our guidance in our assumptions so.
Uhm, you'll recall you know last quarter, we talked a little bit about the strength in international kind of being tampered by softness in the U S and the back half I'm due in part to a more promotional environment. So we see that incremental strike now in Q3 is S. P O S and shipments find better equilibrium and remain cautious at the queue for.
Four will be a little bit more challenging so we've tried to be thoughtful about not just pricing, but also their promotional environment. We're encountering.
Great and just just on the restructuring you guys took some actions around some some of the nonstrategic spend to try some efficiencies maybe just speak to the rationale for for those actions and you know what sort of efficiencies, they're going to be driving and and how that can maybe impact margins.
Sure sure, we'll all start and then ended up the rest of it but if you step back and think about it we spun off a little over four years ago. When when you spin off you look a little bit like your parent company, sometimes a lot like your parents company that just fell from.
We're really thinking about all those savings how we're gonna move those into greater efficiency additional investments into our brands talent design demand creation that you've heard all about today bring all that to the forefront, but now from that mentality standpoint, we put ourselves in a really good position, we made a really big investment and we're going to utilize that in.
Vestments going forward and we're gonna make sure that we go ahead and push that agenda.
This is this is our future and we're ready to embark upon it right now <unk> Yeah, I, just say well you you you saw on the prepared remarks, you know the charges are affected gross margin by about 40 bps in the quarter SG&A by by about 100 bps in the corner and then EPS it at 13 cents.
I think the real takeaway is that you know, we're really shifting b S T and $8 from from non strategic span into strategic span and as you've heard us talk a lot about will really driving that virtuous cycle, so unlocking those greater efficiencies, allowing for those.
Mental investments in our brands and growth enablers that really going to support them more sustainable healthier top line growth moving forward.
Thank you I'll I'll pass about banks Scott.
Thanks will.
Thank you.
Next question is from Jim Duffy, which stifle. Please proceed.
Thank you good morning, everyone really nice work through difficult environment.
Big picture opportunities to discuss but I I want to make sure I understand that the near term dynamics related to your comments Scott can you elaborate I'm comments about near term trends just in the context of the.
The backdrop of what you characterize as a challenging environment R. P. O S turns in recent months actually improving versus terms earlier in the year and I'm, particularly interested in the improving replenishment, where do you <unk> inventory stamm versus historical weeks on hand, and yeah. I guess the question is what's the risk of further disconnect.
But green P O S and replenishment thanks.
I think there's a couple of things that are intersecting here, you'll see a good momentum and that really stems from the fact that we've talked about this a lot that we are pricing right. We've got really great products that are great values, but in addition to that which we haven't done previous but we're doing now we've really brought some great demand creation into the marketplace, but in addition to that.
You've got shipments that are aligning with P. O S. As we head into the rest of the year, which becomes really important for us you've got international in China now coming on stronger than it has been opened it back up so that's a really big deal for US and you know as we move forward throughout the rest of the year, we're going to continue to put that pressure on all of our competitors and continue to invest in art <unk>.
<unk> and Jim we think that that is really an important factor going fork relative to how we're going to invest and we're going to maintain that healthy balance that we have right now.
Great and if I may ask a question on the gross margin Ruston really great progress on the inventory can you be more deliberate with where you are with respect to consuming inventory associated with higher cotton costs and higher freight cost. All this seems like it should be through the piano by fourth quarter of my car.
<unk> about that and then with that in mind, you know in the context of some of your other comments about pricing expectations for a deflationary environment in the category.
<unk> structural opportunity to the 46 per cent gross margin as you outlined it to 2021 Investor day.
Thanks.
Yeah, Yeah. Thanks G M. Good morning, so so in terms of some of the near term you outlined it perfectly. So you know the the peak input cost pressures really came through the P&L in the second quarter.
As we had talked about so we see that kind of easing here those input cost pressures easing in the third quarter before inflicting to a tailwind in the forest.
So that's kind of how I would think about sort of the evolution of those inflationary pressures coming coming forward.
I think you know in terms of longer term, we've had some significant sort of transitory challenges I would say Jim suits are investor day in May of 21, including the record inflation, certainly continued supply chain disruptions and as you you're aware sorta periods of retail inventory imbalances. So.
We're gonna continue to see send those transitory impact in the back half here is I just outline, but I think the key is the structural drivers and the opportunities that remain in place.
We continuous Scott said in his prepared remarks to be under indexed in D C and international over the last 12 months again D to see about 12% of our Rev.
International about 21%.
So I certainly won't Guy this morning beyond twenty-three, but.
But will provide some some additional color at the upcoming Investor day, but but certainly those structural mix improvements and opportunities that are out there gym for that 46% plus gross margin that we would outline have not changed and certainly see an opportunity to to reach those levels.
[noise] those conditions continue to normalize.
Thank you next question <unk> Sir.
U B S. Please proceed.
Great. Thanks for taking my our question <unk> first on the inventory.
Very good progress on I'm, working down and and Q2 improvement and <unk> and it seems like there's you know.
Further opportunities for the second half maybe you can speak a little bit more on your thoughts about how that no moderation in inventory and you know the declines in you are expecting all of that like me too like better cash conversion in any opportunities there with a with a casual generation that you'll have maybe and I'm just following up on on gross margin.
Again, I mean it.
It seems like it's inflicting positive.
<unk> the way you were talking about the <unk> factors affecting you know from the moderation and input cost pressures and I know, you're calling out for like even like the strongest corner your year to be.
Q for maybe you could speak about like.
What are you thinking about the Q3 gross margin you know I know.
You talked about last pressure from from from cough, but you should that imply that margin begin already <unk> and two three or or is it more you know very highly skewed <unk>. Thank you.
Yeah. Good morning, <unk> addressed and I'll I'll go ahead and take those so on the inventory side I'll start there so certainly.
He finished inventory up 17%.
Versus a year and and 16% versus the second quarter of 2019 at pre Covid levels, certainly pleased with the progress. We've made there improvement of from the first quarter, where we were up 52% and then certainly in the sixties in the in the back half of last year. So we're continue.
I'm going to see that sequential improvement that we would outline and really take aggressive steps here in the second quarter to continue to drive that.
You know from moving forward will continue to be proactive we feel good about the quality of our inventory again remains in primarily in those core styles and as we said in our prepared remarks, now see greater opportunity to optimize those inventory levels and expect an additional 75 million of inventory reduction by the end.
Of the year.
The majority of the inventory is in North America, where we continue to see the strongest brand heat M. P. O S strength of Scott talked about.
And we're now projecting Q3 and Q4.
To both finished below prior year levels and expect to in the year and a better alignment with some of our historic inventory days for the business. So I think the comment you made <unk> about cash generation is perhaps the most important here. So this inventory reduction is really driving.
That working capital improvement driving the cash generation in the back half introduced increasing the capital allocation Optionality that's out there.
So pleased with the inventory progress we've made to date more projected here in the back half if we shift over to gross margin.
You know I mentioned, a little bit about where we're seeing inflation again kind of peak inflation hitting in that second quarter gross margin again projected he's moving into Q3 and then in <unk> two a tailwind in the fourth quarter.
We do expand gross margin expansion in the back half with the greatest of your on your gains in the fourth quarter as you kind of indicated.
Really importantly, though I really want to highlight the structural margin drivers as I mentioned on the question from Jim.
We expect to see in the back half here and continuing into 24 remain intact as we continue to just.
Stored our and our growth in these accretive areas such as D to see an international that Scott talked about we remain significantly underindexed in those areas and again that diversified an accretive gross they're really affords us that much of the gross margin opportunities are still very much ahead of us and.
It's really support a more profitable growth algorithm over time, so again, certainly on a journey here managing through sort of the near term transitory pieces, which will improve in the back half again, but those structural drivers remaining intact are really important as we look to the future.
Thank you.
Thank you next question is from Brooke wrote with Goldman Sachs. Please proceed.
Good morning, and thank you so much for taking my question.
Look ahead are these double the head cracking sustainable into second half as you start to work against another tougher compares.
Additional distribution Windsor had any category.
Yeah broke I'll take that this is Scott thanks for the question <unk> Yeah.
You've seen that had been accelerating but the key here is that we're building really good products at a very fair price and a lot of value, bringing those into the family and they're operating very well.
And they are working well with our customers. So our consumers are really lined up with us there.
Makes a lotta sense that were in those categories related to what we've always done in our history. So have a lot of confidence going forward for those categories for sure.
Great, Thanks, and if I could just.
Follow up on International I was hoping that you could talk a little bit more about what you're seeing in terms of brand momentum in China and how the recovery is progressing I think you mentioned in a prepared remarks that the recovery wouldn't necessarily be linear, but I'm curious what you're seeing in the early days of this recovery and how you are thinking about growth and margins.
Alright.
I'll I'll start in Ruston might have a few comments or to kick out of a restaurant, but you know and Q2 as you saw it was meaningful recovery recovery, increasing 93 per cent, but with US I think the key is that we've got really strong partner doors, there and we're really starting to roll out our retail initiative, which is really significant force in.
How we're gonna look and how we're going to operate going forward. So it's a really big initiatives.
Going for for US we have a new leader there Gina who were really excited about breaks an incredible amount of experience in the marketplace. So that's a really big deal for US also but you know going forward are bringing it continue to do well they resonate really well with the consumer there are our largest brand for sure extremely healthy team's doing really well and.
Very optimistic about longterm outlook related to people product marketplace going forward busted anything that yeah, I I just add brick. Good morning, you know just <unk> certainly the comparisons year over year, you know create some noise, whether that's the second quarter of the third quarter or or the the.
Full year.
We are expecting growth in that back have we did mentioned in the prepared remarks that the Q3 declines that we're expecting.
Will be more than offset by the fourth quarter growth. So as you think bakra. You know Q2 was was marked by some pretty significant shutdowns.
In some key jurisdictions in in China. Certainly Q3 was was marked by a kind of a reopening if you will and and certainly many of our wholesale partners.
You know starting to prepare for for holiday 22, and then really some unexpected fourth quarter additional lockdowns in select markets. So those year over year comparisons are are really affected by those factors. We've you've heard us for several quarters now broke talk about.
The recovery in China is not necessarily going to be the linear on a quarter to quarter basis because of some of these compares or uniform across kind of different.
Jurisdictions are locations within the country certainly that's continuing to play out uhm. So it is choppy, but a scott kind of mentioned, where we're pleased with the progress that the retailers are made really on improving retail inventories, which is really important and we're gonna continue to play the long game <unk>.
<unk> with opportunities across both branches, we kind of move forward.
Thank you very much I'll pass on.
Extra.
Thank you.
Next question is from fall kidney with Barclays. Please proceed.
Alright, well thanks for taking my question.
We kind of underperformed versus wrangler and U S wholesale.
Is from more seasonal you mentioned, but mostly curious whether it <unk>. So your customers gravitate more towards the regular brand and how should we think about the U S for the remainder of the year.
Yeah, Paul interesting good morning, I'll I'll go ahead and take that so as you mentioned Lee U S was down 15% in the second quarter.
Really driven by wholesale being down high teens with with D. C kind of high single digits.
And as you know Lee has has a large seasonal business.
That has has changed over the last 45 days or so here as it's gotten significantly warmer but it did have a relatively outsized impact on on that second quarter for Lee.
Which typically those seasonal ship in at second quarter. You know we are confident in the brand and are anticipating a strong Q3 for the brand I think it's Scott are as I indicated we said we expected to see growth in both brands in the U S in the third quarter.
For Lee, specifically, we particularly see strength in that wholesale channel and conditions of have more normalized quarter to date, you know P. O S and shipments kind of finding a better equilibrium and then key retail partners really just being in a healthy your inventory position. So certainly certainly timing on the seasonal.
<unk> impact of the second quarter, but feel good about the brand.
Great. Thank you.
Thank you.
As there are no further questions at this time I am turning to call back.
Spot Baxter foreclosing comments.
Thanks, everyone. It and really appreciate your questions and your engagement with our company. Thanks, and we'll look forward to speaking to you again here in the upcoming third quarter have a happy and healthy and safe rest of the summer and we'll look forward to talking to you soon take care of everybody.
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