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After Kontoor Brands’ Troubled Q3, How Long Until a Turnaround?

It was a tough third quarter for Kontoor Brands, weighed down by U.S. retail woes and global distribution problems.

In a Nutshell: Despite declines in revenue and earnings, Wrangler and Lee parent Kontoor Brands feels better results are on the horizon, as the company offered updated outlooks for the fiscal year.

“We’ve made great progress and our strategic actions are on track,” Scott Baxter, president and CEO, said. “We remain confident that we will continue to drive improved profitability and generate significant cash flow in support of achieving our long-term annualized total shareholder return goal of 8 to 10 percent.”

In the back half of the year, actions to improve distribution in India are expected to help deliver on the lower half of the previously announced adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) outlook for fiscal 2019 of $340 million to $360 million. The company said, “While favorable mix from restructuring and strategic quality-of-sales actions will benefit gross margin in the fourth quarter, unfavorable mix in India will temper the underlying strength.”

Kontoor Brands’ outlook for the fiscal year ended Dec. 28 also includes revenue to still exceed $2.5 billion, reflecting a mid-single-digit decline compared with full-year 2018 adjusted revenue. Excluding the negative impact of foreign currency exchange rates, impacts of a prior year U.S. retailer bankruptcy (Sears) and strategic business exits, full-year 2019 revenue is expected to be relatively consistent with full-year 2018 adjusted revenue.

“The company continues to expect second-half revenue to improve relative to the first half of 2019, with the fourth quarter benefiting the most from strategic actions and the fourth quarter 2018 customer bankruptcy comparison,” Kontoor Brands said.

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Capital expenditures are still expected to range between $55 million and $65 million, including approximately $30 million to $40 million to support the design and implementation of a global enterprise resource planning (ERP) system. As previously announced, the global ERP system implementation is expected to require approximately $80 million to $90 million of capital investment during a two-to-three-year period and is expected to result in significant efficiencies and cost savings once fully implemented.

Sales: Revenue for the third quarter ended Sept. 28 decreased 9 percent year-over-year to $638.14 million, primarily driven by three factors, the company said. These were proactive strategic quality-of-sales initiatives, reflecting actions taken to exit an underperforming country and other global points of distribution, including select channels in India; impacts of the major U.S. retailer bankruptcy in the fourth quarter of 2018; and foreign currency headwinds.

During the quarter, U.S. revenue was $457 million, down 9 percent on a reported basis and 6 percent compared with 2018 adjusted revenues, including the impact of the major U.S. retailer bankruptcy. International revenue was $181 million, down 11 percent on a reported basis, driven primarily by exiting unprofitable points of distribution in India and other planned country exits and business model changes. These factors were partially offset by growth in China and favorable timing of shipments in Europe.

Wrangler brand global revenue decreased 7 percent to $367 million. Global revenues declined 6 percent and U.S. revenue fell 4 percent compared with third quarter 2018 adjusted revenue. The company noted that Wrangler brand’s U.S. wholesale performance was down 2 percent year-to-date compared with 2018 adjusted revenue, driven by the customer bankruptcy.

Lee brand global revenues were down 8 percent to $232 million in the period. Kontoor noted that on a constant currency basis, Lee brand revenue increased 8 percent in China during the third quarter, with broad-based strength across all channels of distribution, including a 10 percent comp store increase and 41 percent increase in digital business.

Earnings: Net income for the quarter dropped 80 percent to $14.5 million from $71.02 million in the same period last year. (EBITDA) declined 10 percent on an adjusted basis to $90 million. Adjusted EBITDA margin decreased 50 basis points to 14.1 percent. Actions taken in India took up approximately $8 million of the adjusted EBITDA impact in the quarter.

Gross margin increased 30 basis points to 40.1 percent on a reported basis. On an adjusted basis, gross margin was up 20 basis points to 40.9 percent. Increases were primarily due to the impacts of restructuring and quality-of-sales initiatives, as well as favorable channel mix, which more than offset the negative impact of strategic actions taken in India and the pressure from foreign currency.

Operating income was down 67 percent to $31.03 million from $95,28 million in the year-ago period.

CEO’s Take: Baxter said: “Third quarter 2019 results were in line with our expectations, as we continued to execute on our strategy of setting the foundation for long-term operational success. We’re beginning to realize the benefits of the previously announced restructuring and cost-savings initiatives, while we continue to stabilize and globalize our organization. And, we’re improving the quality of our sales, including exiting unprofitable points of distribution, changing business models and rationalizing underperforming SKUs. These actions create the building blocks for healthy, sustainable future growth.”