Better gross margins and expense controls offset the impact of Covid-19, leading to a spike in net income in the third quarter for Kontoor Brands.
In a Nutshell: Kontoor Brands Inc., parent to Wrangler and Lee, in reporting third quarter financial results, said while the impacts from the Covid-19 pandemic and macroeconomic factors remain uncertain, the company was providing full-year 2020 adjusted earnings per share (EPS) guidance and additional perspective on its fourth quarter outlook.
Revenue in the fourth quarter is expected to show continued sequential improvement from the third quarter, with revenue anticipated to be flat to down modestly. Adjusted gross margin in the fourth quarter is anticipated to be above the 40.9 percent achieved in the prior year, reflecting continued benefits from ongoing restructuring and quality-of-sales initiatives, as well as higher anticipated growth in more accretive channels such as digital and improving mix within international.
Fourth quarter adjusted selling, general and administrative (SG&A) is expected to increase year-over-year, driven by strategic decisions to amplify investments in demand creation and direct-to-consumer (DTC) in support of both the fourth quarter and long-term revenue.
Full-year 2020 adjusted EPS is anticipated to be in the range of $2.25 to $2.35. Strong cash generation is expected to support continued aggressive debt paydown, which is anticipated to be at least $100 million during the fourth quarter.
Kontoor Brands said it continues to take the necessary, proactive steps to accommodate a prolonged Covid-19 operating environment. The company ended the third quarter with $285 million in cash and equivalents, and approximately $1 billion in long-term debt. At the end of the period, Kontoor Brands achieved its lowest net debt level and strongest liquidity position since becoming an independent, publicly traded company in May 2019.
Due to its strong cash generation in the quarter, the company made additional discretionary repayments on its revolver totaling $100 million. As of September, the Company had $125 million of outstanding borrowings under the revolving credit facility and $368 million available for borrowing against this facility. Strong cash generation is expected to support continued aggressive debt paydown during the fourth quarter.
Inventory at the end of the third quarter of 2020 was $432 million, down $113 million or 21 percent compared to the prior-year period.
In the quarter, selling, general and administrative (SG&A) expenses were $175 million on a reported basis. On an adjusted basis, SG&A was $150 million, or 25.6 percent of revenue, down 230 basis points year-over-year. Adjustments primarily represent costs associated with the global ERP implementation and information technology infrastructure build-out. Tight expense control and restructuring benefits helped offset fixed cost de-leverage due to revenue declines.
Sales: Revenue in the third quarter ended Sept. 26 fell a year-over-year 9 percent to $583 million. The decline was primarily driven by Covid-19 impacts, offset in part by increases in digital, new business development wins and a $33 million shift in the timing of U.S. Wrangler shipments from the second quarter to the third quarter.
During the third quarter, U.S. revenue was $455 million, flat year-over-year. Here also the impacts of Covid-19 were in part offset by growth in digital, with U.S. digital wholesale increasing 68 percent and U.S. owned e-commerce increasing 43 percent, as well as new business development wins and Wrangler timing shift.
International revenue was down 30 percent to $128 million, mainly due to Covid-19 economic impacts. Despite the decline, both the Europe and China businesses experienced a gradual recovery during the quarter, with continued sequential revenue improvements in both regions expected in the fourth quarter.
Wrangler brand global revenue decreased 6 percent to $347 million, with a U.S. revenue up 2 percent thanks to increases in digital, strength in the Western business and the timing shift. Lee brand global revenue decreased 8 percent to $214 million, but U.S. revenue increased 10 percent, a result of new business development wins and increases in digital.
Other global revenue declined 43 percent to $22 million driven by Covid-19 impacts to the company’s VF Outlet stores, as well as planned reductions in the sale of goods manufactured for third parties and the Rock & Republic brand.
Earnings: Net income jumped 319 percent to $60.79 million from $14.5 million in the year-ago quarter. Earnings before interest, taxes, depreciation and amortization (EBITDA) rose 150 percent to $91 million. Adjusted EBITDA was $109 million, increasing 22 percent from the prior year.
EBITDA margin on a reported basis increased to 15.7 percent of revenue. Adjusted EBITDA margin increased 470 basis points to 18.8 percent of revenue. Earnings per share was $1.05 compared with 25 cents in the prior year.
Gross margin increased 410 basis points to 44.2 percent of revenue. Benefits of product costs, as well as favorable channel and product mix, were the primary drivers of the increase.
Operating income rose 167 percent to $83 million. Adjusted operating margin increased 460 basis points to 17.6 percent of revenue, reflecting the benefits of gross margin improvements and tight expense control, which more than offset the significant impacts of Covid-19.
CEO’s Take: Scott Baxter, president and CEO, said: “Our strategic actions delivered strong results in the quarter and are enhancing the Kontoor operating model focused on more profitable and sustainable long-term growth. Investments in our brands, people and partnerships drove significant sequential top line improvement, while restructuring, quality-of-sales initiatives and accretive mix shifts supported solid gross margin increases.
“And, importantly, our robust cash flow generation allowed us to continue to aggressively pay down debt, while also providing the opportunity to reinstate a quarterly dividend in the fourth quarter of 2020, a key tenet of our total shareholder return model,” Baxter added.