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Air Freight Nicks Wrangler Parent’s Margins

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Kontoor Brands said high demand outweighed higher costs, driving up revenues and income in the third quarter.

In a Nutshell: Kontoor Brands Inc., with a portfolio led by the Wrangler and Lee brands, raised its fiscal 2021 outlook on Thursday in reporting third quarter financial results, while acknowledging the impacts from the pandemic and macroeconomic factors remain uncertain.

Revenue is now expected to increase at a high-teens percentage over 2020 to $2.47 billion to $2.48 billion, as compared to a mid-teens percentage in the prior guidance.

Adjusted gross margin is now forecast to rise at the high end of the prior guidance range of 44.5 percent to 45 percent of revenue, compared to 41.2 percent achieved in 2020. The increase is expected to be driven by growth in more accretive channels such as digital and international, somewhat tempered by higher transitory air freight expenses in support of strong demand.

Adjusted earnings per share (EPS) is now expected to be in the range of $4.15 to $4.20, as compared to $3.90 to $4.00 in the prior guidance, driven by operational performance. This EPS guidance includes a 20 cent impact from the incremental demand creation and digital investments in the fourth quarter, somewhat offset by lower interest expense, a lower expected effective tax rate and year-to-date share repurchases, which in aggregate should benefit EPS by 19 cents.

Capital expenditures are expected to be in the range of $40 million to $50 million, including $25 million to $30 million associated with the implementation of the company’s new global ERP system.

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Kontoor Brands said higher transitory air freight expenses in support of strong demand negatively impacted gross margin in the quarter by 180 basis points. However, higher demand creation, digital investments and compensation costs more than offset better fixed cost leverage on improving revenue and restructuring benefits.

Gross margin increased 20 basis points to 44.4 percent of revenue, compared to the same period in the prior year. Adjusted gross margin rose 80 basis points to 44.1 percent of revenue, aided by favorable channel, customer and product mixes, as well as business model changes.

The company reported that selling, general and administrative (SG&A) expenses were $204 million, while adjusted SG&A was $186 million, or 28.5 percent of revenue, up 290 basis points compared to the same period in the prior year. Adjustments primarily relate to costs associated with the global ERP implementation and information technology infrastructure build-out.

Inventory at the end of the third quarter was $409 million, down 5 percent compared to the prior-year period.

Sales: Revenue for third quarter ended Oct. 2 the increased 12 percent to $652 million, primarily driven by strength in digital, including own.com and digital wholesale, as well as improved performance across the U.S. wholesale business and positive trends in international markets. Compared to revenue in the third quarter of 2019, revenue was up 2 percent.

U.S. revenue rose 8 percent over the prior-year period to $493 million, propelled by growth in U.S. wholesale, including new business development wins and strength in digital, with own.com increasing 52 percent and digital wholesale increasing 90 percent. Compared to revenue in the third quarter of 2019, own.com and digital wholesale increased 118 percent and 237 percent, respectively.

International revenue increased 25 percent year over year to $159 million. China revenue rose 22 percent over the same period in the prior year, while European business was up 19 percent.

Wrangler brand global revenue increased 22 percent to $422 million, while Wrangler U.S. revenue increased 20 percent, driven by increases in digital, Western and outdoor.

Lee brand global revenue rose 6 percent to $228 million. The company said in the U.S., strength from improving sell-through of new programs and increases in digital was more than offset by demand fulfillment challenges and comparisons to a significant new distribution gain in the third quarter of 2020. Lee U.S. revenue decreased 4 percent compared to the same quarter last year, but is expected to return to strong growth in the fourth quarter.

Earnings: Net income in the quarter rose 4.3 percent to $63.41 million from $60.79 million in the prior-year period.

Earnings before interest, tax, depreciation and amortization (EBITDA) was $94.23 million. Adjusted EBITDA was up 1 percent to $111 million.

Earnings per share was $1.07 compared to $1.05 in the same period in the prior year. Adjusted earnings per share was $1.28 compared to $1.33.

Adjusted operating income was $102 million, down 1 percent compared to the same period in the prior year. Adjusted operating margin decreased 200 basis points to 15.6 percent of revenue, driven by normalizing of Covid-related expense, as well as higher transitory air freight expenses and amplified investments in demand creation to drive future accelerating revenue growth. These investments more than offset structural gross margin improvements and fixed cost leverage on improving revenue.

CEO’s Take: Scott Baxter, president and CEO of Kontoor Brands, said: “Kontoor is uniquely positioned to win in the marketplace, as evidenced by another quarter of broad-based strength across segments, channels and regions. And we expect our momentum to continue building, as reflected in our raised fiscal year guidance. Our strategic investments in key…enablers such as digital, demand creation and people should fuel our accelerating fundamentals.”

“Additionally, our balanced capital allocation strategy affords us enhanced optionality,” Baxter added. “We are continuing to invest in pillars of growth, while also delivering superior cash returns to our stakeholders. This is highlighted in the recently announced dividend increase and initial share repurchases during the third quarter.”