Wolverine World Wide, Inc. (WWW) Q3 2022 Earnings Report, Transcript and Summary

Greetings and welcome to the Wolverine World Wide Third Quarter 2022 Earnings Call. At this time all participants are in a listen-only mode. A question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Alex Wiseman, Vice President of Finance for Wolverine World Wide. Thank you. You may begin.

Good morning, and welcome to our third quarter 2022 conference call. On the call today are Brendan Hoffman, our President and Chief Executive Officer; and Mike Stornant, our Executive Vice President and Chief Financial Officer. Earlier this morning, we issued our earnings press release and announced our financial results for the third quarter 2022. We also issued a separate press release and filed an 8-K outlining changes to our brand groups and reportable segments which took effect in the fourth quarter. References to financial performance in today’s call reflect the pre-existing stock share. These two press releases are available on many news sites and can be viewed on our corporate website at wolverineworldwide.com. If you would prefer to have a copy of the release sent to you directly, please call Allison Malkin at (203)- 682-8225. This morning’s earnings press release and comments made during today’s earnings call include non-GAAP disclosures, which adjusts, for example, for the impacts of environmental and other related costs net of cost recoveries, foreign exchange rate changes and cost associated with the integration of Sweaty Betty. Prior year non-GAAP disclosures include additional adjustments for debt extinguishment cost and costs associated with the acquisition of the Sweaty Betty brand. These disclosures were reconciled in the attached tables within the body of the release. We have added a supplemental table on our website under the Investor Relations tab at the Webcast and Presentations link to show financial results with and without adjustments for abnormal airfreight levels in 2021 to facilitate year-over-year performance comparisons. I’d also like to remind you that statements describing the company’s expectations, plans, predictions, and projections, such as those regarding the company’s outlook for fiscal year 2022, growth opportunities and trends expected to affect the company’s future performance made during today’s conference call are forward-looking statements under U.S. Securities Laws. As a result, we must caution you that there are a number of factors that could cause actual results to differ materially from those described in the forward-looking statements. These important risk factors are identified in the company’s SEC filings and in our press releases. With that being said, I’d now like to turn the call over to Brendan Hoffman.

Thank you Alex. Good morning everyone, and thank you for joining today’s call. While we were pleased to deliver third quarter revenue growth of 9%, 12% on a constant currency basis, both revenue and profit came in below our expectations reflecting ongoing supply chain disruptions, heightened promotional activity, deteriorating macro conditions. Despite these external headwinds, we saw notable strength in our international business and within our portfolio, Merrell continued its strong momentum delivering 34% revenue growth, 39% on a constant currency basis. Merrell’s performance demonstrates that when we lead the market with product innovation, engage our consumers with powerful and relevant market storytelling, and have access to key products in inventory, we will win. We continue to strengthen the foundation of our business through a refined corporate strategy that is focused on prioritizing the brands that have the highest potential for growth and optimizing the brands that create value for strong profit and cash flow contribution. As we shared in a separate press release issued this morning, last week our Board of Directors approved a new brand group and reportable segment structure that aligns with this approach. This change is effective immediately and includes new leadership appointments to guide these groups. We have also established a profit improvement office to identify and execute initiatives that will unlock margin expansion, ensure we are directing resources to areas of the business that are expected to give us a strong ROI and enable the new structure. I am excited about these changes as they pave the way for Wolverine to become a stronger company that is more powerfully positioned. Mike and I will provide more information on this later in the call. But first, I will share the specific factors that led to our Q3 revenue and profit results, highlight some current strengths in the business and discuss actions to normalize our inventory position. Our third quarter sales increased 9% to $691 million excluding the unfavorable impact of foreign exchange rates, global revenues increased 12%. Adjusted operating profit decreased 10% to $62 million due mostly to higher promotional sales in our DTC channel as compared to unusually low promotions last year. Discounts in wholesale due to late deliveries and the impact of unfavorable foreign exchange rates. I’d like to provide more context on the factors that impacted revenue in the quarter. First, starting with U.S. wholesale, which represents our largest channel and the largest miss versus our outlook for the quarter, as Sperry, Keds, Sweaty Betty, the Wolverine brand and Saucony were heavily impacted by the following key factors. Logistics and warehouse congestion, this starts with our own distribution centers that are currently operating way over capacity making it difficult to receive new product and process outbound shipments. Ongoing congestion within inland transportation networks also remains challenging. This is our number one operational priority, Mike will go into more details regarding our efforts to increase efficiencies in order to improve the flow of our products later in the call. Many wholesales customers are currently dealing with heavy inventories and warehouse constraints. This resulted in certain shipment delays causing some elevated cancellations and additional discounting. Logistics delays and integration timing on Sweaty Betty’s U.S. wholesale business limited the brand’s ability to service its U.S. wholesale orders. Sperry underperformed our expectations as logistics and warehouse congestion led to late deliveries and slowed the introduction of newness which was further exacerbated by declining trends in the boat shoe categories and with the unusual warm weather, a sluggish start to the boot season, all of which led to shipping delays, discounts and order cancellations. Our global direct to consumer channels which include Sweaty Betty, will leverage to clear inventory during the quarter, which drove 4% revenue growth, 9% in constant currency, in line with our expectation. However, higher than expected promotions resulted in lower gross margin during the quarter. Challenging macro conditions in Sweaty Betty’s home market, The UK put extra pressure on performance in the quarter. Keep in mind that at this time last year, lead times were extremely long up to 365 days in some cases as we faced factory closures in Vietnam among other supply chain disruptions. We, like others, moved up deliveries, especially in core evergreen product to ensure we had ample supply to meet our backlog, which was at a historic high. So while we have not navigated the supply chain as seamlessly as we would have liked, we have plans in place that should allow us to improve the flow of goods, increase the rate of on-time deliveries and reduced inventory levels. These actions include reducing forward purchases with our suppliers, especially in core product that we have in the warehouse and forcefully moving through seasonal products. Mike will walk you through our inventory actions and expectations for inventory levels during his remarks. Notwithstanding these challenges, the quarter included noteworthy accomplishments. As I mentioned, the Merrell brand continues to resonate well with customers. Third quarter revenues exceeded expectations of 39% constant currency growth. The Merrell team has done a great job extending the brand’s reach to younger lifestyle consumers with targeted marketing and innovative product launches. It was encouraging to see product availability improved compared to last year when certain Vietnam factories were closed. And our international expansion continued with strong results in the quarter. International revenue is up 43% on a constant currency basis with strong growth across regions. Although we are cautious about macro and political instability in several international markets, we continue to see significant international growth potential for our key brands. Saucony.com revenue was up 30% in the quarter, 33% on a constant currency basis reflecting not only an increase in promotional activity but a strong consumer response to new products showcased in the quarter. Overall, we expect the environment to remain challenging which is reflected in our updated guidance, we have already taken many proactive steps to address the situation and position the company for 2023 and beyond. We remain confident in our ability to elevate our brands and position the company for sustained long-term growth. Our go-forward brand group structure was a critical step. This new structure will allow for better collaboration and increased efficiencies across brands, especially those that are innovating in similar product categories, targeting similar consumers and trading in similar distribution channels. The new brand structure will also allow our centers of excellence to operate more efficiently and effectively. The new groups will be active, consists of Merrell, Saucony, Sweaty Betty and Choco. The footwear brands will report to Chris Hufnagel and Sweaty Betty will continue to report to me. This group includes brands with the highest future growth potential. Work led by Tom Kennedy, consists of Wolverine, Caterpillar, Hy-Test, Bates and Harley Davidson, This group includes brands that will produce stable growth while contributing profit and cash flow to support our highest growth brands. Lifestyle led by Katherine Cousins consists of Sperry, Keds and Hush Puppies. This group represents our turnaround brands. Combined, the group delivers positive cash flow, but the brands are not achieving their potential. We are evaluating the best go-forward options for each brands. Next we also established a profit improvement office that will be led by a new Chief Profit Improvement Officer, who will report into me. We are targeting annual gross savings of $150 million and expect a portion of this to be recognized in 2023. This office is an essential enabler of our new corporate strategy and long-term plans for our highest growth brands. The benefits harvest will allow us to accelerate the return to our historical peak operating margin of 12% as a sustainable foundation upon which to leverage over time and also invest in the highest growth in ROI initiatives. We believe each of our brand has potential, but our new strategy is focused on simplifying the business, prioritizing brands of the biggest growth opportunities and optimizing brands that can create value through strong profit and cash flow contribution. The assessment of our portfolio may require some tough decisions as we address underperforming businesses. This work is one of our top priorities. Now we will move on to discuss the performance of our largest brands. Merrell delivered a record third quarter with revenue of $199 million, up 39% compared to the prior year on a constant currency basis with strong growth across regions, channels and categories. As we look at the assortment, we were pleased with the performance of the long delayed Moab 3, as well as newer innovative categories like Light Hike, with Bravada, our trail ready hiking sneaker. Lifestyle offerings including Hydro Moc and camping and trail running categories continue to be top performers. Our shift of focus to purpose-led brand messaging, as well as other community-focused ESG efforts help broaden the brands reach. Now I want to highlight a number of differentiating factors that contributed to Merrell’s results. We believe we can leverage our learnings from Merrell and transit into other brands to help them grow awareness and shape their digital marketing efforts. First, MTL, Merrell Test Lab is our innovation incubator where all our top products come to life. We test and refine right in the trail using nature as our guide and lead athletes as our North Star to produce our best performing products. Next, we began building a more agile and nimble marketing structure 18 months ago, which included a new in-house photo studio and the addition of key creative talent which are contributing to the brand’s global growth. The agility built into the model has paid dividends especially as we manage through the volatility and product launches resulting marketing activation shifts due to supply chain and stability over the past year. Finally, increased DTC distribution, over 40% of Merrell’s U.S. business is now Direct-to-Consumer. We have more control over the Merrell brand and how it is positioned when being operated in our own environment. Earlier this year, Merrell piloted the integration of its centralized e-commerce commercial team directly into the brand team to more closely connect marketing product and digital functions that maximize agility of speed. This has been very successful and we are rolling this structure to our other brands. The culmination of our efforts led to Merrell being named Brand of The Year by Footwear News and will be recognized at the Footwear News Achievement Awards Gala on Wednesday, November 30th in New York City. Footwear News editors selected Merrell as the brand of the year for leading the way and promoting a more diverse vision of the outdoors through various efforts including forming a women-centric hiking club, investing in big brothers, big sisters of America to make the outdoors more accessible to use and supporting the National Recreation and Park Association to help create more urban green spaces. Merrell has been recognized recently with numerous product awards, including its newly introduced Moab 3, receiving an innovation in design mentioned from fast company. Moab Speed Thermo Mid waterproof being selected for Outside’s Best in Hiking Boots in the 2023 Buyer’s Guide. And its MTL Skyflyer 2 and Rogue hiking boot receiving ISPO awards for product excellence in the apparel industry. As we look to Q4, we are very excited about the product pipeline and expect Merrell to deliver over 20% revenue growth and full year revenue growth in the high-teens. Moving on to Saucony, third quarter revenue came in below our expectations at $130 million down 1% compared to last year but up 4% in constant currency, primarily due to late deliveries caused by congestion in our warehouse and inland transportation network and weakness in the U.S. wholesale distribution. We were encouraged to see that consumer reaction in new product launches when we were able to introduce newness was very positive. To this end, both Campus and Triumphs 20 launched in the quarter and had strong sell throughs reflecting the demanding interest in Saucony. However, limited flow of newness pressured revenues. Our goal to Saucony remains focused on expanding the brand’s reach to every day active consumers. When we are visible to these consumers we see strong results. We are particularly focused on our own digital channel and those of our partners, especially digital tightened given the ability to gain share with these every day customers. We are also seeing success with our efforts to target a younger lifestyle-driven consumer with Saucony originals business, which continues to perform really well around the world. Saucony’s international business was another positive story. Saucony’s sales through our China JV more than doubled in the quarter and in China, our multi-channel strategy is working well including the addition of 16 new stores during the quarter. Efforts to drive brand awareness and excitement around the brand in China include a sponsorship of Hood to Coast Relay that took place in August. The Saucony team launched its House of Speed Consumer Activation Boot at the start and finish line through its 2,500 runners in over 100 media outlets. Saucony sponsored 250 runners, including 15 athletes and one previous Olympic champion, as well as social influencers. As a result of this activation, we saw a significant uptick in the search index for Saucony on TIMO. Saucony’s e-commerce third quarter revenue growth of 30% significantly outpaced the portfolio and this is fueled by strong sell through on the Endorphin 3 and Triumph’s 20 launches. Looking ahead, Saucony remains focused on driving market share globally across roads and trail running categories, as well as expanding our Lifestyle Originals business. In Q4, we expect Saucony to deliver over 20% growth. Moving on to Sweaty Betty, third quarter revenue declined 3%, but increased 13% on a constant currency basis. On a like-for-like pro forma basis, Sweaty Betty’s revenue was down 28%, 16% on a constant currency basis. This performance is below our expectations due to logistic delays that negatively impacted shipments of U.S. wholesale orders, performance was primarily challenged by tough macro environment in its home market, the UK where consumer sentiment continues to deteriorate significantly. Despite near-term macro challenges, we are very excited by Sweaty Betty’s long-term global expansion potential. Two weeks ago, Sweaty Betty opened its first concept store in London, at Battersea Power Station, one of the most comfortable new retail developments in the UK. The Power House store is a perfect physical expression of the brand’s distinct positioning. The store has received a lot of positive publicity and early response from consumers. In the quarter, Sweaty Betty rolled out a new POS system across the entire fleet of stores, which is mobile first and a great tech build house for more seamless transaction in stores. We are exploring ways to leverage this technology in the near term across the other brands in our portfolio. Looking ahead, we expect Sweaty Betty be pressured by macro challenges in the near term and expect Q4 revenues down high-single-digits. Pivoting to the work brands. Wolverine’s third quarter revenue came in below our expectations at $59 million, down 1% compared to the prior year. Congestion in our Beaumont, California Distribution Center resulted in some customer order cancellations and shifting deliveries to Q4 for certain customers. Ked’s third quarter revenues grew 36% on a constant currency basis, driven by strong growth outside of North America. Ked also experienced shipping delays in the U.S. market. The work category remains a steady source of growth underpinned by current industry trends. Warehouse Footwear is one of the areas we experienced continued tailwinds, particularly from female and Hispanic warehouse workers. We continue to leverage strong market share of Caterpillar and Wolverine, which account for 20% of work boot market. All of our boot brands continue to track younger consumers on digital channels, including Amazon and Zappos. From a marketing standpoint, Wolverine has been very successful of collaboration. The brand’s third collaboration with old Rip Van Winkle Bourbon launched on October 25 and sold out in less than 48 hours earning 500 million media impressions. This month, we are launching our third collaboration with Rawlings celebrating the iconic Gold Glove Awards, all recipients with the Gold Glove Awards will be sent a pair. Later this year, we will launch our fourth Metallica Scholars collection, as well as Second Halo collection, following Q1’s limited launch that sold out in minutes and produced plus 20% email list growth. We expect Wolverine’s Q4 revenues to grow high-single-digits, partly driven by a timing shift to some of the shipments into Q4 from Q3 due to logistic issues we cited. Moving to Sperry, Q3 revenue was down 12% as compared to the prior year fell short of our expectations. Congestion in our distribution centers and delays in the U.S. inland freight network were more pronounced in our Louisville distribution center where Sperry resides. Ked is also in this distribution center and faced these same challenges resulting in a revenue miss in Q3 versus our internal plan. Demand trends in the U.S. boat category and women’s sneakers softened in the third quarter compared to earlier in the year. Retailers are being more cautious on buying into these categories as evidenced by order cancellations we experienced in Sperry and Keds during the quarter at a tolerance for accepting late deliveries on these categories is relatively low. Sperry continues to posses high aided brand awareness at 57% and have seen a notable increase in search engine interest. We will leverage as we work aggressively to improve logistics and warehouse efficiencies, so that we can bring in innovative product stories including our Jaws, Seacycled and Moc-Sider boat lines. And in boots, we also expect our who, what, where, warm and wonderful and our Hershel Supply Company brand offerings to be favorably received by consumers. Overall, we expect improvement in the U.S. to take time as Sperry continues to face inconsistent trends in the overall boat shoe category. That said, Sperry continue to make progress on increasing relatively low international penetration. Third quarter revenue from Sperry’s international business increased over 250% versus the prior year and we are seeing some green shoots from our efforts to build brand awareness outside the U.S. Looking ahead, we are planning Sperry’s Q4 revenue to be down in the mid-20s range given softer start to the boot season and a more conservative growth expectations in boat and women sneakers category. Before I conclude, I’d like to point out that we remain committed to supporting our communities, protecting our planet, empowering our team, creating a diverse workforce and managing responsible sourcing and supply chain operations. I am very pleased with the progress we have made and invite you to read through our Global Impact Report published in August, which can be found on our Corporate Responsibility section of our website. In conclusion, while the global macro environment and inventory challenges are expected to attract from our performance in the near term, we are more confident than ever in the future of our brand. We are actively working on improving our inventory positions across our brands to ensure we return to more normal levels as early as possible in 2023. Additionally, our review of the brand portfolio, improvements and planning across the business, enhancements to technology and DE&I and ESG initiatives are embedded in the business as continued processes. Today we shared with you the resegmentation of our brands, leadership changes and the profit improvement office. We look forward to sharing more details with you at our Investor Day sometime in the first half of 2023. We will emerge from current challenging macro conditions as a stronger, more efficient, simple company with a portfolio of brands ready to service our customers around the world. With that, I will turn it over to Mike to discuss our financial results.

Thanks, Brendan. And thank you all for joining the call today. Brendan provided a thorough overview of our Q3 results and I will add some additional insights. However, I will focus most of my comments on actions to normalize our inventory position, our outlook for the fourth quarter and margin opportunities from the newly formed profit improvement office. The third quarter revenue performance included a 20% increase for the Michigan Group, and a 4.3% increase for the Boston Group and a 3.2% decrease for Sweaty Betty. In this morning’s press release, we provided pro forma information for the quarter to show what the results for our new reportable segments would have been including historical reference for 2021 and 2020. For Q4, we will be reporting results under the new structure. Adjusted Q3 gross margin of 40.3% was below our outlook mostly due to higher promotions in our D2C channels and lower than expected wholesale revenue for Sperry Ked, Sweaty Betty and Wolverine brand. We took measures in the quarter to move seasonal and end-of-life inventory, particularly through our D2C channels. Our international distributor sales were a larger percentage of our overall mix in the quarter compared to last year. Adjusted selling, general and administrative expenses of $216.4 million were up $8.7 million or 4.2% compared to the prior year including one additional month of Sweaty Betty expenses this year and higher marketing spend for Merrell and Saucony. Adjusted operating margin was 9% and below our outlook for the quarter driven mostly by the gross margin shortfall previously noted. Adjusted and reported diluted earnings per share for the quarter were $0.48 and $0.56 on a constant currency basis. This compares to $0.56 in the prior year. Now let me provide some insight regarding our inventory. Third quarter inventory of $881 million grew 114%, compared to unusually low levels last year and represents our peak level for 2022. Higher logistics, handling and other product costs represent approximately 15% of the increase. In transit inventory of $281 million was up from $57 million last year. This heavy in transit position was caused by inland logistics congestion and limited capacity in our distribution centers. At this time last year, we faced significant manufacturing challenges including the shutdown of key factories in South Vietnam that heavily impacted our Maryland Saucony brands. The volatile sourcing environment resulted in extremely long lead times of over one year at a time when we saw very strong demand for most brands reported by an historically high order book for our wholesale businesses. In the fourth quarter of 2021, we committed to invest in core inventory for our biggest brand as a way to mitigate the long lead times and ongoing supply chain volatility. During the first half of this year, we saw manufacturing lead times stabilize, while logistics lead times lengthened due to vessel capacity, port congestion and inland freight challenges. These logistics issues combined with congestion at our own distribution centers has hampered our ability to receive new products resulting in delayed shipments and increased order cancellations. Since late June, we have seen demand moderate for our brands, especially in our U.S. wholesale business. This is partially due to logistics delays I just mentioned, but also to a more difficult retail environment and backlog of inventory for certain wholesale customers especially in North America. All of these factors have contributed to the Q3 inventory position. The quality of inventory remains high with over 80% representing core and carryover styles that will be carried into 2023. Importantly, nearly 60% of our inventory is from Merrell, Saucony, Sweaty Betty and Wolverine brands. We have reset monthly inventory targets with a goal of normalizing inventory by Q3 of 2023. We expect year end 2022 inventory of approximately $840 million, a $40 million improvement from the end of Q3. Our key actions to reduce inventory include the following: we’ve identified approximately $125 million of end of life inventory to be liquidated through our D2C channels and key partner relationships. This action will negatively impact our gross margin in the near term especially in the fourth quarter, but will improve the operations of our distribution centers and improve our ability to receive new product for spring 2023. Now that logistics lead times have shortened, we are working with our supply chain partners to reflow goods over the next few months. This action will allow us to reduce the level of in transit inventory and reduced grid line. In addition, we’ve established alternate processes to circumvent the logistics congestion to ensure that our key spring product is delivered on time for our customers. Because of the high quality of core inventory we are carrying into 2023, we are comfortable reducing our 2023 production levels significantly. Currently, our pipeline of in-transit and on-order inventory is down over 35%. We have also reduced our forward coverage targets for certain brands with lower growth potential. We are implementing a new integrated inventory planning process that is designed to allow us to be more nimble and responsive to changes in demand or future supply chain disruptions. This new process includes people and tools that will improve our visibility and accountability. We are confident in our ability to manage the current inventory situation. We have an experienced supply chain team and our brand leaders are focused on this as a key priority. Brendan and I will continue to prioritize this work and expect to see continuous improvements over the coming months. Now we will turn to net debt and liquidity. We ended the quarter with net debt of $1.35 billion and liquidity of $400 million. Our bank defined leverage ratio was 3.4 times. This leverage position is a peak for this fiscal year and relates mostly to the increase in inventory in the quarter. In the first month of the fourth quarter, net debt in liquidity have improved by approximately $100 million. We expect to generate $250 million to $300 million of operating free cash flow in the fourth quarter bringing our bank defined leverage ratio, down closer to three times. Now let me cover our Q4 outlook and our full year outlook. Our revenue outlook of $650 million and $675 million represents growth of approximately 4% at the midpoint of the range, and approximately 9% in constant currency. This performance includes over 20% growth for Merrell and approximately 20% growth for our international business. We now expect fourth quarter adjusted gross margin of approximately 38% compared to 42% last year. The decline reflects the aggressive inventory reduction plan in overall higher promotional environment. Higher logistics and handling cost carried in our on-hand inventory and foreign currency. Adjusted selling, general and administrative expenses are expected to be approximately 37% of sales in the fourth quarter. This is higher than Q3 of 2022, because of the higher mix of Q4 D2C revenue including Sweaty Betty. Adjusted diluted earnings per share is expected to be in the range of a loss of $0.15 to a loss of $0.05. For the full year, we now expect revenue of $2.67 billion to $2.695 billion or approximately 14% constant currency growth at the midpoint of the range. We now expect adjusted diluted earnings per share of $1.41 to $1.51. I will now add some details regarding our profit improvement office. This new office will provide the leadership structure, and rigor to identify and harvest savings and margin for the company. The PIO will be responsible for profit improvement initiatives and will report to Brendan. Our internal goal is to identify $150 million in profit improvement initiatives with a goal of recognizing at least $65 million of this benefit in 2023. We expect the office to unlock savings and efficiency opportunities in the following areas. Supply chain costs, this represents about 65% of the company’s cost structure. We believe the simplification of the business, prioritization of our biggest brand and deeper focus on product cost will yield significantly savings. Our operations team has engaged Alex partners to support a cost savings project related to raw material procurement which is expected to yield savings for our H2 2023. As we streamline our factory and supply base, we are also negotiating for better costs and on-time performance which will benefit 2023. SKU management, more focus will be placed here. We expect this will directly benefit our inventory management and warehouse operations, while reducing product development and sample costs. There will also be more emphasis on allocating new SKUs to our growth brands. Portfolio assessment. The PIO role supports our efforts to address the underperforming segments of our business. This will include organizational and cost savings initiatives that best align with the company’s go forward corporate strategy. Each brand now has a clear role to play in the portfolio. In this context it will help us to make more effective resource and investment decisions for the future. Indirect costs; outside of the supply chain, we are identifying certain cost areas that can be better leveraged across the various business units. We believe our ability to aggregate spend and negotiate through a central procurement process should provide cost savings, improved accountability and higher quality vendors. Another key element of the new performance improvement office is the ability to maintain the identified savings inefficiencies into the future. We plan for the performance improvement office to be a permanent part of our business and to be very visible in the organization. Brendan and I believe that this added level of accountability will be fundamental to accelerate and embed the savings we realize. We are also excited about the work that is already underway and the early successes we are seeing. In closing, I’d like to thank our global team for their commitment and execution during an incredibly volatile time and I’ll now turn the call back over to the operator.

[Operator Instructions] Thank you. Our first question comes from the line of Jim Duffy from Stifel. Please proceed with your question.

Well, thank you. Good morning, guys. Lot to ask about here. I’ll get things started. I wanted to start by talking about the advantages of the realignment of the segments and some of the early initiatives of the profit improvement office. First on the profit improvement office, have you staffed an additional executive? Or is that’s something that falls under your responsibility, Mike?

No, we are going to – it’s Brendan, hey Jim. We are in the process of identifying or looking outside for a Chief Profit Improvement Officer that will report directly to me. Mike will obviously be very involved, but absolutely we are going to structure this. So, the whole organization knows how important this is and this person has a direct pipeline.

Okay. And thanks for mentioning some of the areas of focus like the SKU management, portfolio management, indirect costs and so forth. You also mentioned potential for some hard decisions on the brands. When do you expect to declare that you have the brand roster where you want it to be and you have the team on the field that you want to play the game list?

I think it’s an ongoing process now that we’ve established the new segments and put the leaders in place and we’ve identified, which brands are our growth brands, which brands are our funder brands and which brands are our turnover brands. And so, through that lens, we will make decisions that help us achieve our objectives going forward.

Okay. Very helpful. Maybe I’ll leave it at that and let others ask questions on the fundamentals. Thanks.

Thanks, Jim.

Thanks, Jim.

Thank you. Our next question comes from the line of Abbie Zvejnieks with Piper Sandler. Please proceed with your question.

Hi guys. Thanks for taking my question. I have two. The first one is, inventory levels are obviously higher than you would like and I understand about 80% of that can be carried over into next year and you are able to reduce some of those forward orders. But how will this impact newness across the brands and then how are you thinking on balancing to the current inventory position? And then, balancing that with powering product innovations.

Well, I think it affects newness in a sense that we know we needed to get more focus – or prioritize our SKU management and use newness as a weapon to add excitement and provide energy stories for our brands in our marketing. But I think we got – this will force us to be more disciplined. I think it will actually help our servicing the customer because we will be more focused on core which is the lion share of what our customers are looking for from us and I think at times over the last couple of years, we’ve neglected expanding our core at the expense of time to get newness and enter into new categories that maybe the customers are looking for us from. I think, in the short-term in terms of the inventory levels, as you said 80% of it is carry over and we won’t have to produce a Moab for a year. But the real challenge for us and why we are getting so aggressive at liquidating that the 20% that’s not carryover is just the grid lock that’s caused in our warehouses and just how much that’s impacting our ability to service our customers, particularly through our wholesale channel. So that’s the main focus there as opposed to perhaps other categories where it’s more heavily fashioned and you have a big obsolescence concern.

Got it. And then, secondly, was Saucony being down slightly I think, that was due to order cancellations that US wholesale, and a lot of due to that congestion in the DCs. But I guess, whether you are seeing in terms of different wholesale partner behavior? Are there certain channels, especially run family channel where you are seeing significant order cancellations? And then how do you feel about really the underlying demand of the Saucony brand?

No, I think it’s fairly broad based where we are seeing the challenges in terms of keeping the orders moving, I think most retailers serving that all have come off their forecasts over the last 12 months and have some of their own inventory challenges. Certainly, some categories are doing better than others, but Saucony is in a very competitive space. And right now, given the self-inflicted wounds that we have and some of the grid lock combined with the macro challenges. Our wholesale partners are great partners but they just have very low tolerance for any sort of delays or missteps and they are either looking for really large discounts to still take the orders or just cancellations in general. We feel good about the growth we have in Saucony for this quarter as some of the newness comes in, we also, I am encouraged by the performance of Saucony.com in Q3, which was up like 30%. Some of that was promotion, but some of that was just there we have the ability to control the newness in the flow and showcase it to the customer. So I think that’s one of the other things that in this current moment, we are a little disadvantaged about is our DTC penetration is lower than most of our peers, because we don’t have a store base like others do. So we are overly relied on the wholesalers and at this moment in time, that’s a little more challenging to get the goods moving.

I would just add one thing on just brand health too. Outside of the core U.S. wholesale distribution that we just talked about, the international business is quite strong for Saucony has been for quite some time. We continue to see strength in the lifestyle originals business which is mostly an Italy, Europe based business for us. Our growth in Asia Pac and some of the other regions that Brendan already talked about. So, fundamentally a nice recovery in the fourth quarter for Saucony in terms of growth and continued strength in the international markets, which is about 40% - over 40% of the total brand right now. So, there is some solid positive there underpinning the Saucony business.

Got it. Thank you.

Thanks, Abbie.

Thank you. Our next question comes from the line of Jonathan Komp with Baird. Please proceed with your question.

Yeah, hi, good morning. Thank you. Just a couple of margin related questions. I think first gross margin, such a gap it looks like you are guiding maybe about 80 basis points below the second half of 2019. So I am just wondering as you look at some sort of a baseline, how much of that might be temporary versus sort of a new baseline going forward? And then, Mike said, comments on SG&A, I think you are still at a point of a pretty big uptick, third quarter to fourth quarter in terms of the dollars. How quickly would you expect to be able to impact that and in 2023 are there scenarios where SG&A dollars will be down year-over-year?

Yeah, let me start with the margin comparison to 2019, I think for all the reasons that we talked about, the big drivers for us relate to being much more aggressive on the promotions, certainly through our direct channels focusing on trying to accelerate the reduction of inventories as quickly and rationally as we can. That’s going to have a more prominent impact on 2022 and certainly the back half and we don’t see - we will see some pressure carrying into the first part of next year for sure as we look at some of the liquidation that we’ll do in the first quarter. But I think that the emphasis here is to try to capture as much as exposure and again in the fourth quarter. We have some other cost, transitory costs that are impacting us this year related to handling costs and some of the grid lock that Brendan talked about, which is adding to our logistics and handling cost this year. Some of that will be recognized next year in the P&L, but a lot of it’s been recognized in 2022. We will get the full year benefit of the price increases that we put into place this year. Some them didn’t occur at the very beginning of the year. So that will be a positive for us as we think about next year in the gross margin runrate moving forward. But really importantly, I mean, the profit improvement work that we’ve already started focuses very much on gross margin and product cost and supply chain cost. We think the unlock there could be quite meaningful. It’s going to take a little bit of time to realize that in the P&L just based on how we turn the inventory. But the savings visibility that we have in that particular category is very meaningful. On the SG&A side, in the back half of the year, we continue to invest behind our big brands from a marketing standpoint that’s still for the full year and in the back half of the year exceeds 8% of revenue. That’s a sort of a high point for kind of a more recent comparison and certainly compared to 2019 when it was much lower and we are through the work that we’ve done on the organization and group structure and the other profit improvement work that we’ve already started, we would expect to see improvement in the SG&A profile next year. Jon, we are not giving guidance as to what that number will be, but I think you will see us share that with more detail very soon and as we kind of unlock some of the profit improvement initiatives and share those more specifically.

Yeah, that’s really helpful. Thank you and just one follow-up. We noticed last week the announced changes that some of the corporate bylaws, Brendan or Mike, to the extent you are willing to comment any perspective you can share on the rational and then just a summary of the changes that were made. Thank you.

Yeah, no, just, basic maintenance as we were working through the bylaws with the Board of Directors. Really nothing to call out or report on that change.

Understood. Thanks again.

Thank you. Our next question comes from the line of Mitch Kummetz with Seaport Global. Please proceed with your question.

Yeah, thanks for taking my questions. I guess, first question. As I am thinking about next year, Mike, it sounds like some of this end of life liquidations going to carry into next year. Maybe on the top-line, can you speak to kind of where the spring order book sits and it sounds like you expect product to flow better for spring than what you have been experiencing for fall? And how would you assess maybe the cancellation rest to spring orders next year?

We’ve set a major focus, Mitch and we probably – as mentioned that in our prepared remarks that the focus on scrubbing the order book and validating the order book has been a key priority as we looked at not only the guidance for Q4, but how we see ourselves working through the inventory. And so, due to the high confidence level there, there is a sort of practical approach to cancellation and delay assumptions built into the outlook for Q4 and we’ll be kind of moving at that way for spring as well. You are right in saying that we feel better about how goods will flow as we enter into spring and we are making room especially for our growth brands, for new product and making sure that that doesn’t become, continue to be a headwind for our growth brands in the spring season. And so, from that standpoint, we are feeling more positive and more confident as we focus on the first half of next year. The overhang on the inventory, again it’s a relatively small percentage of the total, but we called out in my comments that we have about a $125 million of inventory that we are focused on moving to relieve that pressure in the warehouse as also to get that behind us. It really opened up the opportunity for our growth brands to bring in new product in the middle to latter part of next year. So, in that respect, we’d expect Q4 to have a bigger margin impact for that type of activity, whether it’s moving faster through some of the oldest product or reserving for any future sales that might impact us next year. But there will certainly be some pressure in the first quarter on margins based on that.

Got it. Okay. Thank you for that. And then, on the gross margins, so, you guys are now looking for around 41% this year. I know that freight has been a drag. It sounds like with container rates, things like that, that’s improving any less air freight, I can’t remember how much air freight you guys were using maybe a year ago. But is there any way to kind of frame the drag from freight that’s embedded in that 41%, especially if you kind of anchor it back to kind of pre-COVID levels before freight kind of got a bit crazy, so?

Well, the air freight this year about $8.5 million and that was mostly in the first half of the year. But we are certainly part of that 41% margin that you are referencing. That’s about double what it would normally be and whatever it normalize anymore, but pre-COVID timeframe. But the big increase in our ocean freight, the extra handling cost that we are dealing with the demerge and detention costs that are kind of part of our logistics cost. Those are significant and I’d say the incurred cost there have probably anywhere between $40 million and $50 million higher than last year. That includes holding containers right at in the parking lot as we work through receiving and things like that. Some of that is on the balance sheet and in fact our inventory cost at the end of the third quarter, but we are starting to work through that inventory and starting to recognize that through the P&L and we did, that’s one of the reasons Q4 margins are down a bit and so, some of that will carry over into next year. But when you think about the runrate of costs and the transitory nature of – especially of the detention and demerge that we are experiencing right now, those are important and I see that significantly improving by the middle of next year for sure.

Okay. That’s helpful. All right. Thank you so much. Yes, go ahead.

Yeah. Thank you. One more comment on the freight too is just, as we are seeing the market rates improve we are starting to see good improvement on the standard ocean rates even compared to our contracts that we entered into in May and so, we would expect that to carry into next year, as well and do some improvement year-over-year in ocean freight side next year.

Okay. Thanks again.

Thank you. Our next question comes from the line of Jay Sole with UBS. Please proceed with your question.

Great. Thank you so much. Brendan, can you maybe just take us into a deeper dive into Sweaty Betty? What you are seeing in that business to what trends look positive gives you confidence for future growth, maybe where has been a little bit of disappointment? That would be helpful. Thank you.

Yeah, well, I think it starts with the 80% based in the UK and we all know what’s happening in the UK right now and in general high streets do most of the trading are way down. So, I mean, I’d say, Jay, that’s the single biggest factor for them. I mean, they’ve had some shipping delays as well that have delayed some of their newness. But, and then just an overall decline momentarily in search for leggings more broadly. So, I think there is a lot that was working against them. I think they have a great runway ahead of them with the market they play in and as we get through the next year in the UK along with the world starts to heal itself. I think they are going to be well positioned to not only expand their business in the UK but we are seeing really good momentum in China, albeit on a small base and an asset light base particularly through TIMO. So we think there is opportunity there and in the U.S. some of the – a big part of the wholesale miss as I called out was self-inflicted on our part. There were some integration problems that we did not anticipate with systems and just some of the mechanics of being an apparel business that caused us here in the U.S. But the good news there was their primary partner still wanted the goods. So, we had to provide a discount. Some of that will shift but it shows that there is that appetite here in the U.S. for Sweaty Betty and while we likely won’t open stores in 2023 as we originally kind of teased out there just due to the shifting economics. We will focus on the digital business here in the business and still with an eye towards opportunistic stores if not in 2023 in the future.

Got it. Thank you so much.

Thank you. Our next question comes from the line of Laurent Vasilescu with BNP Paribas. Please proceed with your question.

Hey guys. This is [Indiscernible] for Laurent. Thanks for taking our question. Maybe on first, it sounds like there were some shifts in wholesale from 3Q to 4Q. Maybe you could quantify that and help us think about 4Q revenue guidance by channel. It sounds like wholesale maybe some shifts.

Yeah, I’ll do it with careful there. I mean, it is shifting but I think we said it’s shifted for the last six quarters just as this thing has been so inconsistent. So, I don’t know if we are going to provide that level of guidance at this point. But certainly, trying to get into the wholesalers in the time of Christmas has been a priority over the last few weeks as Mike said, particularly with our growth brands where we know we can get the response. So..

And I’d also, I mean, just to reiterate what Brendan said about the brand performance in Q4 Merrell and Saucony delivering at or above 20% growth in the quarter. Our international business will be over 25% or expected to be over 25% in the fourth quarter. Again, so another strong quarter from that – from that region or that channel of our business. And as we saw in Q3, we think the headwind or the pressure will continue to be in the U.S. wholesale business and expect our D2C business grow at a similar rate in Q4.

Okay. It’s very helpful. Thanks. And then, maybe on just to dig in a little bit more on the $125 million of end of life and to clear, it sounds like through the next two quarters or so. Is there any way to think about, I guess, revenue growth at some of those liquidations, because obviously that boosts revenue, so just, how are you thinking about that?

We are not providing Q1 guidance yet. So we wouldn’t necessarily parse that out, but I think you are thinking about it. As we are that – we certainly have an order book today on the core business and the global business that would not include some of that incremental inventory reduction. So, as we sort that out and have more clarity on the timing of all of that, we’ll share it.

Okay. Thanks guys.

Thank you. Our final question this morning comes from the line of Sam Poser with William’s Trading. Please proceed with your question.

Thank you for taking my questions. I guess, I’d like to know if you could talk about maybe the margin by brand, I mean, the Merrell business was really good, but how was its EBIT on a year-over-year basis or gross margin as compared to the other brands? And then I have a follow-up.

We don’t necessarily talk about margin by brand, but Merrell’s performance overall was the strongest in the quarter including their ability to deliver normal levels of gross margin as we would have expected. And some of the other brands or channels are more impacted by the promotional environment than Merrell was.

And also the need to discount wholesale orders due to lateness, I think, changes based on the kind of health and growth of the brand right now.

Towards that initiative.

So, you didn’t face the same kind of need to order cancellations or discounts with the Merrell brand that you did with the other brands? Would that be an accurate assessment?

I would say, it’s a sliding scale. I mean, there were certainly actions that need to be taken, but it gets progressive, it changes based on as I said the health of the brand and the inventory position of the brand. So, Sperry, it would be more challenged there and have to provide greater incentives.

So, I guess, the question is how much of what occurred outside of Merrell was macro versus how much of it was – we should have done a better job with the way we execute at these brands and I’ll just use that in the general sense from shifting to product to marketing and so on and so forth?

Yeah, I mean, I am not going to handicap with that. I think that’s – there is both in there. We certainly hindsight is 2020 and there are things that we would have done differently in some of these brands, particularly with the inventory flow. I mean, when we saw business start to slow down over this summer, at that point in time we in hindsight we have been more aggressive with cancellations even though they would have created some liabilities on raw materials if we knew then what we knew now. So, certainly looking back on that and thinking about how we can correct that going forward with better processes and better reporting. I think specific to Sperry, Sam, which is I know is your favor and I think in retrospect we try to extend ourselves into too many categories and we are focused on our core business and just freshening up our core and expanding our core in boat and boots and got a little bit fragmented and I can see it now in our SKU management how it kind of add a wax. So that’s something that in hindsight that was a macro issue that was a self-inflicted issue that obviously got exposed more because of the macro issues. But I think when we see in a few weeks, we can walk you through a little bit more of our line architecture and I think you’ll see some of the changes we are making going forward. But obviously given the lead times, there is work to be done to get there.

Okay. And then lastly, I know you report this in the Q, but can you give us the wholesale or the Direct-to-Consumer sales for each of the – I guess, the Q3 merchandise the segments, Michigan Group, Austin Group and so on. Just for modeling purposes even though that will change – that is changing our mode.

Yeah, the 10-Q comes out tomorrow. So, we are not going to – we’ll probably won’t spend the time right now to go through that and provide that detail. We typically don’t, so.

All right. Well, thanks very much and thanks a lot for the answers.

Thank you. Ladies and gentlemen, that concludes our question and answer session. I’ll turn the call back to Mr. Hoffman for any final comments.

Okay. Thanks everyone for participating in the call and we look forward to keeping you updated and speaking again in the spring. Thank you.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.