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Kontoor Brands, inc (KTB) Q3 2021 Earnings Call Transcript

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KTB earnings call for the period ending September 30, 2021.

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Kontoor Brands, inc (KTB 0.16%)
Q3 2021 Earnings Call
Nov 4, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to Kontoor Brands Q3 earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Eric Tracy, Vice President, Corporate Finance and Investor Relations. Thank you, sir. You may begin your presentation.

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Eric Tracy -- Senior Director of Investor Relations

Thank you, operator, and welcome to Kontoor Brands Third Quarter Earnings Conference Call. Participants on today's call will make forward-looking statements. [Operator Instructions]. Joining me on today's call are Kontoor Brands' Chair, President and Chief Executive Officer, Scott Baxter; and Chief Financial Officer, Rustin Welton. Following our prepared remarks, we will open the call for your questions. We anticipate the call will last about an hour. Scott?

Scott Baxter -- President, Chief Executive Officer & Chairman

Thanks, Eric, and hello to everyone joining us today. If you take one thing away from today's call, let it be this, Kontoor and our Wrangler and Lee brands are in a meaningfully different and advantageous place compared to our past. We are now uniquely positioned to win in the marketplace and to create future value for all our stakeholders. This was evident in our third quarter results, and it's even more evident in the confidence we have in raising our guidance for fiscal '21 and the momentum we see in the holiday and fiscal '22. More on this in a bit. But simply put, our strategies are working.

Our investments are yielding superior returns through the elevation of our brands, increasing permission to price and accelerating growth. No doubt, the current macro environment is placing significant challenges on companies and people. And as we've stated, Kontoor is not immune, but we are keenly focused on controlling the controllables and on the execution of our strategic playbook that has consistently proven itself in setting our foundation during Horizon one and now into Horizon two where we'll look to catalyze growth. When we started the Kontoor journey almost three years ago, our top priority in establishing our organizational culture was to take care of each other. And while we could not have predicted the obstacles we would face in the ensuing years, we believe that this core tenet and the great experience of our team could help us not only navigate difficult times but thrive through them. And I believe we have done just that.

So I want to thank our colleagues around the world for the ongoing collaboration, teamwork and resiliency and continuing to take care and support one another. So how are our strategies driving near-term results? Let me provide some proof points from the third quarter that showcased our strategic emphasis on catalyzing growth across four key areas: first, elevating and accelerating our core U.S. business; second, channel expansion, primarily in our D2C and digital ecosystem; third, diversifying our product mix through category extensions, including outdoor, workwear and T-shirts; and fourth, expanding the brands geographically with a focus on China.

Overall, global Kontoor reported a revenue increase of 12% compared to last year and 2% to 2019. Important to note, this included a negative high single-digit impact from strategic quality of sales actions within our VFO and India businesses. Excluding these actions, global Kontoor reported revenue would have been up 11% over 2019, far outpacing the market. Our U.S. business during the third quarter increased 8%, not only to 2020, but also 8% to 2019. Again, this includes the impact of our proactive measures within our VFO operations. So excluding these actions, the U.S. business would have been up high teens in the third quarter compared to pre-pandemic 2019 levels. And what's crucial is that this growth is healthy, balanced and broad-based across brands, categories and channels.

The U.S. was once again led by our rapidly evolving digital platforms with U.S.-owned dot-com increasing 118% and digital wholesale increasing 237% compared to 2019. U.S. wholesale increased 15% during the quarter, with outsized performance within our Western business augmented by emerging new programs in outdoor, ATG, workwear and female. In demonstrating the health of the Lee and Wrangler brands, our elevated position in the marketplace and increasing ability to take price, our digital AURs are up high single digits in the U.S. year-to-date. Turning next to our global digital business. Our results in the quarter highlight how our strategic investments are unlocking significant value and connecting us closer to our consumer more than ever before.

Q3 saw great growth over last year, but was even more impressive compared with 2019 with reported global own.com in digital wholesale increasing 88% and 182% versus pre-pandemic levels. And the runway for future growth remains significant as we are still highly under-indexed in this accretive channel relative to our peers. Our new ERP platform will enhance our digital efforts. As we globalize our operations, we will continue to lean in on investments to achieve our goal of 10% digital penetration over the next three years. And while our channel and digital evolution has been extraordinary, we are as equally excited by the performance of our tremendous expansion of new categories beyond denim, including outdoor, workwear, T-shirts, Western and female.

While our foundation lies in denim, we are rapidly developing a more diversified portfolio that augments and enhances our core offering. Within outdoor and our ATG line, we are leveraging great performance innovations to drive incremental penetration of existing retail partnerships, while also expanding into new points of distribution across the outdoor specialty and sporting goods channels both domestically and abroad. During the third quarter, our U.S. outdoor business saw 50% growth compared to 2019. Our test of ATG with Academy Sports here in the U.S. and Intersport in Europe are going very well, and we are excited about the opportunities for further expansion in these brand-elevating points of additional distribution for the line.

Our workwear business is also seeing great momentum as reflected in the third quarter results, with more than 60% growth in the U.S. compared to 2019, as we discussed on our last call. We more than doubled our door count to over 3,000 stores for fall '21 compared to spring with one of our key domestic retail partners, and we are really excited about the future opportunities this program affords us in the quarters to come. And the development of our T-shirt category is building momentum with significant new programs set for spring '22. In addition to these new outdoor workwear and T-shirt categories, our Wrangler modern female and Western businesses in the U.S. are performing exceptionally well with substantial year-over-year growth during the quarter, up more than 100% and 50%, respectively.

The broad-based third quarter performance across categories is a direct function of how investments are generating incremental business development opportunities for our brands. And finally, we continue to catalyze growth geographically with solid results in the quarter despite an uneven COVID environment across the globe. Even with ERP go-live in July, our European business saw nice year-over-year improvements up 19% in constant currency compared with 2020 driven by digital, brick-and-mortar reopening and new business development. And in China, our ongoing strategic investments continue to yield strong results, reported third quarter revenue increasing 22% and up 14% in constant currency.

You've heard from some regarding a broader slowdown in China. And while we haven't seen impacts to our business, we are obviously monitoring this closely. However, our brands are in distinctly advantaged positions in the market. Lee has over two decades of experience in the region and is uniquely connected with the Chinese culture while Wrangler is just getting started in China with significant white space ahead, affording us the opportunity to grow in the most productive manner. To fuel this growth across core channels, categories and geographies, you've heard us talk quite a bit about investing behind key enablers.

These pillars in support of growth include enhancing and amplifying demand creation platforms; scaling product and manufacturing innovation with sustainability and ESG as our guiding tenet; unlocking efficiency and productivity gains for the implementation of global ERP supply chain and digital infrastructure; and last, leveraging our world-class talent to build a purpose-led high-performance and increasingly growth-minded culture. I'm going to focus my comments today on our man creation efforts, while Rustin will provide greater insights with respect to our ERP implementation and supply chain. The reason I want to highlight our investments in demand creation is pretty straightforward. We are doing things with both the Wrangler and Lee brands that we've simply never done before. This is reflected in the brand's recently launched marketing campaigns.

First with Lee. If you haven't had a chance to see our newly original campaign that launched in October, I would encourage you to go to lee.com to check it out. Hearing me talk about it simply doesn't do it justice. I promise you we'll be impressed at how this modern, elevated brand expression brings the Lee transformation to life and just how differently the brand is showing up in the marketplace. Produced in collaboration with preeminent photographer and Creative Director, Mark Seliger, and sets the title track Struck by Lenny Kravitz, the work celebrates and encourages those who push boundaries through creativity, ingenuity and hard work. Our cast of originals reflects the multifaceted and diverse Lee consumer from climate warrior and fashion icon, Quanta Chasing Horse; Venice Beach skateboarding legend, Hayden McKenna, the unique character and personality of each cast member reflects what has always made Lee original, the stories behind those who wear them.

The campaign went live in North America in October and includes most all media platforms, with a heavy lean toward digital that will run on streaming services such as Disney and Hulu as well as high-impact display and key social media platforms, including the brand's launch on TikTok. And for those of you in New York, we've also introduced Lee originals on the streets of the city where originality and creativity thrive via strategic out-of-home media in Soho, Bushwook and Williamsburg. The global campaign will be supported by existing and new collaborations and partnerships with key influencers. We are excited about Lee's recent launch and newest partnerships with iconic brand Pendleton.

This limited edition just dropped this week and reimagines essentials from the brand's combined 200-plus years in American apparel. Each pair of gene is made in the U.S. with some of the last remaining salvage denim from Cone Denim's White Oak mill in Greensboro, North Carolina. And this is just the beginning of Lee's new brand messaging and repositioning. We couldn't be more excited to share what's on the horizon in the quarters to come. Turning to the Wrangler Demand creation platform, the brand's newest global ad campaign with a right of life debuted in September in North America with live coverage on the NFL Network. The campaign will also run on retail, digital and social media platforms across North America and Europe. And our collaborations with the Wrangler brand just keep building.

We had the initial launch of our Billabong and Wrangler collab in August with a second drop in September, tying perfectly for back-to-school, the partnership helped drive significant brand awareness with 1.7 million videos created on TikTok using our #SummerMashup. And beginning this fall, Wrangler is officially partnering with Yellowstone for much of the anticipated new season of the highly acclaimed most-watched series on cable TV. Wrangler will always be a symbol of authentic western fashion.

The Wrangler and Yellowstone collaboration came to fruition after much of the denim apparel was organically seen on the show's beloved characters. Collaborating with Paramount Network's Yellowstone brings the lifestyle we've embodied for decades into the spotlight allows us to reach a new audience that is now learning what it means to evoke the cowboy spirit. We're thrilled to be able to add a layer of authenticity to the closets of Yellowstone fans as appreciation for the Western lifestyle continues to surge in popularity in mainstream culture and fashion.

Augmenting our collabs, the brand continues to partner with key influencers that reach a younger, more diverse consumer base. For spring '22, Georgia May Jagger will continue her role as lead brand ambassador and the female face of Wrangler, and we are thrilled to announce our partnership with R&B Grammy-winning musician Leon Bridges. The two-season collaboration will launch in spring of '22 with Leon as the face of Wrangler's men's global product line, followed by a fall limited edition collaboration of key denim in western styles inspired by iconic silhouettes from our archives in Leon's personal style.

Finally, as we look to 2022, our demand creation efforts only build in support of commemorating the Wrangler brand's 75th anniversary. We have a year-long celebration planned to honor Wrangler's historic presence in music and fashion while also highlighting the courage, optimism and triumph of Western culture. Let me close with this. As you can see, there is a lot to be excited about with many proof points that our strategies and investments are fueling broad-based strength across our business. We will continue to amplify these strategic investments, particularly in demand creation and digital during the fourth quarter in support of our planned accelerating top line growth algorithm.

And while we are extremely proud of how we've navigated the last few years in establishing a solid foundation of which to build despite the turbulent macro environment, I want to share a few thoughts on why we are even more confident about what lies ahead. Rustin will provide more details, but a few items based on our current views that support this confidence as we look to 2022. First, we expect fiscal '22 revenue to accelerate above the long-term target of mid-single digits we established at our recent Investor Day with particular strength in the first half, up low double digits; and second, despite macro inflationary pressures, we anticipate '22 gross margins to be at or above '21 levels.

We possess a powerful combination of accelerating fundamental drivers and increasing capital allocation optionality that afford us the opportunity to deliver consistent near-term results while continuing to invest in our business and fund shareholder-friendly actions, including our recent dividend increase of 15% as well as opportunistic share repurchases during the third quarter. As I said at start, Kontoor is in a unique position of strength in the marketplace, and we look forward to executing and delivering superior future TSR for all of our stakeholders. Rustin?

Rustin Welton -- Executive Vice President & Chief Financial Officer

Thank you, Scott, and thank you all for joining us on today's call. As Scott outlined, we are very pleased with our third quarter results and the momentum of the business as we head into holiday in 2022. Simply put, our brands are as healthy as they have ever been with the investments made and solid foundation that has been established since the spin. Before turning to the quarterly review, I want to address a couple of topics that I know are top of mind: macroeconomic inflation and supply chain challenges as well as the status of the ERP implementation. With respect to the widely discussed industry supply chain disruptions, cotton pricing and inflationary pressures, I want to emphasize the following points that we have repeatedly stressed.

First, while we are not immune to these issues, we continue to leverage the agility of our best-in-class supply chain to navigate the environment. And second, we remain focused on what we can control and are steadfastly executing our strategic playbook. In terms of the supply chain, we believe we are relatively advantaged in our position. Our diversified global supply chain operations are differentiated with over 1/3 of our global production coming from our internal manufacturing facilities in the Western Hemisphere, with the balance being sourced from over 20 countries and approximately 225 facilities around the world. No single supplier makes up more than 10% of our cost of goods sold. Internal manufacturing, combined with contracting in the Western Hemisphere, gives us greater flexibility, shorter lead times and allows for enhanced inventory management in the North American market.

Our significant footprint in the Western Hemisphere has provided several advantages over the past few years, including being able to rapidly alter production to align with changing demand signals, minimizing excess and distressed inventory and mitigating exposure to congested coastal ports with extended lead times. In terms of sourcing, I know there are questions around China and Vietnam exposure so I wanted to address each quickly. Less than 3% of our product comes from China and is mostly China for China product, and less than 1% of our product comes from Vietnam. Finally, although we believe our global diversified supply chain is relatively advantaged, we have incurred elevated transitory costs as we anticipated and reflected in our revised outlook last quarter.

These transitory costs were largely driven by air freight as we chase production to meet the accelerated strong demand that Scott highlighted earlier. In terms of inflation and cotton experience roughly a decade ago, we want to be very clear. Our model and our brands are significantly better positioned now to offset pressures. So what gives us confidence to make this statement? Let me provide the following specific reasons. First, our investments into our brands, from design to innovation to demand creation are substantially elevated to support higher price points in AURs. For illustration of how we are distorting investments, we anticipate our full year demand creation spend in 2021 to be up approximately 40% versus 2020, increasing approximately 100 basis points as a percentage of revenue and up approximately 20% versus 2019.

Second, our product assortment and composition has evolved with the emergence of new categories like Wrangler ATG. Distorted growth in categories like outdoor, channels like digital and geographies like international are allowing us to mix up to higher AURs. Third, our cotton composition as a percentage of cost of goods sold, mid-teens today, has diversified into more synthetic fabrications in denim bottoms as well as outdoor performance, ATG and tops. Fourth, our domestic distribution continues to evolve into healthier channels and retailers. A decade ago, our first quality sales were predominantly in the wholesale channel and had much greater exposure to challenged mass and mid-tier retailers, such as Sears, Kmart and Shopko. Today, with our segmented offering, our brands have amplified their tiers of distribution in wholesale, particularly in areas such as Western and digital and begun to distort growth in our own dot-com platforms.

Fifth, structural mix shifts to accretive channels such as digital and international have and should continue to support gross margin, particularly as we remain underpenetrated relative to the market in these areas. Finally, given ongoing negotiations, we won't dimensionalize our inflation and pricing assumptions for 2022. But I will say, we have good visibility into the first half and are confident in the back half given current market conditions. But I want to reiterate what Scott stated earlier, the combination of executing pricing actions higher AURs and structurally accretive mix shifts support our view based on current market conditions, that full year '22 gross margins will be at or above full year '21 levels. Turning to the ERP. On our Q2 earnings call, we shared that we had gone live on our final regional implementation in EMEA early in the third quarter.

Today, I'm very pleased to report that we also exited the final transition service agreements, or TSAs, with our former parent company in the third quarter. We are very pleased and proud of the team who has worked on this critical initiative for Kontoor as the ERP platform is foundational for the continued globalization of the business. Now let's get to our third quarter review. I will focus my comments on key highlights and refer you to this morning's release for additional detail on the quarter. Unless otherwise stated, growth rates are in constant currency compared to the third quarter of 2020. Also, given the impacts COVID-19 had on prior year results, I will provide select references to the same quarter in 2019 for additional context where appropriate, Beginning with revenue, global revenue increased 11%.

Strategic actions to rationalize our VF Outlet fleet in the U.S., discontinue the sale of third-party branded products in all domestic outlet stores and transition to a new licensed business model in India represented approximately six points of headwind in the quarter compared to 2020. Compared to revenue in the third quarter of 2019, global revenue increased 1% or 9%, excluding our strategic actions. On a regional basis for the quarter, U.S. revenues increased 8% compared to the same quarter last year. Growth was broad-based with strength in digital, wholesale and Western. Wrangler's outdoor and female businesses also saw strong gains in the quarter. Within our digital business, U.S. own.com and U.S. digital wholesale increased 52% and 90%, respectively, compared to the same quarter in 2020.

As Scott mentioned, these growth rates were even stronger compared to 2019 with own.com and digital wholesale increasing 118% and 237% versus pre-pandemic levels. Outpacing the U.S., international revenues increased 20%. Growth in the quarter was partially impacted by the previously discussed timing shift into Q2 due to the European ERP go-live. Despite this shift, we saw strength in all channels, double-digit growth in China and continued strength in our digital businesses. Turning to our brands. Global revenue of our Wrangler brand increased 21%. Wrangler U.S. revenue increased 20%, driven by strength in our workwear and Western businesses new focus areas such as outdoor and female as well as ongoing gains in digital with digital wholesale and own.com increasing 93% and 67%, respectively.

Compared to the third quarter of 2019, Wrangler U.S. own.com increased 142%. Wrangler international revenue increased 32%, another proof point that our distorted investments in geographic expansion are paying off. Strength from digital, new business development wins including our ATG program in the sporting goods channel were partially offset by the previously mentioned timing shift in Europe. Lee brand global revenue increased 4%. In the U.S., strength from improving sell-through of new programs and increases in digital was more than offset by the previously mentioned strategic actions that accounted for nearly five points of headwind, demand fulfillment challenges and comparisons to a significant new distribution gain in the third quarter of 2020.

Lee U.S. revenue decreased 4% compared to the same quarter last year but is expected to return to strong growth in the fourth quarter. Lee international revenue increased 15% driven by amplified investments with digital and the ongoing recovery in our brick-and-mortar business. And finally, from a channel perspective, we saw continued broad-based strength compared to the same quarter in 2020. U.S. wholesale increased 15%, while non-U.S. wholesale grew 21%. Despite the previously mentioned strategic actions within the VFO operations, global branded D2C increased 2% on a reported basis and was flat in constant currency with own.com up 39%.

Now on to gross margin. Adjusted gross margin increased 80 basis points to 44.1% of revenue. Favorable channel, customer and product mix as well as business model changes were the primary drivers of the gains, partially offset by increased air freight. I will provide more on our gross margin expectations shortly, but we continue to see benefits from the structural margin enhancements I previously discussed. Mix shifts to highly accretive channels and geographies, proactive supply chain initiatives and AUR mix supported by innovation. Adjusted SG&A increased $36 million versus last year to $186 million. Higher demand creation, digital investments and compensation costs more than offset better fixed cost leverage on improving revenue and restructuring benefits.

Prior year comparisons were affected by reduced spending in 2020 in light of COVID uncertainty. As we have discussed and as seen in the third quarter, we believe these strategic investments such as in digital and demand creation will continue to unlock our catalyzing growth strategy and support expected demand in the fourth quarter and accelerating top line into 2022. Adjusted earnings per share was $1.28 compared to $1.33 in the same period in the prior year and compared to $0.95 in the third quarter of 2019. Now turning to our balance sheet. Third quarter inventories decreased 5% compared to last year. The decline reflects the fourth quarter 2020 actions to reduce the fleet and discontinue the sale of third-party branded products in our domestic outlets as well as the business model change in India.

Excluding these actions, inventory increased approximately 4% compared to the prior year in support of chasing higher projected demand. We finished the third quarter with net debt or long-term debt less cash of $576 million and $215 million in cash and equivalents. Our net leverage ratio or net debt divided by trailing 12-month adjusted EBITDA at the end of the third quarter was 1.4 times, within our targeted range of one to 2 times. And as previously announced, our Board of Directors declared a regular quarterly cash dividend of $0.46 per share, an increase of 15%, a testament to our Board's confidence in the strength of improving fundamentals. Finally, during the quarter, we repurchased $10 million in common stock. At the end of the third quarter, we had $190 million remaining under our current share repurchase authorization. When combined with the strong dividend, we've returned a total of $79 million to shareholders through the first three quarters of 2021.

We will continue to use the share repurchase program to offset dilution while also opportunistically buying shares as market conditions warrant. These accretive shareholder-friendly actions reflect our increasing capital allocation optionality, allowing us to continue to invest in our brands and business while productively returning excess cash to shareholders. This is powerful and further highlights how our model is differentiated. And now on to our outlook. Based on the strength of the third quarter and demand momentum for our brands, we are raising our fiscal 2021 outlook of new gross margin and adjusted EPS.

Revenue is now expected to increase in the high teens range over 2020 to $2.47 billion to $2.48 billion as compared to a mid-teens range in the prior guidance. This includes the mid-single-digit impact from the VF Outlet actions and India business model changes. Unpacking this a bit further, and importantly, comparing to pre-pandemic 2019 levels, third quarter 2021 revenue increased 1% compared to 2019 and was up 9%, excluding the impact from the strategic actions in VFO in India. Our guidance implies fourth quarter revenue will be up 3% to 4% compared with 2019 or up 13%, excluding the impact from the strategic actions in VFO in India.

At the midpoint of our guidance, 2021 revenue is expected to be approximately 6% above 2019 levels, excluding the strategic actions, well above most in the industry. Adjusted gross margin is now expected to increase at the high end of the prior guidance range of 44.5% to 45% of revenue compared to 41.2% 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 airfreight expenses in support of strong demand. SG&A investments will continue to be made in brands and capabilities.

Due to the strengthening revenue and gross margin outlook during the fourth quarter, the company expects to make incremental SG&A investments in demand creation and digital to support expected accelerating revenue growth in 2022. Specifically, compared to our prior guidance, we have chosen to invest an additional $15 million in demand creation and digital during the fourth quarter. Adjusted EPS is now expected to be in the range of $4.15 to $4.20 per share as compared to $3.90 to $4 per share in the prior guidance. This EPS guidance does not assume the benefit of any future share repurchases.

This EPS guidance includes a $0.20 impact from the incremental demand creation and digital investments in the fourth quarter compared to prior guidance, 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 approximately $0.19. Finally, in light of the current environment, I would like to close with a few additional comments on 2022. First, our catalyzing growth strategy is working. The health of and demand for our brands has never been better. And this is manifesting and accelerating demand going into 2022. Based on solid visibility, we expect 2022 revenues to increase at a rate above our mid-single-digit long-term algorithm outlined at our Investor Day.

We expect first half top line growth to be particularly strong, up low double digits. And second, we are not immune to the current inflationary environment. However, assuming current conditions, our best-in-class supply chain, combined with increasing permission to price and elevated AURs as well as expected ongoing benefits from structurally accretive mix shifts, we anticipate 2022 full year gross margins to be at or above 2021 levels. To close, I want to reiterate Scott's comments on the momentum of the business as we head into holiday and the first half of 2022. Our brands are as well positioned as they have ever been, and we are well on our way to meet and exceed our multiyear targets. This concludes our prepared remarks, and I will now turn the call back to our operator. Operator?

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Adrienne Yih with Barclays.

Adrienne Yih -- Barclays -- Analyst

Great. And boy, that's a whole lot of good news in 30 months. So congrats, really well done. My first question is on the low double-digit first half guidance. There are a few companies that are willing to go out and start giving us '22 guide. So there clearly, what you talked about is things that you're seeing up.

And so my question is, are you seeing that in the order book? And how much confidence do you have there? And then the drivers of that, Scott, I always like to get your opinion on the denim cycle. How strong is that? How long is that? And then, Rustin, you mentioned something on average unit retail. Are you planning on taking initial retails up in spring of next year like many others are? And I do have a follow-up

Scott Baxter -- President, Chief Executive Officer & Chairman

All right. Well, thanks, Adrienne. I'll go ahead and start. So really proud of the results that we've shown year-to-date, and I think that's a real catalyst as we grow this company. And I'm really proud of how we've pivoted from Horizon one spanning the company up to Horizon 2, turning ourselves into a growth company. And as you look at all that we've done, I think the thing that's really beneficial for us as we head into '22 is that, that opportunity for us to go to low double digits is a blanket approach.

So all I mean by that is it's happening everywhere. So it's not just in one specific area. It's in our channels, it's in our geographies, China and Europe, it's in our categories. And we introduced all-terrain gear and work and T-shirts, and they're all working really well. So it gives us really good confidence as we head into '22. And yes, it is because we have a really good understanding of our business, and we know where it's going to be. So from an order book standpoint, that does give us confidence. And as we think about the denim cycle very, very early stages.

And I've said before, it's much more than the denim cycle. This is a casualization of what's happening around the world, and we are seeing that take hold. I mean from one part of the globe to the other part of the globe, and it's really exciting to see, and denim is a big, big part of that. But I'll tell you what we've done with T-shirts and all-terrain gear and the outdoor category and people coming back to work, I think the one thing that as I look at the team, how we've pivoted ourselves to go ahead and play in the categories that are really meaningful going forward as an organization, I think, has been very strategic. So thank you.

Rustin Welton -- Executive Vice President & Chief Financial Officer

To your second question about AUR retails, certainly, we're in active negotiations now. So I'm not going to go into specific assumptions, as I indicated in the prepared remarks around '22 cost inflation or pricing assumptions, but I will make a couple of comments. Certainly, as we think about 2022, we're not immune, as we've said, from inflationary pressures that are out there. The second half of 2022, we'll see stronger inflationary pressures than the first half, as you would expect.

And then we're confident given existing conditions that we can offset the COGS inflation through the combination, as we talked about, of the ongoing KTB specific actions around structural mix shifts, higher AURs and cost efficiencies you've heard us talk about for several quarters. as well as strategic pricing. So we'll get into more details on the fourth quarter and specifically around assumptions.

Adrienne Yih -- Barclays -- Analyst

Great. And then, Rustin, a really quick housekeeping one, if you will, what percent of sales is cotton as raw material? You've been...

Rustin Welton -- Executive Vice President & Chief Financial Officer

Yes. We said cotton in the prepared remarks, Adrienne, was approximately mid-teens percent of our cost of goods sold.

Operator

Our next question comes from the line of Bob Drbul with Guggenheim Securities.

Bob Drbul -- Guggenheim Securities -- Analyst

Scott, congratulations on the Chairman title.

Scott Baxter -- President, Chief Executive Officer & Chairman

Thank you, Bob. Appreciate that.

Bob Drbul -- Guggenheim Securities -- Analyst

I guess a couple of questions. When you look at the digital acceleration, it was just quite impressive. So when you look at your capabilities in terms of your ability to continue to meet that high demand, do you think that the 10% number appears too low when you look at it over a longer period of time? Because it just seems like it's really taken off. And then the second question is, when you look at the returns you're getting on the demand creation, just how do you think about that longer term? I guess when you think about '21 into '22 as well, just more thoughts around the levels and sort of how you're spending that it seems like you're getting great returns.

Scott Baxter -- President, Chief Executive Officer & Chairman

Thanks, Bob. I'll take the first one and Rustin will take the second. From a digital standpoint, when we spun, we had a huge opportunity here. And I think it's really a real tribute to the leadership that we've developed within that category for our company, the really great folks that we've hired, the investment that we're making within that category relative to the fact that it's very accretive, and the fact that a couple of things have all come together for us. So we rolled out a new ERP system, so we have new platforms across the globe.

We're creating much better products, what's driving higher AURs in that category, with much better demand creation, so people are driving to our sites. And as you can see, 118% up for the quarter and our own.com is all there. But I think your question is great because it's a challenge that I have up to the team that we can do better than 10%. That's our goal, but we have to do better for our shareholders, and we are going to work really hard to do that, and I have a lot of faith in our group that we can do that. But I'll tell you about we're going to continue to make investments there, too, because we see it as really, really important.

From a demand creation standpoint, it's part of our virtuous cycle of growth, right? When we spun, we knew these brands needed big time investment. And we also had to have smart investments. So we hired two exceptional leaders from a marketing standpoint, and they've really helped us, and you heard me talk about these two new big global campaigns that we've never done anything like that before.

And the reception has been from the community amazing. So as we continue to do that and as we continue to grow our gross margin, we're creating an [Indecipherable] in that fuel to invest back in these brands in a really way, which I'm most encouraged about with the team. So really focused on that. And Rustin, maybe a few comments about the second half?

Rustin Welton -- Executive Vice President & Chief Financial Officer

Yes. So to Scott's point, I think we're seeing those returns, Bob, that you mentioned earlier. And that's what's causing us to lean in and invest again, an additional $15 million or $0.20 into accelerating that digital and demand creation in the fourth quarter. And it's because we're seeing those strong returns from the investments and certainly, you called it out in the Q3 results. As you think about sort of getting to the guide of $4.15 to $4.20, Bob, it's partially offset with, again, in our prepared remarks, we talked a little bit about $0.19 of benefit from below-the-line items like tax and lower interest and year-to-date share repurchases, but feel really good about that combined raise in revenue and gross margin guide that's really netting us to that $4.15 and $4.20 from an operational perspective.

We're just seeing those returns and really playing out. And so that plays into 2022 as well. So just one other point just to call out, Bob, as a reminder, with this updated guide, if we go back to the Investor Day, we talked about a 15%-plus operating margin by 23 with triple-digit expansion in '21. And as you can see, we remain well on track with our raised full year guide. So very confident in the investments we're making.

Operator

Our next question comes from the line of Mauricio Tena with UBS.

Mauricio Tena -- UBS -- Analyst

Great. Just a couple of questions. First, on inventory, can you tell us a little bit more about where you stand on inventory? You mentioned you were up 4%, excluding the business model changes, but I just want to understand if there's an component there? Just to make sure you have enough to support growth and what you're doing in terms of air freight and logistics. And secondly, on the capital allocation optionality, you did also repurchase $125 million in shares. So how should we think about that like going forward in terms of -- could that be like a quarterly number? Or like on an annualized basis, could that -- could we see like a triple digit in terms of million of dollars of capital returns to shareholders based on just share repurchases?

Rustin Welton -- Executive Vice President & Chief Financial Officer

Thanks, Mauricio. This is Rustin. I'll start with the first one around inventory and airfreight, and Scott can jump in on capital allocation. We'll kind of tag team that one. So in terms of your question around inventory, as we indicated in our prepared remarks, we continue to chase demand based on the momentum of the business. And retail inventories remain lean, as everyone knows. We are projecting kind of year-end inventory to increase double digits year-over-year to support this momentum, not just in the fourth quarter, but obviously heading into the first half of '22.

We do expect, as you think rolling forward here, that inventory is going to grow slower than revenue due to those lean retail inventory. So as we're getting product in, we're shipping it out. And then certainly, we've got some internal initiatives as well around SKU rat activities as we talked about a little bit at Investor Day. So we're going to lean into inventory where appropriate, given some of the inflationary pressures and again, the strong demand signal that we're seeing. In terms of airfreight, I mentioned last quarter and we reflected it in our outlook that we were not immune and expected some transitory airfreight costs, which you saw.

Certainly, in the third quarter here with 180 basis points of headwind from airfreight. We believe that will continue. We certainly utilized in the third quarter. We'll continue to utilize airfreight where possible and appropriate to meet that strong demand. Believe that elevated airfreight is transitory, as we talked about, but likely Mauricio to continue into 2022. And maybe just to dimensionalize it a little bit for you. In Q3, our gross margins were 44.1% with 180 basis points of headwind from airfreight. And at the midpoint of our outlook we provided here, implied margins are around 43% for the fourth quarter. Again, elevated airfreight will continue to be a headwind as we chase that strong demand. So certainly aggressively going after the demand signals that we see. Scott, do you want to take capital allocation?

Scott Baxter -- President, Chief Executive Officer & Chairman

Thanks, Mauricio, for the question. So Mauricio, I just want to remind everybody, if you go back to how quickly we paid down our debt, it's a really proud moment for us as an organization. During a really difficult time we paid our debt down quickly in Horizon 1, as we said we would, meeting our promises. And we talked a lot about -- and this means a lot. We talked a lot about the optionality. We said dividend increases, we said share buybacks, we said M&A.

We said that we had the optionality to do that after we paid down the debt. And I think what you're seeing right now is you're seeing the execution of that. So in a very short period of time, this quarter, we've increased the dividend 15% superior dividend, which is important to our TSR. And in addition to that, we started our stock repurchase program. So we started doing what we said we would do, and we're generating $1 billion over this 3-year period. So we still have a lot of optionality just because we've done those two things, we still have a lot more powder that we can use going forward as we see as the best thing to do for our shareholders. Rustin, anything to add?

Rustin Welton -- Executive Vice President & Chief Financial Officer

Yes. I would just sort of say, Mauricio, the multifaceted approach that Scott just laid out really speaks to the power of our operating cash flow, that we can pursue a multifaceted optionality concurrently. I think that's really important to take away. Certainly, this quarter, we talked about the share repo beginning. Just as a reminder, as the guide that we gave this morning, raising our guide is all organic. So you should think about any future share repurchases as incremental. So I just wanted to highlight those points. But thanks, Mauricio, for the question.

Operator

Our next question comes from the line of Erinn Murphy with Piper Sandler.

Erinn Murphy -- Piper Sandler -- Analyst

Let me add my congratulations. I am personally very about your Yellowstone collaboration as well. So very good job on that.

Scott Baxter -- President, Chief Executive Officer & Chairman

Sunday night, Erinn.

Erinn Murphy -- Piper Sandler -- Analyst

I know. It's on my calendar. A couple for me that haven't been asked yet. First on China, I'd love if you could share a little bit more about what you're seeing with the Wrangler business on Tmall now that you're starting to fully annualize that relationship? And then for both brands, how are you positioned into 11/11? And then secondly, could you just remind us how your consumer was impacted by U.S. stimulus last year? And then what have you taken into consideration with that low double-digit first half guide for stimulus?

Scott Baxter -- President, Chief Executive Officer & Chairman

Sure. Erinn, I'll go ahead and take those. This is Scott. So from a China standpoint, we are really -- and I talked about this a little bit on my prepared remarks, we're really pleased with how we're interacting with the Chinese consumer right now. That dates back to the fact that we've been in the market since 1995 and have a really loyal following there, in addition to the fact that we have really strong leadership throughout that region. So I'm really pleased with that. So the Lee brand continues to do well.

From the Wrangler brand kickoff standpoint, yes, it has been about a year now, coming up on a year actually. And it continues to meet the targets that we've set for from the standpoint of how we're rolling it out, how the brand is being received. I think the one thing that will be exciting for us is you're going to see some more demand creation on the Wrangler brand here really soon in China. So that's really exciting. And then from a stimulus standpoint, the consumer, for us, we play in all markets. So for us, that's really important. We play at the highest market and we play in the mass market.

So we have a wide range in consumer. In addition to the fact that we have picked up multiple different programs, which is really important for us, and it's broad-based. So it's not just here. It's in Europe, it's in China. And it's not just in our core, but I do want to make mention that our core business is really important to us. It's really strong. We're really pleased, but we're continuing to do more. And we're not stopping from a sustainability and innovation standpoint, demand creation. We're pushing the envelope, hiring great people, gearing up for a really good horizon to turning this into a real growth vehicle going forward. So thanks for the question. Really appreciate it.

Operator

Our next question comes from the line of Brooke Roach with Goldman Sachs.

Brooke Roach -- Goldman Sachs -- Analyst

Good morning and thank you so much for taking our questions. I was wondering if you could talk a little bit about the recent success of your new distribution wins that you've achieved over the course of the past year. It's great to see how many wins you've seen across partners and channels and subsegments of the brand, but I was wondering if you could talk a little bit about how those programs are performing with each of your partners. Are they comping positively as they anniversary the first year? And how important are some of those new realized distribution wins to the strong 1H revenue outlook into 2022?

Scott Baxter -- President, Chief Executive Officer & Chairman

Okay. Thanks, Brooke. This is Scott. I'll take that. Let's start with Lee. So a year ago, we kicked off a new program with a major customer, one of our win with the winter customers, and that has gone really well. The POS has continued to improve. In addition to that, it's gone so well and the consumer takeout and the acceptance has been good. We're really pleased with the product. We've won some additional programs on the Lee brand with that customer. So really important to us. T-shirt category, which we entered, and we talked a lot about, it's a $100 billion category.

It just accessorizes so well with our bottom, and we've got a couple of really big wins there. We talked about 1,700 doors. And again, we're really pleased with the initial takeout in the POS. Workwear is another example of -- this year, 3,300 new doors, a category that's really, really important. And then I think about things like outdoor. So a couple of years ago, we introduced this line, and it has grown significantly. It's really important to our business. It's given us confidence as a company that we can do things outside of our core. And we've got multiple points of distribution that are working.

But specific to your question, we're testing right now, for instance, here in the U.S. and also in Europe with Intersport and we're testing here with Academy. And both of those tests are going very well, and the POS is going very well. And the consumer takeout is really good. They love the product. So I'm feeling really confident from a new business development standpoint, from a new category standpoint for our team. There's going to be more that we're going to come out with in the future, which is really exciting. But for those specific instances, we feel really good about the first half relative to that and we're building going forward in the future.

Brooke Roach -- Goldman Sachs -- Analyst

Thank you.

Operator

Our next question comes from the line of Sam Poser with Williams Trading.

Sam Poser -- Williams Trading -- Analyst

Thanks for taking my questions. The guidance for the fourth quarter, the implied guidance for the fourth quarter, I mean, how should we think about the Lee and Wrangler business? And are you constrained by inventory at all in Q4 from a revenue perspective, given it's implying a fairly good deceleration? And just based on what I'm looking at, I mean, it's a fairly good deceleration, and it looks like your momentum is a little bit stronger than what you're giving us.

Rustin Welton -- Executive Vice President & Chief Financial Officer

Yes, Sam. It's Rustin. I'll go ahead and take that piece. As we think about the fourth quarter, certainly, Scott laid out all of the things that we're confident about moving into holiday as well as into 2022. We've tried to take into consideration the chasing on the demand and the inventory side and reflecting that guidance. Didn't split out sort of commentary by brand, but we did talk a little bit about the fourth quarter for Lee returning to strong growth.

And so we wanted to -- on the Lee piece, what we're seeing there is really strong POS that's really pulling from consumers, and that's supported by some increased air freight to meet that demand. Lee tends to be, Sam, a little bit more of a sourced business than Wrangler, and we're seeing strong momentum from a POS perspective, seeing strong momentum on the digital side as well. And then there's some additional business development wins, including a holiday program on the Lee piece. So that's driving it.

I think the point I would really bring home on the fourth quarter, Sam, because certainly, as you recall last year, there was a 53rd week, etc, is going back to 2019. And if you exclude those actions around VFO in India, the fourth quarter projection is scheduled to be up 3% to 4%. If you exclude those actions, it's 13%. So again, it speaks to the momentum of the business and really the investments and to Scott's point earlier, the broad-based support we're seeing across channels, categories and geographies that's giving us that confidence.

Sam Poser -- Williams Trading -- Analyst

Thanks. And then on the SG&A, I mean, I'm just sort of backing into numbers, but it looks like -- I mean it looks like you're going to spend over a lot of money on SG&A. And even with -- even before like on the old numbers, it looked like it was going to be a large number. So I mean, how -- is SG&A going to be up $35 million, $45 million from Q3? I mean, is that...

Rustin Welton -- Executive Vice President & Chief Financial Officer

Yes. A couple of things to comment on. As you think about comparisons, Sam, to prior year, particularly Q3, there were some COVID-related sort of expense reductions, given the uncertainty around COVID last year. So that distorts the comparison to prior year a little bit. As you think about Q4 and the investments, I draw you back to the prepared remarks with the Wrangler and Lee campaigns just now dropping. So certainly, we want to get out and support those campaigns.

We're very excited about it, as you heard us talk about on the call and the opportunities that are there. And based upon the returns that we've seen, that's what's giving us that confidence that we want to dial up that $15 million of incremental investment into digital and demand creation. And again, that's going to be a $0.20 headwind on EPS. So we think that is the right move for the investment on the brands, not just in '21, but in '22 and beyond. And in my prepared remarks, you saw how we're inflecting there, Sam. We're going to be up in advertising projected to be up an expected 40% compared to last year's numbers, and that's about 100 basis points and 20% over 2019 numbers as well. So again, very pleased with the investments, and that's what's giving us the confidence to distort and make sure the brands are healthy for the long run.

Operator

Our last question comes from the line of Jim Duffy with Stifel.

Peter McGoldrick -- Stifel -- Analyst

This is Peter McGoldrick on for Jim. It seems like you've got a lot of momentum in the marketing messaging for both brands. Can you provide any insight to demand creation priorities between them? What are the biggest dollar opportunities for investment? And then looking into 2022, are there any marketing opportunities that might not have been there at the beginning of 2021?

Scott Baxter -- President, Chief Executive Officer & Chairman

Yes, Peter, I'll take that. This is Scott. We feel really good about both brands and about the opportunities to invest in both brands. And I think that you heard me talk a little bit earlier about these new global ad campaigns that we kicked off in both. Fairly significant for us, Peter, because that hasn't been done in these brands before. And it's something that's going to set us apart. It's also something that I think is a springboard for the organization to build upon as we go forward and we think about the power of these brands. We're going to learn a lot from both of those two, and I think that's really important. But I think if there's anything I want you to take from I want you to take from the fact that there's a ton of opportunity left here. Demand creation is a huge opportunity for us.

We're going to continue to invest in it. And we're starting to invest at a level that our competition has been investing in for a very long time, and it feels good to get to that point that we need to so that we can go ahead and continue to grow these brands globally. Much more to come going forward. Really excited about the Georgia May Jagger, Leon Bridges, all the different things and the collaborations with Pendleton that Lee is doing. There's just so many things that we haven't done before, but it's all in the logical sequence that will play out over the next couple of years. And our big global ad campaigns were exactly where we wanted to put them, when we wanted to put them because we hit our playbook metrics. So thank you, Peter

Operator

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Scott Baxter for closing remarks.

Scott Baxter -- President, Chief Executive Officer & Chairman

Thanks, everyone. Really, really appreciate the time that you afforded us today. Thanks for being here with us on the journey, and I want to wish all of you a safe, happy holiday season, and we'll look forward to talking to you again next year. So thanks, everybody. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Eric Tracy -- Senior Director of Investor Relations

Scott Baxter -- President, Chief Executive Officer & Chairman

Rustin Welton -- Executive Vice President & Chief Financial Officer

Adrienne Yih -- Barclays -- Analyst

Bob Drbul -- Guggenheim Securities -- Analyst

Mauricio Tena -- UBS -- Analyst

Erinn Murphy -- Piper Sandler -- Analyst

Brooke Roach -- Goldman Sachs -- Analyst

Sam Poser -- Williams Trading -- Analyst

Peter McGoldrick -- Stifel -- Analyst

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