Kontoor Brands, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, three months ended March 30, 2019; comparable period ended March 31, 2018. The filing is for Q1 2019, notwithstanding the request metadata. Financial statements are unaudited, pre-spin-off carve-out statements reflecting the business as historically managed within VF Corporation (VF).
Business context and reporting period
Kontoor designs, sources, markets and distributes apparel primarily under the Wrangler and Lee brands, and also includes VF Outlet operations. VF completed the spin-off on May 22, 2019; Kontoor began trading separately on May 23. The reported quarter therefore precedes the separation, and carve-out allocations and related-party balances may not represent the company’s standalone results or financial position.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Revenue | $648.3 million | $669.7 million |
| Gross margin | 38.1% | 42.9% |
| Operating income | $25.2 million | $92.4 million |
| Net income | $15.4 million | $79.7 million |
| Diluted earnings per share | $0.27 | $1.41 |
| Operating cash flow | $206.5 million | $(114.4) million |
- SG&A was $222.1 million, or 34.3% of revenue, versus $194.8 million, or 29.1%, a year earlier. The reported operating margin was 3.9%, compared with 13.8%.
- Cash and equivalents were $102.9 million at March 30, 2019. Total assets were $2.385 billion, total liabilities $806.4 million and total equity $1.579 billion.
- Current liabilities were $637.2 million. Current assets were $1.781 billion, including $517.9 million of notes receivable from VF and $291.1 million due from related parties. These balances are not equivalent to cash available after the separation.
- At quarter-end, short-term borrowings were $8.4 million and related-party notes payable were $241.9 million. VF’s third-party long-term debt was not allocated to the carve-out statements.
- Operating cash flow benefited substantially from a $256.8 million reduction in amounts due from related parties, primarily reflecting settlement timing for receivables sold through VF’s program. Inventory and receivables used cash. Capital expenditures were $5.3 million; cash decreased by $195.6 million through financing activities, mainly from net transfers to VF.
Material changes versus the prior comparable period
- Revenue fell 3%, including an approximately 3% unfavorable foreign-exchange effect. Wrangler revenue increased 1.4% to $369.9 million; Lee revenue fell 7.8% to $241.5 million; Other revenue declined 13.7% to $36.9 million.
- International revenue declined 9%, primarily reflecting foreign exchange and weaker non-U.S. wholesale sales. U.S. wholesale revenue increased 1%; branded direct-to-consumer revenue declined 7%.
- Operating income fell to $25.2 million from $92.4 million, and net income declined 81%. Gross margin contracted 480 basis points. Management attributed approximately 380 basis points of the gross-margin decline to business-model changes, restructuring and separation transaction costs; distressed sales and adverse product costs also contributed.
- SG&A as a share of revenue increased 520 basis points. Management cited approximately 310 basis points of impact from business-model changes, restructuring and separation costs, with higher bonus expense and advertising also contributing.
- Q1 restructuring charges were $22.8 million, versus $1.9 million a year earlier, including severance, asset impairments, inventory write-downs and other costs. The quarter-end restructuring accrual was $36.6 million, most expected to be paid within 12 months.
- The effective tax rate was 44.7%, versus 15.0%, reflecting different discrete tax items and unbenefited losses in certain Central and South American jurisdictions. The prior-year period included a $6.3 million discrete tax benefit.
Outlook, commentary, risks and unusual items
- No specific revenue, earnings or margin guidance was provided. Management expects to pursue growth in non-U.S. wholesale and branded direct-to-consumer while maintaining focus on U.S. wholesale. It expects restructuring and operational initiatives to reduce future costs, but does not quantify expected savings in this filing.
- Initiatives include exiting selected unprofitable markets, moving the Central and South America region to a distributor model, closing three owned manufacturing facilities in Mexico, reorganizing commercial operations and relocating Lee’s North American headquarters.
- On May 17, 2019, after quarter-end, Kontoor borrowed $1.05 billion under newly established senior secured facilities, primarily to fund a cash transfer to VF. The facilities total $1.55 billion: $750 million five-year term loan A, $300 million seven-year term loan B and $500 million five-year revolving facility. Management expects to use the revolver for working capital and general corporate purposes. Debt covenants and the higher standalone funding burden may constrain the business.
- VF retained certain assets and liabilities, including those related to Argentina operations and the U.S. pension plan; some VF sales and allocated costs also will not continue. Transition and reverse transition services and other commercial arrangements with VF affect post-separation operations. Management cautions that standalone costs and results may differ from the carve-out presentation.
- Principal risks include separation disruption or loss of synergies, foreign-exchange movements, consumer demand, customer concentration and customer financial health, input costs, competition and margin pressure, execution of international and direct-to-consumer plans, supply-chain and cybersecurity risks, and tax, legal and regulatory matters. Management reported no material change to previously disclosed risk factors and no legal proceeding expected to materially harm results or financial condition.
- The company adopted the new lease standard in Q1, recording $77.3 million of operating lease assets and $80.7 million of lease liabilities. Management said adoption did not significantly affect income or cash flow. The Swiss Tax Act approved in May was still under evaluation.
Important facts for investors to verify
- How the $1.05 billion borrowing, debt covenants, interest costs and intended use of the remaining revolving capacity affect post-spin-off leverage and liquidity.
- Whether post-separation operating cash flow is sustainable, given Q1’s substantial benefit from related-party settlement timing.
- Standalone corporate, pension, transition-service and separation costs compared with the historical VF allocations, and whether expected restructuring savings materialize.
- Progress in stabilizing Lee results and margins, reducing foreign-exchange exposure, addressing distressed sales and executing the channel and market strategy.
- Resolution of tax examinations and unrecognized tax benefits, and the eventual impact of the Swiss Tax Act.