Kontoor Brands, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter ended September 28, 2019; filed November 12, 2019. Kontoor, a denim and casual apparel company focused primarily on Wrangler and Lee, became a standalone public company on May 23, 2019, following its spin-off from VF Corporation. Comparisons require caution: 2019 results combine pre-spin-off carve-out financials with post-spin-off standalone results, and management notes that periods are not fully comparable.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $638.1m | $704.2m | $1,896.2m | $2,037.8m |
| Gross margin | 40.1% | 39.8% | 39.0% | 41.0% |
| Operating income | $31.0m | $95.3m | $109.7m | $263.4m |
| Net income | $14.5m | $71.0m | $67.9m | $211.2m |
| Diluted EPS | $0.25 | $1.25 | $1.19 | $3.73 |
- Q3 revenue fell 9%; management attributed the decline to lower sales in both brands and Other, retailer bankruptcy effects, quality-of-sales actions, discontinued manufacturing for VF, business-model changes, and a 1% unfavorable foreign-exchange impact. Nine-month revenue declined 7%, including a 2% unfavorable currency impact.
- Q3 gross margin rose 30 basis points, supported by quality-of-sales actions and favorable channel mix; Separation costs reduced it by about 80 basis points. Nine-month gross margin fell 200 basis points, with business-model changes, restructuring and Separation costs accounting for an estimated 170 basis points of pressure.
- Q3 SG&A was 30.1% of revenue versus 26.3% a year earlier. Separation costs contributed about 220 basis points to the increase; higher demand-creation and bad-debt costs and fixed-cost deleverage also weighed.
- Q3 included a $32.6m non-cash impairment of the Rock & Republic trademark ($25.2m after tax). The charge followed the decision not to extend the brand’s exclusive domestic wholesale distribution and licensing agreement.
- For the first nine months, cash provided by operations was $578.4m, investing activities provided $506.9m, and financing used $1,139.9m. Operating cash flow included $548.3m from settlement of amounts due from VF; investing cash flow included collection of $517.9m in notes receivable from VF. These separation-related cash movements make the totals a poor proxy for recurring cash generation.
- Cash and equivalents were $40.8m at September 28, 2019, down from $96.8m at year-end 2018. Inventory was $545.4m, compared with $473.8m at year-end.
- Debt included $988.1m of term loans (including the current portion) and $6.0m of short-term international borrowings. The company had no revolving-facility borrowings and reported $498.7m of availability, net of standby letters of credit. It was in compliance with debt covenants.
Segments and material changes
- Q3 Wrangler revenue was $367.2m, down 7%; segment profit was $61.1m, down 6%. Lee revenue was $232.2m, down 8%; segment profit was $30.2m, down 17%. Other revenue fell 32% to $38.7m.
- International and direct-to-consumer sales faced market exits, prior business-model changes and foreign-exchange pressure. Growth in China, U.S. digital wholesale and owned e-commerce partially offset declines. U.S. wholesale, 60% of Q3 revenue, declined 6%.
- Standalone corporate costs and interest expense rose following the spin-off. Q3 interest expense was $14.1m versus $0.2m a year earlier; corporate and other expenses were $29.9m versus $6.7m.
- The company recorded $24.6m of restructuring charges in the first nine months, primarily for employee-related benefits, inventory write-downs, asset impairments and other costs. A $5.8m restructuring accrual remained at quarter-end, expected to be paid within 12 months.
Liquidity, outlook and risks
- Management said operating cash flow, cash balances, revolving-credit capacity and access to capital markets were expected to provide adequate liquidity for obligations, investment and planned dividends. The filing does not provide numerical revenue or earnings guidance.
- The company described plans to grow Non-U.S. Wholesale and global branded direct-to-consumer channels, while continuing to focus on U.S. Wholesale. It is exiting unprofitable markets and distribution points, transitioning the CASA region to distributors, closing three owned manufacturing facilities in Mexico, and streamlining its organization and commercial operations.
- Management expects operational initiatives and cost-saving programs to improve efficiency, but results depend on execution and the benefits of the spin-off. Risks cited include consumer demand, customer concentration and financial health, foreign exchange, input costs, competition, supply-chain and IT disruption, brand protection, tax matters and possible asset impairment.
- The company declared a $0.56-per-share quarterly dividend payable December 20, 2019. A ten-year renewable-energy power purchase agreement carries a total commitment of $33.3m, with deliveries expected to begin no later than January 2021.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. It stated that ordinary-course legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether revenue and margin trends improve after accounting for spin-off comparability, market exits, retailer disruption and foreign exchange.
- Recurring operating cash generation and working-capital needs, excluding settlements and collections involving VF.
- Debt repayment, interest costs, covenant headroom and the availability of the revolving credit facility.
- Whether restructuring and Separation costs decline as planned, and whether planned cost savings offset standalone corporate expenses.
- The assumptions supporting the Rock & Republic impairment and any further impairment or restructuring charges.
- Dividend sustainability relative to cash generation, debt service and capital requirements.