Kontoor Brands, Inc. quarterly report, Q2 FY2020

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Business context and reporting period

Kontoor Brands, Inc. designs, sources, markets and distributes apparel primarily under Wrangler and Lee, with VF Outlet operations. This unaudited Form 10-Q covers the second quarter and six months of fiscal 2020, ended June 27, 2020; fiscal 2020 is a 53-week year. The request metadata says “2019 Q2,” but the filing itself is for Q2 FY2020. Comparisons with 2019 are affected by the May 2019 spin-off from VF: pre-spin results were prepared on a carve-out basis, and certain VF transactions and allocated costs did not continue.

Financial performance and liquidity

  • Q2 revenue: $349.3 million, down 43% year over year. Gross profit was $134.4 million; gross margin was 38.5%, down 0.1 percentage point. SG&A was $156.2 million, or 44.7% of revenue versus 29.9% a year earlier. Operating loss was $21.8 million versus operating income of $53.5 million; net loss was $33.3 million, or $0.58 per diluted share, versus net income of $38.0 million, or $0.67 per share.
  • First half: Revenue was $853.8 million, down 32%; gross margin was 38.1% versus 38.4%. Operating loss was $22.0 million versus operating income of $78.7 million; net loss was $36.0 million versus net income of $53.4 million.
  • Segments, Q2: Wrangler revenue fell 31% to $251.7 million, with $28.9 million segment profit and an 11.5% operating margin. Lee revenue fell 58% to $86.0 million, with an $18.4 million segment loss and a negative 21.4% margin. Other revenue fell 70% to $11.6 million.
  • Cash flow, first half: Operating cash provided was $4.4 million versus $580.2 million in 2019; investing cash used was $39.2 million versus cash provided of $509.7 million; financing provided $186.2 million versus cash used of $1.111 billion. The comparison is substantially distorted by 2019 spin-off-related settlements with VF, including receivables and notes.
  • Balance sheet at June 27: Cash and equivalents were $256.3 million; current assets were $919.9 million and current liabilities $330.8 million. Debt, including current portion, was $1.137 billion, up from $913.3 million at December 2019; $225.0 million was drawn on the revolver, with $273.2 million remaining available. Cash less reported debt implies approximately $880 million of net debt. Equity was a deficit of $44.9 million.
  • Other items: First-half capital expenditures were $11.9 million and software purchases were $25.6 million. First-half restructuring charges were $11.6 million. The company recorded an $18.0 million provision for expected credit losses in the first half, including exposure related to a major U.S. retailer bankruptcy. First-half comprehensive loss was $87.6 million, including $51.6 million of other comprehensive loss, principally currency translation and derivatives.

Material changes versus the prior comparable period

  • COVID-19-related store closures, lower retail traffic and consumer spending, and reduced wholesale demand drove steep revenue declines across channels and geographies. Management said results began to improve gradually as Q2 progressed, but expected a prolonged pandemic operating environment through the rest of 2020.
  • Management estimated that approximately $33 million of Fall shipments shifted from Q2 to Q3. Growth in U.S. digital wholesale and owned e-commerce partially offset declines.
  • SG&A deleveraged sharply against lower sales, with higher bad-debt expense and costs associated with the global ERP implementation and standalone-company infrastructure. Cost reductions partly offset these pressures.
  • Interest expense rose to $13.1 million in Q2 and $24.1 million in the first half, primarily reflecting debt incurred in connection with the spin-off. Foreign currency and derivative movements also materially reduced first-half equity through accumulated other comprehensive loss.

Outlook, management commentary, risks and contingencies

  • The filing provides no formal revenue or earnings guidance. Management reduced its 2020 capital expenditure target to $55–$65 million from an initial $55–$70 million range, principally for the global ERP implementation.
  • The company amended its credit agreement in May 2020, establishing temporary covenant relief through no later than the June 2021 compliance certificate, subject to earlier exit conditions. During the relief period, it must maintain a minimum $200 million liquidity floor and comply with leverage limits that step down from 5.50x to 4.50x. Management said it was compliant at June 2020 and expected compliance for at least one year from issuance of the statements.
  • Dividends were suspended for Q2 and Q3 2020 under the amended credit agreement, with reevaluation possible after Q3 subject to covenant compliance. The company paid $31.9 million of dividends in the first half. Management said future dividends depend on financial and other factors.
  • Key risks include further pandemic-related demand, store, factory and supply-chain disruption; customer credit and collections; inventory and working-capital pressures; covenant compliance and access to financing; foreign exchange and interest-rate exposure; and execution risks tied to ERP implementation. A prolonged deterioration could require further credit amendments; inability to secure them could trigger default and repayment obligations. Equity issuance is also restricted under the Tax Matters Agreement until May 23, 2021.
  • Restructuring charges, store asset impairments, credit-loss estimates and tax estimates reflect unusual or judgment-sensitive items. The first half included a $7.7 million net discrete tax benefit, primarily from Swiss tax reform and state tax filings. Management reported no legal proceedings expected to have a material adverse effect.

Important facts for investors to verify

  1. Whether sales recover as stores reopen and the estimated $33 million of Fall shipments shifts into Q3, and whether any renewed restrictions undermine that recovery.
  2. Current cash, revolver availability, borrowing levels and covenant headroom, including the amended liquidity and leverage tests and their step-down schedule.
  3. The size and collectability of receivables following the major retailer bankruptcy, and the adequacy of the credit-loss allowance and inventory valuations.
  4. Whether the stated capital expenditure plan and ERP implementation remain on schedule and within budget, and whether cost actions deliver sustained savings.
  5. The timing and conditions for resuming dividends, given the credit restrictions and management’s stated dependence on financial performance and covenant compliance.