Kontoor Brands, Inc.: Form 10-Q for the period ended Mar 30, 2024

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide readers of our financial statements with a narrative from management's perspective on our financial condition, results of operations and liquidity as well as certain other factors that may affect our future results. This section should be read in conjunction with the Consolidated Financial Statements and related Notes included in this Quarterly Report on Form 10-Q.

The following discussion and analysis includes forward-looking statements. These forward-looking statements are subject to risks, uncertainties and other factors that could cause our actual results to differ materially from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in “Cautionary Statement On Forward-Looking Statements” included later in Part I, Item 2 of this Quarterly Report on Form 10-Q and in Part I, Item 1A "Risk Factors" in our 2023 Annual Report on Form 10-K.

Description of Business

Kontoor Brands, Inc. ("Kontoor," the "Company," "we," "us" or "our") is a global lifestyle apparel company headquartered in the United States ("U.S."). The Company designs, manufactures, procures, sells and licenses apparel, footwear and accessories, primarily under the brand names Wrangler® and Lee®. The Company's products are sold in the U.S. through mass merchants, specialty stores, department stores, company-operated stores and online, including digital marketplaces. The Company's products are also sold internationally, primarily in the Europe, Middle East and Africa ("EMEA"), Asia-Pacific ("APAC") and Non-U.S. Americas regions, through department, specialty, company-operated, concession retail and independently-operated partnership stores and online, including digital marketplaces.

Fiscal Year and Basis of Presentation

The Company operates and reports using a 52/53-week fiscal year ending on the Saturday closest to December 31 of each year. Accordingly, this Form 10-Q presents the first quarter of the Company's fiscal year ending December 28, 2024 ("fiscal 2024"), which is a 52-week fiscal year. For presentation purposes herein, all references to periods ended March 2024, December 2023 and March 2023 correspond to the fiscal periods ended March 30, 2024, December 30, 2023 and April 1, 2023, respectively.

References to fiscal 2024 foreign currency amounts herein reflect the impact of changes in foreign exchange rates from the prior year comparable period and the corresponding impact on translating foreign currencies into U.S. dollars and on foreign currency-denominated transactions. The Company's most significant foreign currency translation exposure is typically driven by business conducted in euro-based countries, the Chinese yuan and the Mexican peso. However, the Company conducts business in other developed and emerging markets around the world with exposure to other foreign currencies.

Amounts herein may not recalculate due to the use of unrounded numbers.

Macroeconomic Environment and Other Recent Developments

Macroeconomic conditions impacting the Company include inflation, elevated interest rates, recessionary concerns and fluctuating foreign currency exchange rates, as well as continuing global supply chain issues and inconsistent economic results in China. These factors continue to contribute to uncertain global economic conditions and consumer spending patterns, which are impacting retailers' and the Company's operations. Additionally, the conflicts in Ukraine and the Middle East are causing disruption in the surrounding areas and greater uncertainty in the global economy.

Inflationary pressures have moderated in recent quarters, and although these pressures continue to impact us, current period results reflect favorability from lower product costs compared to the first quarter of 2023. However, the macroeconomic factors discussed above, primarily inflation, interest rates and recessionary concerns, continued to impact consumer spending patterns leading to retailer actions to proactively manage inventory levels, which impacted our results during the three months ended March 2024.

Recent disruptions to key trade routes, such as the Red Sea and Panama Canal, affected our global supply chain during the first quarter of 2024 but did not have a significant impact on first quarter results. Although we continue to proactively manage our shipping carriers and routes to minimize costs and delays, our results of operations will reflect higher freight costs during 2024.

The Company has responded to ongoing macroeconomic conditions by controlling expenses, adjusting pricing and proactively managing our global supply chain where possible. While we anticipate continued uncertainty related to the macroeconomic environment during 2024, we believe we are appropriately positioned to successfully manage through known operational challenges. We continue to closely monitor macroeconomic conditions, including consumer behavior and the impact of these factors on consumer demand.

21 Kontoor Brands, Inc. Q1 FY24 Form 10-Q

Business Overview

We continue to execute on our Horizon 2 multi-year strategic vision, "Catalyzing Growth," which outlines four growth catalysts: (i) expansion of our core U.S. Wholesale business, (ii) category extensions such as outdoor, workwear and t-shirts, (iii) geographic expansion of our Wrangler® and Lee® brands, and (iv) channel expansion focused on the digital platforms in our U.S. Wholesale and Direct-to-Consumer channels. We are focused on driving brand growth and delivering long-term value to our stakeholders including our consumers, customers, shareholders, suppliers and communities around the world.

In addition, our capital allocation strategy allows us the option to (i) pay down debt, (ii) provide for a superior dividend payout, (iii) effectively manage our share repurchase authorization and (iv) act on strategic investment opportunities that may arise.

During the first quarter of 2024, the Company incurred total restructuring and other transformation charges of $8.4 million related to business optimization activities and actions to streamline and transfer select production within our internal manufacturing network. In late 2023, we launched the planning phase of Project Jeanius, a comprehensive end-to-end business model transformation focused on simplifying the organization and creating significant investment capacity to accelerate growth and increase profitability. Certain of the restructuring and transformation costs incurred during the first quarter of 2024 related to Project Jeanius, and we anticipate additional costs in future periods as we execute on this multi-year initiative. Refer to Note 14 to the Company's financial statements for additional information related to restructuring charges.

FIRST QUARTER OF FISCAL 2024 SUMMARY

• Net revenues decreased 5% to $631.2 million compared to the three months ended March 2023.
• U.S. Wholesale revenues decreased 6% compared to the three months ended March 2023, and represented 71% of total revenues in the current period.
• Non-U.S. Wholesale revenues decreased 8% compared to the three months ended March 2023, and represented 17% of total revenues in the current period.
• Direct-to-Consumer revenues remained flat compared to the three months ended March 2023, and represented 12% of total revenues in the current period.
• Gross margin increased 220 basis points to 45.2% compared to the three months ended March 2023.
• Selling, general and administrative expenses as a percentage of net revenues increased to 31.8% compared to 28.7% for the three months ended March 2023.
• Net income decreased 10% to $59.5 million compared to the three months ended March 2023.
• Diluted earnings per share was $1.05 in the first quarter, compared to $1.16 in the same period last year.

ANALYSIS OF RESULTS OF OPERATIONS

Consolidated Statements of Operations

The following table presents components of the Company's statements of operations:

(Dollars in thousands)

Additionally, the following table presents a summary of the changes in net revenues for the three months ended March 2024 as compared to March 2023:

(In millions)

Three Months Ended March 2024 Compared to the Three Months Ended March 2023

Net revenues decreased 5%, driven by a 6% decrease in U.S. Wholesale revenues primarily attributable to retailer inventory management actions and a decrease in revenue from seasonal product. Non-U.S. Wholesale revenues decreased 8%, primarily driven by a decline in our EMEA wholesale business, partially offset by growth in our digital wholesale business and a 2% favorable impact from foreign currency. Global Direct-to-Consumer revenues remained flat with growth in e-commerce sales offset by declines in retail store sales.

Additional details on changes in net revenues for the three months ended March 2024 as compared to March 2023 are provided in the section titled “Information by Business Segment.”

Gross margin increased 220 basis points, primarily related to 410 basis points from lower product costs and favorable channel mix. This increase was partially offset by 100 basis points from pricing adjustments and product mix and 50 basis points due to restructuring and other transformation charges in the first quarter of 2024.

Selling, general and administrative expenses as a percentage of net revenues increased to 31.8% compared to 28.7% in the prior period, driven by $5.4 million of restructuring and other transformation charges in the first quarter of 2024, a $2.3 million increase in investments in our direct-to-consumer business and information technology and a $1.7 million increase in demand creation costs. These increases were partially offset by a $1.8 million decrease in distribution and freight costs.

The effective income tax rate for the three months ended March 2024 was 20.3% compared to 20.0% in the 2023 period. The three months ended March 2024 and March 2023 included a net discrete tax benefit primarily related to stock-based compensation which decreased the effective income tax rate by 1.0% and 0.2%, respectively. The effective tax rate without discrete items for the three months ended March 2024 was 21.3% compared to 20.2% in the 2023 period. The increase was primarily due to changes in our jurisdictional mix of earnings.

23 Kontoor Brands, Inc. Q1 FY24 Form 10-Q

Information by Business Segment

The Company's two reportable segments are Wrangler® and Lee®. Refer to Note 3 to the Company's financial statements for additional information.

The following tables present a summary of the changes in segment revenues and segment profit for the three months ended March 2024 as compared to the three months ended March 2023:

Segment Revenues:

(In millions)

Segment Profit:

(In millions)

The following sections discuss the changes in segment revenues and segment profit.

Wrangler

(Dollars in millions)

Three Months Ended March 2024 Compared to the Three Months Ended March 2023

Global revenues for the Wrangler® brand decreased 3%, due to declines in the U.S. Wholesale and Non-U.S. Wholesale channels, partially offset by growth in the Direct-to-Consumer channel.

• Revenues in the Americas region decreased 2%, primarily due to a decline in the U.S. wholesale channel driven by retailer inventory management actions. Non-U.S. Americas wholesale revenues decreased 9%, driven by lower sales in Canada, partially offset by a 3% favorable impact from foreign currency.
• Revenues in the APAC region decreased 8%, driven by a decrease in our licensing business.
• Revenues in the EMEA region decreased 11%, resulting from a decline in our wholesale business, partially offset by growth in our direct-to-consumer business and a 3% favorable impact from foreign currency.

Operating margin increased to 18.2%, compared to 16.8% for the 2023 period, driven by lower product costs, favorable channel mix and decreases in distribution and freight costs. These improvements were partially offset by restructuring and other transformation charges, increases in investments in our direct-to-consumer business and information technology and higher demand creation costs.

Lee

(Dollars in millions)

Three Months Ended March 2024 Compared to the Three Months Ended March 2023

Global revenues for the Lee® brand decreased 9%, due to declines in all channels.

• Revenues in the Americas region decreased 10%, driven by a 12% decrease in the U.S. wholesale channel due to retailer inventory management actions and a decrease in revenue from seasonal product, partially offset by growth in our digital wholesale business.
• Revenues in the APAC region decreased 7%, primarily resulting from a decrease in our direct-to-consumer business due to lower retail store sales in China, a decrease in wholesale revenue and a 4% unfavorable impact from foreign currency.
• Revenues in the EMEA region decreased 6%, attributable to a decrease in our wholesale business, partially offset by growth in our digital wholesale business and a 2% favorable impact from foreign currency.

Operating margin decreased to 16.0%, compared to 16.4% for the 2023 period, primarily attributable to unfavorable product mix, pricing adjustments and increases in investments in our direct-to-consumer business. These decreases were partially offset by lower product costs.

Other

In addition, we report an "Other" category to reconcile segment revenues and segment profit to the Company's operating results, but the Other category does not meet the criteria to be considered a reportable segment. Other includes sales and licensing of Rock & Republic®, other company-owned brands and private label apparel.

(Dollars in millions)

25 Kontoor Brands, Inc. Q1 FY24 Form 10-Q

Reconciliation of Segment Profit to Income Before Income Taxes

The costs below are necessary to reconcile total reportable segment profit to income before taxes. Corporate and other expenses, including certain restructuring and other transformation costs, and interest income and expense are not controlled by segment management and therefore are excluded from the measurement of segment profit.

(Dollars in millions)

Three Months Ended March 2024 Compared to the Three Months Ended March 2023

Corporate and other expenses increased $10.0 million, primarily due to an increase in compensation-related expense and restructuring and other transformation charges in the first quarter of 2024.

Interest expense decreased $1.0 million due to lower average debt outstanding during the three months ended March 2024 compared to the three months ended March 2023.

ANALYSIS OF FINANCIAL CONDITION

Liquidity and Capital Resources

The Company's ability to fund our operating needs is dependent upon our ability to generate positive long-term cash flow from operations and maintain our debt financing on acceptable terms. The Company has historically generated strong positive cash flows from operations and continues to take proactive measures to manage working capital. We believe cash flows from operations will support our short-term liquidity needs as well as any future liquidity and capital requirements, in combination with available cash balances and borrowing capacity from our revolving credit facility.

The Company is party to a senior secured Credit Agreement, as amended and restated on November 18, 2021 (the “Credit Agreement”), which provides for (i) a five-year $400.0 million term loan A facility (“Term Loan A”) and (ii) a five-year $500.0 million revolving credit facility (the “Revolving Credit Facility”), collectively referred to as “Credit Facilities,” with the lenders and agents party thereto. Term Loan A requires quarterly repayments of $5.0 million through September 2026, and the remaining principal of $335.0 million is due at maturity in November 2026. Additionally, the Company has outstanding $400.0 million of unsecured 4.125% senior notes due 2029. Refer to Note 11 in the Company's 2023 Annual Report on Form 10-K and Note 7 to the Company's financial statements in this Form 10-Q for additional information regarding the Company’s debt obligations.

As of March 2024, the Company was in compliance with all applicable covenants under the Credit Agreement and expects to maintain compliance with the applicable covenants for at least one year from the issuance of these financial statements. If economic conditions significantly deteriorate for a prolonged period, this could impact the Company’s operating results and cash flows and thus our ability to maintain compliance with the applicable covenants. As a result, the Company could be required to seek new amendments to the Credit Agreement or secure other sources of liquidity, such as refinancing of existing borrowings, the issuance of debt or equity securities, or sales of assets. However, there can be no assurance that the Company would be able to obtain such additional financing on commercially reasonable terms or at all.

The Revolving Credit Facility may be used to borrow funds in both U.S. dollar and certain non-U.S. dollar currencies, and has a maximum borrowing capacity of $500.0 million with a $75.0 million letter of credit sublimit. There were no outstanding borrowings under the Revolving Credit Facility as of March 2024.

The following table presents outstanding borrowings and available borrowing capacity under the Revolving Credit Facility and our cash and cash equivalents balances as of March 2024:

(In millions)

(1) Available borrowing capacity under the Revolving Credit Facility is net of $6.7 million of outstanding standby letters of credit issued on behalf of the Company under this facility.

At March 2024, the Company had $23.9 million of international lines of credit with various banks, which are uncommitted and may be terminated at any time by either the Company or the banks. There were no outstanding balances under these arrangements at March 2024.

During the three months ended March 2024, the Company repurchased 0.3 million shares of Common Stock for $20.0 million, including commissions, under its $300.0 million share repurchase program authorized by the Company's Board of Directors. All shares reacquired in connection with the repurchase program are treated as authorized and unissued shares upon repurchase. As of March 2024, $280.0 million remained available for repurchase under the program.

During the three months ended March 2024, the Company paid $27.8 million of dividends to its shareholders. On April 18, 2024, the Board of Directors declared a regular quarterly cash dividend of $0.50 per share of the Company's Common Stock. The cash dividend will be payable on June 20, 2024, to shareholders of record at the close of business on June 10, 2024.

The Company intends to continue to pay cash dividends in future periods. The declaration and amount of any future dividends will be dependent upon multiple factors including our financial condition, earnings, cash flows, capital requirements, covenants associated with our debt obligations, legal requirements, regulatory constraints, industry practice and any other factors or considerations that our Board of Directors deems relevant.

We anticipate that we will have sufficient cash flows from operations, along with existing borrowing capacity, to support continued investments in our brands, infrastructure, talent and capabilities, dividend payments to shareholders, repayment of our current and long-term debt obligations when due and repurchases of Common Stock. In addition, we would use current liquidity as well as access to capital markets to fund any strategic investment opportunities that may arise.

We currently expect capital expenditures to be approximately $40.0 million in 2024, primarily to support manufacturing, distribution, facility improvement, information technology, and owned retail store investments.

The following table presents our cash flows during the periods:

(In millions)

Operating Activities

During the three months ended March 2024, cash provided by operating activities was $56.5 million as compared to cash used by operating activities of $12.6 million in the prior year period. The increase was primarily due to favorable changes in inventory and accounts payable, partially offset by unfavorable changes in accounts receivable compared to the prior year period.

Investing Activities

During the three months ended March 2024, cash used by investing activities decreased $5.4 million as compared to the prior year period, primarily due to a decrease in capitalized computer software expenditures in the current year period.

Financing Activities

During the three months ended March 2024, cash used by financing activities was $54.6 million as compared to cash provided by financing activities of $17.0 million in the prior year period. The change was primarily due to $50.0 million of net borrowings under the Revolving Credit Facility during the three months ended March 2023 and $20.0 million of Common Stock repurchases made by the Company during the three months ended March 2024.

27 Kontoor Brands, Inc. Q1 FY24 Form 10-Q

Contractual Obligations and Other Commercial Commitments

The section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Contractual Obligations" included in the Company's 2023 Annual Report on Form 10-K provided a summary of our contractual obligations and commercial commitments at the end of 2023 that would require the use of funds. As of March 2024, there have been no material changes in the amounts disclosed in the 2023 Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

We have chosen accounting policies that management believes are appropriate to accurately and fairly report our operating results and financial position in conformity with GAAP. We apply these accounting policies in a consistent manner. Significant accounting policies are summarized in Note 1 to the consolidated financial statements included in the 2023 Annual Report on Form 10-K.

The application of these accounting policies requires that we make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, net revenues, expenses, contingent assets and liabilities and related disclosures. These estimates, assumptions and judgments are based on historical experience, current trends and other factors believed to be reasonable under the circumstances. Management evaluates these estimates and assumptions on an ongoing basis. Because our business cycle is relatively short (i.e., from the date that inventory is received until that inventory is sold and the trade accounts receivable is collected), actual results related to most estimates are known within a few months after any balance sheet date. Several of the estimates and assumptions we are required to make relate to future events and are therefore inherently uncertain, especially as it relates to events outside of our control. If actual results ultimately differ from previous estimates, the revisions are included in results of operations when the actual amounts become known. Refer to Note 1 to the Company's financial statements in this Form 10-Q for considerations related to the macroeconomic environment and other recent developments.

The accounting policies that involve the most significant estimates, assumptions and management judgments used in preparation of the financial statements, or are the most sensitive to change from outside factors, are discussed within "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in the 2023 Annual Report on Form 10-K. There have been no material changes in these policies disclosed in the 2023 Annual Report on Form 10-K.

Recently Issued and Adopted Accounting Standards

Refer to Note 1 to the Company's financial statements in this Form 10-Q for additional information regarding recently issued and adopted accounting standards.

Cautionary Statement on Forward-looking Statements

From time to time, the Company may make oral or written statements, including statements in this quarterly report, that constitute “forward-looking statements” within the meaning of the federal securities laws. These include statements concerning plans, objectives, projections and expectations relating to the Company’s operations or economic performance and assumptions related thereto. Forward-looking statements are made based on management’s expectations and beliefs concerning future events impacting the Company and therefore involve a number of risks and uncertainties. Forward-looking statements are not guarantees, and actual results could differ materially from those expressed or implied in the forward-looking statements. In addition, the forward-looking statements in this report are made as of the date of this filing, and the Company does not undertake, and expressly disclaims any duty, to update such statements, whether as a result of new information, new developments, or otherwise, except to the extent that disclosure may be required by law.

Potential risks and uncertainties that could cause the actual results of operations or financial condition of the Company to differ materially from those expressed or implied by forward-looking statements in this report include, but are not limited to: macroeconomic conditions, including inflation, elevated interest rates, recessionary concerns and fluctuating foreign currency exchange rates, as well as continuing global supply chain issues and geopolitical events, continue to adversely impact global economic conditions and have had, and may continue to have, a negative impact on the Company’s business, results of operations, financial condition and cash flows (including future uncertain impacts); the level of consumer demand for apparel; reliance on a small number of large customers; supply chain and shipping disruptions, which could continue to result in shipping delays, an increase in transportation costs and increased product costs or lost sales; intense industry competition; the ability to accurately forecast demand for products; the Company’s ability to gauge consumer preferences and product trends, and to respond to constantly changing markets; the Company’s ability to maintain the images of its brands; increasing pressure on margins; e-commerce operations through the Company’s direct-to-consumer business; the financial difficulty experienced by the retail industry; possible goodwill and other asset impairment; the ability to implement the Company’s business strategy; the stability of manufacturing facilities and foreign suppliers; fluctuations in wage rates and the price, availability and quality of raw materials and contracted products; the reliance on a limited number of suppliers for raw material sourcing and the ability to obtain raw materials on a timely basis or in sufficient quantity or quality; disruption to distribution systems; seasonality; unseasonal or severe weather conditions; the Company's and its vendors’ ability to maintain the strength and security of information technology systems; the risk that facilities and systems and those of third-party service providers may be vulnerable to and unable to anticipate or detect data security breaches and data or financial loss; ability to properly collect, use, manage and secure consumer and employee data; foreign currency fluctuations; disruption and volatility in the global capital and credit markets and its impact on the Company's ability to obtain short-term or long-term financing on favorable terms; legal, regulatory, political and economic risks; changes to trade policy, including tariff and import/export regulations;

the impact of climate change and related legislative and regulatory responses; compliance with anti-bribery, anti-corruption and anti-money laundering laws by the Company and third-party suppliers and manufacturers; changes in tax laws and liabilities; the costs of compliance with or the violation of national, state and local laws and regulations for environmental, consumer protection, employment, privacy, safety and other matters; continuity of members of management; labor relations; the ability to protect trademarks and other intellectual property rights; the ability of the Company’s licensees to generate expected sales and maintain the value of the Company’s brands; the Company maintaining satisfactory credit ratings; restrictions on the Company’s business relating to its debt obligations; volatility in the price and trading volume of the Company’s common stock; anti-takeover provisions in the Company’s organizational documents; and fluctuations in the amount and frequency of our share repurchases. Many of the foregoing risks and uncertainties will be exacerbated by any worsening of the global business and economic environment.

More information on potential factors that could affect the Company's financial results are described in detail in the Company’s 2023 Annual Report on Form 10-K and in other reports and statements that the Company files with the Securities and Exchange Commission ("SEC").

There have been no material changes in the Company's market risk exposures set forth under Item 7A in our 2023 Annual Report on Form 10-K.

(a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13(a)-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act")). Based on such evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective and operating to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

(b) Internal Control Over Financial Reporting. There have been no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the period to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

29 Kontoor Brands, Inc. Q1 FY24 Form 10-Q

Careful consideration of the risk factors set forth under Part I, Item 1A, “Risk Factors,” of our 2023 Annual Report on Form 10-K should be made. There have been no material changes to the risk factors from those disclosed in Part I, Item 1A of our 2023 Annual Report on Form 10-K.