Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 28, 2019



☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission file number: 001-38854

KONTOOR BRANDS, INC.

(Exact name of registrant as specified in its charter)



North Carolina	83-2680248
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer identification number)

400 N. Elm Street, Greensboro, North Carolina, 27401

(Address of principal executive offices and zip code)

(336) 332-3400

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, No Par Value	KTB	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated filer	☐	Non-accelerated filer	☑	Smaller reporting company	☐	Emerging growth company	☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No þ

The number of shares of common stock, no par value, of the registrant outstanding as of October 25, 2019 was 56,944,576.

KONTOOR BRANDS, INC.

Table of Contents



	Page
Part I — Financial Information

Item 1 — Financial Statements (Unaudited)	3

Consolidated and Combined Balance Sheets: September 2019, December 2018 and September 2018	3

Consolidated and Combined Statements of Income: Three and nine months ended September 2019 and September 2018	4

Consolidated and Combined Statements of Comprehensive Income: Three and nine months ended September 2019 and September 2018	5

Consolidated and Combined Statements of Cash Flows: Nine months ended September 2019 and September 2018	6

Consolidated and Combined Statements of Equity: Nine months ended September 2019 and September 2018	7

Notes to Consolidated and Combined Financial Statements	8

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3 — Quantitative and Qualitative Disclosures about Market Risk	39

Item 4 — Controls and Procedures	39

Part II — Other Information

Item 1 — Legal Proceedings	40

Item 1A — Risk Factors	40

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 5 — Other Information	40

Item 6 — Exhibits	40

Signatures	41

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 2

PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS (UNAUDITED)

KONTOOR BRANDS, INC.

Consolidated and Combined Balance Sheets

(Unaudited)



(in thousands)	September 2019			December 2018			September 2018
ASSETS
Current assets
Cash and equivalents	$	40,804		$	96,776		$	93,135
Accounts receivable, net of allowance for doubtful accounts of $11,385, $10,549 and $10,314 at September 2019, December 2018 and September 2018, respectively	302,582			252,966			318,071
Due from former parent, current	—			547,690			267,605
Notes receivable from former parent	—			517,940			546,740
Inventories	545,426			473,812			540,936
Other current assets	73,162			52,014			48,906
Total current assets	961,974			1,941,198			1,815,393
Due from former parent, noncurrent	—			611			1,100
Property, plant and equipment, net	126,963			138,449			141,346
Operating lease assets	96,590			—			—
Intangible assets, net	17,530			53,059			54,186
Goodwill	212,834			214,516			214,587
Other assets	169,874			110,632			116,698
TOTAL ASSETS	$	1,585,765		$	2,458,465		$	2,343,310
LIABILITIES AND EQUITY
Current liabilities
Short-term borrowings	$	6,028		$	3,215		$	5,617
Current portion of long-term debt	7,500			—			—
Accounts payable	149,685			134,129			163,375
Due to former parent, current	—			16,140			69,542
Notes payable to former parent	—			269,112			269,112
Accrued liabilities	190,353			194,228			178,109
Operating lease liabilities, current	35,992			—			—
Total current liabilities	389,558			616,824			685,755
Operating lease liabilities, noncurrent	64,328			—			—
Other liabilities	95,701			118,189			112,393
Long-term debt	980,607			—			—
Commitments and contingencies
Total liabilities	1,530,194			735,013			798,148
Equity
Common Stock, no par value	—			—			—
Additional paid-in capital	142,340			—			—
Former parent investment	—			1,868,634			1,689,231
Retained earnings	2,066			—			—
Accumulated other comprehensive loss	(88,835		)	(145,182		)	(144,069		)
Total equity	55,571			1,723,452			1,545,162
TOTAL LIABILITIES AND EQUITY	$	1,585,765		$	2,458,465		$	2,343,310

See accompanying notes to unaudited consolidated and combined financial statements.

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 3

KONTOOR BRANDS, INC.

Consolidated and Combined Statements of Income

(Unaudited)



	Three Months Ended September						Nine Months Ended September

(in thousands, except per share amounts)	2019			2018			2019			2018
Net revenues	$	638,138		$	704,246		$	1,896,228		$	2,037,765
Costs and operating expenses
Cost of goods sold	382,181			424,053			1,157,383			1,203,259
Selling, general and administrative expenses	192,293			184,909			596,466			571,080
Non-cash impairment of intangible asset	32,636			—			32,636			—
Total costs and operating expenses	607,110			608,962			1,786,485			1,774,339
Operating income	31,028			95,284			109,743			263,426
Interest income from former parent, net	—			2,104			3,762			5,415
Interest expense	(14,140		)	(200		)	(21,876		)	(981		)
Interest income	712			1,508			3,543			4,176
Other expense, net	(1,456		)	(2,084		)	(3,797		)	(4,522		)
Income before income taxes	16,144			96,612			91,375			267,514
Income taxes	1,642			25,594			23,474			56,342
Net income	$	14,502		$	71,018		$	67,901		$	211,172
Earnings per common share
Basic	$	0.26		$	1.25		$	1.20		$	3.73
Diluted	$	0.25		$	1.25		$	1.19		$	3.73
Weighted average shares outstanding
Basic	56,694			56,648			56,663			56,648
Diluted	57,401			56,648			56,989			56,648

See accompanying notes to unaudited consolidated and combined financial statements.

4 Kontoor Brands, Inc. Q3 FY19 Form 10-Q

KONTOOR BRANDS, INC.

Consolidated and Combined Statements of Comprehensive Income

(Unaudited)



	Three Months Ended September						Nine Months Ended September

(in thousands)	2019			2018			2019			2018
Net income	$	14,502		$	71,018		$	67,901		$	211,172
Other comprehensive income (loss)
Foreign currency translation
Losses arising during the period	(11,358		)	(2,770		)	(5,914		)	(21,587		)
Defined benefit pension plans
Amortization of net deferred actuarial losses	297			—			283			—
Derivative financial instruments
Losses arising during the period	(468		)	—			(2,526		)	—
Reclassification to net income for gains realized	(3,618		)	—			(3,980		)	—
Total other comprehensive income (loss), net of related taxes	(15,147		)	(2,770		)	(12,137		)	(21,587		)
Comprehensive income (loss)	$	(645	)	$	68,248		$	55,764		$	189,585

See accompanying notes to unaudited consolidated and combined financial statements.

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 5

KONTOOR BRANDS, INC.

Consolidated and Combined Statements of Cash Flows

(Unaudited)



	Nine Months Ended September

(in thousands)	2019			2018
OPERATING ACTIVITIES
Net income	$	67,901		$	211,172
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization	23,020			23,669
Stock-based compensation	17,798			14,012
Provision for doubtful accounts	5,386			4,205
Non-cash impairment of intangible asset	32,636			—
Other	(8,904		)	3,904
Changes in operating assets and liabilities:
Accounts receivable	(52,525		)	(82,575		)
Inventories	(79,534		)	(114,012		)
Due from former parent	548,301			(47,090		)
Accounts payable	34,831			(7,480		)
Income taxes	1,715			(3,334		)
Accrued liabilities	14,278			35,307
Due to former parent	(16,065		)	31,525
Other assets and liabilities	(10,457		)	(24,134		)
Cash provided by operating activities	578,381			45,169
INVESTING ACTIVITIES
Capital expenditures	(11,750		)	(17,627		)
Collection of notes receivable from former parent	517,940			1,000
Other, net	729			3,647
Cash provided (used) by investing activities	506,919			(12,980		)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt	1,050,000			—
Payment of debt issuance costs	(12,993		)	—
Principal payments of long-term debt	(50,000		)	—
Repayment of notes payable to former parent	(269,112		)	—
Net transfers to former parent	(1,814,682		)	(19,373		)
Dividends paid	(31,763		)	—
Proceeds from issuance of Common Stock, net of shares withheld for taxes	(514		)	—
Other, net	(10,868		)	1,733
Cash used by financing activities	(1,139,932		)	(17,640		)
Effect of foreign currency rate changes on cash and cash equivalents	(1,340		)	(2,225		)
Net change in cash and cash equivalents	(55,972		)	12,324
Cash and cash equivalents – beginning of period	96,776			80,811
Cash and cash equivalents – end of period	$	40,804		$	93,135

See accompanying notes to unaudited consolidated and combined financial statements.

6 Kontoor Brands, Inc. Q3 FY19 Form 10-Q

KONTOOR BRANDS, INC.

Consolidated and Combined Statements of Equity

(Unaudited)




	Common Stock			Additional Paid-in Capital		Former Parent Investment			Retained Earnings			Accumulated Other Comprehensive Loss			Total Equity
	Common Stock
(in thousands)	Shares	Amounts
Balance, December 2018	—	$	—	$	—	$	1,868,634		$	—		$	(145,182	)	$	1,723,452
Adoption of new accounting standard (ASU 2016-02)	—	—		—		(2,713		)	—			—			(2,713		)
Net income	—	—		—		15,413			—			—			15,413
Foreign currency translation	—	—		—		—			—			758			758
Net transfers to former parent	—	—		—		(157,928		)	—			—			(157,928		)
Balance, March 2019	—	$	—	$	—	$	1,723,406		$	—		$	(144,424	)	$	1,578,982
Net income	—	—		—		16,751			21,235			—			37,986
Stock-based compensation, net	—	—		1,879		—			—			—			1,879
Foreign currency translation	—	—		—		—			—			4,686			4,686
Defined benefit pension plans	—	—		—		—			—			(14		)	(14		)
Derivative financial instruments	—	—		—		—			—			(2,420		)	(2,420		)
Net transfers to former parent	—	—		—		(1,607,415		)	—			68,484			(1,538,931		)
Transfer of former parent investment to additional paid-in capital	—	—		132,742		(132,742		)	—			—			—
Issuance of Common Stock	56,648	—		—		—			—			—			—
Balance, June 2019	56,648	$	—	$	134,621	$	—		$	21,235		$	(73,688	)	$	82,168
Net income	—	—		—		—			14,502			—			14,502
Stock-based compensation, net	79	—		7,719		—			(1,908		)	—			5,811
Foreign currency translation	—	—		—		—			—			(11,358		)	(11,358		)
Defined benefit pension plans	—	—		—		—			—			297			297
Derivative financial instruments	—	—		—		—			—			(4,086		)	(4,086		)
Dividends on Common Stock ($0.56 per share)	—	—		—		—			(31,763		)	—			(31,763		)
Balance, September 2019	56,727	$	—	$	142,340	$	—		$	2,066		$	(88,835	)	$	55,571




	Common Stock			Additional Paid-in Capital		Former Parent Investment			Retained Earnings		Accumulated Other Comprehensive Loss			Total Equity
	Common Stock
(in thousands)	Shares	Amounts
Balance, December 2017	—	$	—	$	—	$	1,480,375		$	—	$	(122,482	)	$	1,357,893
Adoption of new accounting standard (ASU 2014-09)	—	—		—		3,047			—		—			3,047
Net income	—	—		—		79,696			—		—			79,696
Foreign currency translation	—	—		—		—			—		9,701			9,701
Net transfers from former parent	—	—		—		113,445			—		—			113,445
Balance, March 2018	—	$	—	$	—	$	1,676,563		$	—	$	(112,781	)	$	1,563,782
Net income	—	—		—		60,458			—		—			60,458
Foreign currency translation	—	—		—		—			—		(28,518		)	(28,518		)
Net transfers from former parent	—	—		—		171,965			—		—			171,965
Balance, June 2018	—	$	—	$	—	$	1,908,986		$	—	$	(141,299	)	$	1,767,687
Net income	—	—		—		71,018			—		—			71,018
Foreign currency translation	—	—		—		—			—		(2,770		)	(2,770		)
Net transfers to former parent	—	—		—		(290,773		)	—		—			(290,773		)
Balance, September 2018	—	$	—	$	—	$	1,689,231		$	—	$	(144,069	)	$	1,545,162

See accompanying notes to unaudited consolidated and combined financial statements.

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 7

KONTOOR BRANDS, INC.

Notes to Consolidated and Combined Financial Statements

(Unaudited)

NOTE 1 — BASIS OF PRESENTATION

Description of Business

Kontoor Brands, Inc. ("Kontoor," the "Company," "we," "us" or "our") is a global denim and casual apparel company headquartered in the United States ("U.S."). The Company designs, produces, procures, markets and distributes apparel primarily under the brand names Wrangler^®and Lee^®. The Company's products are sold in the U.S. through mass merchants, specialty stores, mid-tier and traditional department stores, company-operated stores and online. The Company's products are also sold internationally, primarily in Europe and Asia, through department, specialty, company-operated, concession retail and independently operated partnership stores and online. VF Outlet™ stores carry Wrangler^® and Lee^® branded products, as well as merchandise that is specifically purchased for sale in these stores.

Spin-Off Transaction

On May 22, 2019, VF Corporation ("VF" or "former parent") completed the spin-off of its Jeanswear business, which included the Wrangler^®, Lee^® and Rock & Republic^® brands, as well as the VF Outlet^TM business. The spin-off transaction (the "Separation") was effected through a pro-rata distribution to VF shareholders of one share of Kontoor common stock for every seven shares of VF common stock held on the record date of May 10, 2019. Kontoor began to trade as a standalone public company (NYSE: KTB) on May 23, 2019.

The Company incurred $1.05 billion of indebtedness under a newly structured third-party debt issuance, the proceeds of which were used primarily to finance a cash transfer to VF in connection with the Separation.

The Company entered into several agreements with VF that govern the relationship of the parties following the Separation, including the Separation and Distribution Agreement, the Tax Matters Agreement, the Transition Services Agreement, the Kontoor Intellectual Property License Agreement, the VF Intellectual Property License Agreement and the Employee Matters Agreement. Under the terms of the Transition Services Agreement, the Company and VF agreed to provide each other certain transitional services including information technology, information management, human resources, employee benefits administration, supply chain, facilities, and other limited finance and accounting-related services for periods up to 18 months, which may be extended subject to the mutual agreement of both parties. The Company has also entered into certain commercial arrangements with VF. Revenues, expenses and operating expense reimbursements under these agreements are recorded within the reportable segments or within the "corporate and other expenses" line item in the reconciliation of segment profit in Note 13 to the Company's financial statements, based on the nature of the arrangements.

Fiscal Year

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 third quarter of the Company's fiscal year ending December 28, 2019 ("fiscal 2019"). For presentation purposes herein, all references to periods ended September 2019, December 2018 and September 2018 correspond to the fiscal periods ended September 28, 2019, December 29, 2018 and September 29, 2018, respectively.

Basis of Presentation - Unaudited Consolidated and Combined Financial Statements

The Company’s financial statements for periods through the Separation date of May 22, 2019 were combined financial statements prepared on a "carve-out" basis as discussed below. The Company’s financial statements for the period from May 23, 2019 through September 28, 2019 were consolidated financial statements based on the reported results of Kontoor Brands, Inc. as a standalone company. The Company’s unaudited consolidated and combined financial statements for all periods presented are referred to throughout this document as “financial statements.”

The accompanying unaudited interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and notes required by generally accepted accounting principles in the United States of America ("GAAP") for complete financial statements. In the opinion of management, the accompanying financial statements contain all normal and recurring adjustments necessary to fairly state the financial position, results of operations and cash flows of the Company for the interim periods presented. The financial statements may not be indicative of the Company's future performance and do not necessarily reflect what the financial position, results of operations and cash flows would have been had it operated as a standalone company for all periods presented. Additionally, operating results for the three and nine months ended September 2019 are not necessarily indicative of results that may be expected for any other interim period or for fiscal 2019. The unaudited financial statements should be read in conjunction with the audited combined financial statements for the fiscal year ended December 29, 2018 included in the Company's Registration Statement on Form 10, as amended and filed with the Securities and Exchange Commission ("SEC") on April 30, 2019 ("2018 Form 10").

8 Kontoor Brands, Inc. Q3 FY19 Form 10-Q

KONTOOR BRANDS, INC.

Notes to Consolidated and Combined Financial Statements

(Unaudited)

Basis of Presentation - Prior to the Separation

Through the Separation date, the Company's combined financial statements were prepared on a carve-out basis. These accompanying unaudited combined financial statements reflected the historical financial position, results of operations and cash flows of the Company for the periods presented, through the Separation date, as historically managed within VF. The unaudited combined financial statements were derived from the consolidated financial statements and accounting records of VF.

The combined statements of income included costs for certain centralized functions and programs provided and administered by VF that were charged directly to the Company. These centralized functions and programs included, but were not limited to, information technology, human resources, accounting shared services, supply chain and insurance.

In addition, for purposes of preparing these combined financial statements on a carve-out basis under U.S. GAAP, a portion of VF's total corporate expenses were allocated to the Company. These expense allocations included the cost of corporate functions and resources provided by or administered by VF including, but not limited to, executive management, finance, accounting, legal, human resources and related benefit costs associated with such functions, such as stock-based compensation and pension. Allocations also included the cost of operating VF's corporate headquarters located in Greensboro, North Carolina.

Costs were allocated to the Company based on direct usage when identifiable or, when not directly identifiable, on the basis of proportional revenues, cost of goods sold or square footage, as applicable. Management considered the basis on which the expenses were allocated to reasonably reflect the utilization of services provided to, or benefit received by, the Company during the periods presented. However, the allocations may not reflect the expenses that would have been incurred if the Company had been a standalone company for the periods presented. Actual costs that may have been incurred if the Company had been a standalone company would depend on a number of factors, including the organizational structure, whether functions were outsourced or performed by employees, and strategic decisions made in areas such as information technology and infrastructure.

The combined financial statements included certain assets and liabilities that were historically held at the VF corporate level but were specifically identifiable or otherwise attributable to the Company. VF's third-party long-term debt and the related interest expense were not allocated to the Company for any of the periods presented as the Company was not the legal obligor of such debt.

All intracompany transactions were eliminated. All transactions between the Company and VF were included in these financial statements. For those transactions between the Company and VF that were historically settled in cash, the Company reflected such balances in the balance sheets as "due from former parent" or "due to former parent." The aggregate net effect of transactions between the Company and VF that were not historically settled in cash were reflected in the balance sheets within "former parent investment" and in the statements of cash flows within "net transfers to former parent."

NOTE 2 — RECENTLY ADOPTED AND ISSUED ACCOUNTING STANDARDS

Recently Adopted Accounting Standards

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842),” an update that requires entities to record most leased assets and liabilities on the balance sheet, and also retains a dual model approach for assessing lease classification and recognizing expense. The FASB subsequently issued updates to provide clarification on specific topics, including adoption guidance, practical expedients and interim transition disclosure requirements. This guidance was adopted by the Company during the first quarter of fiscal 2019 utilizing the optional transition method, which resulted in the recognition of operating lease right-of-use assets, operating lease liabilities and a $2.7 million cumulative effect adjustment to the fiscal 2019 beginning retained earnings in the Company's balance sheet. The adoption of these standards did not have a significant impact on the Company's statement of income and statement of cash flows. Refer to Note 3 to the Company's financial statements for additional information.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities," an update that amends and simplifies certain aspects of hedge accounting rules to better portray the economic results of risk management activities in the financial statements. The FASB has subsequently issued updates to the standard to provide additional guidance on specific topics. This guidance was adopted by the Company during the first quarter of fiscal 2019 and did not have a significant impact on the Company's financial statements.

In February 2018, the FASB issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," an update that addresses the effect of the change in the U.S. federal corporate income tax rate due to the enactment of the Tax Cuts and Jobs Act (the "Tax Act") on items within accumulated other comprehensive income (loss). This guidance was adopted by the Company during the first quarter of fiscal 2019 and did not have a significant impact on the Company's financial statements.

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 9

KONTOOR BRANDS, INC.

Notes to Consolidated and Combined Financial Statements

(Unaudited)

In July 2018, the FASB issued ASU 2018-09, "Codification Improvements," an update that provides technical corrections, clarifications and other improvements across a variety of accounting topics. The transition and effective date guidance is based on the facts and circumstances of each update, many of which became effective for the Company during the first quarter of fiscal 2019. The adoption of this guidance did not have a significant impact on the Company's financial statements.

Recently Issued Accounting Standards

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables. This guidance will be effective for the Company beginning in the first quarter of fiscal 2020. The Company is currently evaluating the impact that adoption of this guidance will have on its financial statements, which is not expected to be significant.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement," an update that modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. This guidance will be effective for the Company beginning in the first quarter of fiscal 2020. The Company is currently evaluating the impact that adoption of this guidance will have on its financial statement disclosures, which is not expected to be significant.

In August 2018, the FASB issued ASU 2018-14, "Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans," an update that modifies the disclosure requirements for employers who sponsor defined benefit pension or other postretirement plans. This guidance will be effective for the Company beginning in the first quarter of fiscal 2020. The Company is currently evaluating the impact that adoption of this guidance will have on its financial statement disclosures, which is not expected to be significant.

In August 2018, the FASB issued ASU 2018-15, "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," an update that aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance will be effective for the Company beginning in the first quarter of fiscal 2020. The Company is currently evaluating the impact that adoption of this guidance will have on its financial statements, which is not expected to be significant.

NOTE 3 — LEASES

The Company enters into operating leases for offices, operational facilities, retail locations, vehicles and other assets that expire at various dates through 2031. Leases for real estate typically have initial terms ranging from 2 to 15 years, generally with renewal options. Leases for equipment typically have initial terms ranging from 3 to 7 years. Most leases have fixed rentals, with many of the real estate leases requiring additional payments for real estate taxes and occupancy-related costs. These lease terms may include optional renewals, terminations or purchases, which are considered in the Company’s assessments when such options are reasonably certain to be exercised.

For retail real estate leases, the Company does not typically include renewal options in the underlying lease term. For non-retail real estate leases, when renewal options are reasonably certain to be exercised, the Company includes the renewal options in the underlying lease term, up to a maximum of ten years. Renewals for all other leases are determined on a lease-by-lease basis.

Upon adoption of ASU 2016-02, the Company elected the package of practical expedients permitted under the new lease standard, which allowed the Company to carry forward its historical assessment of whether a contract contained a lease, how the lease was classified, and if initial direct costs could be capitalized. The Company elected to combine non-lease components with the related lease components for real estate, vehicles and other significant asset arrangements. The Company elected to aggregate the combined items as a single lease component for accounting purposes. Lastly, for leases with a lease term of 12 months or less for all classes of underlying assets, the Company elected not to recognize a right-of-use asset and related lease liability.

Certain of the Company’s leases contain fixed, indexed, or market-based escalation clauses which impact future payments. Certain arrangements contain variable payment provisions, such as payments based on sales volumes or amounts and mileage, or excess mileage. The Company’s leases typically contain customary covenants and restrictions.

The Company determines whether a contract is a lease at inception. This typically requires more judgment in storage and service arrangements where the Company must determine whether its rights to specific physical or production capacity may represent substantially all of the available capacity.

The Company measures right-of-use assets and related lease liabilities based on the present value of remaining lease payments, including in-substance fixed payments, the current payment amount when payments depend on an index or rate (e.g., inflation adjustments, market renewals), and the amount the Company believes is probable to be paid to the lessor under residual value guarantees, when applicable. Lease contracts may include fixed payments for non-lease components, such as maintenance, which are included in

10 Kontoor Brands, Inc. Q3 FY19 Form 10-Q

KONTOOR BRANDS, INC.

Notes to Consolidated and Combined Financial Statements

(Unaudited)

the measurement of lease liabilities for certain asset classes based on the Company’s election to combine lease and non-lease components.

As applicable borrowing rates are not typically implied within our lease arrangements, the Company discounts lease payments based on its estimated incremental borrowing rate at lease commencement, or modification, which is based on the Company’s estimated credit rating, the lease term at commencement and the contract currency of the lease arrangement.

The following table presents the lease-related assets and liabilities recorded in the Company's balance sheet:



(in thousands)	September 2019
Assets
Operating lease assets, noncurrent	$	96,590
Total lease assets	$	96,590

Liabilities
Operating lease liabilities, current	$	35,992
Operating lease liabilities, noncurrent	64,328
Total lease liabilities	$	100,320

Weighted-average remaining lease term (in years)
Operating leases	4.14
Weighted-average discount rate
Operating leases	2.73		%

Lease costs

The following table presents certain information related to the lease costs for operating leases:



(in thousands)	Three Months Ended September 2019		Nine Months Ended September 2019
Operating lease cost	$	9,924	$	28,880
Short-term lease cost (excluding leases of one month or less)	877		2,383
Variable lease cost	873		4,424
Total lease costs	$	11,674	$	35,687

Rent expense associated with operating leases for the three and nine months ended September 2018 totaled approximately $10.6 million and $31.8 million, respectively.

Other information

The following table presents supplemental cash flow and non-cash information related to leases:



(in thousands)	Nine Months Ended September 2019
Cash paid for amounts included in the measurement of lease liabilities - operating cash flows	$	34,486
Right-of-use assets obtained in exchange for new operating leases - non-cash activity	$	38,939

Kontoor Brands, Inc. Q3 FY19 Form 10-Q 11

KONTOOR BRANDS, INC.

Notes to Consolidated and Combined Financial Statements

(Unaudited)

The following table presents maturities of operating lease liabilities as of September 2019:



(in thousands)	Lease Obligations
2019 (excluding the nine months ended September 2019)	$	11,185
2020	36,656
2021	23,796
2022	12,980
2023	9,639
Thereafter	13,013
Total future minimum lease payments	107,269
Less: amounts related to imputed interest	(6,949		)
Present value of future minimum lease payments	100,320
Less: operating lease liabilities, current	(35,992		)
Operating lease liabilities, noncurrent	$	64,328

As of September 2019, the Company has entered into approximately $1.1 million of operating lease arrangements, on an undiscounted basis, that have not yet commenced. The Company continuously monitors and may negotiate contract amendments that include extensions or modifications to existing leases.

The following table presents the future minimum lease payments during the noncancelable lease terms as of December 2018, prior to the adoption of ASU 2016-02: