UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the fiscal year ended December 28, 2019
or
For the transition period from ______ to ______
Commission file number: 001-38854
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. employer identification number) | |
(Address of principal executive offices)
(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 |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☑
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 ☑ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ 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 ☑
The aggregate market value of Common Stock held by non-affiliates of the registrant on June 29, 2019, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $1,587,000,000 based on the closing price of the registrant's Common Stock on the New York Stock Exchange.
As of February 28, 2020, there were 57,042,089 shares of Common Stock of the registrant outstanding.
Documents Incorporated By Reference:
Portions of the definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 21, 2020 are incorporated by reference into Part III of this Annual Report on Form 10-K, which definitive Proxy Statement shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Annual Report on Form 10-K relates.
KONTOOR BRANDS, INC
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Kontoor Brands, Inc. 2019 Form 10-K - Table of Contents
PART I
Special Note On Forward-Looking Statements
We have made statements in this Annual Report on Form 10-K that are forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include projections, forecasts or assumptions of our future financial performance, our anticipated growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. Known or unknown risks, uncertainties and other factors that could cause the actual results of operations or financial condition of Kontoor to differ materially from those expressed or implied by such forward-looking statements are summarized in Item 1A. of this Annual Report on Form 10-K.
Our forward-looking statements are based on our beliefs and assumptions using information available at the time the statements are made. We caution the reader not to place undue reliance on our forward-looking statements as (i) these statements are neither a prediction nor a guarantee of future events or circumstances and (ii) the assumptions, beliefs, expectations and projections about future events may differ materially from actual results. We undertake no obligation to update any of these forward-looking statements after the date of this Annual Report on Form 10-K to conform our prior statements to actual results or revised expectations, except to the extent required by law.
Where You Can Find More Information
All periodic and current reports, registration statements and other filings that Kontoor has filed or furnished to the Securities and Exchange Commission (“SEC”), including our registration statement on Form 10, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended ("the "Exchange Act"), are available free of charge from the SEC’s website (www.sec.gov). Our SEC filings are also available on our corporate website at www.kontoorbrands.com as soon as reasonably practicable after they are filed with or furnished to the SEC. Our website and the information contained therein or connected thereto is not incorporated in this Annual Report on Form 10-K.
The following corporate governance documents can be accessed on Kontoor’s website: Kontoor’s Corporate Governance Principles, Code of Business Conduct, and the charters of our Audit Committee, Talent and Compensation Committee and Nominating and Governance Committee. Copies of these documents also may be obtained by any shareholder free of charge upon written request to the Corporate Secretary of Kontoor at 400 N. Elm Street, Greensboro, NC 27401.
After Kontoor’s 2020 Annual Meeting of Shareholders, Kontoor intends to file with the New York Stock Exchange (“NYSE”) the certification regarding Kontoor’s compliance with the NYSE’s corporate governance listing standards as required by NYSE Rule 303A.12.
ITEM 1. BUSINESS. |
Overview
Kontoor Brands, Inc. is a global lifestyle apparel company focused on the design, manufacturing, sourcing, marketing and distribution of a portfolio of brands, including two of the world's most iconic consumer brands: Wrangler® and Lee®. We are headquartered in the United States ("U.S."). As used in this Annual Report on Form 10-K, the terms “Kontoor,” the "Company,” “we,” "us," and “our” used herein refer to Kontoor Brands, Inc. and its consolidated subsidiaries, collectively, unless the context indicates otherwise.
The Company operates and reports using a 52/53 week fiscal year ending on the Saturday closest to December 31 of each year. For presentation purposes herein, all references to periods ended December 2019, December 2018 and December 2017 correspond to the 52-week fiscal periods ended December 28, 2019, December 29, 2018 and December 30, 2017, respectively.
Kontoor is strongly positioned as a leader in the global apparel industry. We endeavor to provide customers with superior high-quality products that look good and fit right, giving people around the world the freedom and confidence to express themselves. Our business is founded upon a strategic sourcing model and best-in-class supply chain, with industry-leading sustainability standards. We are focused on leveraging our global platform to drive brand growth and deliver long-term value for our stakeholders, including our consumers, customers, shareholders and suppliers.
Our two key brands, Wrangler® and Lee®, benefit from heritages spanning over 200 combined years and together with our other brands accounted for approximately 170 million units of apparel sold in 2019. During 2019, we manufactured approximately 38% of our products in our owned and leased facilities, and distributed our products worldwide primarily through both major brick & mortar and e-commerce retailers. We believe our experienced management team is executing a strategy that provides a better product and brand experience to our consumers, primarily by delivering on our high standards of product design and innovation, and offering a wide variety of compelling products across channels and categories.
1 Kontoor Brands, Inc. 2019 Form 10-K
We focus on continuously improving the most important elements of our products, which include fit, fabric, finish, and overall construction, while continuing to provide our products to consumers at attractive price points. We leverage innovation and design advancements as well as our unique brand heritages to create marketing campaigns that communicate our brand positioning, product attributes, and overall value proposition to consumers. We believe these marketing campaigns further elevate our brands, build our loyal global consumer base, and ultimately drive net revenue growth.
Kontoor has a presence in more than 65 countries and generated approximately $2.5 billion in global net revenues across our various channels in 2019. We sell our products primarily through our established wholesale and expanding digital channels, and utilize our branded brick & mortar locations to supplement our go-to-market strategy. We benefit from strong relationships with many of our customers who we believe depend on our ability to reliably and timely replenish our high-volume products.
Within the U.S., where the Company generated 75% of its net revenues in 2019, we offer apparel and accessories largely through our wholesale channel, which consists of mass and mid-tier retailers, specialty stores including western specialty retail, department stores, and retailer-owned and third-party e-commerce sites. We also sell our products in the U.S. through direct-to consumer channels, including full-price stores, outlet stores and our own websites. Outside the U.S., where the Company generated 25% of its net revenues in 2019, we operate through similar wholesale channels and third-party e-commerce sites as in the U.S., and also utilize distributors, agents, licensees and partnership stores, along with our full-price stores, outlet stores and our own websites.
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 OutletTM 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.
On May 17, 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 ("TSA"), the Kontoor Intellectual Property License Agreement, the VF Intellectual Property License Agreement and the Employee Matters Agreement. Under the terms of the TSA, 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 3 to the Company's financial statements, based on the nature of the arrangements.
Corporate Information
Kontoor was incorporated in North Carolina on November 28, 2018 and became a standalone public company on May 23, 2019 following the Separation. Our principal executive offices are located at 400 N. Elm Street, Greensboro, North Carolina 27401 and our telephone number is 336-332-3400. Our website is www.kontoorbrands.com. Our website and the information contained therein or connected thereto is not incorporated in this Annual Report on Form 10-K.
Our Competitive Strengths
• | Iconic Brands with Significant Global Scale. |
Our two key brands are steeped in rich heritage and authenticity. The Wrangler® and Lee® brands have an established global presence in the apparel market. Products bearing our brands are sold in more than 65 countries, and we believe they have strong consumer connectivity worldwide. We market our brands and products to highlight their differentiated position and product attributes. We strive to maximize our consumer reach by leveraging each brand’s “best practices” to drive growth across product categories and expand our overall net revenues and earnings profile.
Founded over 70 years ago, Wrangler® is a classic American brand deeply rooted in U.S. western apparel and positioned as clothing ready for everyday life. Wrangler® branded products have a worldwide presence and span a wide range of product categories including denim and non-denim bottoms, shirts, jackets and other outerwear and accessories. We believe the Wrangler® brand appeals to a broad range of consumers worldwide who appreciate the brand’s western heritage, quality and superior value. Outside the U.S., the brand typically occupies a more premium positioning and carries a higher average price point.
Founded over 130 years ago, Lee® is an authentic apparel brand with a heritage of purposeful craftsmanship and innovation. Lee® branded products offer versatile styling and superior comfort in denim and casual apparel for a multitude of activities, and target an active consumer interested in a stylish look through innovation designed for functional and visual appeal. The Lee® brand generates approximately 45% of its net revenues outside the U.S., with a significant portion attributable to China and certain countries in Europe. In particular, since entering the Chinese market in 1995, the Lee® brand has developed a leading market position in that country.
Kontoor Brands, Inc 2019 Form 10-K 2
• | Deep Relationships with Brick & Mortar Retail and E-Commerce Leaders |
We have developed long-term relationships with many leading global brick & mortar and e-commerce retailers, whom we believe rely on our iconic brands, leading product quality and value, and innovation to address evolving consumer needs in our product categories. By fostering these relationships, we have become an important vendor for many of our customers and have built leading category positions, which in turn supports the availability of our brands to consumers and our ability to introduce new products and categories. We also endeavor to provide sophisticated logistics, planning, and merchandising expertise to support our customers, which we believe enables a level of insight that builds more integrated customer relationships. Over time, we believe we have developed an aptitude for addressing our customers’ unique and challenging inventory replenishment and planning needs, and have built a reputation as a reliable partner in a dynamic retail environment.
• | Integrated Supply Chain Built to Support Volume and Replenishment |
We are continually refining our supply chain to maximize efficiency and reinforce our reputation of reliability with our customers. Through our vertically integrated supply chain we manufacture, source and distribute a significant quantity of high-volume apparel products that are frequently replenished by our retail partners. Our product procurement and distribution strategies, combined with our internal manufacturing facilities and retail floor space management programs, allow us to maintain what we believe is a competitive advantage and create increased operating flexibility versus other apparel suppliers. Our supply chain is built to support large volumes and to meet customer needs while balancing cost and operational requirements. Our ten internal manufacturing facilities, both owned and leased, are all located in the Western Hemisphere, where their proximity to our primary markets enables us to deliver inventory in a consistent and timely manner. We also have established global third-party sourcing and distribution networks that we leverage across product categories and various regions. We believe our flexible and balanced approach to manufacturing and distribution allows us to better manage our production needs.
Many of our largest volume and highest velocity product styles continue from year to year, with design and innovation elements periodically updated to maintain our products’ relevance with consumers. We utilize real-time data provided by our customers to ensure timely delivery of our products and optimize our customers’ inventory levels. We believe our vertically integrated operations in combination with inventory and supply-demand reconciliation processes allow us to excel in meeting our retail customers’ rapid order requirements.
• | Highly Experienced Management Team and Board of Directors |
We have assembled a senior management team that is highly focused on growing our brands’ net revenues, delivering strong and consistent financial results, and building a cohesive corporate culture. Together, our management team has over 50 years of combined experience in the apparel and accessories industry and brings deep global industry expertise to the Company. Additionally, the Kontoor management team was assembled prior to the Separation and has been working together to stand up and operate the Company for over a year. Our President and Chief Executive Officer, Scott H. Baxter, served in various senior leadership positions at VF, including most recently as Group President of Jeanswear, and prior to that as Group President of Americas West, where he was responsible for overseeing brands such as The North Face® and Vans®. Our Executive Vice President and Chief Financial Officer, Rustin Welton, most recently served as Vice President and Chief Financial Officer of Americas East, and prior to that as VF's Vice President and Chief Financial Officer for the Jeanswear Coalition, Imagewear Coalition, and Central/South America, Workwear, Timberland® and VF Outlet™ businesses. Our two Executive Vice Presidents and Global Brand Presidents, Thomas E. Waldron and Christopher Waldeck, maintain operational responsibility for the Wrangler® and Lee® brands, respectively, and have significant experience managing our brands. Our Executive Vice President, General Counsel and Secretary, Laurel Krueger, most recently served as Executive Vice President, General Counsel and Corporate Secretary of Signet Jewelers Limited, a leading global retailer of diamond jewelry, and has held a variety of legal leadership roles at publicly traded companies in retail and manufacturing. We are also guided by a strong Board of Directors who bring valuable industry and management insight to Kontoor. Our Board is led by our Non-Executive Chairman, Robert Shearer, who has extensive familiarity with our business and our industry, having served as Senior Vice President and Chief Financial Officer of VF from 2005 through 2015. We believe the depth of experience and deep industry knowledge of our management team and Board of Directors will drive the success of our new company.
• | Resilient Business Model That Delivers Consistent Results |
Our business has historically generated significant net revenues, strong profits, and attractive cash flows due to our global reach, leading market positions, deep customer relationships, and the vertical integration of our supply chain. We believe we offer high product value and quality to our consumers, who respond to our value proposition by consistently purchasing our products over time. Over the last five years, we generated net revenues in excess of $2.5 billion each year, and consistently delivered operating margins of 12% or greater each year except for 2019, when we delivered an operating margin of 7%. This decrease was primarily due to an $82.1 million increase in selling, general and administrative ("SG&A") costs during 2019, which negatively impacted operating margin by 3%, and a $32.6 million non-cash impairment charge in 2019 which also negatively impacted operating margin by 1%. SG&A expenses included $83.1 million of restructuring and Separation costs in 2019 compared to $28.6 million in 2018. Our strong margin profile combined with our diligent approach to operational excellence and capital management have produced meaningful cash flows. We believe our consistent financial results will provide us with the opportunity to consistently invest in our business, return capital to shareholders and repay debt.
3 Kontoor Brands, Inc. 2019 Form 10-K
Our Strategies
Our management team is fully dedicated to leveraging our capabilities and driving our strategic initiatives. We have flexibility to deploy our strong free cash flow towards our operating and capital allocation priorities to achieve these strategic initiatives.
• | Scale advantage in our core denim business |
We believe the combination of our brands, scale and global platform is differentiated in our industry. Historically, our brands have largely operated independently across geographic regions with regard to management, product design and marketing. With one integrated senior leadership team to manage our brands and operations globally, we are able to implement an operating model that more efficiently leverages our global brands, scale and platforms while remaining relevant in our markets. We have built a leadership team based in Greensboro, North Carolina, that includes Global Presidents of both the Wrangler® and Lee® brands, as well as global leaders of the design, merchandising and marketing departments. This centralized senior management team with global responsibility is working closely with our regional teams to deliver a unified brand and product design experience while ensuring market-specific nuances are maintained. Through this integrated platform and management structure, we believe we will amplify the global strength of our brands, improve operating efficiency and increase the overall demand for our products.
• | Accelerate positions in high-value segments, channels and geographies |
We believe there is an opportunity to expand the distribution of our products with new and existing brick & mortar and e-commerce customers internationally and in the U.S. We expect the integration and collaboration of our brands’ global leadership teams will help drive distribution opportunities for the Wrangler® and Lee® brands in both new and established markets by leveraging each brand’s relative distribution strengths across regions. Specifically, China provides an attractive geography to expand our existing presence and distribute more products across a range of price segments, especially as it relates to our Wrangler® brand. In Europe, we intend to refine our strategy to become more consumer-centric in addressing how and where our customers want to purchase our products. In the U.S., we see an opportunity to continue to grow with our major retail customers as well as drive distribution of our more premium products through higher-end department and specialty stores. We also expect to leverage our leading brand positions to increase our penetration with major global e-commerce players as well as with our own websites, as digital continues to grow in consumer importance worldwide.
• | Build advantaged positions to reach new consumers |
We see potential to enhance our existing product assortment, broaden our product offering and expand into adjacent product categories. We leverage our global innovation network to develop cognitive, design, textile and product construction advancements that target the needs of our existing and potential new target consumer groups. We strive to create new products to attract a wide range of consumers, including women and younger generations, while seeking to ensure our core offering continues to serve the needs of our consumers. We are also pursuing new categories such as outdoor and accelerating existing categories such as workwear that utilize our existing brand and product strengths. We have also introduced higher-end products at premium price points in the U.S. Successful execution of our product expansion strategies should broaden the appeal of our brands and products to new consumers, extend our reach into new product categories and ultimately drive the overall net revenues of our business.
• | Drive an unwavering focus on margin expansion and improving capital efficiency |
We expect to realize efficiencies across our business as we continue to create a more centralized global organization and pursue cost savings initiatives. As part of our centralized approach to our global business, our management team will provide global oversight for their respective business functions, including supply chain, digital and strategy, while seeking to ensure that we maintain our worldwide presence and regional relevance. Focusing on our near- to medium-term business strategy, we are focused on optimizing our business and accelerating our performance in fundamental areas, including margin expansion and cash flow generation. Our primary areas of financial focus during 2020 will be to (i) continue aggressive pay-down of debt; (ii) provide for a superior dividend payout; and (iii) implement technology solutions to enable global efficiency, such as our recently initiated implementation of the Company's global enterprise resource planning system ("ERP").
• | Create a highly engaged and performance-driven team with a total shareholder return and ownership culture |
We believe there is an opportunity to create value by aligning total shareholder return with the way we attract, engage, educate and reward our employees, as well as the ways we employ sustainable business practices and engage with the communities in which we do business. We aim to instill an energized culture with a deep focus on performance, ownership and accountability by embedding drivers and outcomes of total shareholder return within key metrics and incentives. We have designed diversity and inclusion goals to reshape our workforce as we believe this is key to driving innovation, and a results-oriented culture. Our strategy also includes pursuit of sustainable business activities in areas of water, waste and cotton. We are committed to corporate social responsibility, as we believe it not only is the right thing to do, but also provides an opportunity to create value for our stakeholders through an actively engaged workforce, deeper consumer engagement and potential cost savings.
Our Brands and Business Segment Information
We own and operate a portfolio of apparel brands that each aim to address the differentiated needs of their consumers. Our two key brands, Wrangler® and Lee®, have product designs targeted at specific consumers, and also offer various collections for specific channels and retailers.
Kontoor Brands, Inc 2019 Form 10-K 4
Our two reportable segments are Wrangler® and Lee®, which include sales of branded products, along with various sub-brands and collections as discussed under each respective brand below. In addition, we present an Other category for purposes of reconciliation of reportable segment net revenues and profits to the Company's consolidated operating results, but the Other category is not considered a reportable segment. See below for additional information on the brands, channels of distribution and geographies included in each segment.
• | Wrangler® |
Wrangler® is an iconic American heritage brand rooted in the western lifestyle, with over 70 years of history offering denim, apparel, and accessories for men and women. Wrangler® branded products are available through wholesale arrangements with mass and mid-tier retailers, specialty stores, department stores, independently owned and operated partnership stores, and e-commerce platforms, as well as through owned retail stores and websites. Wrangler® branded products are available in the U.S., Canada and Mexico, the United Kingdom and continental Europe, the Middle East, India, and through licensees across Australia, Asia, Africa and Central and South America. We offer multiple sub-brands and collections within the Wrangler® brand that we develop to target specific consumer demographics and consumer end-uses, including: 20X®, Aura from the Women at Wrangler®, Cowboy Cut®, Premium Patch®, Riggs Workwear®, Rock 47®, Rustler®, W1947®, Wrangler Retro®, Wrangler Rugged Wear® and All Terrain GearTM by Wrangler®.
• | Lee® |
Lee® is an iconic American denim and apparel brand, which celebrated 130 years of heritage and authenticity in 2019. Lee® product collections include a uniquely styled range of jeans, pants, shirts, shorts, and jackets for men, women, boys and girls, with boys and girls jackets currently licensed in the U.S. The Lee® brand delivers trend-forward styles with exceptional fit and comfort through innovative fabric solutions and advanced design technology. Lee® branded products are distributed domestically and internationally through the wholesale channel including department stores, mass merchants, specialty stores, independently owned and operated partnership stores, and e-commerce platforms, as well as through owned retail stores and websites. Lee® branded products are available in the U.S., Canada, Mexico, the United Kingdom and continental Europe, the Middle East, India, China, and through licensees across Australia, Asia, Africa and Central and South America. The Lee® brand offers multiple sub-brands and collections, making it attractive for a broader consumer base, including: Body OptixTM, Lee101TM, Lee® Riders®, Performance SeriesTM, Shape IllusionsTM and Vintage Modern®.
• | Other |
Other includes sales of third-party branded merchandise at VF Outlet™ stores, sales and licensing of Rock & Republic® branded apparel, and sales of products manufactured for third-parties. Rock & Republic® is a premium apparel brand and is marketed to consumers as a modern and active lifestyle brand. Rock & Republic® products have been historically sold in the U.S. through an exclusive domestic wholesale distribution and licensing agreement, and we are currently pursuing changes in distribution of the brand both inside and outside the U.S. by leveraging our retail and e-commerce relationships. Sales of Wrangler® and Lee® branded products at VF Outlet™ stores are not included in Other and are reported in the respective segments discussed above.
The Other category also includes transactions with VF for pre-Separation activities, none of which will continue in 2020. These transactions include sales of VF-branded products at VF Outlet™ stores, as well as sales to VF for products manufactured in our plants, use of our transportation fleet and fulfillment of a transition services agreement related to VF’s sale of its Nautica® brand business in mid-2018.
Distribution Channels and Customers
Our distribution channels include U.S. Wholesale, Non-U.S. Wholesale, Branded Direct-to-Consumer and Other. We utilize these channels based on the optimal route to reach our consumers in the physical and digital locations they frequent within their geographies. We also operate the U.S.-based VF Outlet™ business, which carries both of our primary brands as well as VF-branded products and third-party branded merchandise.
• | U.S. Wholesale |
The U.S. Wholesale channel is our largest distribution channel and accounted for approximately 63% of our net revenues in 2019. Within this channel, our Wrangler® and Lee® branded products are marketed and sold by mass and mid-tier retailers, specialty stores including western specialty retail, department stores, and retailer-owned and third-party e-commerce sites. This channel also includes sales and licensing of Rock & Republic® products. A portion of our U.S. Wholesale net revenue is attributable to digital sales from our wholesale partners’ websites, third-party e-commerce platforms such as Amazon, and other pure-play digital retailers. Third-party e-commerce platforms and pure-play digital retailers are a growing and important portion of this channel.
Our mass merchant customers include national retailers such as Target and Walmart, as well as various regional retail partners. Our mid-tier and traditional department store customers include national retailers such as Belk, JCPenney, Kohl’s, Macy’s, and various other retail partners. The specialty store channel, which includes revenue from Wrangler® Riggs Workwear® and Wrangler® Western branded products, consists primarily of national accounts such as Boot Barn and Tractor Supply Company as well as upscale modern specialty stores.
We foster close and longstanding relationships with our wholesale customers, having partnered with each of our top three brick & mortar wholesale customers for over 25 years. In addition, we engage in an active dialogue with many of our key wholesale customers and receive proprietary insights about how our products are performing on a timely basis. Our brands’ top U.S. Wholesale customers include
5 Kontoor Brands, Inc. 2019 Form 10-K
Amazon, Kohl’s, Target and Walmart. One customer, Walmart, accounted for greater than 10% of the Company's total net revenues in each of the last three years (approximately 34% in 2019, 32% in 2018 and 33% in 2017). Sales to our customers are typically on a purchase order basis and not subject to long-term agreements.
In addition, a small portion of sales in our U.S. Wholesale channel are from domestic licensing arrangements where we receive royalties based on a percentage of the licensed products’ net revenues. Most of the agreements provide for a minimum royalty requirement. See “Licensing Arrangements” herein for more information.
• | Non-U.S. Wholesale |
The Non-U.S. Wholesale channel represents the majority of our international business and accounted for approximately 21% of our net revenues in 2019. The majority of the Wrangler® and Lee® international product business is located in Europe, Middle East and Africa ("EMEA") and Asia-Pacific ("APAC"), where we sell our products through department stores and specialty stores. In Canada and Mexico, our branded products are marketed through mass merchants, department stores, and specialty stores, while in South America our branded products are sold in department and specialty stores. Additionally, our Non-U.S. Wholesale channel includes non-U.S. sales on digital platforms operated by our wholesale partners, as well as sales in partnership stores located across EMEA, APAC and South America. Partnership stores are owned and operated by our licensees, distributors and other independent parties. They are primarily mono-brand retail locations selling our Wrangler® and Lee® branded products that have the appearance of Kontoor-operated stores, and as such represent an important vehicle for presenting our brands to international consumers. Similar to the U.S. Wholesale channel, we use proprietary insights from our wholesale customers to strategically refine our products and adjust our go-to-market approach.
Geographically, our net revenue in EMEA is concentrated in developed markets such as France, Germany, Italy, Poland, Scandinavia, Spain and the United Kingdom. We access the APAC market primarily through our business in China and India. Canada is the largest international market for Wrangler® branded products, while China is the largest international market for Lee® branded products.
In addition, a small portion of sales in our Non-U.S. Wholesale channel are from international licensing arrangements where we receive royalties based on a percentage of the licensed products’ net revenues. Most of the agreements provide for a minimum royalty requirement. See “Licensing Arrangements” herein for more information.
• | Branded Direct-to-Consumer |
Our Branded Direct-to-Consumer channel represents the distribution of our products via concession retail locations internationally, Wrangler® and Lee® branded full-price stores globally and Company-owned outlet stores globally. This channel also includes sales of our branded products in VF Outlet™ locations, and digital sales via www.wrangler.com and www.lee.com. Our Branded Direct-to-Consumer channel allows us to display the brands’ product lines in a manner that supports the brands’ positioning, providing an in-store and online user experience that enables us to address the needs and preferences of our consumers. This channel accounted for approximately 11% of our net revenues in 2019.
Our 166 concession retail stores are located internationally and consist of mono-brand and dual-brand stores. Under a typical concession arrangement, we have a dedicated sales area within our customers’ stores, and pay a concession fee for use of the space based on a percentage of retail sales. The concession model allows our partners to dedicate specific sales areas to our brands and helps differentiate and enhance the presentation of our products.
Our 33 owned full-price Wrangler® or Lee® branded retail stores are located in the U.S., Europe and Asia, and include both mono-brand stores, which exclusively carry either Wrangler® or Lee® branded products, and dual-brand stores, which carry both Wrangler® and Lee® branded products. We also have a limited number of dual-branded Wrangler® and Lee® outlet stores in the U.S., as well as a limited number of dual-branded Wrangler® and Lee® clearance center stores.
We also operate multiple outlet stores in the U.S., in both premium outlet malls and more value-based outlet locations. The majority of our sites in the U.S. are traditional VF Outlet™ locations featuring Wrangler® and Lee® branded products, as well as VF-branded and third-party branded products. Branded Direct-to-Consumer channel net revenues include all sales from VF Outlet™ locations except for VF-branded and third-party branded merchandise, which are reported in the Other channel described below.
We continue to prioritize serving our customers through digital platforms that enhance the user experience and drive customer interaction in digital and physical environments. Digitally enabled transactions on our own websites are also included in this channel. Transactions generated from our own websites represents a growing portion of our net revenues, and helps elevate the connection consumers have with our brands. Wrangler® and Lee® branded products are currently available through our own websites in 14 countries.
Through our full-price stores, outlet stores and own websites, our Branded Direct-to-Consumer channel allows us to achieve the fullest expression of our brands, bringing the complete stories of our brands' purposes, heritages and products to life.
• | Other |
The Other channel includes sales of third-party branded merchandise at VF Outlet™ stores and sales of products manufactured for third-parties. Sales of Wrangler® and Lee® branded products at VF Outlet™ stores are not included in Other and are reported in the Branded Direct-to-Consumer channel discussed above. The Other channel accounted for approximately 5% of our net revenues in 2019, and while this channel is not a strategic focus, we are committed to optimizing profitability in our VF Outlet™ stores.
Kontoor Brands, Inc 2019 Form 10-K 6
The Other channel also includes transactions with VF for pre-Separation activities, none of which will continue in 2020. These transactions include sales of VF-branded products at VF Outlet™ stores, as well as sales to VF for products manufactured in our plants, use of our transportation fleet and fulfillment of a transition services agreement related to VF’s sale of its Nautica® brand business in mid-2018.
Licensing Arrangements
We seek to maximize our brands’ market penetration and consumer reach by entering into licensing agreements with independent parties. Pursuant to these licensing agreements, we typically grant our licensing partner an exclusive or non-exclusive license to use one of our brands in connection with specific licensed categories of products in specific geographic regions. Our licensing partners leverage the strength of our brands and our customer relationships to sell products in their licensed categories and/or geographic regions. Categories in which we currently have licensing agreements include jeanswear, casual apparel, belts, footwear, small leather goods and headwear.
We retain oversight and approvals of the design, quality control, advertising, marketing, and distribution of licensed products to ensure adherence to our brand and product quality standards. License agreements are for fixed terms of typically two to five years. Each licensee pays royalties based on its sales of licensed products, with the majority of agreements requiring a minimum royalty payment. Licensing net revenue was $32.1 million in 2019.
Design and Product Development
Our product design and innovation effort across fit, fabric, finish, and quality is an important element of our strategy. We leverage our expertise in these important areas to provide our consumers high-quality and high-value products. We operate a multi-site approach to product design and development, with hubs located in the U.S., Belgium, Hong Kong, and India. In the U.S. and EMEA, product design is housed within the merchandising, marketing, consumer insights, innovation, and executive teams to ensure product design delivers against brand positioning, consumer needs, and target costs.
Our product development team, which includes technical development, pattern-making, and engineering, works closely with our product design team to facilitate collaboration between the product and design functions. These two teams collaborate from initial concept to product creation in order to craft a lifestyle association to our Wrangler® and Lee® branded products. Our vigorous product development is supported by a robust go-to-market process that seeks to ensure brand continuity across business units and strong, consistent execution. We have two primary selling seasons, spring and fall, but certain product lines offer more frequent introductions of new merchandise.
In addition to our design functions, we operate two global innovation centers. Our research into advanced fiber and fabric technologies takes place in our material science lab in Greensboro, NC. Our research and development work in cognitive science, design and construction advancements as well as multi-sensory retail and data analytics are held at our cognitive and design science lab in Irvine, California. These locations are staffed with dedicated scientists, engineers and designers who leverage our proprietary consumer insights to create new designs, manufacturing and material technologies as well as intellectual propriety. Both centers are part of our global innovation network that partners with leading design, fashion and textile engineering universities as well as textile innovation centers, and research labs. Our global innovation network is integral to our long-term growth as they allow us to deliver new products and experiences that aim to meet our consumers’ needs, which we believe drives demand for our products.
Manufacturing, Sourcing and Distribution
Our global supply chain organization is responsible for the operational planning, manufacturing, sourcing, and distribution of products to our customers. We believe we have developed a high degree of expertise in managing the complexities associated with a global supply chain that produced or sourced approximately 164 million apparel units in 2019. Our supply chain employs a centralized leadership model with localized regional expertise. Within our internal manufacturing facilities, we innovate and design our own proprietary equipment to drive our production output and capabilities. We focus on engineering and efficiency, which we believe provides an ongoing competitive advantage in our internal manufacturing facilities. We leverage our manufacturing expertise in our sourcing operations, where we have developed longstanding relationships with third-party contract manufacturers and distributors. We believe this manufacturing and sourcing approach, coupled with strategic inventory and retail floor space management programs with many of our major retail customers, gives us operational flexibility as we continue to expand our distribution.
• | Sourcing and Manufacturing |
We believe the combination of our internal manufacturing and contract manufacturing across different geographic regions provides a well-balanced, flexible approach to product procurement. Within our own manufacturing facilities, we purchase raw materials from numerous U.S. and international suppliers to meet our production needs. Raw materials include products made from cotton, polyester, spandex, and lycra blends, as well as thread and trim (such as product identification, buttons, zippers and snaps). Fixed price commitments for fabric and certain supplies are typically set on a quarterly basis for the next quarter’s purchases. No single supplier represents more than 10% of our total cost of goods sold. We operate global sourcing hubs, which are responsible for managing contract manufacturing and procurement of product, including supplier oversight, product quality assurance, sustainability within the supply chain, responsible sourcing, and transportation and shipping functions.
We operate ten manufacturing facilities (seven owned facilities in Mexico and three leased facilities in Nicaragua). We also source products from approximately 277 contract manufacturing facilities in over 20 countries. We have recently taken steps to streamline and
7 Kontoor Brands, Inc. 2019 Form 10-K
right-size our supply chain operations, including the closure of three owned manufacturing facilities in Mexico. During 2019, approximately 38% of our units were manufactured in our internal manufacturing facilities, and approximately 62% were sourced from contract manufacturers. Products obtained from contractors in the Western Hemisphere frequently have a higher cost than products obtained from contractors in Asia. However, internal manufacturing combined with contracting in the Western Hemisphere gives us greater flexibility, shorter lead times and allows for enhanced inventory management in the U.S. market. In making decisions about the location of manufacturing operations and suppliers, we consider several factors including the raw material source, the market the product will be sold in, production lead times, duties and tariffs, product cost, product complexity and the ability to pursue upside demand. Additionally, we continually monitor risks and developments related to duties, tariffs, quotas and other factors and we often manufacture and source products from countries with tariff preferences and free trade agreements.
• | Distribution |
Products are shipped from our contract manufacturers and internal manufacturing facilities to distribution centers around the world. We directly operate the majority of our distribution centers and we carefully select third-party distribution centers as needed in certain regions. All of our distribution centers are strategically located to provide speed and service to our consumers at the most efficient cost possible. Additionally, our established long-term third-party distribution relationships ensure maximum capacity, connectivity, responsiveness, and overall service coverage around the globe. In international markets where we do not have brick & mortar operations, our products are marketed through our distributors, as well as agents, licensees, and single-brand or multi-brand partnership stores.
Inventory Management
Inventory management is key to the cash flows and operating results of our business. We manage our inventory levels based on existing orders, anticipated sales and the delivery requirements of our customers, which requires close coordination with our customers. For new product introductions, which often require large initial launch shipments, we may commence production before receiving orders for those products. Key areas of focus include added discipline around the purchasing of product, inventory optimization and channel placement, as well as better planning and execution in disposition of excess inventory through our various channels. Our inventory strategy is focused on continuing to meet consumer demand, while improving our inventory efficiency over the long-term through the recently initiated implementation of the Company's global ERP system.
Advertising and Customer Support
Our advertising and marketing efforts focus on differentiating our brands’ positioning and highlighting our product qualities. We are focused on creating globally unified brand messages with appropriate regional nuances in order to maximize our brand recognition, and drive brand demand from initial end consumer awareness to long-term loyalty. In conjunction with the appointment of our new global heads of marketing, we will continue to develop integrated, multi-channel marketing strategies designed to effectively reach the target consumers of each of our brands. We pursue this strategy through our use of a variety of media channels and other public endorsements, including traditional media such as television, print, and radio, as well as digital media channels such as display, online video, social media, paid search and influencers. We employ marketing analytics to optimize the impact of advertising and promotional spending, and to identify the types of spending that provide the greatest return on our marketing investments.
We also participate in cooperative advertising on a shared cost basis with major retailers in print and digital media, radio and television. We provide advertising support to our wholesale customers in the form of point-of-sale fixtures and signage to enhance the presentation and brand image of our products. Our websites, www.wrangler.com, www.lee.com, and corresponding regional websites, enhance consumer understanding of our brands and help consumers find and buy our products. We employ a support team for each brand that is responsible for customer service at the consumer level as well as a sales force that manages our customer relationships.
Seasonality
Our operating results are subject to some variability due to seasonality, with net revenues typically being slightly higher during the back-to-school and holiday shopping seasons. This limited variation results primarily from the differences in seasonal influences on revenues between our Wrangler and Lee segments. With changes in our mix of business and the growth of our retail operations, historical quarterly revenue and profit trends may not be indicative of future trends. Working capital requirements vary throughout the year. Working capital typically increases early in the year as inventory builds to support peak shipping periods and then moderates later in the year as those inventories are sold and accounts receivable are collected. Cash provided by operating activities is usually substantially higher in the second half of the year due to higher net income during that period and reduced working capital requirements.
Competition
The apparel industry is highly competitive, highly fragmented and characterized by low barriers to entry with many regional, local and global competitors. We believe we compete in the apparel and accessories sector by leveraging our brands, scale, and ability to develop high-quality, innovative products at competitive prices that meet consumer needs.
Our primary branded competitors are large, globally focused apparel companies that also participate in a variety of categories, including, but not limited to, athletic wear, denim, exclusive or private labels, casual lifestyle apparel, outerwear and workwear. A select list of key competitors includes Calvin Klein, Carhartt, Diesel, Guess, Levi’s, Tommy Hilfiger and Uniqlo. Additionally, we see a large and growing offering from private label apparel created for retailers such as Amazon, Gap, H&M, Old Navy, Target and Walmart.
Kontoor Brands, Inc 2019 Form 10-K 8
Intellectual Property
We believe trademarks, trade names, patents and domain names, as well as related logos, designs and graphics, provide substantial value in the development and marketing of our products, and are important to our continued success. We have registered our intellectual property in the U.S. and in other countries where our products are manufactured and/or sold. In particular, our trademark portfolio consists of over 7,000 trademark registrations and applications in the U.S. and other countries around the world, including U.S. and foreign trademark registrations for our two key brands, Wrangler® and Lee®. Although the laws vary by jurisdiction, in general, trademarks remain valid and enforceable provided that the marks are used in connection with the related products and services and the required registration renewals are filed. Typically, trademark registrations can be renewed indefinitely as long as the trademarks are in use. We also place high importance on product innovation and design, and a number of these innovations and designs are the subject of patents. However, we do not regard any segment of our business as being dependent upon any single patent or group of related patents.
Social Responsibility, Community Outreach and Sustainability
We are a purpose-led organization and are committed to environmental sustainability, labor welfare and community development, not only because today’s consumers demand the highest standards from the brands they utilize, but because we believe these values are consistent with what our brands represent and are the right thing to do to enhance global welfare. Corporate sustainability and responsibility is an important priority for the Company and the Board. The Board is responsible for promoting the exercise of responsible corporate citizenship and monitoring adherence to Kontoor’s standards. The Nominating and Governance Committee reviews and evaluates Kontoor’s strategies, programs, policies and practices relating to environmental, social and governance issues and impacts to support the sustainable and responsible growth of Kontoor’s business. Kontoor believes that in order to grow as a Company, it has a responsibility to help improve the well-being of its communities. Kontoor articulates its commitments to corporate sustainability and responsibility in its Code of Conduct which can be found on Kontoor’s website (www.kontoorbrands.com). In addition, Kontoor plans to file the Company’s first sustainability report in late May 2020.
Environmental Matters
We are subject to various federal, state, local and foreign laws and regulations that govern our activities, operations and products that may have adverse environmental, health and safety effects, including laws and regulations relating to generating emissions, water discharges, waste, product and packaging content and workplace safety. Noncompliance with these laws and regulations may result in substantial monetary penalties and criminal sanctions. Compliance with environmental laws and regulations historically have not had a material impact on our operations, and we are not aware of any proposed regulations or remedial obligations that could trigger significant costs or capital expenditures in order to comply.
Governmental Regulations
We are subject to U.S. federal, state and local laws and regulations that could affect our business, including those promulgated under the Occupational Safety and Health Act, the Consumer Product Safety Act, the Flammable Fabrics Act, the Textile Fiber Product Identification Act, the rules and regulations of the Consumer Products Safety Commission and various environmental laws and regulations. Our international businesses are subject to similar laws and regulations in the countries in which they operate. Our operations also are subject to various international trade agreements and regulations. While we believe that we are in compliance in all material respects with all applicable governmental regulations, current governmental regulations may change or become more stringent or unforeseen events may occur, any of which could have a material adverse effect on our financial position or results of operations.
Employees
We employed approximately 15,100 people as of December 28, 2019, of which approximately 3,700 were located in the U.S. In international markets, a significant percentage of employees are covered by trade sponsored or governmental bargaining arrangements. Employee relations are considered to be good.
Backlog
The dollar amount of the Company’s order backlog as of any date may not be indicative of actual future shipments and, accordingly, is not material to an understanding of the business taken as a whole.
9 Kontoor Brands, Inc. 2019 Form 10-K
ITEM 1A. RISK FACTORS. |
You should carefully consider each of the following risks and all of the other information contained in this Annual Report on Form 10-K before investing in our common stock. Our business, prospects, results of operations, financial condition or cash flows could be materially and adversely affected by any of these risks, and, as a result, the trading price of our common stock could decline.
Risks Relating to Our Business
Our revenues and profits depend on the level of consumer spending for apparel, which is sensitive to global economic conditions and other factors. A decline in consumer spending could have a material adverse effect on us.
The success of our business depends on consumer spending on apparel, and there are a number of factors that influence consumer spending, including actual and perceived economic conditions, disposable consumer income, interest rates, consumer credit availability, unemployment, stock market performance, weather conditions, energy prices, consumer discretionary spending patterns and tax rates in the international, national, regional and local markets where our products are sold. The current global economic environment is unpredictable, and adverse economic trends or other factors could negatively impact the level of consumer spending, which could have a material adverse impact on us.
The apparel industry is highly competitive, and our success depends on our ability to gauge consumer preferences and product trends, and to respond to constantly changing markets.
We compete with numerous apparel brands and manufacturers. Competition is generally based upon brand name recognition, price, design, product quality, selection, service and purchasing convenience. Some of our competitors are larger and have more resources than us in certain product categories and regions. In addition, we compete directly with the private label brands of our wholesale customers. Our ability to compete within the apparel industry depends on our ability to:
• | Anticipate and respond to changing consumer preferences and product trends in a timely manner; |
• | Develop attractive, innovative and high-quality products that meet consumer needs; |
• | Maintain strong brand recognition; |
• | Price products appropriately; |
• | Provide best-in-class marketing support and intelligence; |
• | Ensure product availability and optimize supply chain efficiencies; |
• | Adapt to a more digitally driven consumer landscape; |
• | Produce or procure quality products on a consistent basis; and |
• | Obtain sufficient retail store space and effectively present our products at retail. |
Failure to compete effectively or to keep pace with rapidly changing consumer preferences, markets and product trends could have a material adverse effect on our business, financial condition and results of operations. Moreover, there are significant shifts underway in the wholesale and retail (e-commerce and retail store) channels. We may not be able to manage our brands within and across channels sufficiently, which could have a material adverse effect on our business, financial condition and results of operations.
Our results of operations could be materially harmed if we are unable to accurately forecast demand for our products.
There can be no assurance that we will be able to successfully anticipate changing consumer preferences and product trends or economic conditions, and, as a result, we may not successfully manage inventory levels to meet our future order requirements. We often schedule internal production and place orders for products with independent manufacturers before our customers’ orders are firm. If we fail to accurately forecast consumer demand, we may experience excess inventory levels or a shortage of product required to meet the demand. Inventory levels in excess of consumer demand may result in inventory write-downs, the sale of excess inventory at discounted prices or excess inventory held by our wholesale customers, which could have a negative impact on future sales, an adverse effect on the image and reputation of our brands and negatively impact profitability. On the other hand, if we underestimate demand for our products, our manufacturing facilities or third-party manufacturers may not be able to produce products to meet consumer requirements, and this could result in delays in the shipment of products and lost revenues, higher costs for our freight or expedited shipments, as well as damage to our reputation and relationships. These risks could have a material adverse effect on our brand image as well as our results of operations and financial condition.
Our business and the success of our products could be harmed if we are unable to maintain the images of our brands.
Our success to date has been due in large part to the growth of our brands’ images and our customers’ connection to our brands. If we are unable to timely and appropriately respond to changing consumer demand, including customers' desire for sustainable products, the names and images of our brands may be impaired. Even if we react appropriately to changes in consumer preferences, consumers
Kontoor Brands, Inc 2019 Form 10-K 10
may consider our brands’ images to be outdated or associate our brands with styles that are no longer popular. In addition, brand value is based in part on consumer perceptions on a variety of qualities, including merchandise quality and corporate integrity. Negative claims or publicity regarding us, our brands or our products could adversely affect our reputation and sales regardless of whether such claims are accurate. Social media, which accelerates the dissemination of information, can increase the challenges of responding to negative claims. In the past, many apparel companies have experienced periods of rapid growth in sales and earnings followed by periods of declining sales and losses. Our businesses may be similarly affected in the future. In addition, we have sponsorship contracts with a number of athletes, musicians and celebrities and feature those individuals in our advertising and marketing efforts. Actions taken by those individuals associated with our products could harm their reputations, which could adversely affect the images of our brands.
If we are unsuccessful in establishing effective advertising, marketing and promotional programs, our sales could be negatively affected.
Inadequate or ineffective advertising could inhibit our ability to maintain brand relevance and drive increased sales. Additionally, if our competitors increase their spending on advertising and promotions, if our advertising, media or marketing expenses increase, or if our advertising and promotions become less effective than those of our competitors, we could experience a material adverse effect on our business, results of operations and financial condition.
Our profitability may decline as a result of increasing pressure on margins.
The apparel industry is subject to significant pricing pressure caused by many factors, including intense competition, consolidation in the retail industry, rising commodity and conversion costs, pressure from retailers to reduce the costs of products, changes in consumer demand and shifts to online shopping and purchasing. Customers may increasingly seek markdown allowances, incentives and other forms of economic support. If these factors cause us to reduce our sales prices to retailers and consumers, and we fail to sufficiently reduce our product costs or operating expenses, our profitability will decline. This could have a material adverse effect on our results of operations, liquidity and financial condition.
We may not succeed in our business strategy.
One of our key strategic objectives is growth. We seek to grow organically and potentially, in the future, through acquisitions. We seek to grow by expanding our share with winning customers; stretching brands to new regions, channels, and categories; managing costs; leveraging our supply chain across Kontoor Brands; and expanding our direct-to-consumer business with emphasis on our e-commerce business. However, we may not be able to grow our existing businesses. For example:
• | We may not be able to transform our model to be more consumer- and retail-centric; |
• | We may not be able to expand our market share with winning customers, or our wholesale customers may encounter financial difficulties and thus reduce their purchases of our products; |
• | We may not be able to expand our brands in Asia or other geographies, transform our business in certain regions or achieve the expected results from our supply chain initiatives; |
• | We may not be able to successfully integrate our Wrangler® and Lee® brand platforms or achieve the expected growth, cost savings or synergies from such integration; |
• | We may have difficulty recruiting, developing or retaining qualified employees; |
• | We may not be able to achieve our direct-to-consumer expansion goals and manage our growth effectively; |
• | We may not be able to offset rising commodity or conversion costs in our product costs with pricing actions or efficiency improvements; |
• | We may have difficulty completing potential acquisitions or dispositions, and we may not be able to successfully integrate a newly acquired business or achieve the expected growth, cost savings or synergies from such integration; and |
Failure to implement our strategic objectives may have a material adverse effect on our business.
A significant portion of our revenues and gross profit is derived from a small number of large customers. The loss of any of these customers or the inability of any of these customers to pay us could substantially reduce our revenues and profits.
A small portion of our customers account for a significant portion of net revenues. Sales to our ten largest customers accounted for 53% of total net revenues in 2019, and our top customer, Walmart, accounted for 34%, 32% and 33% of our total net revenues in 2019, 2018 and 2017, respectively. We expect that these customers will continue to represent a significant portion of our net sales in the future. Sales to our wholesale customers are generally on a purchase order basis and not subject to long-term agreements. A decision by any of our major wholesale customers to significantly decrease the volume of products purchased from us could substantially reduce net revenues and have a material adverse effect on our financial condition and results of operations. Our larger customers generally have the scale to develop supply chains that enable them to change their buying patterns, or develop and market their own private label and other economy brands that compete with some of our products. This ability also makes it easier for them to resist our efforts to increase prices, reduce inventory levels and, potentially, discontinue our products. Many of our largest customers have already developed significant private label brands under which they design and market apparel and accessories that compete directly with our products.
11 Kontoor Brands, Inc. 2019 Form 10-K
These retailers have assumed an increasing degree of inventory risk in their private label products and, as a result, may first cancel advance orders with us in order to manage their own inventory levels downward during periods of unseasonable weather or weak economic cycles. In addition, if any of our customers devote less selling space to our categories of apparel, our sales to those customers could be reduced even if we maintain our share of their apparel business. Any such reduction in our categories of apparel selling space could result in lower sales and our business, results of operations, financial condition and cash flows may be adversely affected.
We rely significantly on information technology. Any inadequacy, interruption, integration failure or security failure of this technology could harm our ability to effectively operate our business.
Our ability to effectively manage and operate our business depends significantly on information technology systems. We rely heavily on information technology to track sales and inventory and manage our supply chain, and the majority of our systems are currently supplied to us by VF pursuant to the TSA associated with the Separation. We are also dependent on information technology, including the Internet, for our direct-to-consumer sales, including our e-commerce operations and retail business credit card transaction authorization. We expect to upgrade or replace many of these systems as we transition from the TSA. Despite our preventative efforts, our systems and those of our third-party service providers may be vulnerable to damage, failure or interruption due to viruses, data security incidents, technical malfunctions, natural disasters or other causes, or in connection with upgrades to our systems or the implementation of new systems. The failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, difficulty in integrating new systems or systems of acquired businesses or a breach in security of these systems could adversely impact the operations of our business, including management of inventory, ordering and replenishment of products, manufacturing and distribution of products, e-commerce operations, retail business credit card transaction authorization and processing, corporate email communications and our interaction with the public on social media.
We are subject to data security and privacy risks that could negatively affect our business operations, results of operations or reputation.
In the normal course of business, we often collect, retain and transmit certain sensitive and confidential customer information, including credit card information, over public networks. There is a significant concern by consumers and employees over the security of personal information transmitted over the Internet, identity theft and user privacy. Data security attacks are increasingly sophisticated, and if unauthorized parties gain access to our networks or databases, or those of our third-party service providers, they may be able to steal, publish, delete or modify our private and sensitive information, including credit card information and personal information. Despite the security measures we currently have in place and our commitment to risk management practices, our facilities and systems and those of our third-party service providers may be vulnerable to, and unable to anticipate or detect, data security breaches and data loss. In addition, employees or third-party service providers may intentionally or inadvertently cause data security breaches, through failing to follow polices, trainings, or otherwise, that result in the unauthorized release of personal or confidential information. We take, and require our third-party service providers that store, process or transmit personal or sensitive information on our behalf to take, reasonable measures to protect data and comply with applicable laws related to information security and privacy. But we cannot control the efforts of third-party service providers and cannot guarantee the compliance of their systems and processes. We and our customers could suffer harm if valuable business data or employee, customer and other proprietary information were corrupted, lost or accessed or misappropriated by third parties due to a security failure in our systems or one of our third-party service providers. It could require significant expenditures to remediate any such failure or breach, severely damage our reputation and our relationships with customers, result in unwanted media attention and lost sales and expose us to risks of litigation and liability. In addition, as a result of recent security breaches at a number of prominent retailers, the media and public scrutiny of information security and privacy has become more intense and the regulatory environment has become increasingly uncertain, rigorous and complex. As a result, we may incur significant costs to comply with current and new state, federal, and international laws regarding the protection and unauthorized disclosure of personal and other sensitive information such as the General Data Protection Regulation in the European Union and the California Consumer Privacy Act in California, U.S.A.. As the regulatory environment relating to information security and privacy becomes increasingly more demanding with many new requirements surrounding the handling, protection and use of personal and other sensitive information, the increased complexity in these types of laws and inherent conflicts between jurisdictions may result in our inability or failure to comply with applicable requirements, despite our focus and efforts. Any failure to comply with the laws and regulations surrounding the protection of personal information could subject us to legal and reputational risks, including significant fines for non-compliance, any of which could have a negative impact on revenues and profits.
Our business is exposed to the risks of foreign currency exchange rate fluctuations. Our hedging strategies may not be effective in mitigating those risks.
Approximately 25% of our total net revenues in 2019 are derived from markets outside the U.S. Our international businesses operate in functional currencies other than the U.S. dollar. Changes in currency exchange rates affect the U.S. dollar value of the foreign currency-denominated amounts at which our international businesses purchase products, incur costs or sell products. In addition, for our U.S.-based businesses, the majority of products are sourced from independent contractors or our manufacturing facilities located in foreign countries. As a result, the costs of these products are affected by changes in the value of the relevant currencies. Furthermore, much of our licensing net revenue is derived from sales in foreign currencies. Changes in foreign currency exchange rates could have an adverse impact on our financial condition, results of operations and cash flows.
In accordance with our operating practices, we plan to hedge a significant portion of our foreign currency transaction exposures arising in the ordinary course of business to reduce risks in our cash flows and earnings. Our hedging strategy may not be effective in reducing all risks, and no hedging strategy can completely insulate us from foreign exchange risk.
Kontoor Brands, Inc 2019 Form 10-K 12
Further, our use of derivative financial instruments may expose us to counterparty risks. Although we plan to enter only into hedging contracts with counterparties having investment grade credit ratings, it is possible that the credit quality of a counterparty could be downgraded or a counterparty could default on its obligations, which could have a material adverse impact on our financial condition, results of operations and cash flows.
Our operations and earnings may be affected by legal, regulatory, political and economic risks.
Our ability to maintain the current level of operations in our existing markets and to capitalize on growth in existing and new markets is subject to legal, regulatory, political and economic risks. These include the burdens of complying with U.S. and international laws and regulations, unexpected changes in regulatory requirements and the economic uncertainty associated with the recent exit of the United Kingdom from the European Union (“Brexit”) or any other similar referendums that may be held.
Changes in regulatory, geopolitical policies and other factors may adversely affect our business or may require us to modify our current business practices. While enactment of any such change is not certain, if such changes were adopted, our costs could increase, which would reduce our earnings.
Changes to trade policy, including tariff and import/export regulations, may have a material adverse effect on our business, financial condition and results of operations.
Changes in policies governing foreign trade and manufacturing in the countries where we currently sell our products or conduct our business could adversely affect our business. The U.S. presidential administration has instituted or proposed changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the U.S., economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we conduct our business. It may be time-consuming and expensive for us to alter our operations in order to adapt to or comply with any such changes.
As a result of recent policy changes of the U.S. presidential administration, there may be greater restrictions on international trade. Moreover, the new tariffs and other changes in U.S. trade policy have in the past and could continue to trigger retaliatory actions by affected countries, and certain foreign governments have instituted or are considering imposing retaliatory measures on certain U.S. goods. We do a significant amount of business that would be impacted by changes to the trade policies of the U.S. and foreign countries (including governmental action related to tariffs, international trade agreements, or economic sanctions). Such changes have the potential to adversely impact the U.S. economy or certain sectors thereof, our industry and the global demand for our products, and as a result, could have a material adverse effect on our business, financial condition and results of operations.
Failure to comply with anti-bribery, anti-corruption and anti-money laundering laws could subject us to penalties and other adverse consequences.
We are subject to the United States Foreign Corrupt Practices Act, in addition to the anti-bribery, anti-corruption, and anti-money laundering laws of the foreign jurisdictions in which we operate, such as the U.K. Bribery Act. Although we implement policies and procedures designed to promote compliance with these laws and audit our third-party material suppliers and contracted manufacturing facilities, our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies. Any such violation, or allegations of such violation, could result in sanctions or other penalties and have an adverse effect on our business, reputation and operating results.
Our business and results of operations could be negatively impacted by public health crises beyond our control.
We operate facilities and sell our products across the world and we may be impacted by international public health crises beyond our control. This could disrupt our operations and negatively impact sales of our products. Our customers and suppliers also manage global operations and could experience similar disruption. For example, in December 2019, a novel strain of coronavirus was reported to have surfaced in Wuhan, China. This situation and preventative or protective actions that governments have taken in respect of the coronavirus have resulted in a period of business disruption, including closures of stores where our products are sold, limited store operating hours, reduced customer traffic and consumer spending, labor shortages and delays in manufacturing and shipment of products and raw materials to and from China. The coronavirus has spread to a number of other countries, including the United States, and efforts to contain the spread of the coronavirus have intensified. To the extent the impact of the coronavirus continues or worsens, we may have difficulty obtaining the materials necessary for the manufacturing of our products, factories which produce our products may remain closed for sustained periods of time, and industry-wide shipment of products may be negatively impacted.
Changes in tax laws could increase our worldwide tax rate and materially affect our financial position and results of operations.
As a global business, we are subject to taxation in the U.S. and numerous foreign jurisdictions. Many jurisdictions in which we operate are currently expecting changes to their respective taxation regimes or adoption of additional regulations. Specifically, countries in the European Union and around the globe have adopted and/or proposed changes to current tax laws. Organizations such as the Organisation for Economic Co-operation and Development have published action plans that, if adopted, could increase our tax obligations in countries where we conduct business. Due to the large scale of our U.S. and international business activities, many of these enacted and proposed changes to the taxation of our activities could increase our worldwide effective tax rate and harm our financial position and results of operations.
13 Kontoor Brands, Inc. 2019 Form 10-K
We may have additional tax liabilities.
As a global company, we determine our income tax liability in various tax jurisdictions based on an analysis and interpretation of local tax laws and regulations. This analysis requires a significant amount of judgment and estimation and is often based on various assumptions about the future actions of the local tax authorities. These determinations are the subject of periodic U.S. and international tax audits. Although we accrue for uncertain tax positions, our accrual may be insufficient to satisfy unfavorable findings. Unfavorable audit findings and tax rulings may result in payment of taxes, fines and penalties for prior periods and higher tax rates in future periods, which may have a material adverse effect on our financial condition, results of operations or cash flows.
Our balance sheet includes intangible assets and goodwill. A decline in the fair value of an intangible asset or of a business unit could result in an asset impairment charge, which would be recorded as an operating expense in our statement of income.
Our policy is to evaluate indefinite-lived intangible assets and goodwill for possible impairment as of the beginning of the fourth quarter of each year, or whenever events or changes in circumstances indicate that the fair value of such assets may be below their carrying amount. In addition, intangible assets that are being amortized are tested for impairment whenever events or circumstances indicate that their carrying value may not be recoverable. For these impairment tests, we use various valuation methods to estimate the fair value of our business units and intangible assets. If the fair value of an asset is less than its carrying value, we would recognize an impairment charge for the difference. For example, we recorded a $32.6 million non-cash impairment charge related to the Rock & Republic® trademark intangible asset in 2019. Refer to Note 7 to the Company's financial statements.
It is possible that we could have an impairment charge for goodwill or trademark and trade name intangible assets in future periods if (i) overall economic conditions in future years vary from our current assumptions, (ii) business conditions or our strategies for a specific business unit or brand change from our current assumptions, (iii) investors require higher rates of return on equity investments in the marketplace or (iv) enterprise values of comparable publicly traded companies, or of actual sales transactions of comparable companies, were to decline, resulting in lower comparable multiples of net revenues and earnings before interest, taxes, depreciation and amortization and, accordingly, lower implied values of goodwill and intangible assets. A future impairment charge for goodwill or intangible assets could have a material effect on our consolidated financial position or results of operations.
We use third-party suppliers and manufacturing facilities worldwide for a substantial portion of our raw materials and finished products, which poses risks to our business operations.
During 2019, approximately 62% of our units were purchased from independent manufacturers primarily located in Asia, with substantially all of the remainder produced by Kontoor Brands-owned and -operated manufacturing facilities located in Mexico and Nicaragua. Any of the following could impact our ability to produce or deliver our products, or our cost of producing or delivering products and, as a result, our profitability:
• | Political or labor instability in countries where our facilities, contractors and suppliers are located; |
• | Changes in local economic conditions in countries where our facilities, contractors, and suppliers are located; |
• | Political or military conflict could cause a delay in the transportation of raw materials and products to us and an increase in transportation costs; |
• | Disruption at domestic and foreign ports of entry could cause delays in product availability and increase transportation times and costs; |
• | Heightened terrorism or security concerns could subject imported or exported goods to additional, more frequent or lengthier inspections, leading to delays in deliveries or impoundment of goods for extended periods; |
• | Decreased scrutiny by customs officials for counterfeit goods, leading to more counterfeit goods and reduced sales of our products, increased costs for our anti-counterfeiting measures and damage to the reputation of our brands; |
• | Disruptions at suppliers and manufacturing or distribution facilities caused by natural and man-made disasters; |
• | Disease epidemics and health-related concerns could result in closed factories, reduced workforces, scarcity of raw materials and scrutiny or embargo of our goods produced in infected areas; |
• | Imposition of regulations and quotas relating to imports and our ability to adjust timely to changes in trade regulations could limit our ability to produce products in cost-effective countries that have the required labor and expertise; |
• | Imposition of duties, taxes and other charges on imports; and |
• | Imposition or the repeal of laws that affect intellectual property rights. |
Although no single supplier and no one country is critical to our overall production needs, if we were to lose a supplier it could result in interruption of finished goods shipments to us, cancellation of orders by customers and termination of relationships. This, along with the damage to our reputation, could have a material adverse effect on our net revenues and, consequently, our results of operations.
Kontoor Brands, Inc 2019 Form 10-K 14
In addition, although we audit our third-party material suppliers and contracted manufacturing facilities and set strict compliance standards, actions by a third-party supplier or manufacturer that fail to comply could expose us to claims for damages, financial penalties and reputational harm, any of which could have a material adverse effect on our business and operations.
We are in the process of designing and implementing an Enterprise Resource Planning ("ERP") software system, which could result in operational difficulties and additional expenses.
We are in the process of designing and implementing a company-wide ERP software program and the related infrastructure to support future growth and to integrate our processes. Our ERP software program has involved, and will continue to involve, substantial expenditures on system hardware and software, as well as design, development and implementation activities. Operational disruptions during the course of these activities could materially impact our operations and adversely affect our ability to process orders, manage our inventory, ship products, provide customer support, fulfill contractual obligations or otherwise operate our business. Additionally, future cost estimates related to our new ERP software system are based on assumptions which are subject to wide variability.
Our business is subject to national, state and local laws and regulations for environmental, consumer protection, employment, privacy, safety and other matters. The costs of compliance with, or the violation of, such laws and regulations by us or by independent suppliers who manufacture products for us could have a material adverse effect on our operations and cash flows, as well as on our reputation.
Our business is subject to comprehensive national, state and local laws and regulations on a wide range of environmental, consumer protection, employment, privacy, safety and other matters. We could be adversely affected by costs of compliance with or violations of those laws and regulations. In addition, while we do not control their business practices, we require third-party suppliers to operate in compliance with applicable laws, rules and regulations regarding working conditions, employment practices and environmental compliance. The costs of products purchased by us from independent contractors could increase due to the costs of compliance by those contractors.
Failure by us or our third-party suppliers to comply with such laws and regulations, as well as with ethical, social, product, labor and environmental standards, or related political considerations, could result in interruption of finished goods shipments to us, cancellation of orders by customers and termination of relationships. If one of our independent contractors violates labor or other laws, implements labor or other business practices or takes other actions that are generally regarded as unethical, it could jeopardize our reputation and potentially lead to various adverse consumer actions, including boycotts that may reduce demand for our merchandise. Damage to our reputation or loss of consumer confidence for any of these or other reasons could have a material adverse effect on our results of operations, financial condition and cash flows, as well as require additional resources to rebuild our reputation.
Fluctuations in wage rates and the price, availability and quality of raw materials, including commodity costs, and finished goods could increase costs.
Fluctuations in the price, availability and quality of fabrics such as denim, including cottons, blends, synthetics, and wools, or other raw materials used by us in our manufactured products, or of purchased finished goods, could have a material adverse effect on our cost of goods sold or our ability to meet our customers’ demands. The prices we pay depend on demand and market prices for the raw materials used to produce them. The price and availability of such raw materials may fluctuate significantly, depending on many factors, including general economic conditions and demand, crop yields, energy prices, weather patterns, freight rates and speculation in the commodities markets. Prices of purchased finished products also depend on wage rates in Asia and other geographic areas where our independent contractors are located, as well as freight costs from those regions. Inflation can also have a long-term impact on us because increasing costs of materials and labor may impact our ability to maintain satisfactory margins. For example, the cost of the materials that are used in our manufacturing process, such as oil-related commodity prices and other raw materials, such as cotton, dyes and chemicals, and other costs, such as fuel, energy and utility costs, can fluctuate as a result of inflation and other factors. Similarly, a significant portion of our products are manufactured in other countries and declines in the value of the U.S. dollar may result in higher manufacturing costs. In addition, fluctuations in wage rates required by legal or industry standards could increase our costs. In the future, we may not be able to offset cost increases with other cost reductions or efficiencies or to pass higher costs on to our customers. This could have a material adverse effect on our results of operations, liquidity and financial condition.
We rely on a limited number of North American mills for raw material sourcing, and we may not be able to obtain raw materials on a timely basis or in sufficient quantity or quality.
We rely on a limited number of third-party suppliers for raw materials in North America. Such products may be available, in the short-term, from only one or a very limited number of sources. In 2019, approximately 76% of our raw materials were provided by our top three suppliers in North America. We have no long-term contracts with our suppliers or manufacturing sources, and we compete with other companies for raw materials, production and quota capacity. We may experience a significant disruption in the supply of raw materials from current sources or, in the event of a disruption, we may be unable to locate alternative materials suppliers of comparable quality at an acceptable price, or at all. In addition, if we experience significant increased demand, or if we need to replace an existing supplier or manufacturer due to consolidation, closure or otherwise, we may be unable to locate additional supplies of raw materials or additional manufacturing capacity on terms that are acceptable to us, or at all, or we may be unable to locate any supplier or manufacturer with sufficient capacity to meet our requirements or to fill our orders in a timely manner. Identifying a suitable supplier is an involved process that requires us to become satisfied with their quality control, responsiveness and service, financial stability and labor and other ethical practices. Even if we are able to expand existing or find new manufacturing sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers in our methods, products and quality control standards.
15 Kontoor Brands, Inc. 2019 Form 10-K
Delays related to supplier changes could also arise due to an increase in shipping times if new suppliers are located farther away from our markets or from other participants in our supply chain. Any delays, interruption or increased costs in the supply of raw materials or manufacture of our products could have a material adverse effect on our ability to meet customer demand for our products and could result in lower net revenue and income from operations both in the short and long term.
The retail industry has experienced financial difficulty that could adversely affect our business.
Recently there have been consolidations, reorganizations, restructurings, bankruptcies and ownership changes in the retail industry. These events individually, and together, could materially, adversely affect our business. These changes could impact our opportunities in the market and increase our reliance on a smaller number of large customers. In the future, retailers are likely to further consolidate, undergo restructurings or reorganizations or bankruptcies, realign their affiliations or reposition their stores’ target markets. In addition, consumers have continued to transition away from traditional wholesale retailers to large online retailers. These developments could result in a reduction in the number of stores that carry our products, an increase in ownership concentration within the retail industry, an increase in credit exposure to us or an increase in leverage by our customers over their suppliers.
Further, the global economy periodically experiences recessionary conditions with rising unemployment, reduced availability of credit, increased savings rates and declines in real estate and securities values. These recessionary conditions could have a negative impact on retail sales of apparel. The lower sales volumes, along with the possibility of restrictions on access to the credit markets, could result in our customers experiencing financial difficulties including store closures, bankruptcies or liquidations. This could result in higher credit risk to us relating to receivables from our customers who are experiencing these financial difficulties. If these developments occur, our inability to shift sales to other customers or to collect on our trade accounts receivable could have a material adverse effect on our financial condition and results of operations.
Our ability to obtain short-term or long-term financing on favorable terms, if needed, could be adversely affected by geopolitical risk and volatility in the capital markets.
Any disruption in the capital markets could limit the availability of funds or the ability or willingness of financial institutions to extend capital in the future. This could adversely affect our liquidity and funding resources or significantly increase our cost of capital. An inability to access capital and credit markets may have a material adverse effect on our business, results of operations, financial condition and cash flows.
Our failure to maintain satisfactory credit ratings could adversely affect our liquidity, capital position, borrowing costs and access to capital markets.
Any downgrades in our credit ratings by the major independent rating agencies could increase the cost of borrowing under any indebtedness we may incur. There can be no assurance that we will be able to maintain our credit ratings, and any additional actual or anticipated changes or downgrades in our credit ratings, including any announcement that our ratings are under review for a downgrade, may have a negative impact on our liquidity, capital position and access to capital markets.
We have debt obligations that could restrict our business and adversely impact our results of operations, financial condition or cash flows.
On May 17, 2019, the Company entered into a $1.55 billion senior secured credit facility under which it 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. At inception, this facility consisted of a five-year $750.0 million term loan A facility (“Term Loan A”), a seven-year $300.0 million term loan B facility (“Term Loan B”) and a five-year $500.0 million revolving credit facility (the “Revolving Credit Facility”) (collectively, the “Credit Facilities”) with the lenders and agents party thereto. The Credit Facilities contain certain affirmative and negative covenants customary for financings of this type, including maintenance of ratios for consolidated earnings before interest, taxes, depreciation and amortization to both consolidated debt and interest. If the Company fails to comply with any covenants, the lenders may terminate their obligation to make advances and declare any outstanding obligations to be immediately due and payable. This debt obligation could restrict our future business strategies and could adversely impact our future results of operations, financial condition or cash flows. Additionally, the Separation increased our overall interest expense and decreased the overall debt capacity and commercial credit available to the Company.
This level of debt could have significant consequences on our future operations, including:
• | Making it more difficult for us to meet our payment and other obligations under our outstanding debt; |
• | Resulting in an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which could result in all of our debt becoming immediately due and payable; |
• | Reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes; |
• | Limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industry in which we operate and the general economy; and |
• | Placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged. |
Kontoor Brands, Inc 2019 Form 10-K 16
Any of the above-listed factors could have a material adverse effect on our business, financial condition and results of operations. We may also incur substantial additional indebtedness in the future.
In addition, any future indenture or credit agreements that we may enter into may include restrictive covenants that, subject to certain exceptions and qualifications, restrict or limit our ability and the ability of our restricted subsidiaries to, among other things, incur additional indebtedness, pay dividends, make certain investments, sell certain assets and enter into certain strategic transactions, including mergers and acquisitions. These covenants and restrictions could affect our ability to operate our business, and may limit our ability to react to market conditions or take advantage of potential business opportunities as they arise.
The loss of members of our executive management and other key employees could have a material adverse effect on our business.
We depend on the services and management experience of our executive officers and business leaders who have substantial experience and expertise in our business. The unexpected loss of services of one or more of these individuals could have a material adverse effect on us. Our future success also depends on our ability to recruit, retain and engage our personnel sufficiently. Competition for experienced and well-qualified personnel is intense and we may not be successful in attracting and retaining such personnel.
Most of the employees in our production and distribution facilities are covered by collective bargaining agreements, and any material job actions could negatively affect our results of operations.
In North America, most of our production and distribution employees are covered by various collective bargaining agreements, and outside North America, most of our production and distribution employees are covered by either industry-sponsored and/or government-sponsored collective bargaining mechanisms. Any work stoppages or other job actions by these employees could harm our business and reputation.
Our direct-to-consumer business includes risks that could have a material adverse effect on our results of operations.
We sell merchandise direct-to-consumer through our e-commerce sites. Our direct-to-consumer business is subject to numerous risks that could have a material adverse effect on our results. Risks include, but are not limited to, (i) U.S. or international resellers purchasing merchandise and reselling it overseas outside of our control, (ii) failure of the systems that operate the stores and websites, and their related support systems, including computer viruses, theft of customer information, privacy concerns, telecommunication failures and electronic break-ins and similar disruptions, (iii) credit card fraud and (iv) risks related to our direct-to-consumer distribution centers and processes. Risks specific to our e-commerce business also include (i) diversion of sales from our wholesale customers, (ii) difficulty in recreating the in-store experience through direct channels, (iii) liability for online content, (iv) changing patterns of consumer behavior and (v) intense competition from online retailers. Our failure to successfully respond to these risks might adversely affect sales in our e-commerce business, as well as damage our reputation and brands.
We may be unable to protect our trademarks and other intellectual property rights.
Our trademarks, trade names, patents, and other intellectual property rights are important to our success and our competitive position. We are susceptible to others copying our products and infringing, misappropriating or otherwise violating our intellectual property rights, especially with the shift in product mix to higher priced brands and innovative new products in recent years.
Actions we have taken to establish and protect our intellectual property rights may not be adequate to prevent copying of our products by others or to prevent others from seeking to invalidate our trademarks or block sales of our products as a violation of the trademarks and intellectual property rights of others. In addition, unilateral actions in the U.S. or other countries, including changes to or the repeal of laws recognizing trademark or other intellectual property rights, could have an impact on our ability to enforce those rights.
Some of our brands, such as Wrangler® and Lee®, enjoy significant worldwide consumer recognition. The higher pricing of those products creates additional risk of counterfeiting and infringement, misappropriation or other violation by third parties. The counterfeiting of our products or the infringement, misappropriation or other violation of our intellectual property rights by third parties could diminish the value of our brands and adversely affect our net revenues.
The value of our intellectual property could diminish if others assert rights in or ownership of our trademarks and other intellectual property rights, or trademarks that are similar to our trademarks. We may be unable to successfully resolve these types of conflicts to our satisfaction. In some cases, there may be trademark owners who have prior rights to our trademarks because the laws of certain foreign countries may not protect intellectual property rights to the same extent as do the laws of the U.S. In other cases, there may be holders who have prior rights to similar trademarks.
There have been, and there may in the future be, opposition and cancellation proceedings from time to time with respect to some of our intellectual property rights. In some cases, litigation may be necessary to protect or enforce our trademarks and other intellectual property rights. Furthermore, third parties may assert intellectual property claims against us, and we may be subject to liability, required to enter into costly license agreements, if available at all, required to rebrand our products and/or prevented from selling some of our products if third parties successfully oppose or challenge our trademarks or successfully claim that we infringe, misappropriate or otherwise violate their trademarks, copyrights, patents or other intellectual property rights. Bringing or defending any such claim, regardless of merit, and whether successful or unsuccessful, could be expensive and time-consuming and have a negative effect on our business, reputation, results of operations and financial condition.
17 Kontoor Brands, Inc. 2019 Form 10-K
We are subject to the risk that our licensees may not generate expected sales or maintain the value of our brands.
During 2019, we generated $32 million in net revenues from licensing royalties. Although we generally have significant control over our licensees’ products and advertising, we rely on our licensees for, among other things, operational and financial controls over their businesses. Failure of our licensees to successfully market licensed products or our inability to replace existing licensees, if necessary, could adversely affect our net revenues, both directly from reduced royalties received and indirectly from reduced sales of our other products. Risks are also associated with a licensee’s ability to:
• | Obtain capital; |
• | Manage labor relations; |
• | Maintain relationships with its suppliers; |
• | Manage credit risk effectively; |
• | Maintain relationships with its customers; and |
• | Adhere to our Global Compliance Principles. |
In addition, we rely on our licensees to help preserve the value of our brands. Although we attempt to protect our brands through approval rights over design, production processes, quality, packaging, merchandising, distribution, advertising and promotion of our licensed products, we cannot completely control the use of our licensed brands by our licensees. The misuse of a brand by a licensee, including through the marketing of products under one of our brand names that do not meet our quality standards, could have a material adverse effect on that brand and on us.
If we encounter problems with our distribution system, our ability to deliver our products to the market could be adversely affected.
We rely on owned or independently operated distribution facilities to warehouse and ship product to our customers. Our distribution system includes computer-controlled and automated equipment, which may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, power interruptions or other system failures. Because substantially all of our products are distributed from a relatively small number of locations, our operations could also be interrupted by earthquakes, floods, fires or other natural disasters affecting our distribution centers. We maintain business interruption insurance, but it may not adequately protect us from the adverse effects that could be caused by significant disruptions in our distribution facilities, such as the long-term loss of customers or an erosion of brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the transportation of product to and from our distribution facilities. Transportation of our products may be interrupted due to events such as marine disasters, bad weather or natural disasters, mechanical or electrical failures, public health crises, grounding, capsizing, fire, explosions and collisions, piracy, cyber attacks, human error and war and terrorism resulting in delays, damages or losses. If we encounter problems with our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve operating efficiencies could be materially adversely affected.
Our revenues and cash requirements are affected by seasonality.
Our business is typically affected by seasonal trends, with a higher proportion of net revenues and operating cash flows generated during the second half of the fiscal year, which includes the back-to-school and holiday selling seasons. Poor sales in the second half of the fiscal year would have a material adverse effect on our full year operating results and cause higher inventories. In addition, fluctuations in sales and operating income in any fiscal quarter are affected by the timing of seasonal wholesale shipments and other events affecting retail sales.
We may be adversely affected by unseasonal or severe weather conditions.
Our business may be adversely affected by unseasonal or severe weather conditions. Periods of unseasonably warm weather in the fall or winter, or periods of unseasonably cool and wet weather in the spring or summer, can negatively impact retail traffic and consumer spending. In addition, severe weather events such as snowstorms or hurricanes typically lead to temporarily reduced retail traffic. Any of these conditions could result in negative point-of-sale trends for our merchandise and reduced replenishment shipments to our wholesale customers.
Climate change, and related legislative and regulatory responses to climate change, may adversely impact our business.
There is increasing concern that a gradual rise in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe, an increase in the frequency, severity and duration of extreme weather conditions and natural disasters, and water scarcity and poor water quality. These events could adversely impact the cultivation of cotton, which is a key resource in the production of our products, disrupt the operation of our supply chain and the productivity of our contract manufacturers, increase our production costs, impose capacity restraints and impact the types of apparel products that consumers purchase. These events could also compound adverse economic conditions and impact consumer confidence and discretionary spending. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.
Kontoor Brands, Inc 2019 Form 10-K 18
In many countries, governmental bodies are enacting new or additional legislation and regulations to reduce or mitigate the potential impacts of climate change. If we, our suppliers or our contract manufacturers are required to comply with these laws and regulations, or if we choose to take voluntary steps to reduce or mitigate our impact on climate change, we may experience increases in energy, production, transportation and raw material costs, capital expenditures or insurance premiums and deductibles, which could adversely impact our operations. Inconsistency of legislation and regulations among jurisdictions may also affect the costs of compliance with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate.
Risks Relating to the Separation
We may not realize the anticipated benefits from the Separation, which could harm our business.
We may not be able to achieve the full strategic and financial benefits expected to result from the Separation, or such benefits may be delayed or not occur at all. The Separation is expected to enhance strategic and management focus, provide a distinct investment identity and allow us to efficiently allocate resources and deploy capital. We may not achieve these and other anticipated benefits.
If we fail to achieve some or all of the benefits expected to result from the Separation, or if such benefits are delayed, our business could be harmed.
Our historical combined financial information is not necessarily representative of the results that we would have achieved as an independent, publicly traded company and may not be a reliable indicator of our future results.
Our historical combined financial information included in this Annual Report on Form 10-K was derived from VF’s consolidated financial statements and accounting records and are not necessarily indicative of our future results of operations, financial condition or cash flows, nor do they reflect what our results of operations, financial condition or cash flows would have been as an independent public company during the periods presented. Such historical combined financial information included in this Annual Report on Form 10-K is not necessarily indicative of our future results of operations, financial condition or cash flows primarily because of the following factors:
• | Prior to the Separation, our business was operated by VF as part of its broader corporate organization, rather than as an independent company. VF or one of its affiliates provided support for various corporate functions for us, such as information technology, shared services, medical insurance, procurement, logistics, marketing, human resources, legal, finance and internal audit; |
• | Our historical combined financial results reflect the direct, indirect and allocated costs for such services historically provided by VF, and these costs may significantly differ from the comparable expenses we would have incurred as an independent company; |
• | Our working capital requirements and capital expenditures historically have been satisfied as part of VF’s corporate-wide cash management and centralized funding programs, and our cost of debt and other capital may significantly differ from that which is reflected in our historical combined financial statements; |
• | The historical combined financial information may not fully reflect the costs associated with the Separation, including the costs related to operating as an independent public company; |
• | Our historical combined financial information does not reflect our obligations under the various transitional and other agreements we entered into with VF in connection with the Separation, though costs under such agreements are similar to what was charged to the business in the past; and |
• | Historically, our business was integrated with that of VF and we benefited from VF’s size and scale in costs, employees and vendor and customer relationships. Thus, costs we incur as an independent company may significantly exceed comparable costs we would have incurred as part of VF and some of our customer relationships may be weakened or lost. |
Please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our historical combined financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K.
VF continues to perform functions for us on a transitional basis, and we may incur significant costs to perform these functions ourselves following the transition period.
VF historically performed many important corporate functions for us, including internal audit, finance, accounting, tax, human resources, procurement, information technology, information security, supply chain, logistics, distribution, litigation management, real estate, environmental and public affairs. Following the Separation, VF continues to provide some of these services to us on a transitional basis, for a period of up to two years following the transfer of VF's assets and liabilities related to Kontoor Brands or its subsidiaries (the "Restructuring") and VF’s distribution to its shareholders of all the shares of Kontoor Brands’ common stock (the "Distribution") pursuant to a Transition Services Agreement that we entered into with VF. VF may not successfully execute all of these functions during the transition period or we may have to expend significant efforts or costs materially in excess of those estimated under the Transition Services Agreement. Any interruption in these services could have a material adverse effect on our business, results of operations, financial condition and cash flows.
19 Kontoor Brands, Inc. 2019 Form 10-K
In addition, at the end of this transition period, we will need to perform these functions ourselves or hire third parties to perform these functions on our behalf. The costs associated with performing or outsourcing these functions may exceed the amounts reflected in our historical combined financial statements that were incurred as a business segment of VF. We began to incur costs in the second quarter of 2019 to establish the necessary infrastructure. A significant increase in the costs of performing or outsourcing these functions could materially and adversely affect our business, results of operations, financial condition and cash flows.
The obligations associated with being a public company require significant resources and management attention.
As a result of the Separation, we are directly subject to the reporting and other requirements of the Exchange Act and the rules of the NYSE. These reporting and other obligations place significant demands on our management and our administrative and operational resources, including accounting resources, and we expect to face increased legal, tax, accounting, administrative and other costs and expenses relating to these demands that we had not incurred as a segment of VF. Our investment in compliance with existing and evolving regulatory requirements will result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
If we fail to maintain effective internal controls, we may not be able to report our financial results accurately or timely or prevent or detect fraud, which could have a material adverse effect on our business or the market price of our securities.
In accordance with Section 404 of the Sarbanes-Oxley Act, beginning with our second Annual Report on Form 10-K required to be filed with the SEC, our management will be required to conduct an annual assessment of the effectiveness of our internal control over financial reporting and include a report on these internal controls in our annual reports, and our independent registered public accounting firm will be required to formally attest to the effectiveness of our internal controls. When required, this process will require significant documentation of policies, procedures and systems, review of that documentation by our internal auditing and accounting staff and our outside independent registered public accounting firm, and testing of our internal controls over financial reporting by our internal auditing and accounting staff and our outside independent registered public accounting firm. This process will involve considerable time and attention, may strain our internal resources, and will increase our operating costs. We may experience higher than anticipated operating expenses and outside auditor fees during the implementation of these changes and thereafter. If management or our independent registered public accounting firm determines that our internal control over financial reporting is not effective, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected, and we could become subject to investigations by the SEC, the NYSE or other regulatory authorities, which could require additional financial and management resources. In addition, if our controls are not effective, our ability to accurately and timely report our financial position could be impaired, which could result in late filings of our annual and quarterly reports under the Exchange Act, restatements of our combined financial statements, a decline in our stock price, suspension or delisting of our common stock from the NYSE, and could have a material adverse effect on our business, financial condition, prospects and results of operations.
In connection with the Separation, VF has agreed to indemnify us for certain liabilities and we have agreed to indemnify VF for certain liabilities. If we are required to act under these indemnities to VF, we may need to divert cash to meet those obligations, which could adversely affect our financial results. Moreover, the VF indemnity may not be sufficient to insure us against the full amount of liabilities for which it will be allocated responsibility, and VF may not be able to satisfy its indemnification obligations to us in the future.
Pursuant to the Separation and Distribution Agreement and other agreements with VF, VF has agreed to indemnify us for certain liabilities, and we have agreed to indemnify VF for certain liabilities. Payments that we may be required to provide under indemnities to VF are not subject to any cap, may be significant and could negatively affect our business, particularly under indemnities relating to our actions that could affect the tax-free nature of the Separation. Third parties could also seek to hold us responsible for the liabilities that VF has agreed to retain, and under certain circumstances, we may be subject to continuing contingent liabilities of VF that arise relating to our operations during the time that we were a business segment of VF, such as certain tax liabilities which relate to periods during which our taxes were reported as a part of VF; liabilities retained by VF which relate to contracts or other obligations entered into jointly by our and VF’s retained business; pension and other post-employment liabilities, including unfunded liabilities, that apply to VF, including Kontoor; environmental liabilities related to sites at which both VF and Kontoor operated; and liabilities arising from third-party claims in respect of contracts in which both VF and Kontoor supplied goods or provide services.
VF has agreed to indemnify us for certain of such contingent liabilities. While we have no reason to expect that VF will not be able to support its indemnification obligations to us, we can provide no assurance that VF will be able to fully satisfy its indemnification obligations or that such indemnity obligations will be sufficient to cover our liabilities for matters which VF has agreed to retain, including such contingent liabilities. Moreover, even if we ultimately succeed in recovering from VF any amounts for which we are indemnified, we may be temporarily required to bear these losses ourselves. Each of these risks could have a material adverse effect on our business, results of operations and financial condition.
Kontoor Brands, Inc 2019 Form 10-K 20
We only have limited access to the insurance policies maintained by VF for events occurring prior to the Separation and VF’s insurers may deny coverage to us under such policies.
In connection with the Separation, we entered into agreements with VF to address several matters associated with the Separation, including insurance coverage. The Separation and Distribution Agreement provides that Kontoor Brands no longer has insurance coverage under VF insurance policies in connection with events occurring before, as of or after the Distribution, other than coverage for (i) events occurring prior to the Distribution and covered by occurrence-based policies of VF as in effect as of the Distribution and (ii) events or acts occurring prior to the Distribution and covered by claims-made policies of VF as in effect as of the Distribution. However, VF’s insurers may deny coverage to us for losses associated with occurrences prior to the Separation. Accordingly, we may be required to temporarily or permanently bear the costs of such lost coverage. Additionally, claims for losses associated with occurrences prior to the Separation may result in a substantial increase in our insurance premiums.
Some of our directors and officers may have actual or potential conflicts of interest because of their equity ownership in VF.
Because of their current or former positions with VF, some of our directors and executive officers own shares of VF common stock and / or have options to acquire shares of VF common stock, and the individual holdings may be significant for some of these individuals compared to their total assets. This ownership may create, or may create the appearance of, conflicts of interest when these directors and officers are faced with decisions that could have different implications for VF or us. For example, potential conflicts of interest could arise in connection with the resolution of any dispute that may arise between VF and us regarding the terms of the agreements governing the Separation and the relationship thereafter between the companies.
We potentially could have received better terms from unaffiliated third parties than the terms we received in our agreements with VF.
The agreements we entered into with VF in connection with the Separation were negotiated while we were still part of VF’s business. Accordingly, during the period in which the terms of those agreements were negotiated, we did not have an independent Board of Directors or a management team independent of VF. The terms of the agreements negotiated in the context of the Separation relate to, among other things, the allocation of assets, intellectual property, liabilities, rights and other obligations between VF and us, and arm’s-length negotiations between VF and an unaffiliated third-party in another form of transaction, such as a buyer in a sale of a business transaction, may have resulted in more favorable terms to the unaffiliated third-party. For example, we agreed to license back to a subsidiary of VF, on a royalty-free basis, all of the intellectual property (other than trademarks) transferred to us in connection with the Separation for use throughout VF’s business, even if such intellectual property is not currently used in VF’s business, and this intellectual property may be used to compete against us in the future.
If the Restructuring and Distribution, together with certain related transactions, do not qualify as transactions that are tax-free for U.S. federal income tax purposes or non-U.S. tax purposes, VF and/or holders of VF common stock could be subject to significant tax liability.
It is intended that the Distribution, together with certain related transactions, will qualify as a tax-free “reorganization” within the meaning of Section 368(a)(1)(D) of the Internal Revenue Code of 1986, as amended (the "Code") and a tax-free distribution within the meaning of Section 355 of the Code. The consummation of the Separation and the related transactions was conditioned upon the receipt of opinions of certain of our tax advisers to the effect that such transactions would qualify for this intended tax treatment. In addition, it is intended that the Restructuring steps will qualify as transactions that are tax-free for U.S. federal income tax and applicable non-U.S. tax purposes. The opinions relied on certain representations, assumptions and undertakings, including those relating to the past and future conduct of our business, and the opinions would not be valid if such representations, assumptions and undertakings were incorrect. Notwithstanding the opinions, the IRS could determine that the Distribution should be treated as a taxable transaction for U.S. federal income tax purposes if it determines that any of the representations, assumptions or undertakings that were relied on for the opinions are false or have been violated, if it disagrees with the conclusions in the opinions, or for other reasons, including as a result of significant changes in the stock ownership of VF or us after the Distribution.
If the Restructuring and Distribution fail to qualify for tax-free treatment, for any reason, VF and/or holders of VF common stock would be subject to substantial U.S. and/or applicable non-U.S. taxes as a result of the Restructuring, Distribution and certain related transactions, and we could incur significant liabilities under applicable law or as a result of the Tax Matters Agreement.
We are subject to significant restrictions on our actions in order to avoid triggering significant tax-related liabilities.
The Tax Matters Agreement generally prohibits us from taking certain actions that could cause the Distribution and certain related transactions to fail to qualify as tax-free transactions, including:
• | During the two-year period following the date of the Distribution (or otherwise pursuant to a “plan” within the meaning of Section 355(e) of the Code), we may not cause or permit certain business combinations or transactions to occur; |
• | During the two-year period following the date of the Distribution, we may not discontinue the active conduct of our business (within the meaning of Section 355(b)(2) of the Code); |
21 Kontoor Brands, Inc. 2019 Form 10-K
• | During the two-year period following the date of the Distribution, we may not sell or otherwise issue our common stock, other than pursuant to issuances that satisfy certain regulatory safe harbors set forth in Treasury regulations related to stock issued to employees and retirement plans; |
• | During the two-year period following the date of the Distribution, we may not redeem or otherwise acquire any of our common stock, other than pursuant to open-market repurchases of less than 20% of our common stock (in the aggregate); |
• | During the two-year period following the date of the Distribution, we may not amend our articles of incorporation (or other organizational documents) or take any other action, whether through a shareholder vote or otherwise, affecting the voting rights of our common stock; and |
• | More generally, we may not take any action that could reasonably be expected to cause the Separation and certain related transactions to fail to qualify as tax-free transactions for U.S. federal income tax purposes or for non-U.S. tax purposes. |
If we take any of the actions above and such actions result in tax-related losses to VF, we generally will be required to indemnify VF for such tax-related losses under the Tax Matters Agreement. Due to these restrictions and indemnification obligations under the Tax Matters Agreement, we may be limited in our ability to pursue strategic transactions, equity or convertible debt financings or other transactions that may otherwise be in our best interests. Also, our potential indemnity obligation to VF might discourage, delay or prevent a change of control that our shareholders may consider favorable.
Our accounting and other management systems and resources may not be adequately prepared to meet the financial reporting and other requirements to which we are subject.
Prior to the Separation, our financial results were included within the consolidated results of VF, and we were not directly subject to reporting and other requirements of the Exchange Act. As a result of the Separation, we are directly subject to reporting and other obligations of the Exchange Act. These and other obligations place significant demands on our management, administrative, and operational resources, including accounting and information technology resources. To comply with these requirements, we are in the process of duplicating information technology infrastructure, implementing additional financial and management controls, reporting systems and procedures and hiring additional accounting, finance, tax, treasury and information technology staff. If we are unable to do this in a timely and effective fashion, our ability to comply with our financial reporting requirements and other rules that apply to reporting companies could be impaired and our business could be harmed.
Risks Relating to Our Common Stock
As a new public company, the market price and trading volume of our common stock may be volatile and shareholders may not be able to resell their shares at or above the initial market price of our common stock following the Separation.
An active trading market may not be sustained for our common stock, and we cannot predict the prices at which our common stock will trade. The market price of our common stock could fluctuate significantly due to a number of factors, many of which are beyond our control, including:
• | Fluctuations in our quarterly or annual earnings results or those of other companies in our industry; |
• | Failures of our operating results to meet the estimates of securities analysts or the expectations of our shareholders, or changes by securities analysts in their estimates of our future earnings; |
• | Announcements by us or our customers, suppliers or competitors; |
• | Changes in market valuations or earnings of other companies in our industry; |
• | Changes in laws or regulations which adversely affect our industry or us; |
• | General economic, industry and stock market conditions; |
• | Future significant sales of our common stock by our shareholders or the perception in the market of such sales; |
• | Future issuances of our common stock by us; and |
• | The other factors described in these “Risk Factors” and elsewhere in this Annual Report on Form 10-K. |
These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our shareholders brought a lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management from our business.
The trading market for our common stock may also be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or
Kontoor Brands, Inc 2019 Form 10-K 22
more of the analysts who cover us downgrade our stock, or if our results of operations do not meet their expectations, our stock price could decline.
Provisions in our amended and restated articles of incorporation and amended and restated bylaws and certain provisions of North Carolina law could delay or prevent a change in control of Kontoor Brands.
The existence of certain provisions of our amended and restated articles of incorporation and amended and restated bylaws and North Carolina law could discourage, delay or prevent a change in control of Kontoor Brands that a shareholder may consider favorable. These include provisions:
• | Providing for a classified Board of Directors until our annual meeting of shareholders held in 2023; |
• | Providing that our directors may be removed by our shareholders only for cause while our Board is classified; |
• | Providing that the removal of our directors with or without cause after our Board is de-classified must be approved by the holders of at least 80% of the voting power of Kontoor Brands; |
• | Providing the right to our Board of Directors to issue one or more classes or series of preferred stock without shareholder approval; |
• | Authorizing a large number of shares of stock that are not yet issued, which would allow our Board of Directors to issue shares to persons friendly to current management, thereby protecting the continuity of our management, or which could be used to dilute the stock ownership of persons seeking to obtain control of us; |
• | Prohibiting shareholders from calling special meetings of shareholders or taking action by written consent; |
• | Establishing advance notice and other requirements for nominations of candidates for election to our Board of Directors or for proposing matters that can be acted on by shareholders at our annual shareholder meetings; and |
• | Requiring the affirmative vote of the holders of at least 80% of the voting power of Kontoor Brands to approve certain business combinations. |
We believe these provisions will protect our shareholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with our Board of Directors and by providing our Board of Directors with more time to assess any acquisition proposal. These provisions are not intended to make us immune from takeovers. However, these provisions apply even if a takeover offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our Board of Directors determines is not in our and our shareholders’ best interests.
Our amended and restated articles of incorporation designate North Carolina as the exclusive forum for certain litigation that may be initiated by our shareholders, which could limit our shareholders’ ability to obtain a favorable judicial forum for disputes with us and limit the market price of our common stock.
Pursuant to our amended and restated articles of incorporation, to the fullest extent permitted by law, and unless we consent in writing to the selection of an alternative forum, the North Carolina Business Court (or another state or federal court located in North Carolina, if a dispute does not qualify for designation to the North Carolina Business Court or the North Carolina Business Court otherwise lacks jurisdiction) shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf; (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors or officers or other employees to us or our shareholders; (iii) any action asserting a claim against us or any director or officer or other employee of ours arising pursuant to any provision of North Carolina law or our amended and restated articles of incorporation or our amended and restated bylaws; or (iv) any action asserting a claim against us or any director or officer or other employee of ours relating to the internal affairs doctrine. Our amended and restated articles of incorporation further provide that if an action described in the preceding sentence is filed in a court other than as specified above in the name of any shareholder, such shareholder is deemed to have consented to (i) personal jurisdiction before any state or federal court located in North Carolina, as appropriate, in connection with any action brought in any such court to enforce our amended and restated articles of incorporation and (ii) having service of process made upon such shareholder in any such action by service upon such shareholder’s counsel in the action as agent for such shareholder. The forum selection clause in our amended and restated bylaws may limit our shareholders’ ability to obtain a favorable judicial forum for disputes with us and limit the market price of our common stock.
Shareholders' percentage ownership in Kontoor Brands may be diluted in the future.
In the future, shareholders' percentage ownership in Kontoor Brands may be diluted because of equity issuances for acquisitions, strategic investments, capital market transactions or otherwise, including equity awards that we grant to our directors, officers and employees. Our compensation committee intends to grant additional equity awards to our employees. These awards would have a dilutive effect on our earnings per share, which could adversely affect the market price of our common stock. From time to time, we plan to issue additional equity awards to our employees under our employee benefits plans.
In addition, our amended and restated articles of incorporation authorize us to issue, without the approval of our shareholders, one or more classes or series of preferred stock having such designations, powers, preferences and relative, participating, optional and other rights, and such qualifications, limitations or restrictions as our Board of Directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of our common stock. For example, we could grant
23 Kontoor Brands, Inc. 2019 Form 10-K
holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or dividend, distribution or liquidation preferences we could assign to holders of preferred stock could affect the residual value of the common stock.
Our common stock is and will be subordinate to all of our future indebtedness and any preferred stock, and effectively subordinated to all indebtedness and preferred equity claims against our subsidiaries.
Shares of our common stock are common equity interests in us and, as such, will rank junior to all of our future indebtedness and other liabilities. Additionally, holders of our common stock may become subject to the prior dividend and liquidation rights of holders of any class or series of preferred stock that our Board of Directors may designate and issue without any action on the part of the holders of our common stock. Furthermore, our right to participate in a distribution of assets upon any of our subsidiaries’ liquidation or reorganization is subject to the prior claims of that subsidiary’s creditors and preferred shareholders.
We cannot assure shareholders that our Board of Directors will declare dividends in the foreseeable future.
While we currently return capital to shareholders through quarterly cash dividends, our Board of Directors may not declare dividends in the future or may decrease the amount of a dividend as compared to a prior period. The declaration and amount of any future dividends will be determined and subject to authorization by our Board of Directors and will be dependent upon multiple factors including our financial condition, earnings, cash flows, capital requirements, our ability to obtain debt and equity financing on acceptable terms as contemplated by our growth strategy and the terms of our outstanding indebtedness, legal requirements, regulatory constraints, industry practice and any other factors or considerations that our Board of Directors deems relevant. We may incur expenses or liabilities or be subject to other circumstances in the future that reduce or eliminate the amount of cash that we have available for distribution as dividends, including as a result of the risks described herein.
ITEM 1B. UNRESOLVED STAFF COMMENTS. |
None.
Kontoor Brands, Inc 2019 Form 10-K 24
ITEM 2. PROPERTIES. |
We conduct manufacturing, distribution and administrative activities in owned and leased facilities. We operate ten manufacturing-related facilities and eight distribution centers around the world. Our global headquarters are located in Greensboro, North Carolina, and house our various sales, marketing and corporate business functions.
The following table presents our principal properties as of December 28, 2019:
Location | Approximate Square Feet | Use | Owned or Leased | ||||
Greensboro, North Carolina | 140,000 | Global Headquarters | Owned | ||||
Hong Kong, China | 44,000 | Office/Sourcing Hub | Leased | ||||
Panama City, Panama | 8,000 | Sourcing Hub | Leased | ||||
Antwerp, Belgium | 38,000 | Office | Leased | ||||
Reading, Pennsylvania | 25,000 | Office | Leased | ||||
Shanghai, China | 13,000 | Office | Leased | ||||
Mexico City, Mexico | 13,000 | Office | Leased | ||||
Mocksville, North Carolina | 503,000 | Distribution Center | Owned | ||||
Hackleburg, Alabama | 443,000 | Distribution Center | Owned | ||||
Seminole, Oklahoma | 394,000 | Distribution Center | Owned | ||||
El Paso, Texas | 385,000 | Distribution Center | Leased | ||||
Luray, Virginia | 435,000 | Distribution Center | Owned | ||||
Prague, Czech Republic | 275,000 | Distribution Center | Leased | ||||
Mexico City, Mexico | 162,000 | Distribution Center | Leased | ||||
Bangalore, India | 116,000 | Distribution Center | Leased | ||||
Acanceh, Mexico | 306,000 | Manufacturing Facility | Owned | ||||
Torreon, Mexico | 304,000 | Manufacturing Facility | Owned | ||||
Izamal, Mexico | 93,000 | Manufacturing Facility | Owned | ||||
Tekax, Mexico | 92,000 | Manufacturing Facility | Owned | ||||
LaRosita, Mexico | 90,000 | Manufacturing Facility | Owned | ||||
San Pedro, Mexico | 88,000 | Manufacturing Facility | Owned | ||||
San Antonio del Coyote, Mexico | 88,000 | Manufacturing Facility | Owned | ||||
Managua, Nicaragua | 126,000 | Manufacturing Facility | Leased | ||||
San Marcos, Nicaragua | 118,000 | Manufacturing Facility | Leased | ||||
Masatepe City, Nicaragua | 108,000 | Manufacturing Facility | Leased | ||||
As of December 28, 2019, we operated 129 retail stores across the Americas, EMEA and APAC regions. Retail stores are typically leased under operating leases and include renewal options.
We believe that all of our facilities, whether owned or leased, are well maintained and in good operating condition and expect they will accommodate our ongoing and foreseeable business needs.
ITEM 3. LEGAL PROCEEDINGS. |
There are no pending material legal proceedings, other than ordinary, routine litigation and claims incidental to the business, to which Kontoor or any of its subsidiaries is a party or to which any of their property is the subject.
ITEM 4. MINE SAFETY DISCLOSURES. |
Not applicable.
25 Kontoor Brands, Inc. 2019 Form 10-K
PART II
ITEM 5. MARKET FOR KONTOOR’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Market for Common Stock
Kontoor’s Common Stock is listed on the NYSE under the symbol “KTB”. Kontoor began to trade as a standalone public company on May 23, 2019. As of February 28, 2020, there were 2,892 holders of record of our Common Stock.
Dividend Policy
Quarterly dividends of Kontoor Brands, Inc. Common Stock, when declared, are paid on or about the 20th day of March, June, September and December.
Stock Performance Graph
The following graph compares the cumulative total shareholder return of Kontoor's Common Stock with that of the S&P 500 Index and the S&P 1500 Apparel, Accessories & Luxury Goods Sub Industry Index (“S&P 1500 Apparel Index”) for the period from May 7, 2019 (the effective date of the registration of KTB Common Stock) to December 28, 2019. The graph assumes that $100.00 was invested on May 9, 2019 (first day of trading activity) and all dividends and other distributions were reinvested through the last trading day of fiscal 2019. Past performance is not necessarily indicative of future performance.
Cumulative Total Return | ||||||||||
Company / Index | May 9, 2019 | December 28, 2019 | ||||||||
Kontoor Brands, Inc. | $ | 100.00 | $ | 108.13 | ||||||
S&P 500 Index | 100.00 | 111.19 | ||||||||
S&P 1500 Apparel Index | 100.00 | 104.46 | ||||||||
Recent Sales of Unregistered Securities
There were no sales of unregistered securities in the fourth quarter of 2019.
Issuer Purchases of Equity Securities
There were no purchases of our own equity securities in the fourth quarter of 2019, except for approximately 39,700 shares withheld to settle employee tax withholding related to vesting of awards.
Kontoor Brands, Inc 2019 Form 10-K 26
ITEM 6. SELECTED FINANCIAL DATA. |
The following table presents our selected historical financial information as of and for each of the years in the five-year period ended December 28, 2019.
We derived the selected historical financial data as of December 28, 2019 and December 29, 2018, and for each of the years in the three-year period ended December 28, 2019, from our audited consolidated and combined financial statements included elsewhere in this Annual Report on Form 10-K. In addition, we derived the selected historical data as of December 30, 2017 and for the year ended December 31, 2016 from our audited combined financial statements included in our Registration Statement on Form 10. We derived the selected historical financial data as of December 31, 2016, and as of and for the year ended January 2, 2016, from our unaudited combined financial information that is not included in this Annual Report on Form 10-K. In management’s opinion, the unaudited combined financial information has been prepared on the same basis as our audited combined financial statements and includes all adjustments necessary for a fair statement of the information for the periods presented.
Our historical audited combined financial statements and our unaudited combined financial information through the date of Separation included certain VF expenses that were charged to us for certain centralized functions and programs provided and administered by VF. In addition, a portion of VF's total corporate expenses was allocated to such financial statements. Refer to Note 1 to the Company's financial statements for additional information on the carve-out basis of accounting. These costs may not be representative of the actual costs to operate as a standalone public company. In addition, our historical financial information did not reflect any expected changes as a result of the Separation, including changes in financing, operations, cost structure and personnel needs of our business. Consequently, the financial information included here may not necessarily reflect our financial position, results of operations and cash flows in the future or what our financial condition, results of operations and cash flows would have been had we been a standalone public company for all periods presented.
The selected historical financial data presented below should be read in conjunction with our audited consolidated and combined financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.
(Dollars and shares in thousands, except per share amounts) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||
Summary of Operations | ||||||||||||||||||||||
Net revenues | $ | 2,548,839 | $ | 2,763,998 | $ | 2,830,106 | $ | 2,926,464 | $ | 3,008,776 | ||||||||||||
Operating income (1) | 168,290 | 333,042 | 357,418 | 408,698 | 506,025 | |||||||||||||||||
Net income (1) (2) | 96,654 | 263,073 | 116,191 | 315,030 | 376,802 | |||||||||||||||||
Earnings per common share - basic (3) | $ | 1.71 | $ | 4.64 | $ | 2.05 | $ | 5.56 | $ | 6.65 | ||||||||||||
Earnings per common share - diluted (3) | $ | 1.69 | $ | 4.64 | $ | 2.05 | $ | 5.56 | $ | 6.65 | ||||||||||||
Dividends per share (4) | $ | 1.12 | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Dividend payout ratio (4) | 65.8 | % | — | % | — | % | — | % | — | % | ||||||||||||
Financial Position (5) | ||||||||||||||||||||||
Working capital (6) | $ | 499,053 | $ | 1,324,374 | $ | 935,125 | $ | 864,815 | $ | 846,776 | ||||||||||||
Current ratio | 2.3 | 3.1 | 2.5 | 2.4 | 2.3 | |||||||||||||||||
Total assets (6) | $ | 1,517,156 | $ | 2,458,465 | $ | 2,126,410 | $ | 2,158,292 | $ | 2,083,809 | ||||||||||||
Long-term debt, less current maturities (7) | 913,269 | — | — | — | — | |||||||||||||||||
Equity (8) | 69,257 | 1,723,452 | 1,357,893 | 1,392,847 | 1,327,722 | |||||||||||||||||
Debt to total capital ratio (9) | 93.0 | % | 13.6 | % | 16.8 | % | 16.5 | % | 17.1 | % | ||||||||||||
Other Statistics | ||||||||||||||||||||||
Operating margin | 6.6 | % | 12.0 | % | 12.6 | % | 14.0 | % | 16.8 | % | ||||||||||||
Cash provided (used) by operations (2) (10) | $ | 777,788 | $ | (96,303 | ) | $ | 168,601 | $ | 323,952 | $ | 297,904 | |||||||||||
Capital expenditures | 22,679 | 21,038 | 25,584 | 27,575 | 23,583 | |||||||||||||||||
Software purchases | 14,807 | 1,663 | 879 | 570 | 1,560 | |||||||||||||||||
(1) | We recorded a non-cash impairment charge of $32.6 million related to the Rock & Republic® trademark intangible asset in 2019. During 2019 and 2018, we recorded restructuring and separation charges of $83.1 million and $28.6 million, respectively. During 2017 and 2016, we recorded restructuring charges of $9.5 million and $21.6 million, respectively. Restructuring charges were not significant in 2015. |
(2) | During 2019, we recorded $35.7 million of interest due to borrowings on the Company's credit facilities established with the Separation. During 2017, we recorded a $136.7 million provisional tax charge related to the impact of the Tax Cuts and Jobs Act (the "Tax Act"), of which $110.6 million related to the transition tax and was deemed settled in cash with VF at December 2017. |
(3) | The computation of basic and diluted earnings per share ("EPS") is based on net income divided by the basic weighted average number of common shares and diluted weighted average number of common shares outstanding, respectively. On May 22, 2019, the Separation was effected through a pro-rata distribution of one share of the Company's common stock for every seven shares of VF common stock held at the close of business on the record date of May 10, 2019. As a result, on May 23, 2019, the Company had 56,647,561 shares of common stock outstanding. This share |
27 Kontoor Brands, Inc. 2019 Form 10-K
amount was utilized for the calculation of basic and diluted earnings per share for all periods presented through the Separation date. After the Separation date, actual outstanding shares are used to calculate both basic and diluted weighted average number of common shares outstanding.
(4) | Dividend payout ratio is defined as dividends per share divided by earnings per diluted share. During 2019, the Company paid $63.6 million of dividends to its shareholders related to our first two quarterly cash dividends of $0.56 per share. |
(5) | We adopted the accounting standard on leases in the first quarter of 2019, which resulted in a cumulative adjustment of $2.7 million to increase former parent investment within equity. We adopted the accounting standard on revenue recognition in the first quarter of 2018, which resulted in a cumulative adjustment of $3.0 million to increase former parent investment within equity. We early adopted the accounting standard on intra-entity transfers in the first quarter of 2017, which resulted in a cumulative adjustment of $70.2 million to former parent investment within equity and reduction in other assets in the balance sheet at January 1, 2017. |
(6) | Fluctuations in working capital and total assets are related to balances due from and to former parent, all of which were settled at the Separation date. |
(7) | On May 17, 2019, the Company entered into a $1.55 billion senior secured credit facility under which it incurred $1.05 billion of indebtedness, the proceeds of which were used primarily to finance a cash transfer to VF in connection with the Separation. During 2019, the Company made $127.0 million of total principal payments, which included optional prepayments. Unamortized original issue discount and debt issuance costs totaled $9.7 million at December 2019. |
(8) | Represents Kontoor stockholders’ equity as a standalone public company since May 23, 2019 and former parent investment (capital contributions and earnings from operations less dividends) in Kontoor and accumulated other comprehensive income for 2015 through the Separation date. |
(9) | Total capital is defined as equity plus long-term and short-term debt. Short-term debt includes short-term borrowings and former parent notes payable. With the exception of December 2019, former parent notes payable approximated $269.1 million in all years presented. |
(10) | Cash used by operations in 2018 was adversely impacted by a $323.3 million reduction in cash proceeds from settlement of the intercompany sale to VF of certain of the Company's trade accounts receivable. |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
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 “Special Note On Forward-Looking Statements” included in Part I of this 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, 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 OutletTM 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.
On May 17, 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.
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. For presentation purposes herein, all references to periods ended December 2019, December 2018 and December 2017 correspond to the 52-week fiscal years ended December 28, 2019, December 29, 2018 and December 30, 2017, respectively.
Basis of Presentation
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 of accounting, which reflected the business as historically managed within VF. The balance sheets and cash flows included only those assets and liabilities directly related to the Jeanswear and VF OutletTM businesses, and the statements of income included the historically reported results of those businesses along with allocations of a portion of VF’s total corporate expenses. Refer to Note 1 to the Company's financial statements for additional information on the carve-out basis of accounting.
The Company’s financial statements for the period from May 23, 2019 through December 28, 2019 were based on the reported results of Kontoor Brands, Inc. as a standalone company. This results in a lack of comparability between periods in the statements of income, primarily in selling, general and administrative expenses. Effective with the Separation, the Company began implementing business model changes, which included the exit of unprofitable markets in Europe, the transition of our former Central and South America
Kontoor Brands, Inc 2019 Form 10-K 28
("CASA") region to a licensed model and the discontinuation of certain transactions with VF. Thus, certain revenues and costs presented in the carve-out statements of income did not continue after the Separation. Additionally, the Company's balance sheet at December 2019 includes only the assets and liabilities associated with the entities that transferred at the Separation, some of which are different from those that were reported on a carve-out basis at December 2018.
References to foreign currency amounts for the years ended December 2019 and December 2018 herein reflect the changes in foreign exchange rates from the years ended December 2018 and December 2017, respectively, 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. 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.
Business Overview
As a newly formed standalone public company as of May 22, 2019, we have worked to stabilize, position and streamline our presence around the world, and our active, strategic brand management has positioned us favorably for long-term success. As part of a centralized approach to our global business, our management team is providing global oversight for their respective business functions, including supply chain, digital, direct-to-consumer and strategy, while seeking to ensure that we maintain our worldwide presence and regional approach. We have undergone transformational change to improve operational performance, address internal and external factors and set the stage for long-term profitable growth. We have launched significant cost-savings initiatives during 2019 as we began to refine a global go-to-market approach that will sustain our long-term commitment to total shareholder return. The Company is focused on growing our three strategic channels, with higher rates of growth anticipated in our Non-U.S. Wholesale channel as we pursue a broader set of products, channels and geographic opportunities for the Wrangler® and Lee® brands, and in the digital platforms of our global Branded Direct-to-Consumer channel. The U.S. Wholesale channel will continue to receive our full focus and commitment, but with slower anticipated rates of growth than the Non-U.S. Wholesale and global Branded Direct-to-Consumer channels. Additionally, we have made significant investments during 2019 to support the design and implementation of a global ERP system that will continue into 2020 and 2021.
During 2019, both prior to and after the Separation we have pursued global initiatives related to business model changes, restructuring programs and costs incurred to effect the Separation and establish ourselves as a standalone public company ("Separation costs"), which have and will continue to result in improved profitability. These initiatives have included exiting unprofitable markets in Europe and South America, the transition of our former CASA region to a licensed model, streamlining and right-sizing supply chain operations including the closure of three owned manufacturing facilities in Mexico, streamlining our global organizational structure including a redesign of our commercial organization in the U.S. and Asia, and relocating the Lee® brand’s North American headquarters to Greensboro, North Carolina. Subsequent to the Separation, the Company has continued to service commercial arrangements with VF, which include sales of VF-branded products at VF Outlet™ stores, as well as sales to VF for products manufactured in our plants, use of our transportation fleet and fulfillment of a transition services agreement related to VF’s sale of its Nautica® brand business in mid-2018, none of which will continue in 2020. We will continue to implement proactive strategic quality-of-sales programs to improve efficiencies throughout the organization, such as exiting unprofitable points of distribution, including select channels in India, changing business models and rationalizing underperforming styles.
Focusing on our near- to medium-term business strategy, we are focused on optimizing our business and accelerating our performance in fundamental areas, including margin expansion and cash flow generation. Longer term, we are focused on accelerating revenue generation and additional strategic actions to fuel and sustain long-term performance and our competitive advantage around the world. We anticipate opportunities to further enhance our value-creation ability through investment in our core business. Our primary areas of financial focus during 2020 will be to (i) continue aggressive pay-down of debt; (ii) provide for a superior dividend yield; and (iii) implement technology solutions to enable global efficiency.
Additionally, we continue to monitor the COVID-19 coronavirus situation and the potential impact on our global operations. In terms of supply chain impacts, there are currently no material disruptions in either manufacturing or sourcing of materials.
HIGHLIGHTS OF THE YEAR ENDED DECEMBER 2019 |
• | Net revenues decreased 8% to $2,548.8 million compared to the year ended December 2018, driven by decreases in all segments and a 1% unfavorable impact from foreign currency. |
• | U.S. Wholesale revenues decreased 4% compared to the year ended December 2018, primarily due to the negative impact of a major U.S. retailer bankruptcy in the fourth quarter of 2018, proactive quality-of-sales initiatives and reduced sales of certain lower margin lines of business. These declines were partially offset by growth in our U.S. digital wholesale business. The U.S. Wholesale net revenues represented 63% of total revenues in the current year. |
• | International revenues decreased 15% compared to the year ended December 2018, due to a 5% unfavorable impact from foreign currency and declines in the Non-U.S. Wholesale channel primarily driven by strategies actioned by the Company in 2019, which included the exit of unprofitable points of distribution in India, strategic actions to exit direct operations in underperforming |
29 Kontoor Brands, Inc. 2019 Form 10-K
countries in Europe and South America and business model changes. International revenues represented 25% of total revenues in the current year.
• | Branded Direct-to-Consumer revenues decreased 5% on a global basis compared to the year ended December 2018, primarily due to business model changes actioned by the Company in 2019 and a 3% unfavorable impact from foreign currency. These declines were partially offset by 16% growth in the U.S. digital business through our owned e-commerce sites. The global Branded Direct-to-Consumer channel represented 11% of total revenues in the current year. |
• | Gross margin decreased 90 basis points to 39.4% compared to the year ended December 2018. Gross margin was negatively impacted by approximately 140 basis points during the current year due to business model changes, restructuring programs and Separation costs, partially offset by favorable channel mix in the current year. |
• | Selling, general & administrative expenses as a percentage of revenues increased 320 basis points. Business model changes, restructuring programs and Separation costs negatively impacted the current year by approximately 300 basis points. The remaining increase as a percentage of net revenues was primarily driven by deleverage of fixed costs on lower revenues. |
• | Net income decreased 63% to $96.7 million compared to the year ended December 2018, primarily due to the business results discussed above and a $32.6 million ($25.2 million after-tax) non-cash impairment of the Rock & Republic® trademark intangible asset during the current year. |
ANALYSIS OF RESULTS OF OPERATIONS |
Consolidated and Combined Statements of Income |
The following table presents a summary of the changes in net revenues for the years ended December 2019 and December 2018:
(In millions) | 2019 Compared to 2018 | 2018 Compared to 2017 | |||||||
Net revenues — prior year | $ | 2,764.0 | $ | 2,830.1 | |||||
Operations | (178.6 | ) | (61.5 | ) | |||||
Impact of foreign currency | (36.6 | ) | (4.6 | ) | |||||
Net revenues — current year | $ | 2,548.8 | $ | 2,764.0 | |||||
2019 Compared to 2018
Net revenues decreased 8% due to declines in the Wrangler and Lee segments, as well as declines in the Other category. These declines were primarily due to proactive quality-of-sales initiatives including business model changes and exits of select markets, programs and points of distribution, the negative impact of a major U.S. retailer bankruptcy in the fourth quarter of 2018, reduced sales of certain lower margin lines of business, the discontinuation of manufacturing for VF and a 1% unfavorable impact from foreign currency. The declines were partially offset by growth in our U.S. digital wholesale partners and owned e-commerce sites.
2018 Compared to 2017
Net revenues decreased 2% primarily due to declines in the Wrangler and Lee segments. These declines were primarily due to a number of global macroeconomic challenges that primarily impacted our wholesale channels, which were partially offset by strength in our direct-to-consumer business. Both our U.S. Wholesale and Non-U.S. Wholesale channels declined in 2018 compared to 2017. The U.S. Wholesale channel was unfavorably impacted in 2018 by the continued effects of a key customer’s inventory de-stocking decision, along with door closures following the bankruptcy of a major U.S. retailer in the fourth quarter of 2018. This decline was partially offset by strong growth with our digital wholesale partners and growth in other key brick & mortar retail accounts. Our Non-U.S. Wholesale channel was adversely affected by foreign exchange impacts from the highly inflationary economy in Argentina, as well as inventory reduction decisions by certain retailers in the non-US Americas region and the ongoing effects of the economic demonetization in India. Our Branded Direct-to-Consumer channel continued to grow, driven by the performance of our own websites.
Additional details on 2019, 2018 and 2017 revenues are provided in the section titled “information by reportable segment.”
The following table presents components of the Company's statements of income as a percent of total net revenues:
2019 | 2018 | 2017 | ||||||||
Gross margin (net revenues less cost of goods sold) | 39.4 | % | 40.3 | % | 41.4 | % | ||||
Selling, general and administrative expenses | 31.5 | % | 28.3 | % | 28.8 | % | ||||
Non-cash impairment of intangible asset | 1.3 | % | — | % | — | % | ||||
Operating income | 6.6 | % | 12.0 | % | 12.6 | % | ||||
Kontoor Brands, Inc 2019 Form 10-K 30
2019 Compared to 2018
Gross margin decreased 90 basis points. Business model changes, restructuring programs and Separation costs negatively impacted the current year by approximately 140 basis points. This decrease was partially offset by the impact of favorable channel mix in the current year.
Selling, general and administrative expenses as a percentage of revenues increased 320 basis points. Business model changes, restructuring programs and Separation costs negatively impacted the current year by approximately 300 basis points. The remaining increase as a percentage of net revenues was primarily driven by deleverage of fixed costs on lower revenues.
Non-cash impairment of intangible asset reflects a $32.6 million impairment of the Rock & Republic® trademark recorded in August 2019. There were no intangible asset impairments in 2018.
The effective income tax rate was 28.5% for the year ended December 2019 compared to 22.6% for the year ended December 2018. The 2019 effective income tax rate included a net discrete tax expense of $3.8 million, comprised of $3.5 million of tax expense primarily related to an increase in unrecognized tax benefits and interest, $2.1 million of net tax expense related to recording valuation allowances on beginning balance deferred tax assets at the date of Separation and the impact of a corresponding change in assertion on unremitted earnings, $1.9 million of tax expense related to adjustments to tax balances transferred from former parent at the Separation and $3.7 million of tax benefit related to stock compensation. The $3.8 million of net discrete tax expense in 2019 increased the effective income tax rate by 2.8% compared to an increase of 1.4% for discrete items in 2018.
Without discrete items, the effective income tax rate for the year ended December 2019 increased 4.5%, primarily due to losses incurred in certain foreign jurisdictions and the tax impacts of GILTI, partially offset by favorable changes in our jurisdictional mix of earnings. Our effective income tax rate for foreign operations was 20.1% and 17.2% for the years ended December 2019 and December 2018, respectively.
2018 Compared to 2017
Gross margin decreased 110 basis points. Increased manufacturing labor, overhead and product costs negatively impacted the year ended December 2018, and was partially offset by favorable pricing, the benefit of facility closures and a mix shift toward higher margin products. Additionally, restructuring charges were higher in 2018 due to the exit of a manufacturing facility.
Selling, general and administrative expenses as a percentage of revenues decreased 50 basis points. 2018 was impacted by lower advertising spend following the timing of strategic investments in late 2017 to improve our brand messaging, lower compensation-related costs associated with reduced headcount and a reduction in costs allocated to us by VF due to being a smaller portion of VF’s total operating results in 2018. These decreases were partially offset by higher restructuring charges for severance costs related to ongoing efforts to enhance our cost efficiency and profitability, Separation transaction costs to advisors, attorneys and other third parties that were not incurred in 2017, as well as an increase in the non-service components of net periodic pension costs.
Income taxes decreased $166.0 million during the year ended December 2018 compared to the year ended December 2017 primarily due to the transitional impact of the Tax Act that resulted in a provisional net charge of $136.7 million during the fourth quarter of 2017.
The effective income tax rate was 22.6% for the year ended December 2018 compared to 67.6% for the year ended December 2017. The effective income tax rate was substantially lower in 2018 when compared to 2017 primarily due to the discrete tax expense associated with the Tax Act recorded in 2017. The Tax Act reduced the federal tax rate on U.S. earnings to 21% and moved from a global taxation regime to a modified territorial regime. As part of the legislation, U.S. companies were required to pay a tax on historical earnings generated offshore that had not been repatriated to the U.S. Additionally, revaluation of deferred tax asset and liability positions at the lower federal base rate of 21% was required. The transitional impact of the Tax Act resulted in a provisional net charge of $136.7 million during the fourth quarter of 2017. This amount was primarily comprised of $110.6 million related to the transition tax and $19.4 million of tax expense related to revaluing U.S. deferred tax assets and liabilities using the new U.S. corporate tax rate of 21%. Other provisional charges of $6.7 million were primarily related to establishing a deferred tax liability for foreign withholding and state taxes on unremitted foreign earnings.
The 2018 effective income tax rate included a net discrete tax expense of $4.8 million, comprised of $5.5 million of net tax expense related to the Tax Act, $2.4 million of net tax expense related to unrecognized tax benefits and interest and $3.1 million of tax benefit related to stock compensation. The $4.8 million net discrete tax expense in 2018 increased the effective income tax rate by 1.4% compared to an increase of 36.2% for discrete items in 2017.
Without discrete items, the effective income tax rate for the year ended December 2018 decreased 10.2%, primarily due to the impact of the Tax Act, including a lower U.S. corporate income tax rate that was effective beginning January 1, 2018. Our effective income tax rate for foreign operations was 17.2% and 19.3% for the years ended December 2018 and December 2017, respectively.
31 Kontoor Brands, Inc. 2019 Form 10-K
Information by Business Segment |
Management at each of the brands has direct control over and responsibility for corresponding net revenues and operating income, hereinafter termed "segment revenues" and "segment profit," respectively. Our management evaluates operating performance and makes investment and other decisions based on segment revenues and segment profit. Common costs for certain centralized functions are allocated to the segments as discussed in Note 3 to the Company's financial statements.
The following tables present a summary of the changes in segment revenues and segment profit for the years ended December 2019 and December 2018:
Segment Net Revenues
(In millions) | Wrangler | Lee | Total | |||||||||
Segment revenues — 2017 | $ | 1,619.3 | $ | 1,005.8 | $ | 2,625.1 | ||||||
Operations | (7.0 | ) | (51.1 | ) | (58.1 | ) | ||||||
Impact of foreign currency | (10.1 | ) | 5.5 | (4.6 | ) | |||||||
Segment revenues — 2018 | $ | 1,602.2 | $ | 960.2 | $ | 2,562.4 | ||||||
Operations | (66.8 | ) | (58.6 | ) | (125.4 | ) | ||||||
Impact of foreign currency | (17.3 | ) | (19.3 | ) | (36.6 | ) | ||||||
Segment revenues — 2019 | $ | 1,518.1 | $ | 882.3 | $ | 2,400.4 | ||||||
Segment Profit
(In millions) | Wrangler | Lee | Total | |||||||||
Segment profit — 2017 | $ | 280.3 | $ | 107.2 | $ | 387.5 | ||||||
Operations | (17.9 | ) | (18.6 | ) | (36.5 | ) | ||||||
Impact of foreign currency | 3.6 | 4.1 | 7.7 | |||||||||
Segment profit — 2018 | $ | 266.0 | $ | 92.7 | $ | 358.7 | ||||||
Operations | (63.3 | ) | (22.9 | ) | (86.2 | ) | ||||||
Impact of foreign currency | 12.3 | (1.6 | ) | 10.7 | ||||||||
Segment profit — 2019 | $ | 215.0 | $ | 68.2 | $ | 283.2 | ||||||
The following sections discuss the changes in segment revenues and segment profit.
Wrangler
Year Ended December | Percent Change | ||||||||||||||||||||
(Dollars in millions) | 2019 | 2018 | 2017 | 2019 | 2018 | ||||||||||||||||
Segment revenues | $ | 1,518.1 | $ | 1,602.2 | $ | 1,619.3 | (5.2 | )% | (1.1 | )% | |||||||||||
Segment profit | $ | 215.0 | $ | 266.0 | $ | 280.3 | (19.2 | )% | (5.1 | )% | |||||||||||
Operating margin | 14.2 | % | 16.6 | % | 17.3 | % | |||||||||||||||
2019 Compared to 2018
Global revenues for the Wrangler® brand decreased 5%, driven by declines in all channels.
• | Revenues in the Americas region decreased 4%, primarily due to a 2% decrease in U.S. wholesale revenues resulting from reduced sales of certain lower margin lines of business and the negative impact of a major U.S. retailer bankruptcy in the fourth quarter of 2018. Non-U.S. Americas wholesale revenues decreased 32%, primarily due to business model changes in the CASA region and a 5% unfavorable impact from foreign currency. |
• | Revenues in the APAC region decreased 29%, primarily due to results in India which reflected the economic impact of demonetization and our exit of certain unprofitable points of distribution, as well as a 3% unfavorable impact from foreign currency. |
• | Revenues in the EMEA region decreased 13%, primarily due to business model changes and a 5% unfavorable impact from foreign currency. |
Kontoor Brands, Inc 2019 Form 10-K 32
Operating margin decreased to 14.2% compared to 16.6% for 2018, primarily due to higher product costs, unfavorable mix driven by lower international sales, higher restructuring and Separation costs as well as business model changes in 2019.
2018 Compared to 2017
Global revenues for the Wrangler® brand decreased 1% due to declines in non-U.S. wholesale and branded direct-to-consumer revenues, offset by growth in U.S. wholesale revenues.
• | Revenues in the Americas region were flat due to declines in non-U.S. wholesale and branded direct-to-consumer revenues, offset by growth in U.S. wholesale revenues. Branded brick & mortar revenues in the Americas region decreased, primarily due to declines in sales through our VF OutletTM stores, offset by growth in our owned websites. The U.S. Wholesale channel increase was attributable to strong growth with our digital wholesale partners and growth in certain key brick & mortar retail accounts. Revenues in the non-U.S. Americas region decreased 16% due to declines in wholesale and branded brick & mortar revenues, primarily due to a 13% unfavorable impact from foreign currency related to the highly inflationary economy in Argentina. |
• | Revenues in the APAC region decreased 4%, primarily due to declines in wholesale revenues associated with the ongoing effects of economic demonetization in India and a 3% unfavorable impact from foreign currency. |
• | Revenues in the EMEA region decreased 2%, primarily due to declines in wholesale and branded direct-to-consumer revenues attributed to door closures and an unseasonably warm summer weather pattern, partially offset by a 4% favorable impact from foreign currency. |
Operating margin decreased to 16.6% compared to 17.3% for 2017, primarily due to higher restructuring costs related to severance, additional strategic investments in our direct-to-consumer business and product development costs, all of which resulted in reduced expense leverage on lower revenues in 2018.
Lee
Year Ended December | Percent Change | ||||||||||||||||||||
(Dollars in millions) | 2019 | 2018 | 2017 | 2019 | 2018 | ||||||||||||||||
Segment revenues | $ | 882.3 | $ | 960.2 | $ | 1,005.8 | (8.1 | )% | (4.5 | )% | |||||||||||
Segment profit | $ | 68.2 | $ | 92.7 | $ | 107.2 | (26.4 | )% | (13.5 | )% | |||||||||||
Operating margin | 7.7 | % | 9.7 | % | 10.7 | % | |||||||||||||||
2019 Compared to 2018
Global revenues for the Lee® brand decreased 8%, driven by declines in all channels.
• | Revenues in the Americas region decreased 6%, primarily due to a 7% decrease in U.S. wholesale revenues resulting from the negative impact of a major U.S. retailer bankruptcy in the fourth quarter of 2018 and reduced sales in certain lower margin lines of business. Non-U.S. Americas revenues decreased 13%, primarily due to business model changes in the CASA region and a 2% unfavorable impact from foreign currency. |
• | Revenues in the APAC region decreased 7%, primarily due to a 4% unfavorable impact from foreign currency and results in India which reflected the economic impact of demonetization and our exit of certain unprofitable points of distribution. |
• | Revenues in the EMEA region decreased 16%, primarily due to business model changes, softer European demand and a 5% unfavorable impact from foreign currency. |
Operating margin decreased to 7.7% compared to 9.7% for 2018, primarily due to higher product costs, unfavorable mix driven by lower international sales, higher restructuring and Separation costs as well as business model changes in 2019.
2018 Compared to 2017
Global revenues for the Lee® brand decreased 5%, driven by declines in U.S. wholesale revenues, which were partially offset by growth in branded direct-to-consumer revenues.
• | Revenues in the Americas region decreased 9%, primarily due to declines in U.S. wholesale revenues. The U.S. Wholesale channel was adversely impacted by a key customer’s inventory destocking decision related to our Lee® Riders® brand, as well as door closures following bankruptcy filings by a limited number of key retailers. This decline was partially offset by strong growth in our sales through our VF OutletTM stores. Revenues in the non-U.S. Americas region decreased 14%, primarily due to declines in wholesale revenues related to inventory reductions at a key retailer and a 4% unfavorable impact from foreign currency, led by the highly inflationary economy in Argentina. |
33 Kontoor Brands, Inc. 2019 Form 10-K
• | Revenues in the APAC region decreased 1%, primarily due to declines in wholesale revenues that were adversely affected by higher product returns related to a market transition in a key market, partially offset by growth in branded direct-to-consumer revenues led by our concessions business and a 1% favorable impact from foreign currency. |
• | Revenues in the EMEA region were flat, primarily due to growth in wholesale revenues and a 4% favorable foreign currency impact, offset by declines in our branded direct-to-consumer revenues driven by door closures and an unseasonably warm summer weather pattern. |
Operating margin decreased to 9.7% compared to 10.7% for 2017, primarily due to higher manufacturing labor, overhead and product costs, while selling, general and administrative expenses remained flat on lower revenues in 2018.
Other
In addition, we report an "Other" category for purposes of a reconciliation of segment revenues and segment profit to the Company's operating results, but the Other category is not considered a reportable segment based on evaluation of the aggregation criteria. Other includes sales of third-party branded merchandise at VF Outlet™ stores, sales and licensing of Rock & Republic® branded apparel, and sales of products manufactured for third-parties. Sales of Wrangler® and Lee® branded products at VF Outlet™ stores are not included in Other and are reported in the respective segments discussed above. The Other category also includes transactions with VF for pre-Separation activities, none of which will continue going forward. These transactions include sales of VF-branded products at VF Outlet™ stores, as well as sales to VF for products manufactured in our plants, use of our transportation fleet and fulfillment of a transition services agreement related to VF’s sale of its Nautica® brand business in mid-2018.
Year Ended December | Percent Change | ||||||||||||||||||
(Dollars in millions) | 2019 | 2018 | 2017 | 2019 | 2018 | ||||||||||||||
Revenues | $ | 148.5 | $ | 201.6 | $ | 205.0 | (26.3)% | (1.7)% | |||||||||||
Profit (loss) | $ | 2.8 | $ | — | $ | (0.8 | ) | * | * | ||||||||||
Operating margin | 1.9 | % | — | % | (0.4 | )% | |||||||||||||
*Calculation not meaningful.
2019 Compared to 2018
Other revenues decreased 26% as transactions with VF for pre-Separation activities decreased to $22.6 million compared to $51.0 million during 2018. In addition, VF Outlet™ store revenues decreased 12% compared to 2018 as a result of a decrease in comparable store sales and total square footage.
2018 Compared to 2017
Other revenues decreased 2% primarily due to a 12% decrease in our VF OutletTM store revenues resulting from exiting unprofitable doors and underperforming categories, partially offset by revenues generated from fulfilling a transition services agreement related to VF’s sale of its Nautica® brand business in mid-2018 and increased sales to VF. Total sales to VF increased to $51.0 million compared to $45.5 million in 2017. Our profit and operating margin improvement was primarily due to the margin earned on fulfilling the Nautica® transition services agreement.
Reconciliation of |