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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number: 001-38854
KONTOOR BRANDS, INC.
(Exact name of registrant as specified in its charter)
North Carolina
 
83-2680248
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. employer identification number)
400 N. Elm Street
27401
Greensboro
,
North Carolina
(Address of principal executive offices)

(Zip Code)
(336) 332-3400
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, No Par Value
KTB
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ    No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes þ    No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
 
Accelerated filer
 
 
 
 
 
 
 
Non-accelerated filer
 
  
Smaller reporting company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes    No þ 
The number of shares of common stock, no par value, of the registrant outstanding as of July 27, 2019 was 56,879,295.



KONTOOR BRANDS, INC.
Table of Contents
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Kontoor Brands, Inc. Q2 FY19 Form 10-Q 2



PART I — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS (UNAUDITED)
KONTOOR BRANDS, INC.
Consolidated and Combined Balance Sheets
(Unaudited)
(in thousands)
 
June 2019
 
 
December 2018
 
June 2018
ASSETS
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
Cash and equivalents
 
$
76,687

 
 
$
96,776

 
$
86,356

Accounts receivable, less allowance for doubtful accounts of $11,102 at June 2019, $10,549 at December 2018 and $7,345 at June 2018
 
254,049

 
 
252,966

 
262,525

Due from former parent, current
 

 
 
547,690

 
553,976

Notes receivable from former parent
 

 
 
517,940

 
546,740

Inventories
 
538,168

 
 
473,812

 
491,836

Other current assets
 
79,397

 
 
52,014

 
45,202

Total current assets
 
948,301

 
 
1,941,198

 
1,986,635

Due from former parent, noncurrent
 

 
 
611

 

Property, plant and equipment, net
 
131,727

 
 
138,449

 
142,263

Operating lease assets
 
90,416

 
 

 

Intangible assets, net
 
50,953

 
 
53,059

 
55,263

Goodwill
 
213,761

 
 
214,516

 
216,080

Other assets
 
153,044

 
 
110,632

 
120,439

TOTAL ASSETS
 
$
1,588,202

 
 
$
2,458,465

 
$
2,520,680

LIABILITIES AND EQUITY
 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
 
Short-term borrowings
 
$
2,829

 
 
$
3,215

 
$
5,062

Current portion of long-term debt
 
7,500

 
 

 

Accounts payable
 
159,214

 
 
134,129

 
136,620

Due to former parent, current
 

 
 
16,140

 
59,424

Notes payable to former parent
 

 
 
269,112

 
269,112

Accrued liabilities
 
177,582

 
 
194,228

 
166,881

Operating lease liabilities, current
 
34,439

 
 

 

Total current liabilities
 
381,564

 
 
616,824

 
637,099

Operating lease liabilities, noncurrent
 
58,594

 
 

 

Other liabilities
 
86,189

 
 
118,189

 
115,894

Long-term debt
 
979,687

 
 

 

Commitments and contingencies
 

 
 

 

Total liabilities
 
1,506,034

 
 
735,013

 
752,993

Equity
 
 
 
 
 
 
 
Common stock, no par value
 

 
 

 

Additional paid-in capital
 
134,621

 
 

 

Former parent investment
 

 
 
1,868,634

 
1,908,986

Retained earnings
 
21,235

 
 

 

Accumulated other comprehensive loss
 
(73,688
)
 
 
(145,182
)
 
(141,299
)
Total equity
 
82,168

 
 
1,723,452

 
1,767,687

TOTAL LIABILITIES AND EQUITY
 
$
1,588,202

 
 
$
2,458,465

 
$
2,520,680


See accompanying notes to unaudited consolidated and combined financial statements.


3 Kontoor Brands, Inc. Q2 FY19 Form 10-Q


KONTOOR BRANDS, INC.
Consolidated and Combined Statements of Income
(Unaudited)

 
 
Three Months Ended June
 
 
Six Months Ended June
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except per share amounts)
 
2019
 
 
2018
 
 
2019
 
 
2018
Net revenues
 
$
609,746

 
 
$
663,856

 
 
$
1,258,090

 
 
$
1,333,519

Costs and operating expenses
 
 
 
 
 
 
 
 
 
 
 
Cost of goods sold
 
374,177

 
 
396,785

 
 
775,202

 
 
779,206

Selling, general and administrative expenses
 
182,049

 
 
191,337

 
 
404,173

 
 
386,171

Total costs and operating expenses
 
556,226

 
 
588,122

 
 
1,179,375

 
 
1,165,377

Operating income
 
53,520

 
 
75,734

 
 
78,715

 
 
168,142

Interest income from former parent, net
 
1,423

 
 
1,660

 
 
3,762

 
 
3,311

Interest expense
 
(7,638
)
 
 
(416
)
 
 
(7,736
)
 
 
(781
)
Interest income
 
1,408

 
 
1,386

 
 
2,831

 
 
2,668

Other expense, net
 
(1,370
)
 
 
(1,241
)
 
 
(2,341
)
 
 
(2,438
)
Income before income taxes
 
47,343

 
 
77,123

 
 
75,231

 
 
170,902

Income taxes
 
9,357

 
 
16,665

 
 
21,832

 
 
30,748

Net income
 
$
37,986

 
 
$
60,458

 
 
$
53,399

 
 
$
140,154

Earnings per common share
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.67

 
 
$
1.07

 
 
$
0.94

 
 
$
2.47

Diluted
 
$
0.67

 
 
$
1.07

 
 
$
0.94

 
 
$
2.47

Weighted average shares outstanding
 
 
 
 
 
 
 
 
 
 
 
Basic
 
56,648

 
 
56,648

 
 
56,648

 
 
56,648

Diluted
 
56,920

 
 
56,648

 
 
56,779

 
 
56,648

See accompanying notes to unaudited consolidated and combined financial statements.




Kontoor Brands, Inc. Q2 FY19 Form 10-Q 4



KONTOOR BRANDS, INC.
Consolidated and Combined Statements of Comprehensive Income
(Unaudited)

 
 
Three Months Ended June
 
 
Six Months Ended June
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
 
2019
 
 
2018
 
 
2019
 
 
2018
Net income
 
$
37,986

 
 
$
60,458

 
 
$
53,399

 
 
$
140,154

Other comprehensive income, net of taxes
 

 
 

 
 

 
 

 Foreign currency translation
 

 
 

 
 

 
 

Gains (losses) arising during the period
 
4,686

 
 
(28,518
)
 
 
5,444

 
 
(18,817
)
Defined benefit pension plans
 


 
 


 
 


 
 


Current period actuarial gains (losses)
 
(14
)
 
 

 
 
(14
)
 
 

Derivative financial instruments
 


 
 


 
 


 
 


Gains (losses) arising during the period
 
(2,058
)
 
 

 
 
(2,058
)
 
 

Reclassification to net income for (gains) losses realized
 
(362
)
 
 

 
 
(362
)
 
 

Total other comprehensive income (loss), net of taxes
 
2,252

 
 
(28,518
)
 
 
3,010

 
 
(18,817
)
Comprehensive income
 
$
40,238

 
 
$
31,940

 
 
$
56,409

 
 
$
121,337

See accompanying notes to unaudited consolidated and combined financial statements.




5 Kontoor Brands, Inc. Q2 FY19 Form 10-Q


KONTOOR BRANDS, INC.
Consolidated and Combined Statements of Cash Flows
(Unaudited)

 
 
Six Months Ended June
 
 
 
 
 
 
(in thousands)
 
2019
 
 
2018
OPERATING ACTIVITIES
 
 
 
 
 
Net income
 
$
53,399

 
 
$
140,154

Adjustments to reconcile net income to cash provided (used) by operating activities:
 
 
 
 
 
Depreciation and amortization
 
16,025

 
 
16,089

Stock-based compensation
 
11,473

 
 
5,552

Provision for doubtful accounts
 
2,985

 
 
375

Other
 
(1,068
)
 
 
(1,594
)
Changes in operating assets and liabilities:
 
 
 
 
 
Accounts receivable
 
4,355

 
 
(17,425
)
Inventories
 
(69,655
)
 
 
(60,721
)
Due from former parent
 
548,301

 
 
(332,361
)
Accounts payable
 
43,331

 
 
(36,564
)
Income taxes
 
5,692

 
 
(4,286
)
Accrued liabilities
 
230

 
 
20,009

Due to former parent
 
(16,065
)
 
 
21,393

Other assets and liabilities
 
(18,852
)
 
 
(15,619
)
Cash provided (used) by operating activities
 
580,151

 
 
(264,998
)
INVESTING ACTIVITIES
 
 
 
 
 
Capital expenditures
 
(9,300
)
 
 
(13,035
)
Repayments of notes receivable from former parent
 
517,940

 
 
1,000

Other, net
 
1,081

 
 
5,050

Cash provided (used) by investing activities
 
509,721

 
 
(6,985
)
FINANCING ACTIVITIES
 
 
 
 
 
Proceeds from issuance of long-term debt
 
1,050,000

 
 

Debt issuance costs
 
(12,993
)
 
 

Principal payments of long-term debt
 
(50,000
)
 
 

Repayment of notes payable from former parent
 
(269,112
)
 
 

Net transfers (to) from former parent
 
(1,814,682
)
 
 
279,859

Other, net
 
(14,169
)
 
 
675

Cash (used) provided by financing activities
 
(1,110,956
)
 
 
280,534

Effect of foreign currency rate changes on cash and cash equivalents
 
995

 
 
(3,006
)
Net change in cash and cash equivalents
 
(20,089
)
 
 
5,545

Cash and cash equivalents – beginning of period
 
96,776

 
 
80,811

Cash and cash equivalents – end of period
 
$
76,687

 
 
$
86,356



See accompanying notes to unaudited consolidated and combined financial statements.


Kontoor Brands, Inc. Q2 FY19 Form 10-Q 6



KONTOOR BRANDS, INC.
Consolidated and Combined Statements of Equity
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Former Parent Investment
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss
 
Total Equity
 
 
 
 
 
 
 (in thousands)
 
Shares
 
Amounts
 
 
 
 
Balance, December 2018
 

 
$

 
$

 
$
1,868,634

 
$

 
$
(145,182
)
 
$
1,723,452

Adoption of new accounting standard (ASU 2016-02)
 

 

 

 
(2,713
)
 

 

 
(2,713
)
Net income
 

 

 

 
15,413

 

 

 
15,413

Foreign currency translation
 

 

 

 

 

 
758

 
758

Net transfers to former parent
 

 

 

 
(157,928
)
 

 

 
(157,928
)
Balance, March 2019
 

 
$

 
$

 
$
1,723,406

 
$

 
$
(144,424
)
 
$
1,578,982

Net income
 

 

 

 
16,751

 
21,235

 

 
37,986

Stock-based compensation, net
 

 

 
1,879

 

 

 

 
1,879

Foreign currency translation
 

 

 

 

 

 
4,686

 
4,686

Defined benefit pension plans
 

 

 

 

 

 
(14
)
 
(14
)
Derivative financial instruments
 

 

 

 

 

 
(2,420
)
 
(2,420
)
Net transfers to former parent
 

 

 

 
(1,607,415
)
 

 
68,484

 
(1,538,931
)
Transfer of former parent investment to additional paid-in capital
 

 

 
132,742

 
(132,742
)
 

 

 

Issuance of common stock
 
56,648

 

 

 

 

 

 

Balance, June 2019
 
56,648

 
$

 
$
134,621

 
$

 
$
21,235

 
$
(73,688
)
 
$
82,168


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Former Parent Investment
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss
 
Total Equity
 
 
 
 
 
 
 
 (in thousands)
 
Shares
 
Amounts
 
 
 
 
 
Balance, December 2017
 

 
$

 

 
$
1,480,375

 
$

 
$
(122,482
)
 
$
1,357,893

Adoption of new accounting standard (ASU 2014-09)
 

 

 

 
3,047

 

 

 
3,047

Net income
 

 

 

 
79,696

 

 

 
79,696

Foreign currency translation
 

 

 

 

 

 
9,701

 
9,701

Net transfers from former parent
 

 

 

 
113,445

 

 

 
113,445

Balance, March 2018
 

 
$

 
$

 
$
1,676,563

 
$

 
$
(112,781
)
 
$
1,563,782

Net income
 

 

 

 
60,458

 

 

 
60,458

Foreign currency translation
 

 

 

 

 

 
(28,518
)
 
(28,518
)
Net transfers from former parent
 

 

 

 
171,965

 

 

 
171,965

Balance, June 2018
 

 
$

 
$

 
$
1,908,986

 
$

 
$
(141,299
)
 
$
1,767,687


See accompanying notes to unaudited consolidated and combined financial statements.









7 Kontoor Brands, Inc. Q2 FY19 Form 10-Q

KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)



NOTE 1 — BASIS OF PRESENTATION

Description of Business
Kontoor Brands, Inc. ("Kontoor," the "Company," "we," "us" or "our") is a global denim and casual apparel company headquartered in the United States ("U.S."). The Company designs, produces, procures, markets and distributes apparel primarily under the brand names Wrangler® and Lee®. The Company's products are sold in the U.S. through mass merchants, specialty stores, mid-tier and traditional department stores, company-operated stores and online. The Company's products are also sold internationally, primarily in Europe and Asia, through department, specialty, company-operated, concession retail and independently operated partnership stores and online. VF Outlet™ stores carry Wrangler® and Lee® branded products, as well as merchandise that is specifically purchased for sale in these stores.
Spin-Off Transaction
On May 22, 2019, VF Corporation ("VF" or "former parent") completed the spin-off of its Jeans 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 separate public company (NYSE: KTB) on May 23, 2019.
The Company incurred $1.05 billion of indebtedness under a newly structured third-party debt issuance, the proceeds of which were used primarily to finance a cash transfer to VF in connection with the Separation.
The Company entered into several agreements with VF that govern the relationship of the parties following the Separation, including the Separation and Distribution Agreement, the Tax Matters Agreement, the Transition Services Agreement, the Kontoor Intellectual Property License Agreement, the VF Intellectual Property License Agreement and the Employee Matters Agreement. Under the terms of the Transition Services Agreement, the Company and VF agreed to provide each other certain transitional services including information technology, information management, human resources, employee benefits administration, supply chain, facilities, and other limited finance and accounting related services for periods up to 18 months. 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 12, based on the nature of the arrangements.
Fiscal Year
The Company operates and reports using a 52/53 week fiscal year ending on the Saturday closest to December 31 of each year. Accordingly, this Form 10-Q presents the second quarter of the Company's fiscal year ended December 28, 2019 ("fiscal 2019"). For presentation purposes herein, all references to periods ended June 2019, December 2018 and June 2018 correspond to the fiscal periods ended June 29, 2019, December 29, 2018 and June 30, 2018, respectively.
 
Basis of Presentation - Unaudited Consolidated and Combined Financial Statements
The Company’s financial statements for periods through the Separation date of May 22, 2019 are combined financial statements prepared on a carve-out basis as discussed below. The Company’s financial statements for the period from May 23, 2019 through June 29, 2019 are consolidated financial statements based on the reported results of Kontoor Brands, Inc. as a standalone company. Accordingly, the second quarter of 2019 included consolidated and combined financial statements, whereas all prior periods included combined financial statements. 
The Company’s unaudited consolidated and combined financial statements for all periods presented are referred to throughout this document as “financial statements.”
The accompanying unaudited interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and notes required by generally accepted accounting principles in the United States of America ("GAAP") for complete financial statements. In the opinion of management, the accompanying financial statements contain all normal and recurring adjustments necessary to fairly state the financial position, results of operations and cash flows of the Company for the interim periods presented. The financial statements may not be indicative of the Company's future performance and do not necessarily reflect what the financial position, results of operations, and cash flows would have been had it operated as an independent company for all periods presented. Additionally, operating results for the three and six months ended June 2019 are not necessarily indicative of results that may be expected for any other interim period or for fiscal 2019. The unaudited financial statements should be read in conjunction with the audited combined financial statements for the fiscal year ended December 29, 2018 included in our Registration Statement on Form 10, as amended and filed with the Securities and Exchange Commission on April 30, 2019 ("2018 Form 10").
Basis of Presentation - Prior to the Separation
Through the Separation date, the Company's combined financial statements are prepared on a "carve-out" basis. These accompanying unaudited combined financial statements reflect the historical financial position, results of operations and cash flows of the Company for the periods presented, through the Separation date, as historically managed within VF. The unaudited combined financial statements have been derived from the consolidated financial statements and accounting records of VF.
The combined statements of income include costs for certain centralized functions and programs provided and administered by VF that are charged directly to the Company. These centralized functions and programs include, but are not limited to, information technology, human resources, accounting shared services, supply chain and insurance.
In addition, for purposes of preparing these combined financial statements on a "carve-out" basis under U.S. GAAP, a portion of VF's total corporate expenses are allocated to the Company. These expense allocations include the cost of corporate functions and resources provided by or administered by VF including, but not


Kontoor Brands, Inc. Q2 FY19 Form 10-Q 8


KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


limited to, executive management, finance, accounting, legal, human resources, and related benefit costs associated with such functions, such as stock-based compensation and pension. Allocations also include the cost of operating VF's corporate headquarters located in Greensboro, North Carolina.
Costs are allocated to the Company based on direct usage when identifiable or, when not directly identifiable, on the basis of proportional revenues, cost of goods sold or square footage, as applicable. Management considers the basis on which the expenses have been allocated to reasonably reflect the utilization of services provided to, or benefit received by, the Company during the periods presented. However, the allocations may not reflect the expenses that would have been incurred if the Company had been a standalone company for the periods presented. Actual costs that may have been incurred if the Company had been a standalone company would depend on a number of factors, including the organizational structure, whether functions were outsourced or performed by employees, and strategic decisions made in areas such as information technology and infrastructure.
 
The combined financial statements include certain assets and liabilities that have historically been held at the VF corporate level but are specifically identifiable or otherwise attributable to the Company. VF's third-party long-term debt and the related interest expense have not been allocated to the Company for any of the periods presented as the Company was not the legal obligor of such debt.
All intracompany transactions are eliminated. All transactions between the Company and VF are included in these financial statements. For those transactions between the Company and VF that were historically settled in cash, the Company has reflected such balances in the balance sheets as "due from former parent" or "due to former parent." The aggregate net effect of transactions between the Company and VF that were not historically settled in cash are reflected in the balance sheets within "former parent investment" and in the statements of cash flows within "net transfers to former parent."

NOTE 2 — RECENTLY ADOPTED AND ISSUED ACCOUNTING STANDARDS
Recently Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842),” an update that requires entities to record most leased assets and liabilities on the balance sheet, and also retains a dual model approach for assessing lease classification and recognizing expense. The FASB subsequently issued updates to provide clarification on specific topics, including adoption guidance, practical expedients and interim transition disclosure requirements. This guidance was adopted by the Company during the first quarter of fiscal 2019 utilizing the optional transition method, which resulted in a $2.7 million cumulative effect adjustment to beginning retained earnings for fiscal 2019. The adoption of these standards did not have a significant impact on the Company's statement of income and statement of cash flows. Refer to Note 3 of the Company's financial statements for additional information.
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities," an update that amends and simplifies certain aspects of hedge accounting rules to better portray the economic results of risk management activities in the financial statements. The FASB has subsequently issued updates to the standard to provide additional guidance on specific topics. This guidance was adopted by the Company during the first quarter of fiscal 2019 and did not have a significant impact on the Company's financial statements.
In February 2018, the FASB issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," an update that addresses the effect of the change in the U.S. federal corporate income tax rate due to the enactment of the Tax Act on items within accumulated other comprehensive income (loss). This guidance was adopted by the Company during the first quarter of fiscal 2019 and did not have a significant impact on the Company's financial statements.
 
In July 2018, the FASB issued ASU 2018-09, "Codification Improvements," an update that provides technical corrections, clarifications and other improvements across a variety of accounting topics. The transition and effective date guidance is based on the facts and circumstances of each update; however, many of them became effective for the Company at the beginning of fiscal 2019. The adoption of this guidance did not have a significant impact on the Company's financial statements.
Recently Issued Accounting Standards
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables. This guidance will be effective for the Company beginning in fiscal 2020. Early adoption is permitted. The Company is currently evaluating the impact that adoption of this guidance will have on the consolidated and combined financial statements. The adoption of this guidance is not expected to have a significant impact on the Company's financial statements.
In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement," an update that modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. This guidance will be effective for the Company beginning in fiscal 2020. Early adoption is permitted. The Company is currently evaluating the impact that adoption of this guidance will have on its financial statement disclosures. The adoption of this guidance is not expected to have a significant impact on the Company's financial statements.
In August 2018, the FASB issued ASU 2018-14, "Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans," an update that modifies


9 Kontoor Brands, Inc. Q2 FY19 Form 10-Q

KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


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


NOTE 3 — LEASES
The Company enters into operating leases for offices, operational facilities, retail locations, vehicles and other assets that expire at various dates through 2031. Leases for real estate typically have initial terms ranging from 3 to 15 years, generally with renewal options. Leases for equipment typically have initial terms ranging from 2 to 7 years. Most leases have fixed rentals, with many of the real estate leases requiring additional payments for real estate taxes and occupancy-related costs. These lease terms may include optional renewals, terminations or purchases, which are considered in the Company’s assessments when such options are reasonably certain to be exercised.
For retail real estate leases, the Company does not typically include renewal options in the underlying lease term. For non-retail real estate leases, when renewal options are reasonably certain to be exercised, the Company includes the renewal options in the underlying lease term, up to a maximum of ten years. Renewals for all other leases are determined on a lease-by-lease basis.
Upon adoption of ASU 2016-02, the Company elected the package of practical expedients permitted under the new lease standard, which allows the Company to not reassess whether a contract contains a lease, how the lease is classified, and if initial direct costs can be capitalized. The Company elected to combine non-lease components with the related lease components for real estate, vehicles and other significant asset arrangements. The Company treats the combined items as a single lease component for accounting purposes. Lastly, the Company elected not to recognize a right-of-use asset and related lease liability for leases with a lease term of 12 months or less for all classes of underlying assets.
 
Certain of the Company’s leases contain fixed, indexed, or market-based escalation clauses which impact future payments. Certain arrangements contain variable payment provisions, such as payments based on sales volumes or amounts and mileage, or excess mileage. The Company’s leases typically contain customary covenants and restrictions.
The Company determines whether a contract is a lease at inception. This typically requires more judgment in storage and service arrangements where the Company must determine whether its rights to specific physical or production capacity may represent substantially all of the available capacity.
The Company measures right-of-use assets and related lease liabilities based on the present value of remaining lease payments, including in-substance fixed payments, the current payment amount when payments depend on an index or rate (e.g., inflation adjustments, market renewals), and the amount the Company believes is probable to be paid to the lessor under residual value guarantees, when applicable. Lease contracts may include fixed payments for non-lease components, such as maintenance, which are included in the measurement of lease liabilities for certain asset classes based on the Company’s election to combine lease and non-lease components.
As applicable borrowing rates are not typically implied within our lease arrangements, the Company discounts lease payments based on its estimated incremental borrowing rate at lease commencement, or modification, which is based on the Company’s estimated credit rating, the lease term at commencement and the contract currency of the lease arrangement.


Kontoor Brands, Inc. Q2 FY19 Form 10-Q 10


KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


The following table presents the lease-related assets and liabilities recorded in the Company's balance sheet:
(in thousands)
 
June 2019
Assets
 

Operating lease assets, noncurrent
 
$
90,416

Total lease assets
 
$
90,416

 
 
 
Liabilities
 

Operating lease liabilities, current
 
$
34,439

Operating lease liabilities, noncurrent
 
58,594

Total lease liabilities
 
$
93,033

 
 
 
Weighted-average remaining lease term (in years)
 

Operating leases
 
4.08

Weighted-average discount rate
 

Operating leases
 
2.46
%


Lease costs
The following table presents certain information related to the lease costs for operating leases:
(in thousands)
 
Three Months Ended June 2019
 
Six Months Ended June 2019
Operating lease cost
 
$
11,343

 
$
18,956

Short-term lease cost (excluding leases of one month or less)
 
1,015

 
1,506

Variable lease cost
 
735

 
3,551

Total lease costs
 
$
13,093

 
$
24,013


Rent expense associated with operating leases for the three and six months ended June 2018 totaled approximately $10.6 million and $21.2 million, respectively.

Other information
The following table presents supplemental cash flow information related to leases:
(in thousands)
 
Six Months Ended June 2019
Cash paid for amounts included in the measurement of lease liabilities:
 

Operating cash flows impact - operating leases
 
$
22,950

Right-of-use assets obtained in exchange for new operating leases
 
$
23,446




11 Kontoor Brands, Inc. Q2 FY19 Form 10-Q

KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


The following table reconciles maturities of operating lease liabilities as of June 2019 to the lease liabilities reflected in the Company's balance sheet:
(in thousands)
 
Lease Obligations
2019 (excluding the six months ended June 2019)
 
$
29,732

2020
 
29,141

2021
 
17,358

2022
 
8,285

2023
 
5,379

Thereafter
 
9,647

Total future minimum lease payments
 
99,542

Less: amounts related to imputed interest
 
(6,509
)
Present value of future minimum lease payments
 
93,033

Less: operating lease liabilities, current
 
(34,439
)
Operating lease liabilities, noncurrent
 
$
58,594


As of June 2019, the Company has entered into approximately $1.3 million of operating lease arrangements, on an undiscounted basis, that have not yet commenced. The Company continuously monitors and may negotiate contract amendments that include extensions or modifications to existing leases.
The following table presents the future minimum lease payments during the noncancelable lease terms as presented under ASC 840:
(in thousands)
 
December 2018
2019
 
$
33,562

2020
 
29,246

2021
 
17,810

2022
 
7,932

2023
 
4,353

Thereafter
 
4,582

Total future minimum lease payments
 
$
97,485


NOTE 4 — REVENUES
The Company recognizes revenue when performance obligations under the terms of a contract with the customer are satisfied based on the transfer of control of promised goods or services. The transfer of control typically occurs at a point in time based on consideration of when the customer has (i) an obligation to pay for, (ii) physical possession of, (iii) legal title to, (iv) risks and rewards of ownership of and (v) accepted the goods or services. The timing of revenue recognition within the wholesale channels occurs either on shipment or delivery of goods based on contractual terms with the customer. The timing of revenue recognition in the direct-to-consumer channels generally occurs at the point of sale within Company-operated or concession retail stores and either on shipment or delivery of goods for e-commerce transactions based on contractual terms with the customer. For finished products shipped directly to customers from our suppliers, the Company’s promise to the customer is a performance obligation to provide the specified goods and the Company has discretion in establishing pricing, and thus the Company is the principal in the arrangement and revenue is recognized on a gross basis at the transaction price.
The duration of contractual arrangements with our customers in the wholesale and direct-to-consumer channels is typically less than one year. Payment terms with customers are generally
 
between 30 and 60 days. The Company does not adjust the promised amount of consideration for the effects of a significant financing component as it is expected, at contract inception, that the period between the transfer of the promised good or service to the customer and the customer payment for the good or service will be one year or less.
The amount of revenue recognized in the wholesale and direct-to-consumer channels reflects the expected consideration to be received for providing the goods or services to the customer, which includes estimates for variable consideration. Variable consideration includes allowances for trade terms, sales incentive programs, discounts, markdowns, chargebacks and product returns. Estimates of variable consideration are determined at contract inception and reassessed at each reporting date, at a minimum, to reflect any changes in facts and circumstances. The Company utilizes the expected value method in determining its estimates of variable consideration, based on evaluations of specific product and customer circumstances, historical and anticipated trends and current economic conditions.
Revenue from the sale of gift cards is deferred and recorded as a contract liability until the gift card is redeemed by the customer, factoring in breakage as appropriate, which considers whether the


Kontoor Brands, Inc. Q2 FY19 Form 10-Q 12


KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


Company has a legal obligation to remit the value of the unredeemed gift card to any jurisdiction under unclaimed property regulations.
The VF Outlet™ stores maintain customer loyalty programs where customers earn rewards from qualifying purchases, which are redeemable for discounts on future purchases or other rewards. For its customer loyalty programs, the Company estimates the standalone selling price of the loyalty rewards and allocates a portion of the consideration for the sale of products to the loyalty points earned. The deferred amount is recorded as a contract liability, and is recognized as revenue when the points are redeemed or when the likelihood of redemption is remote.
The Company has elected to treat all shipping and handling activities as fulfillment costs and recognize the costs as "selling, general and administrative expenses" at the time the related revenue is recognized. Shipping and handling costs billed to customers are included in "net revenues." Sales taxes and value added taxes collected from customers and remitted directly to governmental authorities are excluded from the transaction price.
The Company has licensing agreements for its symbolic intellectual property, most of which include minimum guaranteed royalties. Royalty income is recognized as earned over the respective license term based on the greater of minimum guarantees or the licensees’ sales of licensed products at rates specified in the licensing contracts. Royalty income related to the minimum guarantees is recognized using a measure of progress with variable amounts recognized only when the cumulative earned royalty exceeds the minimum guarantees. As of June 2019, the Company expects to recognize $77.4 million of fixed consideration related to the future minimum guarantees in effect under its licensing agreements and expects such amounts to be recognized over time through December 2029. The variable consideration is not disclosed as a remaining performance obligation as the licensing arrangements qualify for the sales-based royalty exemption.
The Company has applied the practical expedient to recognize incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that otherwise would have been recognized is one year or less.
 
Performance Obligations
Disclosure is required for the aggregate transaction price allocated to performance obligations that are unsatisfied at the end of a reporting period, unless the optional practical expedients are applicable. The Company elected the practical expedients to not disclose the transaction price allocated to remaining performance obligations for i) variable consideration related to sales-based royalty arrangements and ii) contracts with an original expected duration of one year or less.
As of June 2019, there were no arrangements with transaction price allocated to remaining performance obligations other than (i) contracts for which the Company has applied the practical expedients discussed above and (ii) fixed consideration related to future minimum guarantees.
For the three and six months ended June 2019, revenue recognized from performance obligations satisfied, or partially satisfied, in prior periods was not material.
Contract Balances
Accounts receivable represent the Company's unconditional right to receive consideration from a customer and are recorded at net invoiced amounts, less an estimated allowance for doubtful accounts.
Contract assets are rights to consideration in exchange for goods or services that have been transferred to a customer when that right is conditional on something other than the passage of time. Once the Company has an unconditional right to consideration under a contract, amounts are invoiced and contract assets are reclassified to "accounts receivable." The Company's primary contract assets relate to sales-based royalty arrangements.
Contract liabilities are recorded when a customer pays consideration, or the Company has a right to an amount of consideration that is unconditional, before the transfer of a good or service to the customer, and thus represent the Company's obligation to transfer the good or service to the customer at a future date. The Company's primary contract liabilities relate to gift cards, loyalty programs and sales-based royalty arrangements.
The following table provides information about accounts receivable, contract assets and contract liabilities recorded in the Company's balance sheets:
(in thousands)
 
June 2019
 
 
December 2018
 
June 2018
Accounts receivable, net
 
$
254,049

 
 
$
252,966

 
$
262,525

Contract assets (a)
 
2,529

 
 
2,841

 
1,387

Contract liabilities (b)
 
2,787

 
 
2,311

 
3,215

(a) 
Included in "other current assets" in the Company's balance sheets.
(b) 
Included in "accrued liabilities" in the Company's balance sheets.
The Company recognized revenue that was previously included in the contract liability balances of $0.2 million and $1.5 million for the three and six months ended June 2019, respectively, and $0.3 million and $1.5 million for the three and six months ended June 2018, respectively. The changes in the contract asset and contract liability balances primarily result from the timing differences between the Company's satisfaction of performance obligations and the customer's payment.


13 Kontoor Brands, Inc. Q2 FY19 Form 10-Q

KONTOOR BRANDS, INC.
Notes to Consolidated and Combined Financial Statements
(Unaudited)


Disaggregation of Revenue
The following tables disaggregate our revenues by channel and geography, which provides a meaningful depiction of how the nature, timing and uncertainty of revenues are affected by economic factors. Revenues from licensing arrangements have been included within the U.S. or Non-U.S. Wholesale channels, based on the respective region covered by the agreement. Branded Direct-to-Consumer revenues include the distribution of our products via concession retail locations internationally, Wrangler® and Lee® branded full-price stores globally and Company-owned outlet stores globally. The Branded Direct-to-Consumer channel also includes our branded products sold in our U.S.-based VF Outlet™ stores and our products that are marketed and distributed online via www.wrangler.com and www.lee.com. The Other channel includes (i) sales of VF-branded and third-party branded merchandise in our VF Outlet™ stores, (ii) sales to VF for products manufactured in our plants and use of our transportation fleet and (iii) revenues from fulfilling a transition services agreement related to VF's sale of its Nautica® brand business in mid-2018.

Three Months Ended June 2019
 
 
 
 
 
 
 
 
(in thousands)
Wrangler
 
Lee
 
Other
 
Total
Channel revenues

 

 

 

U.S. Wholesale
$
299,040

 
$
108,757

 
$
4,710

 
$
412,507

Non-U.S. Wholesale
40,569

 
56,845

 
633

 
98,047

Branded Direct-To-Consumer
24,383

 
41,306

 
14

 
65,703

Other

 

 
33,489

 
33,489

Total
$
363,992

 
$
206,908

 
$
38,846

 
$
609,746

 
 
 
 
 
 
 
 
Geographic revenues

 

 

 

U.S.
$
317,831

 
$
130,795

 
$
38,002

 
$
486,628

International
46,161

 
76,113

 
844

 
123,118

Total
$
363,992

 
$
206,908

 
$
38,846

 
$
609,746

 
Three Months Ended June 2018
 
 
 
 
 
 
 
 
(in thousands)
Wrangler
 
Lee
 
Other
 
Total
Channel revenues

 

 

 

U.S. Wholesale
$
311,222

 
$
100,674

 
$
7,094

 
$
418,990

Non-U.S. Wholesale
59,624

 
73,076

 
26

 
132,726

Branded Direct-To-Consumer
26,899

 
44,023

 
27

 
70,949

Other

 

 
41,191