Kontoor Brands, Inc. (KTB) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. This section should be read in conjunction with the Consolidated Financial Statements and related Notes included in Part IV of this Annual Report on Form 10-K. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Form 10-K for the fiscal year ended January 1, 2022, for discussion of the results of operations for the year ended January 1, 2022, compared to the year ended January 2, 2021.

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 and in Part I, Item 1A "Risk Factors" in 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, distributes and licenses apparel, footwear and accessories, primarily under the brand names Wrangler® and Lee®. The Company's products are sold in the U.S. through mass merchants, specialty stores, mid-tier and traditional department stores, company-operated stores and online. The Company’s products are also sold internationally, primarily in the Europe, Middle East and Africa ("EMEA") and Asia-Pacific (“APAC”) regions, through department, specialty, company-operated, concession retail and independently-operated partnership stores and online.

Fiscal Year and Basis of Presentation

The Company operates and reports using a 52/53 week fiscal year ending on the Saturday closest to December 31 of each year. For presentation purposes herein, all references to periods ended December 2022, December 2021 and December 2020 correspond to the 52-week fiscal years ended December 31, 2022 and January 1, 2022 and the 53-week fiscal year ended January 2, 2021, respectively.

References to fiscal 2022 and 2021 foreign currency amounts herein reflect the impact of changes in foreign exchange rates from fiscal 2021 and 2020, 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, the Chinese yuan and the Mexican peso. However, the Company conducts business in other developed and emerging markets around the world with exposure to other foreign currencies.

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

Macroeconomic Environment and Other Recent Developments

Macroeconomic conditions, including inflation, rising interest rates, recessionary concerns, distress in global credit markets and foreign currency exchange rates, as well as ongoing supply chain disruptions, labor challenges and the COVID-19 pandemic, continue to adversely impact global economic conditions, as well as the Company's operations. We do not have significant operations in Russia or Ukraine, and exited our distribution arrangement in Russia in 2022. However, the conflict between Russia and Ukraine continues to cause disruption in the surrounding areas and greater uncertainty in the global economy.

Inflationary pressures increased key input costs and softened consumer demand beginning late in the second quarter of 2022 and continued through the second half of 2022. The rise in interest rates during the second half of 2022 also contributed to reduced consumer discretionary spending, resulting in retailer actions to reduce their inventory levels which negatively impacted our sales, primarily during the third quarter of 2022.

We continued to experience delays in product and raw material availability into the first half of 2022 due largely to global supply chain disruptions, driven in part by port congestion and transportation delays, and incurred transitory costs, including air freight to expedite shipments to meet customer demand. Many global supply chain disruptions became less prevalent during the second half compared to the first half of 2022. Accordingly, we were able to reduce our use of air freight, but experienced increases in other input costs, including ocean freight.

We experienced store closures, disruptions in distribution and restrictions on consumer mobility in certain regions of China during 2022 due to COVID-19 and related restrictions, which had a significant impact on sales and operations in APAC. We took actions to manage these impacts including the expansion of our credit lines in the region during the second quarter of 2022 to ensure sufficient liquidity.

All of the above factors contributed to increased inventory levels, primarily in core product. This increase was most significant in the third quarter of 2022. To manage inventory, we adjusted receipts on sourced goods and took downtime in our internal manufacturing

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facilities in the fourth quarter of 2022. These conditions drove higher provisions for inventory losses in 2022 compared to the prior year. We continue to work with our customers and vendors to meet ongoing demand and minimize supply chain impacts.

While we anticipate continued macroeconomic uncertainty during 2023, we believe that we are appropriately positioned to successfully manage through known operational challenges. We continue to closely monitor macroeconomic conditions, including consumer behavior and the impact of these factors on consumer demand and our business.

Business Overview

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

To support our growth initiatives, we took actions to globalize our operating model and relocate our European headquarters to Geneva, Switzerland ("EMEA restructuring"), and incurred $13.7 million of severance and employee-related benefits, $2.6 million of the associated pension curtailment gain and $1.5 million of other costs associated with these actions. Refer to Note 21 to the Company's financial statements for additional information related to restructuring charges. We also made significant investments to support the design and implementation of our global enterprise resource planning ("ERP") system and information technology infrastructure build-out ("ERP implementation"), which was completed in 2021. In 2022, we continued to invest in areas such as digital and information technology that leverage our global ERP platform. Certain prior year comparisons are affected by ERP implementation costs incurred in 2021.

In addition to continued organic investments in our brands and capabilities, the options in our capital allocation strategy are to (i) pay down debt, (ii) provide for a superior dividend payout, (iii) effectively manage our share repurchase authorization and (iv) act on strategic investment opportunities that may arise.

HIGHLIGHTS OF THE YEAR ENDED DECEMBER 2022

•Net revenues increased 6% to $2.6 billion compared to the year ended December 2021, driven by growth in the U.S. Wholesale and Direct-to-Consumer channels, partially offset by a 2% unfavorable impact from foreign currency and a decline in the Non-U.S. Wholesale channel as discussed below.

•U.S. Wholesale revenues increased 11% compared to the year ended December 2021, due to strength across the channel, including growth in new business and U.S. digital wholesale. U.S. Wholesale revenues represented 72% of total revenues in the current year.

•Non-U.S. Wholesale revenues decreased 8% compared to the year ended December 2021, driven by a 7% unfavorable impact from foreign currency and a decline in our APAC business due to COVID-19 restrictions in China. Non-U.S. wholesale revenues represented 17% of total revenues in the current year.

•Direct-to-Consumer revenues increased 1% on a global basis compared to the year ended December 2021, primarily due to growth in our owned e-commerce sites, partially offset by a decline in retail store sales and a 3% unfavorable impact from foreign currency. Direct-to-Consumer revenues represented 11% of total revenues in the current year.

•Gross margin decreased 160 basis points to 43.1% compared to the year ended December 2021, primarily driven by increased product and ocean freight costs due to inflationary pressures, as well as higher provisions for inventory losses. These decreases were partially offset by benefits from strategic pricing.

•Selling, general and administrative expenses as a percentage of revenues decreased to 29.6% compared to 33.3% for the year ended December 2021, primarily due to a 300 basis point decrease in costs related to the Company's ERP implementation, lower compensation-related expense and lower retail store expenses. These decreases were partially offset by ongoing investments in information technology, costs related to the EMEA restructuring, and increases in distribution expense in the current period.

•Net income increased 26% to $245.5 million compared to the year ended December 2021, primarily due to the business results discussed above.

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ANALYSIS OF RESULTS OF OPERATIONS

Consolidated Statements of Operations

The following table presents a summary of the changes in net revenues for the years ended December 2022 and December 2021:

2022 Compared to 2021

Net revenues increased 6%, attributable to growth in the U.S. driven by new business, digital wholesale and our owned e-commerce sites. These increases were partially offset by a decline in our APAC business due to COVID-19 restrictions in China and a 2% unfavorable impact from foreign currency.

Additional details on 2022 and 2021 revenues are provided in the section titled “Information by Business Segment.”

The following table presents components of the Company's statements of operations as a percent of net revenues:

2022 Compared to 2021

Gross margin decreased 160 basis points primarily driven by increased product and ocean freight costs due to inflationary pressures, as well as higher provisions for inventory losses. These decreases were partially offset by benefits from strategic pricing.

Selling, general and administrative expenses as a percentage of net revenues decreased to 29.6% compared to 33.3% for the year ended December 2021, primarily due to a 300 basis point decrease in costs related to the Company's ERP implementation, lower compensation-related expense and lower retail store expenses. These decreases were partially offset by ongoing investments in information technology, costs related to the EMEA restructuring, and increases in distribution expense in the current period.

The effective income tax rate for the year ended December 2022 was 23.1% compared to 20.1% for the year ended December 2021. The 2022 effective income tax rate included a net discrete tax expense primarily related to changes in deferred tax valuation allowances. The net discrete tax expense for the year ended December 2022 increased the effective income tax rate by 3.4%. The year ended December 2021 included a net discrete tax benefit primarily related to benefits from stock-based compensation, partially offset by changes in deferred tax valuation allowances. The net discrete tax benefit for the year ended December 2021 decreased the effective income tax rate by 0.1%.

The effective tax rate without discrete items for the year ended December 2022 was 19.7% compared to 20.2% for the year ended December 2021. The decrease was primarily due to changes in our jurisdictional mix of earnings. Our effective income tax rate for foreign operations was 8.3% and 10.4% for the years ended December 2022 and December 2021, respectively.

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Information by Business Segment

Management at each of the segments has direct control over and responsibility for corresponding net revenues and operating income, hereinafter termed "segment revenues" and "segment profit," respectively. The chief operating decision maker allocates resources and assesses performance based on the global brand operating results of Wrangler® and Lee®, which are the Company's segments. 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 2022 and December 2021:

Segment Revenues

Segment Profit

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

Wrangler

2022 Compared to 2021

Global revenues for the Wrangler® brand increased 11%, driven by growth in the U.S. Wholesale and Direct-to-Consumer channels, partially offset by a decline in the Non-U.S. Wholesale channel.

•Revenues in the Americas region increased 13%, primarily due to a 12% increase in the U.S. Wholesale channel, as well as growth in our owned e-commerce sites. Increases in the U.S. Wholesale channel were driven by strength in our Western, Traditional and Workwear businesses and growth in the U.S. digital wholesale business. Non-U.S. Americas wholesale revenues increased 18%, primarily due to new business growth in Mexico and the less significant impact of COVID-19 compared with the prior year, partially offset by a 3% unfavorable impact from foreign currency.

•Revenues in the APAC region decreased 31%, driven by a decrease in our India business, where we have transitioned to a licensed model, and a 4% unfavorable impact from foreign currency.

•Revenues in the EMEA region decreased 6%, primarily driven by a 12% unfavorable impact from foreign currency, partially offset by an increase in retail store sales.

Operating margin decreased to 18.4% compared to 18.7% for 2021, primarily driven by increased product and ocean freight costs due to inflationary pressures and higher distribution costs. These decreases were partially offset by benefits from strategic pricing, lower compensation-related expense and restructuring and separation costs. During 2021, operating margin was negatively impacted by 30 basis points due to restructuring and separation costs, and there were no restructuring costs that impacted operating margin during 2022.

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Lee

2022 Compared to 2021

Global revenues for the Lee® brand decreased 1%, with growth in the U.S. Wholesale channel more than offset by declines in the Non-U.S. Wholesale and Direct-to-Consumer channels and a 3% unfavorable impact from foreign currency.

•Revenues in the Americas region increased 8%, primarily due to a 10% increase in the U.S. wholesale channel, as well as growth in our owned e-commerce sites, partially offset by a decrease in retail store sales. Increases in U.S. Wholesale were driven by strength across the channel, including our U.S. digital wholesale business. Non-U.S. Americas wholesale revenues increased 18%, primarily due to higher sales in Mexico and the less significant impact of COVID-19 compared with the prior year period.

•Revenues in the APAC region decreased 24%, primarily due to declines in wholesale revenues and decreased retail store sales in China due to COVID-19 restrictions, and a 3% unfavorable impact from foreign currency.

•Revenues in the EMEA region decreased 5%, primarily due to a 12% unfavorable impact from foreign currency, partially offset by an increase in retail store sales.

Operating margin decreased to 13.8% compared to 14.5% for 2021, primarily driven by increased product and ocean freight costs due to inflationary pressures and higher distribution costs. These decreases in operating margin were partially offset by benefits from strategic pricing and lower compensation-related expense, retail store expenses and restructuring and separation costs. During 2021, operating margin was negatively impacted by 30 basis points due to restructuring and separation costs, and there were no restructuring costs that impacted operating margin during 2022.

Other

In addition, we report an "Other" category in order to reconcile segment revenues and segment profit to the Company's operating results, but the Other category does not meet the criteria to be considered a reportable segment. Other primarily includes sales and licensing of Rock & Republic®, other company-owned brands and private label apparel. Other also included sales of third-party branded merchandise at company-owned outlet stores through the first quarter of 2021, after which they were discontinued.

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Reconciliation of Segment Profit to Income Before Income Taxes

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

2022 Compared to 2021

Corporate and other expenses decreased $52.0 million, primarily due to decreased costs related to the exit of the transition service agreements with our former parent in August 2021 and the Company's ERP implementation. These decreases were partially offset by $13.7 million of costs related to the EMEA restructuring.

Interest expense decreased $4.0 million, primarily due to accelerated amortization of the original issue discount and debt issuance costs associated with refinancing and early repayments in 2021 on our Credit Facilities (as defined below), partially offset by higher borrowing rates for long-term debt during 2022 compared to 2021.

ANALYSIS OF FINANCIAL CONDITION

Liquidity and Capital Resources

The Company's ability to fund our operating needs is dependent upon our ability to generate positive long-term cash flow from operations and maintain our debt financing on acceptable terms. The Company has historically generated strong positive cash flows from operations. However, during the second half of 2022, elevated retailer inventories, reduced consumer discretionary spending and the negative impact on our sales drove higher Kontoor inventory levels, resulting in increased working capital and reduced cash flows from operations. The Company is taking proactive measures to manage working capital. We believe cash flows from operations will be able to support our short-term liquidity needs as well as any future liquidity and capital requirements, in combination with available cash balances and borrowing capacity from our amended revolving credit facility.

In May 2019, the Company entered into a $1.55 billion senior secured credit facility (the "Credit Agreement"). 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.

On November 18, 2021, the Company completed a refinancing pursuant to which it issued $400.0 million of unsecured 4.125% senior notes due 2029 (the “Notes”) and amended and restated its Credit Agreement (the “Amended Credit Agreement”). The Amended Credit Agreement provides for (i) a five-year $400.0 million term loan A facility (“Amended Term Loan A”), with mandatory repayments beginning in March 2023 and (ii) a five-year $500.0 million revolving credit facility (the “Amended Revolving Credit Facility”) (collectively, the “Amended Credit Facilities”) with the lenders and agents party thereto. The net proceeds from the offering of the Notes, together with $7.6 million of cash on hand, were used to repay $265.0 million of the principal amount outstanding under Term Loan A, and all of the $133.0 million principal amount outstanding under Term Loan B.

These debt obligations could restrict our future business strategies and could adversely impact our future results of operations, financial conditions or cash flows. Refer to Note 10 to the Company's financial statements in this Form 10-K for additional information regarding the Company's Notes and Amended Credit Facilities, including covenants and interest rates thereunder, and borrowing limits and availability as of December 2022.

As of December 2022, the Company was in compliance with all applicable covenants under the Amended Credit Agreement and expects to maintain compliance with the applicable covenants for at least one year from the issuance of these financial statements. If economic conditions significantly deteriorate for a prolonged period, this could impact the Company's operating results and cash flows and thus our ability to maintain compliance with the applicable covenants. As a result, the Company could be required to seek new amendments to the Amended Credit Agreement or secure other sources of liquidity, such as refinancing of existing borrowings, the issuance of debt or equity securities, or sales of assets. However, there can be no assurance that the Company would be able to obtain such additional financing on commercially reasonable terms or at all.

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The Amended Revolving Credit Facility may be used to borrow funds in both U.S. dollar and certain non-U.S. dollar currencies, and has a maximum borrowing capacity of $500.0 million and a $75.0 million letter of credit sublimit. The Company had no outstanding borrowings under the Amended Revolving Credit Facility as of December 2022.

The following table presents outstanding borrowings and available borrowing capacity under the Amended Revolving Credit Facility and our cash and cash equivalents balances as of December 2022:

(1) Available borrowing capacity under the Amended Revolving Credit Facility is net of $12.1 million of outstanding standby letters of credit issued on behalf of the Company under this facility.

At December 2022 and December 2021, the Company had $24.8 million and $10.1 million, respectively, of international lines of credit with various banks, which are uncommitted and may be terminated at any time by either the Company or the banks. There was $7.1 million of outstanding balances under these arrangements at December 2022, and no outstanding balances at December 2021. In addition, short-term borrowings included other debt of $0.2 million at both December 2022 and December 2021.

On August 5, 2021, the Company announced that its Board of Directors approved a share repurchase program (the "Repurchase Program"). The Repurchase Program authorized the repurchase of up to $200.0 million of the Company's outstanding Common Stock through open market or privately negotiated transactions. The timing and amount of repurchases are determined by the Company's management based on its evaluation of market conditions, share price, legal requirements and other factors. The Repurchase Program does not have an expiration date but may be suspended, modified or terminated at any time without prior notice. During the years ended December 2022 and December 2021, the Company repurchased 1.5 million and 1.4 million shares of Common Stock, respectively, for $62.5 million and $75.5 million, respectively, including commissions, under the Repurchase Program. Beginning in 2023, the Company will be subject to a 1% excise tax on net stock repurchases under the Inflation Reduction Act of 2022. All shares reacquired in connection with the Repurchase Program are treated as authorized and unissued shares upon repurchase. Of the $200.0 million authorized for repurchase under the share repurchase program, $62.0 million remained available for repurchase as of December 2022.

During 2022, the Company paid $103.7 million of dividends to its shareholders. On February 21, 2023, the Board of Directors declared a regular quarterly cash dividend of $0.48 per share of the Company's Common Stock. The cash dividend will be payable on March 20, 2023, to shareholders of record at the close of business on March 10, 2023.

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

We anticipate utilizing cash flows from operations to support continued investments in our brands, talent and capabilities, strategic investment opportunities that may arise, dividend payments to shareholders, repayment of our debt obligations over time and repurchases of Common Stock. Management believes that our cash balances and funds provided by operating activities, along with existing borrowing capacity and access to capital markets, taken as a whole, provide (i) adequate liquidity to meet all of our current and long-term obligations when due, (ii) adequate liquidity to fund capital expenditures and planned dividend payouts and (iii) flexibility to repurchase Common Stock and fund strategic investment opportunities.

We currently expect capital expenditures to range from $35.0 million to $40.0 million in 2023, primarily to support manufacturing, information technology, owned brick and mortar stores and distribution.

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The following table presents our cash flows during the periods:

Operating Activities

During 2022, cash provided by operating activities decreased $200.3 million as compared to 2021. The decrease was primarily due to unfavorable changes in working capital accounts, primarily related to increases in inventory as discussed above, as well as accounts payable and accrued liabilities, partially offset by favorable changes in accounts receivable and net income.

Investing Activities

During 2022, cash used by investing activities decreased $9.3 million as compared to 2021, primarily due to declines in capitalized computer software, partially offset by higher property, plant and equipment expenditures.

Financing Activities

During 2022, cash used by financing activities decreased $133.2 million as compared to 2021. This decrease was primarily due to our debt refinancing in 2021 where we repaid $523.0 million of term loans, partially offset by $400.0 million of proceeds from the issuance of the Notes.

Contractual Obligations

The Company believes it has sufficient liquidity to fund its operations and meet its short-term and long-term obligations. The Company's estimated contractual obligations and other commercial commitments at December 2022 and the future periods in which such obligations are expected to be settled in cash are described below.

Contractual commitments on the Company's balance sheets include obligations to make principal payments on $800 million of long-term debt based on the defined terms of our debt agreements. Refer to Note 10 to the Company's financial statements in this Form 10-K for additional information. These debt agreements also require periodic interest payments on floating and fixed rate terms. Future estimated interest payments under these agreements, based on interest rates in effect as of December 2022 and the remaining terms of the debt arrangements, are $40.7 million, $39.9 million, $38.7 million, $35.1 million and $16.5 million for 2023 through 2027, respectively, and $33.0 million thereafter.

The Company has future payments related to "other liabilities" recorded in the balance sheets, which primarily represent long-term liabilities for deferred compensation and other employee-related benefits. Refer to Note 11 and Note 12 to the Company's financial statements in this Form 10-K for additional information.

The Company is obligated under noncancelable operating leases. Refer to Note 19 to the Company's financial statements in this Form 10-K for additional information related to future lease payments.

The Company has unrecorded commitments consisting of inventory obligations, minimum royalty payments and other obligations. Other obligations represent other binding commitments for the expenditure of funds, including (i) amounts related to contracts not involving the purchase of inventories, such as the noncancelable portion of service or maintenance agreements for management information systems, (ii) capital spending and (iii) advertising. Refer to Note 20 to the Company's financial statements in this Form 10-K for additional information.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financial arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

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Critical Accounting Policies and Estimates

We have chosen accounting policies that management believes are appropriate to accurately and fairly report our operating results and financial position in conformity with Generally Accepted Accounting Principles. We apply these accounting policies in a consistent manner. Significant accounting policies are summarized in Note 1 to the Company's financial statements included in Part IV of this Annual Report on Form 10-K.

The application of these accounting policies requires that we make estimates and assumptions about future events and apply judgments that affect the reported amounts of assets, liabilities, net revenues, expenses, contingent assets and liabilities and related disclosures. These estimates, assumptions and judgments are based on historical experience, current trends and other factors believed to be reasonable under the circumstances. Management evaluates these estimates and assumptions on an ongoing basis. Because our business cycle is relatively short (i.e., from the date that inventory is received until that inventory is sold and the trade accounts receivable is collected), actual results related to most estimates are known within a few months after any balance sheet date. In addition, we may retain outside specialists to assist in impairment testing of goodwill and intangible assets. Several of the estimates and assumptions we are required to make relate to future events and are therefore inherently uncertain, especially as it relates to events outside of our control. If actual results ultimately differ from previous estimates, the revisions are included in results of operations when the actual amounts become known.

We believe the following accounting policies involve the most significant management estimates, assumptions and judgments used in preparation of the financial statements or are the most sensitive to change from outside factors. The selection and application of the Company’s critical accounting policies and estimates are periodically discussed with the Audit Committee of the Board of Directors.

Impairment Testing of Long-Lived Assets, Including Intangible Assets and Goodwill

Long Lived Assets — Property, Plant and Equipment and Operating Lease Assets

Description

Our policy is to review property, plant and equipment and operating lease assets for potential impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. We test for potential impairment at the asset or asset group level, which is the lowest level for which there are identifiable cash flows that are largely independent, by comparing the carrying value to the estimated undiscounted cash flows expected to be generated by the asset. If the forecasted undiscounted cash flows to be generated by the asset are not expected to be adequate to recover the asset’s carrying value, a fair value analysis must be performed, and an impairment charge is recorded if there is an excess of the asset’s carrying value over its estimated fair value.

Judgments and Uncertainties

When testing property, plant and equipment or operating lease assets for potential impairment, management uses the income-based discounted cash flow method using the estimated cash flows of the respective asset or asset group. We include assumptions about sales growth and operating margins, considered against our budgets, business plans and economic projections. Assumptions are also made for varying terminal growth rates for years beyond the forecast period. Generally, we utilize operating margin assumptions based on future expectations, operating margins historically realized in the reporting units’ industries and industry marketplace valuation multiples.

The estimated undiscounted cash flows of the asset or asset group through the end of its useful life are compared to its carrying value. If the undiscounted cash flows of the asset or asset group exceed its carrying value, there is no impairment charge. If the undiscounted cash flows of the asset or asset group are less than its carrying value, the estimated fair value of the asset or asset group is calculated based on the discounted cash flows using the reporting unit’s weighted average cost of capital (“WACC”), and an impairment charge is recognized for the difference between the estimated fair value of the asset or asset group and its carrying value.

Effect if Actual Results Differ From Assumptions

We have not made any material changes in the methodology used to evaluate the impairment of property, plant and equipment and operating lease assets during 2022. We do not believe there is a reasonable likelihood there will be a material change in the estimates or assumptions used to calculate impairments, useful lives of property, plant and equipment or term length of leases. However, if actual results are not consistent with our estimates and assumptions used to calculate estimated future cash flows, we may be exposed to potentially material impairments. As of December 2022, the effect of a hypothetical 10% change in the aforementioned key assumptions would not have a material effect on reported results.

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Indefinite-Lived Intangible Assets and Goodwill

Description

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. As part of our annual impairment testing, we may elect to assess qualitative factors as a basis for determining whether it is necessary to perform quantitative impairment testing. If management’s assessment of these qualitative factors indicates that it is not more likely than not that the fair value of the intangible asset or reporting unit is less than its carrying value, then no further testing is required. Otherwise, the intangible asset or reporting unit must be quantitatively tested for impairment.

Judgments and Uncertainties

An indefinite-lived intangible asset is quantitatively tested for possible impairment by comparing the estimated fair value of the asset to its carrying value. Fair value of an indefinite-lived trademark is based on an income approach using the relief-from-royalty method. Under this method, forecasted net revenues for products sold with the trademark are assigned a royalty rate that would be charged to license the trademark (in lieu of ownership), and the estimated fair value is calculated as the present value of those forecasted royalties avoided by owning the trademark. The discount rate is based on the reporting unit’s WACC that considers market participant assumptions, plus a spread that factors in the risk of the intangible asset. The royalty rate is selected based on consideration of (i) royalty rates included in active license agreements, if applicable, (ii) royalty rates received by market participants in the apparel industry and (iii) the current performance of the reporting unit. If the estimated fair value of the trademark intangible asset exceeds its carrying value, there is no impairment charge. If the estimated fair value of the trademark is less than its carrying value, an impairment charge would be recognized for the difference.

Goodwill is quantitatively evaluated for possible impairment by comparing the estimated fair value of a reporting unit to its carrying value. Reporting units are businesses with discrete financial information that is available and reviewed by segment management.

For goodwill impairment testing, we estimate the fair value of a reporting unit using both income-based and market-based valuation methods. The income-based approach is based on the reporting unit’s forecasted future cash flows that are discounted to present value using the reporting unit’s WACC as discussed above. For the market-based approach, management uses both the guideline company and similar transaction methods. The guideline company method analyzes market multiples of net revenues and earnings before interest, taxes, depreciation and amortization (“EBITDA”) for a group of comparable public companies. The market multiples used in the valuation are based on the relative strengths and weaknesses of the reporting unit compared to the selected guideline companies. Under the similar transactions method, valuation multiples are calculated utilizing actual transaction prices and net revenue / EBITDA data from target companies deemed similar to the reporting unit.

Based on the range of estimated fair values developed from the income and market-based methods, we determine the estimated fair value for the reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, the goodwill is not impaired and no further review is required. However, if the estimated fair value of the reporting unit is less than its carrying value, we calculate the impairment loss as the difference between the carrying value of the reporting unit and the estimated fair value.

The income-based fair value methodology requires management’s assumptions and judgments regarding economic conditions in the markets in which we operate and conditions in the capital markets, many of which are outside of management’s control. At the reporting unit level, fair value estimation requires management’s assumptions and judgments regarding the effects of overall economic conditions on the specific reporting unit, along with assessment of the reporting unit’s strategies and forecasts of future cash flows. Forecasts of individual reporting unit cash flows involve management’s estimates and assumptions regarding:

•Annual cash flows, on a debt-free basis, arising from future net revenues and profitability, changes in working capital, capital spending and income taxes for at least a ten-year forecast period.

•A terminal growth rate for years beyond the forecast period. The terminal growth rate is selected based on consideration of growth rates used in the forecast period, historical performance of the reporting unit and economic conditions.

•A discount rate that reflects the risks inherent in realizing the forecasted cash flows. A discount rate considers the risk-free rate of return on long-term treasury securities, the risk premium associated with investing in equity securities of comparable companies, the beta obtained from comparable companies and the cost of debt for investment grade issuers. In addition, the discount rate may consider any company-specific risk in achieving the prospective financial information.

Under the market-based fair value methodology, judgment is required in evaluating market multiples and recent transactions. Management believes that the assumptions used for its impairment tests are representative of those that would be used by market participants performing similar valuations of our reporting units.

Effect if Actual Results Differ From Assumptions

Management makes its estimates based on information available as of the date of our assessment, using assumptions we believe market participants would use in performing an independent valuation of the business. It is possible that our conclusions regarding impairment or recoverability of goodwill or intangible assets in any reporting unit could change in future periods. There can be no assurance that the estimates and assumptions used in our goodwill and intangible asset impairment testing will prove to be accurate

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predictions of the future, if, for example, (i) the businesses do not perform as projected, (ii) overall economic conditions in future years vary from current assumptions (including changes in discount rates), (iii) business conditions or strategies for a specific reporting unit change from current assumptions, including loss of major customers, (iv) investors require higher rates of return on equity investments in the marketplace or (v) enterprise values of comparable publicly traded companies, or actual sales transactions of comparable companies, were to decline, resulting in lower multiples of net revenues and EBITDA. A future impairment charge for goodwill or intangible assets could have a material effect on our financial position and results of operations. As of December 2022, the effect of a hypothetical 10% change in the aforementioned key assumptions would not have a material effect on reported results.

Income Taxes

Description

As a global company, Kontoor is subject to income taxes and files income tax returns in over 50 U.S. and foreign jurisdictions each year. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. The Company could be subject to changes in its tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities. The Company makes an ongoing assessment to identify any significant exposure related to increases in tax rates in the jurisdictions in which the Company operates.

Judgments and Uncertainties

The calculation of income tax liabilities involves uncertainties in the application of complex tax laws and regulations, which are subject to legal interpretation and significant management judgment. The Company’s income tax returns are regularly examined by federal, state and foreign tax authorities, and those audits may result in proposed adjustments. The Company has reviewed all issues raised upon examination, as well as any exposure for issues that may be raised in future examinations. The Company has evaluated these potential issues under the “more-likely-than-not” standard of the accounting literature. A tax position is recognized if it meets this standard and is measured at the largest amount of benefit that has a greater than 50% likelihood of being realized.

Effect if Actual Results Differ From Assumptions

Such judgments and estimates may change based on audit settlements, court cases, proposed tax regulations and interpretation of tax laws and regulations. Income tax expense could be materially affected to the extent the Company prevails in a tax position or when the statute of limitations expires for a tax position for which a liability for unrecognized tax benefits or valuation allowances have been established, or to the extent the Company is required to pay amounts greater than the established liability for unrecognized tax benefits. The Company does not currently anticipate any material impact on earnings from the ultimate resolution of income tax uncertainties. There are no accruals for general or unknown tax expenses.

The Company has $25.7 million of gross deferred income tax assets related to operating loss carryforwards, and $23.0 million of valuation allowances against those assets. Realization of deferred tax assets related to operating loss carryforwards is dependent on future taxable income in specific jurisdictions, the amount and timing of which are uncertain, and on possible changes in tax laws. If management believes that the Company will not be able to generate sufficient taxable income to offset losses during the carryforward periods, the Company records valuation allowances to reduce those deferred tax assets to amounts expected to be ultimately realized. If in a future period management determines that the amount of deferred tax assets to be realized differs from the net recorded amount, the Company would record an adjustment to income tax expense in that future period.

Recently Issued and Adopted Accounting Standards

Refer to Note 1 to the Company's financial statements included elsewhere in this Annual Report on Form 10-K for discussion of recently issued and adopted accounting standards.

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