Advantage Big Guys with Solid Processes and Cash Flow: VF’s Quarter

Before I dive too deep into the financial weeds, let’s look at VF’s overall strategy as explained by CEO Steve Rendle and Chief Financial Officer Scott Roe in their conference call discussing the results for the quarter ended June 30, 2017.

Strategy Stuff

Steve: “…while we expect the retail landscape to remain uncertain, we will invest against our largest growth opportunities to create momentum rather than wait for it.”

They have the cash flow and balance sheet to do this.

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“Sacrifice a Little Growth…for Quality.” VF’s March 31st Quarter

Well, there you have it.  At some level, it is that simple.   But let me complete CFO Scott Roe’s comment in the conference call.  “…we are sharply focused on fundamentals and willing to sacrifice a little growth in the near term for quality. Our efforts are clearly paying off in the gross margin line. And we believe our decisions will improve the long-term health of both our brands and the marketplace.”

They improved their gross margin 1.3% (remember that’s a mixed retail and wholesale gross margin and, unfortunately, they don’t break it down between the two).  Distribution matters these days in brand building, and you can afford to give up some sales if you increase your gross margin that much.  In fact, I’d suggest you get that margin increase precisely because you made some distribution decisions that improved the “quality” of your sales.  Scott notes later, referring to off price business, that they’ve “…already cleaned a lot of that up.”

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How Was VF’s Year?

It’s accurate to say that VF ran into the same issues and economic dislocations as other brands and retailers.  During their fourth quarter, ended December 31, 2016, revenues fell 2.7% from $3.41 billion to $3.32 billion in the quarter ended December 31, 2015 (the prior calendar period- PCP).  Net income was also down from $312 to $264 million, or by 16.7%.

For the year, revenue was almost the same at just over $12 billion.  Net income fell 12.8% from $1.32 in 2016 to $1.07 billion in 2015 (also the PCP).  More details and nuance later.  I wanted you to have those numbers as we talk strategy.

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We’re All in This Together: Things to Think About from VF’s Quarterly Report

We’re All in This Together:  Things to Think About from VF’s Quarterly Report

VF’s 10-Q for the quarter ended September 30 showed up last week.  As usual, I’ll look at the numbers.  But I want to focus on several statements and action VF highlights in their conference call and 10-Q.  They highlight the extent to which we’re all dealing with the same economic and business conditions, and how we’re mostly dealing them in the same way. There’s also a couple of good ideas in here and maybe an “AHA” moment.

I’ll start by quoting CEO Eric Wiseman’s comment on the business environment.

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VF’s June 30 Quarter: It’s Not Easy Out There for Anybody

After the results we’ve seen from VF in previous quarters and years, this quarter’s can only be characterized as disappointing.  Just goes to show you how difficult the market is right now.  They’ve got lots of company.

Total revenue rose just 0.75% to $2.445 billion.  VF ended the quarter with 1,461 brick and mortar stores worldwide. Direct to consumer business was up 6% in the quarter and accounted for 27% of total revenues.  “The increase in direct to consumer revenues…were due to new store openings and an expanding e-commerce business.”  The increase was not, apparently, due to higher comparable store sales or I assume we would have been told about it.  International revenue was 35% of total revenue.

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VF’s Quarter: It’s Not Easy for Anybody Out There

VF filed its 10-Q for the quarter ended April 2nd on May 10th.  The results, while in line with expectations, showed VF under the same kind of pressure other public companies are dealing with.  Even their action sports segment, where most of their growth has been coming from, experienced very modest sales growth and reduced operating income.

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VF’s June 30 Quarter: Damn This Strong Dollar!

VF reported a 4.62% revenue increase in the quarter that ended June 30 compared to the same quarter last year (prior calendar period- PCP). The increase was from $2.402 to $2.514 billion. As usual, we’ll focus on the Outdoor & Action Sports (OAS) segment, as that’s where most of the action seems to be.

Below is the chart from the 10Q that lays out the revenues and operating profits of each of VF’s segments for the quarter and the half year.

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Portfolio Theory at Work at VF; Their Quarterly Results.

VF’s 10Q for the quarter ended September showed another strong result. You can see the 10Q here. However, as with recent quarters, the good news was pretty much limited to their outdoor and action sport segment (OAS). I want to talk a bit about what that might mean, but first, let’s lay out the numbers.

VF’s revenue grew 6.8% from $3.3 to $3.52 billion. Gross margin rose from 47.6% to 48.3%. OAS has the highest gross margin of any of the company’s segments.

SG&A expense rose 8.1% from $0.989 to $1.069 billion. Operating income was $633 million, a 6.2% increase over the $580 million in last year’s quarter. At $20.7 million, net interest expense was almost unchanged. Net income rose from $434 to $471 million.

Okay, let’s break it down a little. Below is the chart from the 10Q that shows revenue and operating profit by segment- by coalition as they call their segments. I’ve included the information for both the quarter and the nine month period.

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What do we see when we evaluate this chart? First, note that OAS revenues were up 10.6% for the quarter. Remember that total quarterly revenues for the whole company rose by 6.8%. That translates into a revenue increase of 1.1% for all the segments combined excluding OAS. So OAS saved the day for VF.

OAS represented 62% of total revenue for the quarter, up from 60% in last year’s quarter. And it generated 67.5% of all operating profits, up from 64.5% in last year’s quarter. OAS operating profit rose by 12.8% from $421 to $475 million, or by $54.2 million. Operating profits in all other segments combined actually fell slightly from $232.4 million to $228.9 million. That’s not good.

OAS, and especially The North Face, Vans, and Timberland, are the engines pulling this train right now. Their revenues grew by 9%, 12% and 15% respectively during the quarter. OAS revenues in the Americas, European and Asia Pacific regions were up, respectively, 11%, 10% and 13%. Direct to consumer (online and their own retail stores) rose 20%. Wholesale revenues were up 8%

Here are some comments from the conference call on brand performance. For The North Face, “In the Americas revenues were up at a low double-digit percentage rate with almost 30% growth in D2C and high single-digit growth in wholesale.”

In Europe, “…The North Face revenues increased at the low single-digit rate. Our wholesale business was essentially flat due to a combination of a sluggish outdoor retail environment and a shift in the timing of product shipments into the fourth quarter. However our D2C business was up nearly 30% in the quarter…” In Asia, North Face revenue rose “…at the mid-single digit rate.”

Now for Vans. “In the Americas, revenues increased at a high single-digit rate.” In Europe, “…revenue grew at the mid-teens rate with D2C growth of 25% and low double-digit increases in the wholesale business.”

“In Asia Vans revenue grew nearly 40% with China increasing more than 40%…”

And finally, Timberland. “Third quarter global revenues were up 15% driven by 18% wholesale growth and a 6% increase in D2C.”

“In the Americas, revenues were up 22% driven by more than 30% growth in the wholesale business. This growth, similar to the second quarter was very balanced across all products and channels…On the apparel side we continue to expand our distribution and see strong sell-through as our fall 2014 collection hits retail floors across our own and wholesale partner doors.” My guess is that Timberland has quite an opportunity in apparel.

“Timberland’s revenues in Europe were up 15% in the third quarter with balanced growth in both D2C and wholesale… In Asia, third quarter revenues increased at the low single digit rate.”

Not a word about Reef. That never surprises me, but I’m always disappointed.

For the whole company, direct to consumer revenues grew 16% quarter over quarter. VF ended the quarter with 1,333 retail stores with direct to consumer revenues representing 22% of total revenues. They expect add around 150 stores a year “…over the 2017 planning period.”

Here’s a quote from the 10Q about the company’s overall business. “VF reported revenue growth of 7% in both the third quarter and first nine months of 2014 [was] driven by growth in the Outdoor & Action Sports coalition, and continued strength in the international and direct-to-consumer businesses.”

I guess if I took the obverse of that, or maybe I mean the converse, it sort or says, “Our wholesale business in the Americas outside of OAS wasn’t specifically too good.”

The balance sheet is fine, and I won’t even risk putting readers to sleep by analyzing it. Current ratio, at 2.0, was the same as a year ago. I would note that inventory was up just 4%- less than the increase in sales. There’s a whole lot of money to be made in good inventory management and not just for VF. It is also, in my judgment, an important part of differentiating and building your brand.

All’s fine with VF as long as all’s fine with Vans, The North Face and Timberland. Some other OAS brands are doing fine we’re told, but those three are responsible for most of VF’s revenue and profit growth right now.

VF has 35 brands in total. They are interested in further acquisitions (because they’ve told us so in the conference call) and have been willing to sell brands that didn’t seem to have the potential they were looking for (most recently, John Varvatos in 2012). They are focused on OAS, they tell us, because that segment represents the best opportunity to increase revenue and gross margin.

The numbers we’ve reviewed above tell us there are some issues with certain brands in other of VF’s segments, though we can’t know exactly which brands. The 24 brands that are not part of OAS did not all grow revenue at 1% during the quarter. Some did better, some worse.  It’s the nature, in fact the justification, for having a portfolio of brands that the overall portfolio can do well even when some brands aren’t performing.  Over time, you can expect different brands to perform at different levels.

I’m wondering if VF, especially if they can find some attractive OAS acquisitions, might not consider selling some of these other brands that are apparently not performing.

Strategically, that’s what I’ll be watching at VF.

All About Outdoor & Action Sports: VF’s Quarter

That the outdoor and action sports segment (OAS) of VF’s business is critical to its overall success is pretty obvious from the numbers. Total company revenue for the quarter rose 8% from $2.22 to $2.4 billion. OAS revenue rose 16% from $1.1 to $1.28 billion. OAS generated more than 53% of the quarter’s total revenues. OAS revenue experienced “…double-digit percentage growth in every region and channel.”

But revenue from VF’s other segments- coalitions as they call them- grew by just one half of one percent from $1.116 to $1.123 billion. These other segments are jeanswear, imagewear, sportswear, contemporary brands, and other.
The same trend can be seen in VF’s operating profit. Total operating profit rose 6% from $269 to $285 million. OAS operating profit was up 16% from $100 to $131 million. Ignoring OAS, total operating profit for the other segments fell 8.4% from $168.6 top $154.5 million.

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VF’s Quarter and Results for the Year: One Sentence Caught my Attention

Okay, strong balance sheet, revenue growth, profitable, blah, blah, blah. I’ll get to all that. But on page 22 of the conference call an analyst asked about their interest in potential acquisitions. The answer from CFO Bob Shearer, in part, was “…how we think about acquisition targets, and we think about it a lot, and yes, we have a list. But we think about brands that are complementary to our brand portfolio that help us reach customers/consumers.” 

I added the italics and bold type. You wouldn’t think that their having a list would get me quite this interested, but it does. Consider what it means. They have a list of companies they might want to buy. I assume they didn’t create this list by throwing darts or rolling die. Maybe there’s a drinking game! Probably not. They had a process whereby they looked at the brands they own, with whom and how they compete, and their customer segmentation. Then they surveyed the universe of competitors and analyzed and selected the ones they thought might be good fits.
 
Okay, I don’t want to make VF sound too omnipotent here. Maybe they aren’t as rigorous as I’m suggesting. Acquisitions in this industry, in my experience, have a large element of serendipity to them. Still, such a process would be consistent with the management rigor I think I hear in their public information. And it would be important managing their portfolio of brands.
 
Just so you see how important, here’s a list of the brands they own and the markets those brands are in.
 
 
That’s a lot of brands, a lot of markets, and quite a bit of market overlap. Randomly buying brands because they were “a good deal” and increased revenue would result in an unmanageable behemoth pretty quickly. That, I assume, is where the rigor of developing the list comes in. Deals they make will be supportive of markets where they already participate and have expertise.
 
Their management rigor also shows up in their operations. VF makes around 500 million units of product a year for 35 brands. They own 28 of their own factories and work with 1,800 contract manufacturers in 60 countries. They’ve got 29 distribution centers and 1,246 retail stores under various brands.
 
In what is probably an understatement, they say in the 10K (you can see it here), “Managing this complexity is made possible by the use of a network of information systems for product development, forecasting, order management and warehouse management, attached to our core enterprise resource management platforms.”
 
Why is this a good thing? Here’s another quote from the 10K.
 
“We believe that we will be able to remain cost competitive in 2014 due to our scale and significance to our suppliers. Absent any material changes, VF believes it would be able to largely offset any increases in product costs through: (i) the continuing shift in the mix of its business to higher margin brands, geographies and channels of distribution; (ii) increases in the prices of its products; and (iii) cost reduction opportunities. The loss of any one supplier or contractor would not have a significant adverse effect on our business.”
 
Not sexy maybe, but I’d characterize all this boring operations stuff as a critical competitive advantage. It’s particularly important for integrating and realizing value from an acquisition. Anybody can buy a company. It takes good management and hard work to integrate it effectively into an existing organization. And careful selection of the acquisition target, which brings us back to their list of company’s they watch. Having tied that together, we can now move on to the numbers.
 
Fourth quarter revenues were $3.29 billion, with a net profit of $368 million, or 11.2%. Outdoor & Action Sports revenues were up 12% for the quarter. The North Face rose by 12% and Vans by 14%. “Vans was up at a low-double-digit rate in the Americas, up 20% in Europe and up at nearly the same rate in Asia.”
 
For the year, VF’s revenues rose 5% from $10.77 to $11.3 billion. The growth was all organic. That is, there were no acquisitions in 2013.
 
38% of revenue was from outside the U.S. Direct to consumer, which includes retail stores, outlet stores and online represented 22% of revenue compared to 21% a year ago. Ecommerce by itself was $327 million, or 2.9% of total revenue. Of their 1,246 retail stores, 1,166 carry only a single VF brand. The other 80 are VF outlet stores. The plan is to open another 150 stores in 2014 focused mostly on Vans, The North Face, Timberland and Splendid.
 
They also note, “In addition to our direct-to-consumer operations, our licensees, distributors and other independent parties own and operate over 3,000 partnership stores…”
 
The Outdoor & Action Sports segment grew from $5.866 to $6.379 billion and represents almost 56% of total revenue for the year. It generated an operating profit of $1.106 billion, representing 57.3% of VF’s total operating profit for the year of $1.93 billion.
 
“The Outdoor & Action Sports Coalition revenues increased 9% in 2013 over 2012 primarily due to an increase in unit volume. The North Face, Vans, and Timberland brands achieved global revenue growth of 7%, 17% and 5%, respectively. U.S. revenues increased 7% in 2013 and international revenues increased 10% with balanced growth in Europe and Asia Pacific. Direct-to-consumer revenues rose 15% in 2013 driven by increases of 28% and 15% for The North Face and Vans brands, respectively. New store openings, comp store growth and an expanding e-commerce business all contributed to the direct-to-consumer revenue growth.”
 
The North Face grew its revenues by 20% in Asia and at a “mid-single digit” rate in Europe. They don’t tell us what happened in the U.S. but given those numbers it seems to imply that things weren’t that good.
 
One analyst, referring to The North Face, asked if they’d seen any changes in the competitive environment. Steve Rendle, Group President of Outdoor and Action Sports Americas answered, “The competitive set in the outdoor industry remains the same. As North Face transcends that outdoor space it takes on a whole lot of new competitors.”
 
Those new competitors a brand encounters as it extends its reach is something I’ve talked about often. It’s a whole new competitive environment and we can all think of brands that haven’t done well trying to extend themselves. But they weren’t VF’s size with its management processes and balance sheet. Part of how they expect to succeed, Steve Rendle says in response to another question, is because The North Face “…is very much a pre-booked business model…we will buy to that order book and that order book is about 90% to 95% of our total revenue.”
 
They don’t, in other words, risk making too much product and over distributing. As you know, I like that a lot. It’s important to building a brand.    
 
Vans, we learn, passed $1 billion in the Americas in 2013. They highlight that Vans is no longer just a footwear brand and is having success moving into apparel. They note that, “According to data from more than 160 US board shops, Vans is a top 10 brand in almost all of our men’s apparel and accessory categories.”
 
Okay, that has to be data from Action Watch. I’m wondering just what it means to be in the top 10. How many brands of men’s apparel or accessories does a specialty shop carry? Wish some analyst had asked for a more detailed explanation.
 
Van’s international business was up 23% for the year. There was a mid-20% increase in Europe and a “high-teen” increase in Asia. I’d like a bit more specific information. Given the overall increase of 17% and the increases they mention for Europe and Asia, what should I assume for the U.S? It’s interesting that they provide percentage growth numbers for the other areas, but not the U.S. or at least the Americas.
 
Gross margin rose from 46.5% to 48.1%. “The increase in gross margin reflects lower product costs and the continued shift in the revenue mix towards higher margin businesses, including Outdoor & Action Sports, international and direct-to-consumer,” management said.
 
Selling, general and administrative expenses rose from $3.597 to $3.841 billion. As a percentage of total revenues it rose from 33.1% to 33.6%. This was partly because they choose to make some additional marketing expenditures “…to support future growth for our largest and fastest growing businesses.” Kind of nice to have a balance sheet that supports that kind of decision making. It was also higher because Timberland was included for a whole year for the first time. Advertising and promotion expense alone was $671.3 million, or 5.9% of revenue.
 
Interest expense was $80.6 million for the year. The weighted average interest rate was 4.5%. I just mention that because I wonder about the impact on VF, and lots of other companies, when interest rates rise substantially. That is going to happen, and if I knew when I’d get very, very rich.
 
Net income was $1.21 billion, up from $1.09 billion last year.
 
The balance sheet is strong, with a current ratio of 2.5 and a debt to total capital ratio of only 19.3%. Inventory was up a bit, but less than you’d expect given the revenue growth. Receivables were up 11.3%- more than twice the revenue growth.
 
If I could ask a couple of balance sheet related questions just because I have an inquiring mind, the first would be about the accrued liabilities. They total $905 million, and are mostly broken down in Note J. But the biggest single entry, for $209 million, is “other.” It’s not that it’s a big number for VF, but I’m curious what’s in it. Oh well, guess we’ll never know.
 
The second would focus on Note M on their retirement and savings benefit plans. Not much a question as a comment. I note that their expected rate of return on plans assets in 2013 was 5.7%. Obviously, the higher your expected return, the less you have to put into the plans each year to meet the obligations. VF’s 5.7% may still, in my opinion, turn out to be a bit high, but it’s certainly reasonable. Good for them for being realistic. When you see a company (or a municipality, or a state) claim their pension plan is “fully funded,” that’s based on certain assumptions about how long people are going to live and how much the plan assets are going to earn. If those assumptions aren’t reasonable, then the plan is probably not fully funded. Ask the pension holders in Detroit.
 
Okay, I know nobody wants to hear any more about that, so I’ll move on.
 
VF’s four growth drivers are leading in innovation, connecting with consumers, serving consumers directly wherever and however they want to engage the company’s brands, and continuing to expand geographically from the Americas to Europe and Asia in mature and emerging markets. Those might sound a bit like platitudes taken in isolation. But in conjunction with the strategies and management processes we’ve highlighted here, they seem credible.