VF’s June 30 Quarter Results; Pretty Impressive

VF released its earnings and had its conference call back on July 21, but the 10Q was only released August 10th.  The results, as you probably already heard, were good. Revenue for the quarter was up 15.4% to $1.8 billion and net income rose 16.2% to $130 million. They accomplished this with a gross margin that fell from 47.1% to 45.9% partly by reducing their marketing, administrative and general expenses as a percentage of revenues to 35.7% from 36.5% in the same quarter last year.

The decline in the gross margin percentage was the result of product cost increases that weren’t fully passed on to their customers. The product margin was actually a bit lower as the reported gross margin benefited by 65 basis points from the closing of a European jeanswear facility. It also benefitted from the higher margins in the direct to consumer business.

They expect some further margin reductions in the rest of the year because of higher cotton prices and their decision not to pass through all the cost increases. They also note that cotton prices have fallen from $3.00 a pound to $1.00 a pound, and hope to see that positively impact product cost starting in 2012. 
 
VF has seen little impact from price increases on unit volume. But they are waiting to see how the consumer reacts to even higher prices in the second half of the year. All brands and retailers are waiting. VF is hoping that if cotton prices come down next year they might be able to recapture some margin they lost when they didn’t raise prices as much as costs rose.
 
Price increases accounted for 3% to 3.5% of the quarter’s total revenue gain of 15.4%. Two-thirds of that came from the U.S. jeans business. 
 
International revenues rose 30% in the quarter. They represented 29% of total revenue. Asia was up 30%. Europe was up 30%, Latin America 40%, and Mexico 26%.  They think international may hit 33% of total revenue this year, and they plan for it to reach 40% in five. If you’re interested in learning more about VF’s growth plans, you might go here.
 
Direct to consumer revenues were up 17% as a result of new store openings, a 46% increase in ecommerce revenue, and growth in comparable store sales. They’ve opened 44 new owned stores this year so far and are on track to open a total of 100. Operating margins for the direct to consumer business is up 3% this quarter, so you can see why they find it attractive.
 
There was no growth from new acquisitions this quarter compared to the same quarter last year. All $246 million came from existing businesses, though $43.5 million was the result of foreign currency translation. It’s great that VF breaks these numbers out in a separate table. 
 
VF, as you’re probably aware, divides its business into six segments they call coalitions. The quarter’s results for those segments are shown below.
 
       

Quarterly Sales

Change Since Same

Coalition Profit
       

In Millions of $

Quarter Last year

In Millions of $

Outdoor & Action Sports
 

$718
 

23.0%
 

$81.5
 

Jeanswear
   

$613
 

10.3%
 

$94.7
 

Imagewear
   

$244
 

15.6%
 

$26.0
 

Sportswear
   

$120
 

10.1%
 

$9.7
 

Contemporary Brands
 

$118
 

11.3%
 

$8.2
 

Other
     

$26
 

-3.2%
 

$0.0
 
                   
 
Most of our interest, for some reason, is in the Outdoor & Action Sports segment that includes Vans, The North Face, and Reef as well as other as six other brands. The North Face and Vans grew 21% and 22% respectively during the quarter. No mention, as usual, of what Reef did. The entire segment grew 14% domestically, and 42% internationally during the quarter (34% in constant dollars).  Revenues in Asia were also up 42% during the quarter compared to the same quarter the previous year.
 
These results don’t include the Timberland acquisition, which is expected to be completed in the third quarter.
 
The balance sheet remains very strong, but there are a couple of interesting things I want to point out. Just to give you a couple of numbers, the current ratio improved from 2.3 to 3.0 and the debt to total capital ratio fell from 24.5% to 18.7%. High current ratios are good, low debt to capital ratios are good for those of you who don’t have a financial background.
 
On January 2, VF changed its inventory accounting method from LIFO (last in, first out) to FIFO (first in, first out) for that inventory it wasn’t already accounting for using FIFO (about 25% of the total). The impact for the first six months of the year would have been to reduce their cost of goods sold by $8 million.
 
Okay, small number so why am I tormenting you with this technical accounting crap? If everything you put into inventory always cost the same, it wouldn’t matter. In an inflationary environment, the product you enter into inventory is going to be at a higher cost than the product you bought earlier. So if you decide you’re going to sell the older inventory first, you decrease your cost of goods sold and increase your profit. 
 
No big deal. This isn’t about VF but it’s about your need to be aware that this accounting change can matter if we’re dealing with product cost inflation, as we have been in the case of products made with cotton. 
 
On a related issue, inventory at the end of the quarter rose almost 17% from a year ago. But they note in the conference call that 9% of that was due to higher product costs. So units in inventory grew at a slower pace consistent with sales growth.
 
Three things stand out for me from reviewing VF’s quarter besides the good financial results. The first is the push into international. They’ve decided, along with a lot of other larger companies, that the growth opportunities are much greater outside of the U.S. The second is the growth of their direct to consumer business. Hardly a new industry trend, but I think we’ll continue to see more of it. Having this many brands with this kind of growth and margins makes it irresistible.
 
Finally, VF chose last year to make an incremental marketing spend of $100 million to promote their brands. They are continuing, and in fact have increased that spend slightly, this year. It shows a lot of confidence in their plan, as well as the strength of their balance sheet.