VF’s Quarterly Results and Strategy: They Do Love Outdoor and Action Sports

VF’s reported revenues rising 16.4% in the quarter ended June 30 compared to the same quarter last year. Net income was up 20% from $129.4 million to $155.3 million. As you look at those headline numbers, there are a couple of things to keep in mind.

 
First, the Timberland acquisition closed on September 13, 2011 so this is the first June quarter where it’s been included, and it was the largest acquisition VF has made. They paid $2.3 billion for Timberland. It’s part of VF’s outdoor and action sports group. During the quarter ended June 30, it contributed revenue of $239.4 million and reported a loss (as expected- apparently that’s just how the second quarter is for Timberland) of $37.2 million.
 
Second, on April 30th VF sold the John Varvatos brand and generated a pretax gain on the sale of $41.7 million. The sale of that brand reduced revenues in the quarter by $14.4 million.
 
Organic revenue growth (growth from brands they already owned) was $125.1 million, or 3%. International business grew 33%, representing about a third of total revenues. 26% of that growth came from Timberland. Direct to consumer revenues were up 37% in the quarter (29% from Timberland) and are 21% of total revenue. VF has opened 58 new stores so far this year, and expects to have opened 130 by year end. Comparable store sales in the stores VF operates were up mid-single digits in the second quarter.
 
Without the Timberland related acquisition expenses of $3.4 million and the gain on the sale of John Varvatos, net income would have been $122.9 million instead of the $155 million reported. Operating income, without the Timberland loss and related acquisition costs, would have been $193.7 million instead of the reported $164 million. By the way, my thanks to whoever it is at VF that presents this information in a fairly easy to figure out format. Oh- and here’s the link to the 10Q.
 
Before we delve deeper into those numbers, I want to remind everybody that back in the middle of June, VF did an investors’ day presentation just on Vans.   You can listen to the whole presentation here, and I suggest you do if you haven’t already.
 
When I wrote about Nike’s annual report a couple of weeks ago, I related it to a book called The New Rules of Retail. VF is discussed in that book as an example of a company that is creating neurological connectivity with its customers, using preemptive distribution, and controlling its value chain to compete as called for and explained in the book. You can see that all over the Vans presentation.
 
So why does VF love its outdoor and action sports segment? It has something to do with the fact that it generated 49% of its total revenues, including Timberland, during the quarter. Its next largest segment is jeanswear, which generated $594 million, down from $613 million in the quarter last year. Those two segments, then, were 76.3% of the quarter’s revenues and they generated 76.4% of operating profit.
 
VF’s overall operating margin was 7.9%, down from 10.3% in last year’s second quarter. 2.3% of that decline was the result of Timberland’s loss in the quarter.   
 
Of the $125 million in organic growth in the quarter referred to above, $113.4 million came from outdoor and action sports. That’s a 12% increase; 16% in constant dollars. Organic growth in operating profit for the whole company during the quarter was $18.4 million. In the outdoor and action sports segment alone it was $25.5 million, so that segment made up for the poorer performance of some others.
 
The North Face is part of outdoor and action sports. Its revenues in the quarter were up 14% (16% in constant currency) and it’s direct to consumer (DC) grew 9%. For the whole year, they expect The North Face to approach $2 billion in revenue.
 
VF is targeting Vans revenue of $2.2 billion by 2016. Revenues in the quarter were up 25% (29% in constant currency). Its DC business rose 18%.
 
Timberland revenues were up “…slightly on a constant dollar basis…” However, VF management sounds positively giddy as they talk about the opportunities in product, operations, and marketing they have with Timberland. It will be rolling out an apparel line in the near future.
 
One analyst asked about the impact of cleaning up Timberland’s distribution. Group President of Outdoor and Action Sports Steve Rendle answered it this way:
 
“As we look to right size that business, we are closing some of the distribution. Simultaneously, we’re rightsizing the product segmentation strategy, getting the right products in the right channels.”
 
Read that again and go listen to their plans for Vans. Read about what they are doing with The North Face in the conference call. You can detect in the conference call (see it here) a certain consistency across Vans, The North Face, and Timberland in terms of product development and the approach to the consumer. I would think there might be some real opportunities there as the brands come at overlapping customer groups from different perspectives.
 
Okay, let’s get back to VF’s overall financial results. Gross margin increased to 46.1% from 45.9% in last year’s quarter. This was “…due to a greater percentage of revenues from higher gross margin businesses, including the Outdoor & Action Sports, international and retail businesses, as well as an improvement of gross margin in our Jeanswear Americas business which reflects increased pricing compared to the prior period.”
 
Marketing, administrative and general expenses as a percent of sales rose from 35.7% in last year’s quarter to 38.4% this year. 2.4% of that increase was the result of the Timberland acquisition as it had higher expense ratios than the rest of VF. I won’t be surprised to see those Timberland ratios come down.
 
0.4% of the increase came from higher domestic pension expense. VF has a defined benefit plan. Those have to be funded based on an actuarial assessment of the number of people who will retire, when they will retire, how long they will live and what the assets in the plan are projected to earn. These days, it’s a bit hard to assume your pension assets will earn 7% and this is requiring some corporations (not just VF) to contribute more to their plans. That reduces net income.
 
Interest expense rose $7.6 million in the quarter because they borrowed money to pay for part of the Timberland acquisition.
 
The balance sheet was inevitably a bit weaker compared to a year ago after they borrowed money to buy Timberland. Long term debt is up $900 million. The current ratio fell from 3 to 1 to 1.9 to one and debt to total capital rose from 18.7% to 35.7%. Inventories rose 22.2% from $1.286 billion to $1.57 billion year over year. However, $246 million of that increase is the result of the Timberland acquisition. Excluding that, the increase was just 3%.
 
Receivables rose from $889 million to $1.03 billion over the year, but $121.7 million of that increase was Timberland. I should note that VF has an agreement with a financial institution to sell certain of its receivables on a nonrecourse basis. VF still manages and collects the sold receivables, but if they are ultimately uncollectable, it’s not VF’s problem. This sale of receivables reduced the accounts receivable on VF’s balance sheet by $135.5 million at June 30, 2012.
 
VF is the third company I’ve written about recently (Skullcandy and Nike being the other two) who seem to be responding to the changing retail/wholesale dynamic in ways that have some similarities. Those responses are consistent with the conditions described in The New Rules of Retail and that book’s prescription for success.
 
I expect VF to do some good things with Timberland. And I’ll be interested to see how VF manages the other brands in its portfolio if outdoor and action sports continues to grow and perform at such a high level.