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.

“…during the past four quarters, weak consumer spending, the warmest winter on record, retail bankruptcies and excess inventory in the off-price channel have had an outsized impact, particularly on our U.S. business. Consistently positive results from our International business, which is about 40% of our revenues, have been somewhat offset by a slight decline in our U.S. business. Simply put, we’ve seen mixed results. By channel, our D2C business has seen steady growth, up 7% year-to-date and we’ve made significant progress towards amplifying our connection with consumers in the space where we directly control our brands.”

And that, I think, pretty much sums it up for the business of anybody who’s reading this.  Eric goes on in the next paragraph to highlight some other business facts that probably sound familiar as well.

“In wholesale, conservative retailer open-to-buys, buy-now, wear-now calendar shifts and leaner inventory positions remain among the top priorities for many retailers. As you’d imagine, this conservatism has put even greater pressure on vendors who are being asked to take on larger inventory risk to meet demand closer to consumer need. And while we don’t like it, rather than speculatively building inventory, we’ve reduced our inventory buys to protect our brands and ensure channel health. And we’re pulling various levers to preserve gross margin expansion and ensure profitability.”

In those two paragraphs, we’ve got:

  1. The never-ending, ever evolving conflict over who’s going to take the inventory risk
  2. The weakness of the U.S. market
  3. The ongoing effort to figure out how brick and mortar and online are best aligned
  4. The importance of the focus on inventory
  5. The desire to protect brand and margin through cautiously managed distribution

VF is the second public company (Zumiez being the first) that I think I’ve noticed trying to get the analysts to gradually come around to being comfortable with the idea that profit improvement may tend to come more from improved expense management and margin control rather than a rapidly growing top line.

The next thing that struck me, on page 31 of the 10-Q, was the company’s use of capital provided by financing activities.  It states, “VF will continue to evaluate its use of capital, giving first priority to business acquisitions and then to direct shareholder return in the form of dividends and share repurchases.”

Am I the only one that noticed they didn’t have investing in their brands as a priority for use of capital?  They have bought back $1 billion of their own stock during the first 9 months of the year.  To be fair, they note in the 10-Q that SG&A expense rose, “…primarily due to increased investments in our key growth priorities, which include direct to consumer and product innovation.”  The total increase in SG&A spending was $6.4 million, or 0.6% over last year’s quarter.  Total SG&A spending during the quarter was $1.052 billion.

My more global take is that VF is not the only company that is both cautious about and having a hard time finding good places to invest in their existing business that offer a better return on investment than buying back their stock given existing interest rates.

I imagine I’m not the only one hoping the Fed raises their indication interest rate in December and then keeps raising them in the new year.

Okay, the numbers in brief.  Revenues during the quarter fell 1.2% compared to last year’s quarter from $3.53 billion to $3.49 billion.  Outdoor and action sports revenues grew 1.7% in the quarter compared to last year’s quarter from $2.297 to $2.336 billion.  It represented 67% of total revenues.  “Revenues in the Americas region declined 1% in the third quarter of 2016. Revenues in the Asia-Pacific region increased 3% despite a 1% negative impact from foreign currency. European revenues increased 7% in the third quarter of 2016, benefitting from a 1% favorable impact from foreign currency.”

North Face revenues were down 1% during the quarter.  Results were “…driven by strong growth in the direct-to-consumer channel and by declines in the wholesale channel.”  Van’s revenues were up 7% (they say 8% in the conference call) during the quarter also driven by an increase in direct to consumer.  Wholesale revenues were flat.

Timberland revenues were flat, showing some increase in wholesale and a decline in direct to consumer.

Revenues for all the other segments- jeanswear, imagewear, sportswear and other- fell during the quarter compared to the same quarter last year.

VF’s overall direct to consumer revenues rose 6% in the quarter.  This is a good place to remind you that direct to consumer means a lot more than “online” as VF ended the quarter with 1,475 retail stores worldwide, up from 1,363 at the end of last year’s quarter.  For some perspective on the size of the direct to consumer business, CEO Wiseman tells us that wholesale is “…over 70% of our total revenue today.”  I wonder what comparable store sales did?  Interestingly, I didn’t see the number mentioned.

They dropped the cost of goods sold by about $44 million and increased their gross profit margin from 47.7% to 48.4%.  Foreign exchange lowered the quarter’s gross profit margin by 0.6%.  The improvement was “…primarily due to pricing, lower product costs and business mix, partially offset by proactive efforts to manage inventory levels.”

Let’s talk briefly about inventory management.  At $2 billion, inventory at quarter’s end was up 1.43% from a year ago.  However, that includes $60 million of “cold weather core product” they choose to hold over from last year and sell as new product this year at full price.  I also note, based on the quote immediately above, that managing their inventory to the level they wanted cost them some gross margin.  In other words, they discounted it to move it.  One more thing on inventory management- VF owns a bunch of its own factories.  President Steve Rendle has the value of those factories in mind when he discusses how to service this market.

“it’s no longer going to be the norm where you set a floor early fall and expect to take reorders through the season and come out the other side in a successful place. I mean, the demand that consumers are now putting on businesses to bring more frequency of new ideas and elevating that brand experience is something that we’re pivoting to be very, very responsive to. And our supply chain really puts us in an advantaged position to be able to look at the number of drops per season for each of our brands and being able to dial that into our model, both how we create the product, but also how we build that product and deliver to our wholesale and our own stores.”

Controlling some of your own production give you more flexibility in putting the right product in the right place at the right time.  I wonder if VF makes any product for other brands.

I’ve already told you there was a small increase in SG&A expense.

Operating income fell from $640 to $635 million.  Outdoor and action sports generated $490.5 million of total operating income during the quarter, or 70.6% of the total.  Interest expense at $24.8 million was up from $22.2 million in last year’s quarter.  Income taxes fell from $160 to $109 million- a nearly 32% decline.

They completed the sale of their Contemporary Brands in August.  They recognized a loss on that sale of $4.5 million compared to a gain of $2.2 million in last year’s quarter.  Net income in the quarter rose from $460 to $498 million, but I hasten to point out that taxes fell by $49 million and that more than explains the whole increase in net income.

Let me close with a few more comments VF makes about circumstances we’re all dealing with.  The first is wholesale demand shifting from the third to fourth quarter due to retailer caution.  Short term impact of bankruptcy and the resulting oversupply or a change in how business gets done?  CEO Wiseman makes this comment:

“…as we came into September, we were a bit surprised by the sheer amount of just not outerwear from the outdoor industry, but all categories from across Apparel. And it’s what’s caused – it’s really brought us to make this decision to really be thoughtful around our go-forward actions and to mitigate the impact that participation in this channel can have on the long-term health of a brand.”

Everybody concerned about their brand should be thinking like that.

President Steve Rendle also makes an important point about branding:

“I think at the center here is powerful brands, consumers absolutely want to connect with them, engage with them and purchase from them. And it’s really in our court to create the compelling products and the demand creation that draws them to us and really create that loyal relationship that we can build on year-over-year.”

What I want to hear when you read that, or at least what I hear, is the importance of listening to and reacting to your customer.  Yes, I know, that’s always been important.  But we don’t have the control over this space that we used to have.  The consumer has it.

Finally, Eric Wiseman made a comment that about something that’s obvious, but that I hadn’t focused on.  Wholesale revenues, he said, are something you send out into the retail world and later, maybe much later, if you’re lucky, you get some feedback on how it sold (or didn’t sell) and why.  When you make it in your own factory and put it in your own direct to consumer channels you control where it is and how it’s merchandised and when you generate revenue, “…it’s because a consumer came into a store and bought something they wanted.”

The lesson is that you get better data faster because you’re delivering the product with more immediacy in an environment you control.  That speed to market and of feedback is what’s required these days.

No wonder brands keep becoming retailers and retailer’s brands.