VF Corp (VFC) — Q2 2017 Earnings Call Transcript

Good morning, and welcome to VF Corporation's second quarter 2017 earnings call. Participants on today's call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC. Unless otherwise noted, amounts that our participants refer to on today's call will be in adjusted and currency-neutral terms, which we defined in the press release that was issued this morning. We use adjusted and currency-neutral amounts as lead numbers in our discussion because we feel they more accurately represent the true operational performance and underlying results of our business. You may also hear us refer to reported amounts, which are in accordance with U.S. GAAP. Reconciliations of GAAP measures to adjusted and currency-neutral amounts can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide management's view of why this information is useful to investors. During the second quarter of 2017, the Company completed the sale of its Licensed Sports Group or LSG business. In conjunction with the LSG divestiture, VF executed its plan to entirely exit the licensing business, which comprises the LSG and JanSport brand collegiate businesses. Accordingly, the Company has classified the assets and liabilities of these businesses as held for sale and included the results of these businesses in discontinued operations for all periods presented. During the third quarter of 2016, the Company completed the sale of its Contemporary Brands businesses. Accordingly, the Company has classified the assets and liabilities of Contemporary Brands businesses as held for sale, and included the results of these businesses in discontinued operations for all periods presented. Unless otherwise noted, results presented on today's call are based on continuing operations. Joining me on today's call will be VF's President and CEO, Steve Rendle; and Chief Financial Officer, Scott Roe. Following our prepared remarks, we'll open the call for questions.

Great. Thank you, Joe, and good morning, everyone. The pace of change in both our industry and the broader consumer landscape continues to happen at an accelerated rate. 2017 is the year of making transformational moves as we begin to evolve VF and our brands to become more consumer and retail centric in everything we do. Six months into the first year of our 2021 strategy, our results are right in line with our expectations, and in fact, we’re doing much better than we anticipated. Our improved performance in the face of an unpredictable retail environment around the world demonstrates the strength of our brand portfolio and diversified value creation model. We're in the early phases of our journey to become a more agile and consumer-centric organization and we are encouraged by our strong start to 2017. During the second quarter, revenue increased 3%, which was slightly ahead of our expectations as core growth engines continued to accelerate. Our big three brands, Vans, The North Face and Timberland, grew at a combined rate of 7%. Our international business grew 6%, including 18% growth in China. Direct-to-consumer grew 14% and our digital business was up more than 35% and growth accelerated to 8% in Workwear. Our digital wholesale accounts, a key growth driver for VF over the next five years also increased at a high single-digit rate through the first half of 2017. Gross margin improved 160 basis points, an exceptional performance which again exceeded our expectations. VF's brands are strong. We remain disciplined in our renewed focus on elevating our creative capabilities, specifically in product design to enrich consumers' brand experience, coupled with stronger marketplace management, is driving more profitable growth and further strengthening our brand equity. EPS was $0.29 in the quarter at the high-end of the range we guided to in April. We also repurchased an incremental $200 million of stock which when combined with our strong dividend brings our anticipated total cash returns to shareholders in 2017 to more than $1.8 billion. Strengthening total shareholder return remains a top priority. As we look to the second half of 2017, we are gaining momentum across key dimensions of our business, and we see several catalysts on the horizon to ignite accelerated growth and value creation in our core growth engines. As a result, we are raising our full-year 2017 revenue outlook to $11.65 billion based on stronger-than-expected growth in our Outdoor & Action sports business, most notably Vans and The North Face brands, D2C and Workwear. Additionally, for the second consecutive quarter we are raising our gross margin guidance now to 49.8%. Our strong gross margin performance is a central element of our diversified value creation model. It provides us the flexibility and fuel to accelerate investment and drive growth behind our largest opportunities. In light of our increased revenue growth in gross margin expectations, we are investing an additional $40 million or $0.08 per share in 2017 to amplify our momentum and fuel accelerated growth as we move into 2018.

Thanks, Steve. Our second quarter results were right in line with our expectations and came in at the high-end of the range we communicated back in April. Revenue growth accelerated to 3% during the quarter, driven by strong results from our core growth engines. Our big three brands were up 7% on a combined basis, led by strength in Vans and The North Face brands, which grew 9% and 6%, respectively. As expected, Timberland delivered 3% growth in the quarter and our Workwear businesses increased 8% collectively, with Timberland PRO, Bulwark and Wrangler RIGGS, all achieving at least 20% growth. Our international business grew 6% with consistent growth across all three regions. China remains our fastest-growing market, generating 18% growth and we were particularly encouraged to see that our direct-to-consumer business was up 14%, including more than 35% growth in our digital business. That's even more impressive considering that our store count is down from the prior quarter and our growth rate accelerated. Our Outdoor & Action Sports, Jeanswear, and international businesses all achieved high teen D2C growth during the quarter. Our D2C business has significant momentum as we head into the second half of the year, but more on that in a minute. Consistent with our expectations, wholesale revenue declined 2% primarily due to the channel pressures in our Jeanswear North American business. International delivered low single-digit growth and our digital wholesale accounts grew at a high single-digit rate through the first half. Gross margin remained strong at 49.7%, up 80 basis points which includes an 80 basis point negative impact from changes in FX. That is a 160 basis point increase currency-neutral and better than our prior expectations.

Earlier this year, I said that VF is a value creation company and some wondered what that meant. This quarter's results begin to provide evidence of our commitment to value creation. We're in the business of creating catalysts through our strong portfolio of diverse global brands. We will continue to reshape our portfolio and accelerate growth, and 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. With that, let's review our second quarter results and dive deeper into our top five brands, Workwear and Sportswear. Starting with The North Face brand. Global revenue increased 6% driven by a 26% increase in Europe, and a 1% growth in both the Americas and Asia. Revenue growth during the quarter was driven by strong results from our D2C business, which increased at a mid-teen rate. Wholesale was relatively flat for the quarter. However, excluding the impact of bankruptcies in the Americas, which didn't really start to impact us into the second half of 2016, global revenue for The North Face increased at a high single-digit rate. For the first half of 2017, global revenue for The North Face increased 7% or 9% excluding the impact of bankruptcies just mentioned. By region, revenue growth in the Americas was driven by mid-teen growth in D2C with strong results from digital, which grew more than 40% in the quarter.

A significant shift in the timing of our order books will likely result in a low single-digit decline in revenue for the third quarter. However, when normalizing for the timing shift, revenue growth for the third quarter will likely be in the low single-digit range.

Hi, guys. Good morning. I guess, the two questions, the first one is more on when you look at the third quarter expectation in some of the detail, on like the order book or the changes in the order book, have there been any material changes to the total number or it's just a shift into the third or the timing of it? And the second question that I have is, around the Jeanswear business, can you just give us an update on the transition it's underway? Is there really a site line to stabilization in the Jeanswear business where the profit pressures are pretty significant?

So Bob, I will take the first part of that. First of all, our visibility versus what you guys can see is really what we tried to bridge here, right. There is really no change in what we see for the full-year relative to the order books. We’re just talking about a little bit of a shift in timing. And just to put that in perspective, we are literally talking about a couple weeks. But that's the difference between Q3 and Q4. So absolutely no change in the big picture. Just a little bit of timing between Q3 and Q4. That's why we tried to zoom out and say if you look at the second half, it's kind of in that mid single-digit range and normalizing, but you’re going to see a little noise when you compare to last year when you specifically look at just the third quarter.

And Bob, your Jeanswear question, really there is little new news and little change to what we’ve talked about in the past. The big picture remains the same, but our visibility is not great and we expect variability as we continue through the year though. We do see a line of sight to an uptick coming back in the fourth quarter. And it's important to remember, in our Jeanswear business our international business continues to be strong, especially in China where we see our Lee women's business continue to grow at double-digit rates fueled by our BODY OPTIX and Jade Fusion innovations.

Thanks. Good morning, everyone. With respect to your cold weather businesses, specifically North Face, but also Timberland, is your view that your retail partners have ordered to reasonable end demand for a normal cold-weather season or are we in a stage here where they’re ordering very tight and looking to chase, and have you based your orders on what you're pulling in terms of inventory, in terms of their orders, or have you put yourself in a position where you have excess inventory in order to chase into that demand?

Yes. Hi, Lindsay. This is Steve. I would describe the outdoor specialty market and the Outdoor Community more broadly as being very cautious, especially given the past two years of inconsistent winter weather. Retailers are being very careful, focusing their investments on brands that show promise and innovative products. Our inventory strategy is carefully aligned with our order book, allowing for thoughtful reordering of key styles within each brand. The strength for us lies in the performance of our direct-to-consumer segment, where we've seen strong comparable sales and exceptional digital performance. The marketplace is clear, and as we look toward the rest of the year, our ability to respond to demand in wholesale is limited. However, if we maintain our momentum in digital and direct-to-consumer, that presents a significant opportunity moving forward, provided that strong trends continue.

There is about 80 basis points of negative impact from foreign exchange. This results in approximately 160 basis points on a currency-neutral basis. That mix has been consistently around 50 to 60 basis points, driven by robust performance in our direct-to-consumer, digital, and international businesses. As we mentioned in February, the cost structure initially serves as a tailwind, transitioning to a slight headwind in the second half of the year. For the full year, it’s not a significant factor. We are currently experiencing some benefits, but these will turn negative in the latter half, although they won't be a major issue. Additionally, we have improved our fundamentals by reducing off-price sales and avoiding excess inventory in the channel. This has allowed for increased sell-through at full price, along with stronger performance in direct-to-consumer and digital.

Congratulations on a strong quarter. I want to ask about the $40 million in additional investment. We recently reviewed the five-year outlook with an investment plan, and now we have this extra $40 million. At a high level, what areas are you considering for this investment? Is it based on recent opportunities that prompted the increase, or is it an extension of what was discussed during the Analyst Day? Additionally, how do you view the payback for this increase, given that you already provided an initial plan? How will this $40 million impact your earnings outlook?

Yes, Michael. This is Steve. Our confidence is driving our decisions. As we assess our year-to-date progress and our outlook for the rest of the year, we feel confident in our plans. We have decided to strategically invest in a few key initiatives we discussed in Boston, aiming to build on our momentum into 2018. Approximately a quarter of the $40 million will focus on demand creation for our top three brands in direct-to-consumer and digital channels. We anticipate this will positively influence this year and the next. About half of the investment will target specific strategic priorities, including design and innovation, data and analytics, our digital platform, advances in manufacturing, and ongoing innovation projects. Talent acquisition and development is also a key long-term driver for us, and we are actively seeking to enhance our capabilities in this area to support our growth.

Thank you. Good morning. I would like to hear about your efforts to enhance your speed to market capabilities and which brands you see the greatest opportunities for that will impact the P&L. I understand this is an area you are actively working on and have made progress in, but I am interested in your thoughts on how you can effectively leverage this to support your D2C goals across the brand.

We discussed this in Boston, and it is a key part of our new five-year strategy. We are focusing on becoming more consumer and retail centric, looking closely at the entire process of product creation and market entry. We have several projects in progress with our biggest brands, where we are significantly reducing product creation timelines and examining ways to streamline this process using digital technology to improve our agility. Additionally, our integrated marketplace strategy involves segmentation and creating specific collections tailored to distribution choices, allowing us to build well-defined and well-merchandised collections that can be delivered in a more relevant and consistent manner. We are moving away from the traditional wholesale model to being more present with carefully merchandised lines, challenging every part of our product creation cycle. Our supply chain is heavily involved in this initiative, guiding our product creation teams on how to work together more efficiently to enhance our speed to market.

I would respond to that, Camilo, by saying that one of the positive outcomes of the disruption and challenges in our industry is that valuations are starting to move in our favor. With our strong balance sheet and the cash we generate, we are positioned as a favorable acquirer in this space. Valuation is just one aspect of the overall equation; it must include the right brand and the right area, where we can be effective owners. While valuation remains a crucial factor and is generally trending in our direction, I believe the current environment is somewhat more favorable compared to the last 12 to 24 months.

Good morning and congrats on the continued momentum in the business. I want to follow up on the incremental investment. In terms of the $0.08 impact, how should we think about it between 3Q and 4Q? And can we potentially further parse out in basis points the SG&A deleverage anticipated for the third quarter versus the leverage expected for the fourth quarter?

Good morning, Laurent. I anticipated a question like that given your development of the extensive model. We haven't fully outlined it yet, but Steve made a remark that relates to the second quarter. You likely noticed some of that additional investment. We initiated it in the second quarter, and it's fairly evenly distributed through the third and fourth quarters. This is how I would respond to your inquiry. Regarding gross margin, we've discussed the full-year outlook, and you can expect the first half to be relatively steady through the latter half. I believe this provides you with the necessary elements to consider the second half of the year and model it accordingly.

Good morning everyone and congratulations on the improved results. As you think of the digital wholesale business and the growth that you’re seeing there, how do you think about your strategy with the Amazons in the world? And then, your thinking about D2C, which seems to have accelerated. What are your plans with store openings and closing in the different regions?

So Dana, I'll begin here. It's more about how we view our digital wholesale partners globally. We have major pure plays as well as key customers we've collaborated with for years, and they are integral to our integrated marketplace with various options we provide, making them a critical component. We mentioned in Boston that our digital wholesale partners will play a significant role in our growth over the next five years. Amazon is a key customer. For some of our brands, we have first-party relationships while others have third-party setups, and certain brands are continuing to explore how they can effectively collaborate with Amazon, especially in the U.S. market long-term. It's fair to say that The North Face will initiate a third-party partnership and launch a trial in the fall of '17, which can also be seen as a pilot, as we aim to integrate Amazon into The North Face's long-term integrated marketplace strategy in the United States.

Yes, I'll begin with that. Good morning, Dana. We noted that our store count decreased slightly compared to last quarter. I want to emphasize this to highlight our commitment to evaluating our portfolio from a profitability perspective. We are concentrating on enhancing the performance of our underperforming stores and prioritizing our successful formats and brands. You'll notice that while this might impact our top line, we are prepared to take those necessary actions. That decision aligns with our goals. Despite this, we remain dedicated to brick-and-mortar stores because we believe they are essential to the integrated marketplace that Steve referred to. This approach represents the highest experience for our brands, and we view it as a vital part of our overall strategy.

Thanks. So on gross margin is it still fair to think about 40 to 50 basis points of underlying expansion from mix just on an annual basis? And if so, can you just walk through the drivers?

Yes. First of all, regarding gross margin, you are correct in that range. Our mix is slightly above our long-term rate. We've indicated that 40 to 50 basis points should be sustainable, and it's quite straightforward. Our highest margin businesses are also our fastest-growing, which has been consistent and we expect that trend to continue, particularly in our international business, digital operations, and D2C, along with Outdoor & Action Sports which generally have higher gross margins. We anticipate that mix will persist. To clarify the formula, as our gross margins expand, we are investing in strategic drivers from an SG&A perspective and seeking leverage across platforms and other expenses, and that’s how this formula functions together.

Good morning. Thank you for taking my question. I have a couple of inquiries. Can you clarify the change in your currency neutral revenue guidance from what was previously provided to what you are announcing now? Additionally, what is the tax rate you anticipate for the full year, and what share count assumptions are incorporated into this guidance?

Yes. I will start. Hey, Sam. Its Scott. So, yes, we said last time low single-digit currency neutral and reported with 2 points of currency, so that obviously if you do the math, that’s about 1%. And now we're raising that to about 2%, at a $11.65 million. So that's how we get from and to and we've given you a very specific revenue target at $11.65 million. As it relates to the tax rate, we said about 20%. And that’s consistent with what we said in our last guidance.

Great. Thanks.

Thank you, everyone. I want to emphasize that we are just beginning our journey to become a more agile and consumer-focused organization. We are pleased with our progress at the start of 2017, but it's important to recognize that we're still at the outset of this journey. Our main growth drivers are achieving high single-digit growth, our gross margins are on the rise, and our fundamental business practices remain strong. We are making deliberate investments in our future growth, and our confidence so far this year allows us to accelerate our efforts in design and innovation, driving demand, while also enhancing our core capabilities in advanced analytics, advanced manufacturing, and talent development. We are committed to building momentum toward our five-year goals and look forward to engaging with you as our strategy develops. Thank you.