VF Corp (VFC) — Q3 2017 Earnings Call Transcript

Good morning, and welcome to VF Corporation's third 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 believe 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 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 Chief Executive Officer, Steve Rendle; and Chief Financial Officer, Scott Roe. Following our prepared remarks, we’ll open the call for questions. Steve?

Thanks Joe, and good morning, everyone. Welcome to our third quarter 2017 conference call. Our third quarter results were a bit stronger than expected, with broad-based strength across core growth engines, international, direct-to-consumer, our big three brands, and Workwear. Our focus and investment in support of our 2021 strategies are driving accelerated growth and value creation across key pillars of our portfolio. We are in the early phases of this strategic journey we began earlier this year and while the rapidly changing consumer landscape and dynamic retail environment around the world is sometimes difficult to predict, we are confident that the choices and capabilities embedded in our strategic growth plan will enable our strong portfolio of diverse global brands to connect more deeply with consumers and fuel accelerated growth. Third quarter revenue increased 4% as our momentum continued to accelerate. As a reminder, our growth rate during the quarter was reduced by about 3% due to the shift in timing of our fall order book, which we discussed during our last call. Our big three brands, Vans, The North Face, and Timberland, grew at a combined rate of 6% in the quarter. Our international business grew 10%, including 14% growth in Europe and 9% growth in China. Direct-to-consumer increased 17%, with more than 35% growth in digital. Our Workwear business grew 11% and our digital wholesale accounts, a key growth driver for VF during the next five years, increased more than 20%. Gross margin improved 180 basis points in the quarter, excluding a negative 80 basis points impact from FX. The continued strength of our gross margin demonstrates the power of our diversified model and the discipline and focus we place on quality growth. Adjusted EPS increased 10% to $1.23 in the quarter. This is ahead of the outlook range we provided in July. Based on our strong third quarter performance and confidence in the balance of the year, we are once again increasing our full-year outlook, raising our dividend for the 45th year in a row, while at the same time committing an additional $25 million to fuel growth. Combined with the $40 million we announced in July, we have now committed $65 million of additional investment behind our strategy relative to our initial outlook in February. We will continue to evolve VF and our brands to become more consumer and retail centric. You are beginning and I stress beginning, to see that come to life in our results. We will reshape our portfolio and align ourselves with our financial aspirations. We’ve made progress thus far in 2017, but we are not finished. We see many unique catalysts to ignite accelerated growth and value creation during the next several years and we look forward to updating you on our progress. And finally, before getting into the specific brand results, as you know, we formally welcomed Williamson-Dickie to the VF family on October 2nd. Our integration teams have worked in a collaborative manner since we announced the transaction. The teams and those that support them, I extend a sincere thank you. While it’s early, I couldn’t be more pleased with the chemistry within the teams and even more confident about the value creation synergies we see within our existing Workwear platform; it’s great to have the Williamson-Dickie people part of VF. With that, let's review our third-quarter results and dive deeper into our top five brands, Workwear, and Sportswear.

Thanks, Steve. Before I get started, let’s review a few housekeeping items that influenced our reported third quarter results. First, we took a $105 million pre-tax non-cash goodwill impairment charge to reduce the carrying value of the intangible assets related to the Nautica brand. Despite recent improvements in financial performance, our strategic assessment of the brand determined the assets to be impaired, which resulted in the related charge. Second, we incurred about $5 million of pre-tax acquisition-related expenses associated with the Williamson-Dickie transaction. On a combined basis, the two items just mentioned negatively impacted our reported earnings by $0.26. Now, let’s review our third quarter results. My comments will focus on our adjusted results excluding the impairment and acquisition related expenses just mentioned. Our third quarter results were strong with broad-based strength across international and direct-to-consumer platforms, outdoor and action sports, and Workwear. Revenue increased 4% to $3.5 billion and excluding the order book timing shift for The North Face and Timberland brands, our underlying growth rate was approximately 7%. Revenue for our big three brands was up 6% on a combined basis led by very strong results from Vans, which was up 26%. The underlying passion for Vans across the globe is truly unique. What gets us most excited is how this deep emotional connection, coupled with the tribal nature of the Vans family, will continue to drive exceptional performance. While we don’t expect to maintain these stellar growth rates indefinitely, these results give us confidence in the vision we have for this brand and the growth targets we laid out in Boston. As expected, The North Face and Timberland brands declined 3% and 2% respectively. However, both brands grew at a low single-digit rate normalizing for the order book timing shift. Our Workwear business increased 11% and importantly our Jeanswear collection continued to sequentially improve driven by Wrangler, which returned to growth in the quarter and was up 4%. International increased 10% as our growth continues to accelerate. Our Europe business was particularly strong, up 14%, and just to put some context around the strength we are seeing in Europe, our big three brands grew 17%, wholesale was up at a low teen rate, including almost 30% growth from our digital partners. Direct-to-consumer increased at a high teen rate, including more than 40% growth in digital, and we achieve double-digit growth across almost every major market. Our European business is clearly firing on all cylinders and as one of our most profitable platforms, when combined with an efficient tax structure, enables us to drive significant value creation. The broad base strength we see across the region will carry into 2018, so a big thank you to the European team. China remains strong and was up 9%, with particular strength in Vans, D2C, and digital. Our direct-to-consumer business was up 17% led by more than 30% growth in digital. Our Outdoor Action Sports, Jeanswear, and international businesses all achieved at least high teen growth, with double-digit comps in our global brick-and-mortar business. Our efforts to steward investment towards store experience and digital while focusing on the productivity of our fleet are showing results. Gross margin remains strong at 50.1%, up 100 basis points, which includes an 80 basis point negative impact from changes in FX; that is 180 basis points increase currency neutral, which is pretty much in line with our first half results. Our stronger than expected gross margin was a result of more favorable mix and better full price sell-through. Our gross margin is the by-product of our disciplined and focused approach to quality growth. Gross margin expansion is a core element of our diversified value creation model and provides us flexibility and fuel to accelerate investments and drive growth behind our largest opportunities. SG&A as a percentage of revenue was up 240 basis points to 33.2% in the quarter. Our ratio was distorted a little bit by the order book timing shift, which resulted in about 40 basis points of deleverage. Let me take a few minutes now and walk you through the remainder of our SG&A increase. More than half of that increase was driven by investments in D2C, demand and product creation, innovation, and technology. In fact, most of the increase was in D2C, particularly in digital, which is where we have momentum and stronger profitability, and when coupled with our higher incentive compensation compared to a weaker performance a year ago, we've accounted for more than 90% of the change. Based on our increased confidence, we've committed an additional $25 million of investments in demand creation and strategic priorities this year. That is in addition to the $40 million we announced last quarter. So relative to the initial outlook we provided in February, we’ve committed $65 million to transform VF into an agile, digitally-enabled, consumer-centric organization. Our third quarter adjusted operating margin declined 140 basis points to 16.9%, including an 80 basis point negative impact from changes in FX. So, on an adjusted basis, EPS increased 10% to $1.23. Relative to the range we provided in July, our third quarter earnings benefited by about $0.07 from FX and a lower tax rate. Turning to our balance sheet, our inventory increased 1%. Our inventory is in good shape and from the days outstanding perspective, it’s starting to come back in line. Given our strong third quarter results and increased growth trajectory we see for the balance of 2017, we are once again raising our full year outlook. Our updated outlook now includes the following: reported revenue is expected to be up 6%, about 5.5% on a currency-neutral basis to approximately $12.1 billion. That compares to our previous expectation of $11.85 billion. Our increased revenue outlook is driven by our core growth engines, Outdoor & Action Sports, most notably Vans, D2C, particularly digital, and broad-based strength across our international business. Our revenue outlook continues to contemplate about $200 million contribution from Williamson-Dickie. Gross margin is expected to approximate 50%, which includes a 50 basis point headwind from FX. This represents a 50 basis point improvement relative to our previous outlook of 49.5%. Adjusted operating margin is now expected to be about 13.4% versus the previous estimate of 13.7%. This includes a 50 basis point negative impact from changes in FX as well as the impact of an additional $25 million investment. Excluding the impact of Williamson-Dickie, we expect our adjusted operating margin to be about 13.6%. Adjusted EPS is now expected to be $3.01, up 1% on a reported basis or up 6% on a currency-neutral basis, relative to the 2016 adjusted EPS of $2.98. Our outlook includes the $0.05 of additional investment, as well as a $0.02 contribution from Williamson-Dickie. As a reminder, our prior outlook was $2.96. Finally, we now expect our cash flow from operations to reach about $1.5 billion. We remain committed to returning cash to shareholders, and our dividend and share repurchase program are key components of our diversified value creation model. Based on our performance and the confidence we have in our strategic growth plan, our Board of Directors approved a 10% increase in the quarterly dividend to $0.46 per share. This marks the 45th consecutive year we’ve increased our annual dividend. With this increase, our calendar 2017 dividend will reach $1.72, a 12% increase compared with the prior year. When combined with our share repurchase, our cash returns to shareholders in 2017 will approach $1.9 billion; that’s an 8% yield based on our current market cap. So, with three quarters behind us, we are confident in our increased growth outlook and have strong momentum as we move into the fourth quarter. Our core growth engines are delivering double-digit growth, our gross margin is strong, our fundamentals are intact, and we are investing in our future. Given our momentum and the confidence we have in our growth plan, we’re putting money to work behind our largest brands in growth platforms while returning additional cash to shareholders.

I want to follow-up on the wholesale business for the fourth quarter. Besides the $100 million shift from 3Q into 4Q, are there any additional shifts between the fourth quarter and next year’s sub-quarter? And then secondly for the fourth quarter stripping out Williamson-Dickie’s revenues, should we assume wholesale revenues on an organic basis will be up mid-single digits year-over-year?

That’s about right. On the second part of your question, Laurent, it should be up about that rate. And no, there are no other big shifts other than order book timing between Q3 and Q4.

And then I wanted to follow-up on the Williamson-Dickie acquisition. Since the acquisition was announced in August, curious to know if you gained any additional learnings you might want to share on the call. And then finally since Williamson-Dickie was an all-cash transaction, can you remind us how much leverage you want to take on if you choose to pursue an additional acquisition?

I will address the second part of your question first, before Steve shares insights on what we’ve learned. We have stated that we’re maintaining our rating, which is generally set at two times EBITDA for our debt-to-EBITDA ratio. However, for the right acquisition, we are open to adjusting that even to a slightly lower rate if the opportunity is compelling. Doing the calculations suggests we have a significant amount of capacity. Additionally, with our robust cash flow, our metrics tend to return to normal quite swiftly. We currently have available resources, and as we consider the impacts from Williamson-Dickie and the rest of our portfolio, we are quickly aligning back to historical levels.

And then Laurent, on what we’ve learned with Williamson-Dickie so far, I mean we’re really still early, but we couldn’t be happier. We have down there a passionate, committed team that looks and acts a lot like VF and are really integrating well with our Imagewear team and the broader Workwear team. The brands are great; we’re very excited about what we’re learning about Dickie’s and the brand’s global fit, and what we think we can do with it here in the United States and the synergies that we’ve called out from the beginning are absolutely there, with committed teams working across 12 major work streams getting after just that exactly.

Good morning and congratulations. As you can think about the strength of the gross margin, how do you think about the puts and takes? Is there anything to note by brand or collection that could be lasting going forward that we should watch for? And just lastly for the incremental investments, any color on where that’s going, how are they seasoned, and your outlook on it? Thank you.

Yeah, good morning Dana. So, a couple of things on that related to gross margin. The story on gross margin really hasn’t changed, it's mix, and the mix is our fast-growing businesses are the highest gross margin. You saw in this quarter results particular strength in D2C and digital, which that coupled with international and particularly Europe, really popped the gross margin in the quarter. But as we look forward, we expect those same drivers to continue, right. It was a little exaggerated in the third quarter also because our wholesale business, for all the reasons we’ve talked about for the long time, was a little bit down from the timing standpoint, but overall, we see that mix driving forward in the next year and beyond.

Dana, regarding demand and our investments, approximately half of the investments made this year are focused on demand creation. This effort is particularly aimed at Q3 and Q4, with a strong emphasis on direct-to-consumer initiatives and our digital platform, while also working to enhance overall brand awareness that benefits both our brand and our wholesale partners. We are also channeling resources into various strategic priorities outlined in our roadmaps, specifically focusing on data analytics, enhancements to our digital platform, advanced manufacturing initiatives, and further developing design capabilities within our major brands.

Thank you. Thanks for taking my question. Good morning. So, if you could talk a little bit more detail about Vans; I mean, the performance there really stands out, as you know. Maybe you can go a little bit deeper in some of the strategies that are working, how you’re executing to generate such consistent strong performance globally in a broad-based way? And then maybe tie in digital and social media, if that's an important element to what's going on with that brand, and if there are learnings that you’re developing around Vans that you can apply to some of the other assets in your portfolio? Thanks.

Great, Omar. Vans' performance is fantastic and the congratulations you put out to our team. So, I think one of the primary reasons this brand is doing so well, it is the team that works on this brand across the globe and their intense focus and deeper understanding of who their consumer is. And we talk a lot about our expressive creator and who they are, what’s important to them and how to reach them with our demand creation and that really is about the social media in the digital platform. Key things that are driving these results, Omar, starts with product, the way our business team there really manages franchises and really thinks through the integrated marketplace, lands, placing the appropriate products in the right locations. And then the appropriate amount of newness, be it, new designs, the collaborations that we do season to season, or the Ultra range that we launched this fall that are completely new products, higher price point, is continuing to move the brand further down its path.

I would tell you, I think probably our single strength natural product, it’s our D2C and how our brand stories are told within our own environments. You can see that here in the U.S. and across the globe, and as we start to really mature and improve that area, we are starting to see us bring a segmented approach to boutiques that come and meet around The New General in Brooklyn to how that complements our street front and mall-based stores and how that all links together with our digital platform. It really is a well-oiled machine, very focused in deep understanding of the consumer, and it really is about the digital connectivity and the storytelling that we tell to the digital platform that we think is one of those key strategic advantages.

I was hoping you could talk a little bit about the FX impact. Seems like there was a pretty large swing from last quarter to this quarter as it relates to the overall guide for the year, since it gets about 150 basis points swing to positive. Could you help us frame how that benefit could continue into 2018 and how we should be thinking about that component as that’s been a pretty big factor?

Yes. So, obviously, first of all, we don’t try to get cues as it relates to currency. We got a basket of currency we’re looking at, and best of our knowledge, we call that essentially where it is for the balance of the year, and that’s reflective and the outlook that we just talked about. As you look into ’18, a couple of things: First remember that we had with a pretty long tail here, so we’re going out 12 to 18 months. So, a lot of this has already been baked at slightly different rates as you look into next year, so you just got to remember that. Also, from a translation standpoint, wherever the currencies are right now, that looks like that’s a tailwind; hopefully that will be the case. I would also just caution you not to focus too much on one factor, right. As we look into next year, costs are up a little bit in the fourth quarter, for example, we’ll see that knock into next year. Yes, currency looks like it’s a tailwind, but you got to look at the balanced picture and we’re not at the point of giving guidance for 2018 at this point. Yes, so Camilo, I’ll take the first part of that. Here is what I would say relative to the investments. And remember, we laid out a strategy and behind that strategy a roadmap of investments. And if you think about the shape that we talked about at the plan in Boston, in general, we’re going to see investments a little more front-loaded and you’re going to see our top-line continue to accelerate. So, it’s not so much. Yes, we are moving faster down a path. Our intent is to continue to invest, to invest around these priorities. So, while it may not be the exact same thing, right, we’re making innovations in our digital platform, for example, you don’t have to do that twice. That will be the next thing when you think about customs, mobility, and a lot of the innovation initiatives, we’re going to continue to make those investments.

And Camilo on the advance manufacturing portion of your question. I mean this is an exciting area and we’ve talked a little bit, not to a great degree because much of what we’re doing here we consider to be fairly proprietary. But I think it’s fair to say, we have gone through and continue to go through really in-depth end-to-end analysis of our total timeline around product creation and breaking down where those elements for us bring innovation and improve speed, efficiency, and really effectiveness. So, on the upstream side, that’s really looking closely at our design and development capabilities and where can we bring technology to improve speed.

But the advance manufacturing piece, which is really a little bit less than half of the total time of our timeline, is about looking at how do we breakdown material manufacturing and other things that we can do around improving speed at material finishing, adjacent to our production facilities and within the production facilities we’re looking at a whole host of technologies to improve efficiency. I would tell you our supply chain is already very automated, if you were to go into our Jeanswear facilities here in the Americas, you’d see a highly automated and efficient model. We think there are improvements to be had there, especially as we can marry up material finishing closer to where we produced. But a lot of things are going on inside the black box that we’re standing up here in North Carolina to really test out our theories, prove it, and then scale it as we can, not only in our own production but with key partners.

Good morning. Thank you for taking my question. I have a couple of inquiries. As we look ahead to next year, I'm curious whether you plan to restate everything regarding the Dickies acquisition and if there will be a new Workwear segment, or how we should approach that.

Yeah, at this point, Sam, we haven't decided to change any of our reporting segments; obviously that's ongoing evaluations that we're looking at in line with portfolio changes. At this point, we haven't made that decision.

Yes, Sam. What you have read there is exciting; that's part of our urban exploration territory. That's part of the really breaking down the consumer, use education into the four individual elements. Urban exploration really is coming from Asia in partnership with our Japanese partners but also the team in China, and what you saw in Paris Fashion Week was a collaboration with a group and you are really innovative, it takes on some of our core heritage mountain jackets, long in lengths and made through our technical standards. But what you see there, Sam, is our ability to speak to a broad segment of consumers through that technical lens of The North Face, and making sure we stay true to the heritage and the performance but also bringing the right product to allow that consumer to express themselves as they look at the brand individually.

A couple of questions for me. First, great strength in the D2C business; e-commerce is accelerating and the numbers imply positive comps at retail with the 1,500 stores across the globe. Can you guys comment on what you’re seeing with respect to traffic and conversion and maybe highlight some of the differences between regions and the brands?

Yeah, Jim, you captured it well. Our D2C business is strong and that’s a big part of our strategic focus; it’s where we are absolutely driving investments not only in creating that traffic, but investing behind operational scale. So, specifically your question on traffic, we are seeing with some of our businesses traffic up year-over-year, certainly see good traffic gains in our European business. But I think we’re really getting the performance is on conversion, in a lot of advances going on to in-store productivity from having the right product at the right time in each of the stores to the quality of the sales experience and our ability to really service consumers quickly and efficiently.

I’d like to expand on what you mentioned regarding the 1,500 stores. Over a year ago, we adjusted our strategy and reduced the number of net openings. We're now at around 50, which is roughly half of our previous pace. Nonetheless, we are still opening about a hundred stores and actively refining our fleet based on performance. Additionally, part of what you’re observing is our efforts to enhance the quality of our fleet in line with the like-for-like initiatives that Steve just discussed.

Hi, good morning, everyone. Let me add my congratulations. Scott, I think this is for you; it looks like you either hit or beat your plan within the Jeanswear closing for Q3. So, I'm just trying to understand what you see in Q4, maybe that causes you to be a little bit more conservative on that segment to that point. Can you help explain why Wrangler bounced back nicely in the U.S. while Lee worsened further from the run rate you saw last quarter?

Yeah. So, first of all, as we said that is the best thing in this; in a couple of areas, it’s tough for different reasons. But, yeah, Wrangler, nice to see sequential improvement and we seem to be generally moving through the plan as expected, despite our visibility. I would say no real change to that situation. To be honest, and in the Lee business we had a tougher than expected performance and particularly on the women's side. Our men's business is showing real strength; I think Steve mentioned that in the prepared remarks. We have several styles and innovations that are really resonating but on the women's side, it's been a tougher picture for us. And based on what we see going forward, some of that is channel-related, some of that is our own issues and I think overall.

Two questions. First for Steve, just on the Vans business, the wholesale distribution. I think you guys mentioned that Americas was up mid-single-digit. Did like recently kind of from, what I would call, more traditional athletic retailers, they’ve called out Vans as a strong brand for them. I’m kind of curious how you’re managing any expansion with those types of retailers. Any concerns with overexposing the brand maybe or alienating any more traditional accounts if you are growing with those types of retailers?

Our Vans business is better than most. The thoughtfulness that they put into their distribution strategy and how they segment product across the different choices that they have. This is something that they spend a tremendous amount of time thinking about. We are in all of those great retailers that sell footwear and athletic lifestyle footwear. And we’re not looking to aggressively open up doors. I think we are very broad-based in thinking about the Vans consumer, from the boutique consumer to the broader application and being very thoughtful around who the partner is, what are the right doors, what’s the right assortment. Then really managing with our partner sell-through so we can keep the right level of newness flowing into those doors to continue to drive that forward growth.

Just really quickly, a couple of things. As you all like to remember, Eric Wiseman will retire from our Board of Directors effective October 28. I would like to take a moment and again thank Eric for the leadership he’s provided all of us here at VF. We owe so much of our past success to his vision, incredible work ethic, along with his thoughtful approach to leading this 60,000-person global enterprise. I’m personally very thankful for his friendship and mentorship over our past 18 years together. Eric, if you’re listening, and I’m sure you are, we all wish for your next chapter to be as exciting and fulfilling as the 22 years that you gave to VF. So, with that, I’d like to thank all of you for joining our call today. We are now nine months into our journey to transform VF into a more agile and consumer-centric enterprise. We are confident in our increased outlook and the momentum that we’re carrying into the fourth quarter. Our core growth engines are delivering double-digit growth, our gross margin is strong, and our operating fundamentals are intact. We’re thoughtfully investing behind our strategic roadmaps and we remain intently focused on delivering value to our shareholders. So again, thank you, and we look forward to talking to you all again in February.