VF’s June 30 Quarter: It’s Not Easy Out There for Anybody

After the results we’ve seen from VF in previous quarters and years, this quarter’s can only be characterized as disappointing.  Just goes to show you how difficult the market is right now.  They’ve got lots of company.

Total revenue rose just 0.75% to $2.445 billion.  VF ended the quarter with 1,461 brick and mortar stores worldwide. Direct to consumer business was up 6% in the quarter and accounted for 27% of total revenues.  “The increase in direct to consumer revenues…were due to new store openings and an expanding e-commerce business.”  The increase was not, apparently, due to higher comparable store sales or I assume we would have been told about it.  International revenue was 35% of total revenue.

The most interesting thing they said about revenue was that department stores represent only 3% of their total revenue and that they are “…much more weighted towards specialty and sporting goods…” I guess I was surprised that this large a company doesn’t do more business in the department store channel, but I’d say good for them.

The gross profit margin went from 48.0% in last year’s quarter to 48.1%.  It would have been up around 0.7% in the quarter if not for foreign exchange issues.

SG & A expense kicked up slightly to $965 million from $947 million last year.  Operating income fell 3.5% from $219 to $211.4 million.

Interest expense of $23.6 million was up from $22.9 million last year due mostly to higher interest rates.  Net income fell from $170.8 to $51 million.

VF would like you to know that on June 29, they agreed to sell their contemporary brands segment (The 7 For All Mankind, Splendid and Ella Moss brands) for $120 million subject to the usual working capital adjustments.  They took a loss of $100.6 million on the sale and show, on their income statement, a net loss from discontinued operations of $97.3 million for the quarter.  They had a $3 million gain from discontinued operations in last year’s quarter.  If we ignore both those numbers, net income in last year’s quarter would have been $167.8 million.  This quarter’s net income would come in at $148.3 million, down 11.6%.

The balance sheet hasn’t changed much.  The current ratio fell from 1.66 to 1.53, inventories rose 5.8% to $1.776 billion, equity fell 6.4% to $4.65 billion, and total liabilities to equity rose slightly from 0.97 to 1.08.

I do want to touch on the inventory number.  What we learn (they’ve said this before actually) is that VF carried over some first quality winter inventory.  They didn’t write it down, they didn’t blow it out, and they expect to sell it for full retail this winter.  They aren’t the only ones taking this approach, and I think it’s a good one, though not as good as buying closer to requirements in the first place of course.  That’s easier to say than to do.

I don’t know how much inventory we’re talking about, and I don’t know if they have or will do the same with other seasonal inventory.  I guess the result, in general, will be reduced quarterly inventory volatility.  Doing this, of course, requires having a balance sheet that allows you to carry inventory longer than you otherwise would.  VF has that.

In the first six months of 2015, VF’s cash flow showed cash used by operating activities of $253 million.  In 2016, operating activities generated $11.4 million.  They tell us that, “The increase in cash flows in the first six months of 2016 is primarily due to a $250 million discretionary contribution to the domestic qualified pension plan in the first quarter of 2015 that did not recur in 2016.”

Why would you make a discretionary contribution to a pension plan?  One possible reason is because your plan assumes a return on the pension fund assets of something like 7%, but you aren’t confident the assets are actually going to be able to earn that without taking a lot more risk.  If that’s the case here, those of you who are relying on a pension from VF should be thanking your lucky stars you work or worked for a company both able and responsible enough to do this.

You might take a moment to consider the situation of pension plans, insurance companies and, by the way, savers (like maybe some of you?) who used to rely on a 6% or so basically risk free return as a major source of funding.  Thanks all you central banks around the world for basically screwing up the market under which there was a meaningful relationship between risk and returns.  Yeah, that kind of was a political comment.

Outdoor and Action Sports revenue grew just under 1% during the quarter to $1.42 billion.  That represented 58% of total revenue, up from 57.5% in last year’s quarter.  Its operating profit was $123.2 million, down from $134.9 million in last year’s quarter.

Vans’ revenue rose 6%.  Kudos to Doug Palladini for what he and the VF team have done with the brand.  I’m still not entirely sure how they seem to be able to make it appeal to pretty much everybody.

The North Face was up 2% and Timberland was down 7%.  You probably noticed some recent management changes at Timberland.  They are expecting Timberland to face a “…challenging sales environment…” in the second half of the year.

“Global revenues for Outdoor & Action Sports increased 2% in the first six months of 2016 compared with 2015, reflecting 3% operational growth partially offset by a negative 1% impact from foreign currency. Revenues in the Americas region increased 2% in the first half of 2016, net of a negative 1% impact from foreign currency. Revenues in the Asia-Pacific region increased 3% despite a 2% negative impact from foreign currency. European revenues increased 2% in the first half of 2016 compared with the 2015 period, reflecting a positive 1% impact from foreign currency.”

“Wholesale revenues [for Outdoor and Action Sports] were down 3% in both the second quarter and first six months of 2016, primarily due to elevated inventory levels at customers in our key channels of distribution in North America and Europe.”  That’s a pretty common problem around the industry.  Bankruptcies have put a lot of inventory in the market.

It’s tough out there, and it’s the big players with solid balance sheets that are in the best position to take advantage of it in the long term. A lot of the blocking and tackling that goes into managing in this environment isn’t very exciting to write about, but it’s critically important.

VF management didn’t say anything about new store opening plans, but they were clearly excited about growing their ecommerce business which they characterized as high margin and their most profitable format.  They described a “…new digital and ecommerce technology engine…” they are rolling out.

I will be very interested to see how they manage their brick and mortar footprint going forward.