VF Corporation — Q3 FY2020 Form 10-Q
Reporting period: Fiscal third quarter ended December 28, 2019; comparisons are with the quarter ended December 29, 2018. Unless noted, amounts below are for continuing operations. VF completed the spin-off of its Jeans business on May 22, 2019; prior-period continuing results have been presented on a comparable basis, while discontinued-operation results remain in total net income.
Financial performance
- Revenue: Q3 net revenue was $3.385 billion, up 5% year over year. Organic growth contributed $183.8 million; foreign exchange reduced revenue by $22.4 million. For the first nine months, revenue was $9.049 billion, up 5%.
- Profit and margins: Q3 operating income was $578.8 million versus $520.8 million; operating margin rose to 17.1% from 16.1%. Gross margin increased 110 basis points to 55.7%. Continuing-operations income was $452.7 million, or $1.13 diluted EPS, versus $409.1 million, or $1.02. Total net income was $465.0 million versus $463.5 million; total diluted EPS was $1.16 in both periods.
- Nine-month results: Operating income was $1.291 billion versus $1.179 billion, with operating margin of 14.3% versus 13.7%. Continuing-operations income was $1.199 billion and diluted EPS was $2.99, compared with $886.6 million and $2.21. A $169.7 million net discrete tax benefit, primarily from the Swiss Tax Act, materially benefited the 2019 period.
- Segments, Q3: Outdoor revenue grew 3% to $1.659 billion, with segment profit up 3%; Active revenue grew 8% to $1.239 billion and segment profit grew 5%; Work revenue rose 2% to $480.1 million, but segment profit declined 3%. Active’s operating margin declined 80 basis points; Outdoor margin was flat.
- Channels and geography: Q3 direct-to-consumer revenue grew 7%, e-commerce grew 16%, and international revenue grew 8%. Direct-to-consumer represented 46% and international 42% of Q3 revenue.
- Cash flow: First-nine-month operating cash flow from continuing operations was $828.4 million, down from $1.112 billion. Capital expenditures were $186.3 million and software purchases were $37.3 million. Cash used by investing activities was $171.6 million; cash used by financing activities was $622.1 million.
- Liquidity and debt: December cash and equivalents were $584.0 million. Short-term borrowings were $56.0 million and long-term debt was $2.110 billion. Operating lease liabilities were $1.366 billion. Working capital was $2.194 billion and the current ratio was 2.1:1. Debt-to-total-capital was 43.6% including operating lease liabilities and 32.2% excluding them. Approximately $2.2 billion remained available under the Global Credit Facility and commercial paper capacity.
Material changes and management commentary
- Revenue growth reflected organic gains across segments and continued strength in direct-to-consumer and international sales; unfavorable currency and prior-year divestitures partly offset growth.
- Management attributed gross-margin improvement to a mix shift toward higher-margin businesses and favorable foreign-currency transaction effects. SG&A as a share of revenue increased, partly due to headquarters and brand relocation costs, strategic decisions in South America, and growth investments.
- Operating cash flow declined year over year, primarily because of greater working-capital cash use, including timing of bonus, transaction, relocation, and other strategic-business payments.
- Inventories were $1.565 billion, up from $1.402 billion at December 2018. Management cited business growth, elevated occupational-work inventory, and mixed holiday-season results, especially in the Americas.
- VF adopted lease accounting in fiscal 2020, recognizing operating lease right-of-use assets and liabilities. The balance sheet now includes $1.299 billion of operating lease assets; approximately $295 million of signed leases had not yet commenced.
Outlook, risks, contingencies and unusual items
- The filing does not provide a clear numerical earnings or revenue guidance range. Management said cash balances, operating cash flow, credit facilities, and access to capital markets were expected to provide adequate liquidity for obligations, capital spending, planned dividends, and investment opportunities.
- On January 21, 2020, VF announced it was considering divesting the occupational portion of its Work segment, representing approximately half of Work revenue. This was a consideration, not a completed transaction.
- VF recorded a $22.9 million pension settlement charge in Q3 after lump-sum distributions of approximately $130 million settled about $170 million of projected benefit obligations. Other Q3 headwinds included relocation costs and continued growth investments.
- The Swiss Tax Act generated a $164.4 million tax benefit in Q2; further adjustments were expected in Q4 following enactment in the canton of Ticino. The unusually low nine-month effective tax rate of 2.1% therefore should not be assumed to recur.
- In a tax dispute concerning the 2011 Timberland acquisition, VF said it was vigorously defending its position and did not expect a material adverse impact. If the IRS prevailed, the company estimated net interest expense could be up to $151 million and tax expense could increase by approximately $136 million.
- Timberland goodwill and trademark impairment testing found no impairment; goodwill fair value exceeded carrying value by 27%. Management warned that failure to achieve projected recovery and growth could result in future impairment.
- After quarter-end, VF declared a $0.48 quarterly dividend, reported additional share repurchases, and announced tender offers for certain notes due 2033 and 2037 and redemption of $500 million of notes due 2021. The company stated an intent to repurchase up to $500 million of shares in Q4, subject to change.
- Other disclosed risks include foreign exchange, consumer demand, competitive and margin pressure, supply-chain and information-security disruptions, execution of the Jeans spin-off and Denver relocation, and tax and legal uncertainties. Management reported no material change in risk factors and concluded disclosure controls were effective.
Key facts for investors to verify
- Underlying growth and profitability after separating the one-time Swiss tax benefit from recurring results.
- Inventory levels and sell-through following the mixed 2019 holiday season, particularly in the Americas and occupational Work businesses.
- Progress and potential financial effects of the contemplated occupational-work divestiture.
- Timberland brand performance against the forecasts supporting the impairment analysis, and any later impairment indicators.
- Resolution and potential exposure from the IRS Timberland tax dispute and the Swiss tax adjustments expected in Q4.
- Cash conversion, share repurchase pace, and debt and lease obligations, including the impact of announced note tenders and redemption.