VF Corporation — Q3 2017 Form 10-Q
Business context and period. This unaudited filing covers the three and nine months ended September 30, 2017; comparative periods ended October 1, 2016. VF sells apparel, footwear and accessories through its Outdoor & Action Sports, Jeanswear, Imagewear and Sportswear businesses. Results reflect continuing operations unless noted. VF plans to end fiscal 2017 on December 30, then report a three-month transition period through March 31, 2018, before moving to a fiscal year ending in March.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $3.509 billion | $3.328 billion | $8.450 billion | $8.283 billion |
| Operating income | $483.9 million | $608.2 million | $943.4 million | $1.114 billion |
| Continuing operations income | $386.8 million | $485.2 million | $716.3 million | $863.7 million |
| Diluted EPS from continuing operations | $0.97 | $1.16 | $1.77 | $2.04 |
| Operating cash flow | Not separately reported for the quarter | $6.7 million | $47.2 million |
- Q3 revenue rose about 5% (including a 1% favorable currency effect); year-to-date revenue rose about 2%. Gross margin improved to 50.1% from 49.1% in Q3 and to 50.0% from 48.9% year to date. Currency reduced gross margin by approximately 80 and 70 basis points, respectively.
- Operating margin fell to 13.8% from 18.3% in Q3 and to 11.2% from 13.5% year to date. Higher SG&A investment, compensation costs and a $104.7 million Nautica goodwill impairment outweighed revenue and gross-margin gains.
- Reported consolidated net income, including discontinued operations, was $386.1 million in Q3 and $705.2 million year to date, versus $498.5 million and $809.8 million, respectively, in 2016. Discontinued operations contributed losses of $0.6 million and $11.1 million in 2017.
- Direct-to-consumer revenue grew 18% in Q3 and 13% year to date; e-commerce grew 38% and 32%. International revenue grew 13% and 7%, respectively. Outdoor & Action Sports was the largest growth driver, while Jeanswear revenue and profit declined.
Balance sheet, cash flow and liquidity
- At September 30, cash and equivalents were $1.546 billion; total assets were $10.875 billion. Short-term borrowings were $1.985 billion, current long-term debt $253.8 million and long-term debt $2.144 billion. Debt to total capital was 52.7%, up from 31.9% at December 2016; the current ratio was 1.5 versus 2.4.
- Nine-month operating cash flow was only $6.7 million, down from $47.2 million. Cash was absorbed by increases in receivables ($625.6 million) and inventories ($390.4 million); management notes that cash generation is seasonally stronger in the second half.
- Investing activities provided $25.1 million, including $213.5 million of proceeds from the Licensed Sports Group sale, offset in part by $124.4 million of capital expenditures and $53.5 million of software purchases. Financing activities provided $301.4 million, including a $1.959 billion net increase in short-term borrowings; VF also repurchased $1.2 billion of stock and paid $503.0 million of dividends.
- The $2.25 billion revolving credit facility supported the commercial paper program. At quarter end, commercial paper borrowings were $1.9 billion and reported availability was $287.4 million. Management said cash, operating cash generation, credit facilities and market access provide adequate liquidity for obligations, investment and planned dividends.
Material changes, outlook and risks
- VF completed its $800.7 million cash acquisition of Williamson-Dickie on October 2, 2017, funded primarily with short-term borrowings; about $890 million had been borrowed near quarter end in preparation. On November 1, VF repaid $250 million of 5.95% notes. VF also agreed to acquire Icebreaker, expected to close in April 2018, at a purchase price described as not material.
- The $104.7 million noncash goodwill impairment followed a strategic assessment of Nautica. Its trademark was not impaired, but VF cautioned that future impairment conclusions could change with performance, forecast assumptions, discount rates or market inputs. VF also recorded $8.6 million of fixed-asset impairment.
- VF reported no formal revenue or earnings guidance in this filing. Management cited continued investment in direct-to-consumer, product innovation, demand creation and technology. It expected no significant additional costs in 2017 from its 2016 restructuring and anticipated substantial completion by year-end.
- Risks highlighted include consumer demand and fashion shifts, online competition, customer concentration and financial health, margin pressure, foreign exchange, supply-chain disruption, raw-material costs, execution of growth plans, cybersecurity, weather, and goodwill or other asset impairment. Management reported effective disclosure controls and no material change in internal controls.
- Tax matters include a $31.9 million Belgian tax assessment paid in January 2017 and recorded as a receivable while appeals remain unresolved; VF may not recover it if the matter is adversely resolved. A disputed IRS adjustment concerning Timberland’s 2011 tax return also remained unresolved. Management considered its tax provision adequate.
Important facts for investors to verify
- Whether the sharp fall in operating cash flow reflects seasonal working-capital timing or a persistent cash-conversion issue.
- Post-acquisition debt, liquidity and leverage after Williamson-Dickie funding and repayment of the $250 million notes.
- Whether Nautica’s performance and valuation assumptions lead to further goodwill or intangible-asset impairment.
- Whether Jeanswear weakness and wholesale channel pressures persist, and whether direct-to-consumer and e-commerce growth can sustain margins.
- Resolution and potential cash consequences of the Belgium tax appeal and Timberland IRS dispute.