VF Corporation — Q1 2016 Form 10-Q
Business context and reporting period. VF Corporation reported its first fiscal quarter, ended April 2, 2016, compared with the quarter ended April 4, 2015. VF is an apparel, footwear and accessories company whose reportable businesses include Outdoor & Action Sports, Jeanswear, Imagewear, Sportswear and Contemporary Brands. Amounts below are in U.S. dollars.
Financial performance
- Revenue: $2.839 billion, up 0.1% from $2.837 billion. Operational growth of $44 million was largely offset by a $42 million foreign-currency headwind.
- Profit and margins: Operating income was $336.3 million, down 15.5%; operating margin fell to 11.8% from 14.0%. Gross margin declined to 48.2% from 49.0%. Net income was $260.3 million, down 9.8%; diluted EPS was $0.61 versus $0.67.
- Taxes: The effective tax rate was 18.0%, versus 23.8%, including a $19.6 million net discrete tax benefit. This included a $15.8 million benefit from early adoption of stock-compensation guidance, equivalent to $0.03 per diluted share.
- Cash flow: Operating cash use was $145.6 million, compared with $400.9 million used a year earlier. The improvement was primarily because a $250 million discretionary domestic pension contribution made in Q1 2015 did not recur. Investing cash use was $43.3 million; financing cash use was $190.0 million.
- Liquidity and debt: Cash and equivalents were $585.8 million at quarter-end. Short-term borrowings were $1.137 billion and long-term debt was $1.401 billion; total debt including current long-term debt was approximately $2.542 billion. Working capital was $1.443 billion, the current ratio was 1.6:1, and debt to total capital was 34.2%. Management said cash, operating cash flow, credit facilities and capital-market access provide adequate liquidity.
- Capital returns: VF repurchased 11.3 million shares for $713.8 million and paid $155.6 million in dividends. Quarterly dividends were $0.37 per share; the board declared another $0.37 dividend payable June 20, 2016.
Changes versus the comparable quarter
- Foreign currency reduced revenue growth by 2% and diluted EPS by 9%, according to management. Excluding currency, revenue increased in every region.
- Cost of goods sold and SG&A rose faster than revenue. SG&A increased to 36.3% of revenue from 35.0%; the comparison also reflects a $16.6 million one-time gain on sale of a VF Outlet location in Q1 2015. Excluding currency, gross margin improved 20 basis points, supported by lower product costs, pricing and business mix, partly offset by efforts to manage elevated inventories.
- Outdoor & Action Sports revenue grew 2%, but coalition profit fell to $227.8 million from $260.8 million, affected by currency and higher investment. Jeanswear revenue grew 2% and profit rose to $137.3 million. Imagewear revenue fell 5%, while profit was approximately flat. Sportswear revenue fell 13% and profit fell to $4.8 million. Contemporary Brands revenue declined 15%; profit was $1.7 million. “Other” recorded a $2.4 million loss, versus $14.5 million profit, largely reflecting the prior-year outlet-sale gain.
- Direct-to-consumer revenue grew 7% and accounted for 26% of total revenue, compared with 24%. International revenue increased 1% despite a 3% currency headwind and represented 41% of total revenue.
- Inventory was $1.763 billion, up from $1.612 billion at December 2015. Management attributed the increase to seasonality and cold-weather products carried forward to meet expected second-half demand.
Outlook, commentary and risks
- The filing provides no specific numerical full-year revenue, earnings or margin guidance. Management noted that first-half operating cash flow is typically lower as inventory builds for second-half sales, and expressed confidence that liquidity would support obligations, capital spending, planned dividends and potential investments.
- Management cited investment in direct-to-consumer operations, product development and innovation as priorities. VF had 1,541 company-owned retail stores at quarter-end. In Sportswear, Nautica faced reduced traffic and department-store challenges; management was closing unprofitable stores and transitioning certain apparel categories to a licensed model. Vans wholesale sales were pressured by retailer inventory management.
- Key risks identified include foreign-exchange movements, consumer demand and fashion trends, margin pressure, customer and supplier concentration or disruption, inventory-demand forecasting, distribution and information-system disruptions, impairment, and legal, regulatory, political and tax matters.
- Tax contingencies: The IRS proposed material adjustments to Timberland’s 2011 tax return; VF disputed them and had petitioned the U.S. Tax Court. The EU had ordered recovery of tax benefits related to Belgium’s excess-profit tax regime for 2010–2014; the Belgian government appealed. VF said it was assessing the matter and did not expect an adverse outcome to be material. Unrecognized tax benefits and associated interest increased by $106.6 million to $179.7 million during the quarter.
- VF reported no material changes to previously disclosed legal proceedings or risk factors, no significant change in market-risk exposures, and effective disclosure controls.
Important facts for investors to verify
- Whether operational growth can offset currency pressure, and whether weaker Sportswear and Contemporary Brands trends stabilize.
- Whether elevated inventory converts to second-half sales as planned, without additional discounting or margin deterioration.
- How much of reported earnings benefited from the $19.6 million discrete tax benefit, and the eventual outcome and cash impact of the Timberland and Belgian tax matters.
- Whether share repurchases and dividends remain supportable alongside higher short-term borrowing; $635.5 million of the $1.75 billion revolving facility was available at quarter-end after commercial paper and letters of credit.
- Whether operating cash flow improves as seasonal inventory is sold and receivables are collected; Q1 cash use alone is not representative of the full year, according to management.