VF Corporation — Q2 2016 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and six months ended July 2, 2016; comparable periods ended July 4, 2015. Unless noted, operating results below are continuing operations. VF sells apparel, footwear and accessories through its Outdoor & Action Sports, Jeanswear, Imagewear and Sportswear coalitions, among others.
Key financial results
Amounts in millions, except per-share data and percentages.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Total revenues | $2,445.3 | $2,427.0 | $5,210.2 | $5,176.8 |
| Operating income | $211.4 | $219.0 | $543.7 | $610.3 |
| Continuing-operations income | $148.3 | $167.8 | $405.2 | $451.0 |
| Continuing diluted EPS | $0.35 | $0.39 | $0.95 | $1.04 |
| Net income, including discontinued operations | $51.0 | $170.8 | $311.3 | $459.5 |
| Total diluted EPS, including discontinued operations | $0.12 | $0.40 | $0.73 | $1.06 |
| Gross margin | 48.1% | 48.0% | 48.1% | 48.4% |
| Operating margin | 8.6% | 9.0% | 10.4% | 11.8% |
- Cash flow: First-half operating cash flow was $11.8 million, versus cash used of $252.7 million a year earlier; the prior-year period included a discretionary $250 million domestic pension contribution. Investing used $101.3 million, primarily for capital expenditures ($82.6 million) and software ($17.4 million). Financing used $188.5 million.
- Liquidity and debt: At July 2, cash and equivalents were $676.3 million; working capital was $1.407 billion and the current ratio was 1.5:1. Short-term borrowings were $1.404 billion and long-term debt was $1.401 billion. Debt to total capital was 37.7%, up from 25.6% at December 2015. Commercial paper and standby letters of credit totaled $1.396 billion, leaving $852.5 million available under the $2.25 billion revolving facility.
- Capital returns: VF repurchased 13.2 million shares for $833.8 million in the first half and paid $309.6 million in dividends. First-half dividends per share were $0.74, versus $0.64 in 2015. The board declared a $0.37 quarterly dividend payable September 19, 2016.
Material changes and management commentary
- Revenue increased 1% in both Q2 and the first half. Growth reflected Outdoor & Action Sports, Jeanswear, direct-to-consumer and international sales, partly offset by Sportswear declines. Foreign exchange reduced revenue by $17.4 million in Q2 and $59.3 million in the first half.
- Q2 coalition revenue/profit trends: Outdoor & Action Sports +1.7%/−8.7%; Jeanswear +3.4%/+4.1%; Imagewear +2.6%/+2.7%; Sportswear −19.2%/−56.4%. In the first half, Sportswear revenue fell 16.0% and profit fell 59.4%.
- Q2 gross margin improved 10 basis points, but first-half gross margin declined 30 basis points. Currency reduced gross margin by an estimated 70 basis points in Q2 and 120 basis points in the first half. Excluding currency, management cited pricing, lower product costs and mix as drivers of improvement, partly offset by actions to manage inventory.
- SG&A as a share of revenue rose 50 basis points in Q2 and 90 basis points in the first half, primarily due to investment in direct-to-consumer and product innovation. Those costs, currency effects and weaker coalition profitability contributed to lower operating income and continuing-operations EPS.
- Direct-to-consumer revenue grew 6% in Q2 and 7% in the first half, driven by new stores and e-commerce; it represented 27% of Q2 revenue. International revenue rose 5% in Q2 and 3% in the first half, with currency headwinds.
Outlook, unusual items and risks
- Contemporary Brands sale: On June 29, VF agreed to sell 7 For All Mankind, Splendid and Ella Moss to Delta Galil for $120 million cash, subject to working-capital adjustments, with closing expected in Q3 2016 subject to customary conditions. VF classified the businesses as discontinued operations and assets held for sale. Its preliminary estimated after-tax disposal loss was $100.6 million; Q2 discontinued-operations loss was $97.3 million after related operating results and tax effects. VF expected to continue operating the European 7 For All Mankind assets and provide transition services for limited periods after closing.
- Inventory and seasonality: Inventory increased to $1.776 billion from $1.555 billion at year-end, mainly reflecting seasonal buildup and cold-weather product carried forward for expected second-half demand. Management said operating cash flow is typically lower in the first half and substantially higher in the second half as inventory sells and receivables are collected. Inventory purchase obligations increased about $306.4 million due to seasonality.
- Financing and capital allocation: VF increased its revolving credit facility and commercial paper program from $1.75 billion to $2.25 billion. Management said available cash, operating cash flow, credit capacity and capital-market access should be adequate for obligations, planned capital expenditures and dividends, and potential investments. It gave no specific earnings or revenue guidance in the supplied filing text.
- Contingencies: VF appealed the EU decision concerning Belgian excess-profit tax rulings and received a Belgian assessment for tax and interest; it had not paid the assessment and recorded no additional accrual, believing previously recognized benefits were more likely than not to be sustained. A Timberland 2011 tax examination is also disputed in U.S. Tax Court. Management said neither matter was expected to have a material financial-statement impact, while noting uncertainty.
- Principal risks identified: Foreign exchange, consumer demand, margin pressure, changing fashion trends, demand forecasting, customer and supplier concentration/financial strength, raw-material availability and cost, distribution and manufacturing disruption, international and direct-to-consumer execution, information security, intellectual property, impairment, tax, legal/regulatory and political risks, and adverse weather.
Investor facts to verify
- Whether the Contemporary Brands sale closed on the expected terms and timing, and how final proceeds and disposal loss compared with estimates.
- Whether the increased inventory converts to second-half sales and cash flow as management anticipated, particularly given customer inventory levels and Sportswear weakness.
- Whether revenue and margins recover or remain pressured by foreign exchange, SG&A investment and weaker coalition performance.
- How short-term borrowing, liquidity and debt-to-capital evolve after substantial share repurchases and dividend payments.
- Developments in the Belgian tax appeal and Timberland tax dispute, including any change in assessments, accruals or expected cash payments.