威富公司 (VFC) 2002 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Vanity Fair Corporation conference call.

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I would now like to introduce your host for today's conference, Miss Vanessa Schwartz of FRB Webber Shanwick.

Miss Schwartz, you may begin the conference.

Good morning, and thank you for participating in the Vanity Fair Corporation second quarter conference call.

You should have all received a copy of the press release issued earlier today.

If you did not, please contact Thomas Walsh at FRB Webber Shanwick at 212-445-8459 and he will send one out to you and confirm your name on either the fax or e-mail list.

Starting our call today is Mackey McDonald, chairman and Chief Executive Officer of Vanity Fair corporation.

Before we begin, I'd like to remind everybody that certain statements included in today's remarks and in the question and answer session may constitute forward-looking statements within the meaning of the federal securities laws.

Forward-looking statements are not guarantees and actual results may differ materially from those expressed or implayed in the forward-looking statements.

Important factors that could cause the actual results of operations or financial condition of the company to differ are discussed in the documents filed by the company with the Securities and Exchange Commission.

Now, I'd like to turn the call over to Mackey.

Thank you, Vanessa, and good morning.

Thanks for joining our second quarter conference call.

With me today are Chief Financial Officer Bob Shearer, Cindy Canoble, our financial relations, and our coalition chairman, John Schamberger, Eric Wiseman, Terry Lay and George Derhofer.

We're extremely pleased with our performance in the quarter.

This is a record second quarter for VF, both in terms of earnings per share and cash flow.

Our conservativism, our approach to the day's difficult markets and our brand management skills are paying dividends this year in the form of much better than expected earnings.

We knew we had put the right initiatives in place to improve our profitability and it's great to see the effect they're having on our bottom line.

Our cost structure's in excellent shape, giving us significant leverage for future sales increases.

Based on results achieved in the first half, we're now increasing our earnings guidance for the third quarter and for the full year.

Bob will be going over the numbers in more detail in a moment, but I'd like to make some comments about our businesses and what we're seeing at retail.

Although the June same-store comparisons reported last week by many retailers were slightly better than expected, we're still seeing mixed results overall.

This is pointed to an anemic retail apparel selling environment.

I'm pleased to note that by and large, our brands are continuing to gain share.

The mass channel continues to be stronger than department or specialty stores as consumers search for value.

Overall, retail inventories are in good shape and VF's inventories are in excellent shape, down over 300 million in the quarter.

I'll just spend a few minutes talking about what we're seeing in each one of our core business.

Market share for our two primary jeans brands were up according to our most recent data.

In the first five months of '02, Wrangler moved from a 10% share to a 10.3% share, while Lee improved from 4.2 to 4.4%.

We have a number of key market initiatives this year supported by a 16% increase in marketing spending in the jeanswear area.

These include Wrangler Hero, Five Star Denim, new missy products for Riders, and a casual pants line in Wal-Mart, Lee dungarees, which now comprises 40% of Lee's men's business, is one of the fastest growing young men's brands in the middle tier.

Our Lee women's business is also the expected to have a strong sales increase in the second half of the year.

Domestic jeans sales of dollars in units were down in the first half but expected to be up in the second half of the yearm.

For the year, sales dollars will be down primarily due to selected price decreases and the financial difficulties experienced by some of our customers.

Unit sales for the year, however, are expected to be about flat.

In intimate apparel, our department and chain store businesses remain strong and we saw sales increases in our Vanity Fair, Lily of France and Tommy Hilfiger businesses in the second quarter.

In the mass channel, our results are mixed with a decline in Vassaret and stable performance in Bestform.

We do expect improvement in the second half of the year with a new product launch from Vassaret backed by a significant investment in consumer advertising.

In fact, we're planning a 29% increase in marketing investment in our US intimates business this year.

Our private label business is also down this year, as anticipated although slightly better than our plan.

A big initiative for our intimates group this year was the integration of Bestform and Vanity Fair.

I'm pleased to report they did an excellent job of completing this initiative on time with no business disruptions and with cost savings that are expected to exceed our original expectations.

Many of you received enough data on our international jeans business a few weeks ago in our lunch with VF session.

Overall market conditions in Europe remain challenging as well but we're seeing good response from such product innovations as Denim 42, broken twill and retro styles.

We continute to expect an overall sales increase in our European jeans business this year.

In imagewear we're continuing to make excellent progress in consolidating our units, cutting costs and improving our sourcing all contributing to a significant recovery in profitability this year.

Our core workwear sales continue to be soft as anticipated in our plan, reflecting a mixed economic recovery that has yet to see a meaningful rebound in employment levels.

At the same time, we're capturing a number of new business opportunities.

An example of how we're offering one-stop solutions to large multinational companies and government agencies is our recent award to be the sole uniform provider for the Transportation Security Administration or TSA, which was formed following the events of September the 11th.

TSA will be hiring 55,000 employees to work at over 400 airports around the country.

They selected us based on our ability to deliver a total package based on an accelerated rollout.

We're also expecting a healthy increase in our life and sports business this year driven by our NFL license.

As you know, we're excited about the prospects for our outdoor brands, The North Face, Jansport and Eastpak.

Spring sell-throughs for The North Face are very good with reorders 50% above plan.

Following '02 preseason bookings are 17 above prior year levels.

On June the 1st, we launched a new sportswear line called A5, scheduled for Spring '03 delivery.

A5 products will have The North Face ID with A5 used as a secondary logo.

A5 leverages the technical heritage of The North Face and the lifestyle products that deliver quality, value and accessible price points. we're addressing this with improved value, stronger assortments and more back-to-school advertising.

Internationally, all of our outdoor brands are performing strongly.

That's a quick review of our major businesses.

Now, I'll turn it over to Bob to review the quarter's financials in more detail.

Thanks, Mackey, and good morning, everyone.

As you know, we previously forecasted a 5% increase in second quarter earnings compared to last year.

Now, that estimate excluded nonrecurring items related to previously announced restructuring and the business exits.

Due to better than expected margins across most of our businesses, adjusted earnings per share, excluding the nonrecurring items came in at a very strong 77 cents per share, and that's an increase of 28%.

The improvement was broad-based and gives us increased confidence in our outlook for the rest of the year.

A significant factor in our earnings increases is the improvement in gross margins that reflects our continued move offshore, improved capacity utilization and lower sales of distressed goods.

Since 1999, we've moved from having 28% of our US sales from domestic production to about 15% by the end of this year.

We expect improved gross margin comparisons in the third and fourth quarters of this year as well.

As we saw in the first quarter, the net cost of restructuring activity in the current quarter was less than expected.

In fact, the net effect was actually a boost to reported earnings.

This is a result of better than expected operating results in our Jantzen business, which we recently sold to Perry Ellis International, as well as the reversal of prior year's restructures charges.

On a six-month basis, restructuring costs were offset by higher than expected income from exited business and other credits related to the restructuring activities resulting in virtually no impact on reported income or net earnings per share.

All of this activity, including both costs and credits alike are treated as nonrecurring and accordingly are excluded from adjusted earnings per share.

As we complete our strategic repositioning program, we do expect to incur net restructuring costs in the second half of the year.

Previously, we had indicated two components to these costs, $15 million related to business exits and 25 to $30 million for other cost reductions.

The total impact was estimated at 25 cents per share.

The majority of the impact related to the business exits is behind us and was substantially less than we had anticipated.

With respect to the remaining cost reduction actions, we're on schedule.

Because of the lower costs related to the business exits, we see the total impact of receipt structuring coming into close to 20 cents per share rather than the 25 cents per share previously estimated.

The change in other operating income reflects the absence of goodwill amortization expense.

As we've noted, the change in the accounting rules for goodwill eliminates annual expense of $30 million, benfitting earnings buy 32 cents per share in 2002 compared to 2001.

On a pure apples to apples basis, that is, excluding the effects of goodwill amortization expense and nonrecurring items in both years, operating margins were 12.8% in 2002, compared to 11.8% in 2001, and the 2002 quarter includes additional marketing spending, representing 60 basis points of margin.

Previously, we've targeted an increase of 7 to 10% in marketing for the year and it now looks like we'll be up closer to 11%.

Clearly, we're seeing fundamental improvement in the underlying profitability of our core businesses.

Lower interest expense reflects lower net borrowings while the decrease in the tax rate is affected by a number of factors, including the elimination of goodwill amortization which was not deductible.

In terms of our balance sheet, inventories are down $319 million from a year ago and that's a decrease of 26%.

That's a great achievement by our operating group.

Our cash flow from operations was extremely strong at 262 million.

That's the highest achieved in any previous first six months.

As noted in the release, cash flow from operations could top the $500 million mark this year.

Our priorities for cash flow include acquisitions, debt reduction, share repurchase and dividends.

During the quarter, we repurchased a million shares.

Absent any acquisitions, we plan to continue this rate of purchase through the year.

To reiterate our guidance for the rest of the year, we're raising our earnings estimates for both the third quarter and the year.

Third quarter earnings are now expected to rise by 20%, excluding unusual items.

Earnings per share for the year, again, excluding unusual items and the writeoff of goodwill should increase by 25%, that's versus our prior forecast of an increase of 15%, and if you take that one step further and exclude goodwill expense in 2001, our 2002 earnings would rise 12%, and that's versus the 5% we had previously anticipated.

This improvement is being driven by better than expected margins.

We had targeted a 100 basis point improvement in operating margins, but currently we believe we can double that improvement to 200 basis points.

Thank you, Bob.

Clearly, we've set the stage for a great second half.

We've put in place a cost structure that allows us to fully take advantage of our future sales increases, and in the third quarter, sales in our core businesses, that is excluding exited businesses, are expected to rise 4%.

In particular, we expect strength in our Lee, Vanity Fair, Lily of France, Tommy Hilfiger, intimates, life and sports, European jeans and outdoor businesses.

That concludes our remarks.

I would now like to open it up to questions.

Thank you.

Ladies and gentlemen, if you have a question at this time, please press the one key on your touch tone telephone.

If your question has been answered or you wish to remove yourself from the queue, please press the pound key.

If you are using a speakerphone, please lift the handset before asking a question.

Our first question comes from Dennis Rosenberg of Credit Suisse First Boston.

You may proceed.

Good morning and congratulations on terrific results.

Thanks, Dennis.

Acquisitions have been a key part of your growth strategy.

That seems to be the part that's notably been absent over the first half.

Without discussing any specifics, do you think that you will see any meaningful acquisitions this year?

Yes, as we've said, Dennis, we are looking for acquisitions.

We think this is the right kind of market for acquisitions.

We're looking for acquisitions in jeanswear, intimates and outdoor that offer new opportunities, new market segments through geographic markets that complement our current portfolio brands.

We're also looking for obviously the right financial equation that will have, so that the acquisitions will be on the slightly dilutive or accretive and very short period of time, and as we work through, we feel like there will be opportunities in these areas for us in the next year.

Okay, could you discuss the effect of the weak dollar going forward, if you were to assume the bill stays at parity with the dollar, a significant factor but a bit of upside.

Okay, and finally, the European business, European jeans business, based on the press release, it sounds like it was down mid single digits in this quarter.

It was up in the first quarter and you're projecting it up for the rest of the year, so what was the difference in the second quarter?

We were up 8% first quarter and on the currency adjusted basis down three in the second.

What shifted it to cause it to be down in the second?

Well, from a retail takeout standpoint, as Mackey said, overall the business has been somewhat tough but our major ship in the quarters or first and third quarter and it's information driven and fabric and finish and some what continue to lead the way and it's really in the function of delivering the next seasons items for the third quarter.

Thank you.

Thank you our next question comes from Bob Dervell of Lehman Brothers.

You may proceed.

Good morning.

Nice earnings.

A couple questions.

First, for Bob, on the gross margin line, can you maybe further elaborate a little bit what really drove the strong gross margin, you know, maybe part of it was inventory levels.

I mean, can you give us a little bit more color on that?

Yeah, and you're right, Bob, there are several factors that are contributing to the improvement.

First of all, of course the restructuring actions is a big piece.

Moving more of the overall production outside of the US to lower cost locations.

Secondly, we've been very efficient in making those moves, maybe even a little more efficient than we had, we thought we might be.

So that's been a real plus as well.

In addition to that, what we're seeing is a sales of lower distress, to your point, our inventories are very low.

Our distress levels are very low, so we're not selling much distressed so that helps the margins as well.

So all of those factors are playing a role in the improved gross margins.

And do you see in this type of gross margin sustainable for the rest of this year?

Yes, one of the points I should make.

As you remember last year, we had some fairly significant downtime, and a big piece of that was, in fact, in the second quarter of last year.

So that also was a factor in the significance of the move from last year to this year, but as we look at the second half of the year, we will see a continuation of, again, a couple hundred basis points of improvement in the gross margin area.

Okay, and then next question would be on the new outer wear business, can you add a little bit more detail on the distribution, the pricing, you know, exactly how you're targeting this and marketing this.

You're talking about A5?

Yes.

On the A5 piece, let me just talk a little bit more about that.

What it is, it's non-technical outdoor lifestyle product, but it's for a user, that's really the point, and the way we say it, what we want to do is increase our share of our core consumer's duffle bag.

So they may have gone to someone else for this product in the past but we now can supply this for our core consumer product in - versus of our techwear product, it's more of a performance fabric.

A5 is more cotton-based.

So your question on distribution, it is absolutely the same distribution where we are with the rest of our product.

In terms of price points, obviously because it's cot on-based, they are significantly lower price points.

It doesn't have the technical features of the techwear.

So the price points are lower, a little more accessible but that is also true with of course with the product category.

Is it sportswear more than outerwear?

It's sportswear more than outerwear.

Think of it as climbing shorts, that type of thing but again, more of a cotton-based fabric.

And then one final question for you, Bob.

On the tax rate for the full year, where do you think you shake out with all the goodwill exclusion, et cetera?

Right now, it looks, Bob, right about are we are for the first half of the year at about 36%.

Thank you.

Yup.

Our next question comes from Tom Lewis of C.R.

King and Associates.

You may proceed.

Good morning, guys and nice work.

Thank you, Tom.

First question, two or three quarters ago you commented an increased competitive pressure from private label, particularly in mass.

Last quarter, you indicated that maybe that was kind of abating.

Could you kind of speak to that trend?

Well, overall across all product categories that continues to be a strong influence in the marketplace.

A lot of that has to do with retailer competition, as retailers attempt to compete with their competitor down the street, if they're national carrying the same brands, then it's a little bit easier, so there is a continued move towards their own brands from retailer standpoint.

What we're finding, though, as that balance swings towards too much private label, then it really begins to have an impact on their over all.

So a balance of national brands and private brands seems to be the most successful strategy as you will find with successful retailers such as Kohl's, and therefore, while we see that private label emphasis continuing with some retailers, we also see some beginning to try to balance up their mix a little bit more, and therefore, have the appropriate mix of national brands and private brands.

Okay, and on that note and maybe it's too fine a point to be fair to fair it out, but can you tell us if your share gains in jeanswear have been more at the expense of private label or brands or national brands?

I wouldn't say it was at the expense of private label brands right now.

The share gain of 3/10 of a percent, 2/10 of a percent.

It's a nice direction to be at.

I would say in part, there were some tertiary brands out there that they have kind of consolidated into their own private label and we've probably taken some share from some of those smaller brands out there.

Okay, and with respect to your movement of production offshore, has that been predominantly to outside vendors or put it another way, to what degree are you moving it to VF-owned facilities say in central America as opposed to going to outside vendors?

It really is both.

The long-term basis we'll be doing a bit more Asian.

Of course, that's all outside vendors, but we'll also be putting more in our own plants in Mexico and other areas.

Okay, and last question, barring some opportunity, use of cash, how might we project interest expense in the second half relative to occurred in the second half of the last year.

Keep up the good work.

Steve Martin of Slater Capital.

You may proceed.

Hi, thanks a lot, and I want to echo my congratulations.

Can you comment on the other income line and the components in that versus last quarter?

Yes, the biggest change in other income is the elimination of goodwill expense.

And that's the biggest, that's the majority of the change.

That was 8 or $9 million last year.

8 million.

That's in the other operating income line?

Right.

Okay, and the components of EBITDA, can you break that down for me for the quarter as opposed to the six months?

The components -

Well, the depreciation, amortization of goodwill.

Oh, okay.

Yes, let me just get that.

Depreciation, is that what you're looking for for the six months?

Well, no, not for the six months but for the quarter.

Well, depreciation's pretty well-split.

There's not a lot of change.

It's pretty even quarter to quarter so you can take the six months and divide by two.

Okay, and amortization of goodwill?

There's no amortization, of course, in this six months.

Okay, versus?

With the new accounting rules, goodwill amortization has been eliminated.

Versus the 18 - on last year's 18 and-a-half million, would that have been split nine and nine?

It would have been, yup.

That's what we're saying, the change we're talking about, yup.

Got you, and on the guidance, the 25%?

Right.

That is over the, let me just find the paragraph, that is over the, what number for last year?

268, $2.68.

That's what I thought.

Thank you very much.

My other questions have been answered.

Okay.

Our next question comes from Carol Murray of Salomon Smith Barney.

You may proceed.

Hi, good morning.

Good morning, Carol.

A couple of questions.

First, for the period that you gave the market share increases for jeans, I think you said it was the first five months of this year.

What was the overall market direction in terms of dollar sales?

Was the five months up or down?

It was up, if you look at SPD numbers they'd say it was up primarily driven by the junior market.

Okay, so sales were up for.

How does - I guess that's a point of sales, so that doesn't really correlate exactly with your shipping patterns?

Correct, there's usually a lag in there of a couple of months.

With respect for your EPS guidance for the year, you commented on what you're looking for for the third quarter in terms of your core sales being flat.

When we look out for the full year for 2002, where do you think we'll end up on your core sales?

In the third quarter, Carol, what we said was that the core sales will be up by 4%.

The overall sales we're expecting to be about flat, but core sales, excluding the business exits, core sales should be up by about 4%.

Okay.

Okay, and for the year, with the first half behind us, and what we see in the second half of the year, we're expecting to be down in core sales by about 3%.

Again, that's with the balance of the first half and second half.

Down 3%, and on the reported basis?

Well, that is on core sales, and on the total reported basis, the number is about 6%.

Down six, okay.

Okay, Mackey, could you maybe walk us through on your acquisition strategy in jeans, what part of the market or demographic area are you targeting?

You know, there's been a couple of jeanswear transactions in the market this year, Gloria Vanderbilt, LEI, and I was just curious whether you're looking to augment to your presence this in the existing channels or you're looking for something to kind of layer in at a higher price point.

Yes, we're looking obviously to strengthen those areas that we currently don't have the strength with both the Wrangler and Lee brands or our whole portfolio of brands, and this is true of the jeans business as well as intimate apparel and outdoor.

So we are looking at those segments where we don't have as much strength and that would be the juniors and young men's businesses as well as the department store channel of distribution, and the ideal acquisition for us would be the lifestyle brand that would cover multiple product categories, including jeanswear and intimate apparel, as well as others, and also in the outdoor sides to look for brands that would cover multiple outdoor product categories.

We also are looking for brands that have international impact, already have a strong international presence.

That would be the ideal acquisition for us in those same categories.

Not to try to get too specific, but you know, there's one obvious candidate, which obviously is in financial distress, but there are many properties out there that kind of meet these criterion in terms of lifestyle international, I mean, are you - it seems that that's, while it's a broad representation of what you'd like.

It doesn't sound like there are very many properties out there.

Yeah, you named a few brands before.

You probably couldn't name a brand we haven't looked at from the standpoint of where it would fit within our portfolio of brands and also whether or not it financially is at the right price to give us the kind of return we would want.

So we look at a lot of opportunities before we decide on one on the acquisition side, as you probably know.

Okay.

Bob, could you just comment a little bit about two areas.

One, you know, as we look out to the second half of the year, your inventory management has been superior.

When does that start to kind of, well, really what is your target ininventory in terms of a turn level I guess is a better way to think about it, and then secondly, on the cap.ex. front for the first six past, we're pretty much on track with the prior guidance.

We believe that by the end of the year, we'll still see an overall reduction in inventories, and as we said in the past, we expect that to be about $70 million.

That's what we'd see at this point in time, and most of that, a lot of that does, in fact, come from the business exits but we also expect to see some marginal improvement from the core businesses as well.

Now, that will change, that will change if business proves to be a little stronger than what we see right now or at least as we're planning at this point in time.

We continue to plan our inventories very conservatively, but if the business picks up, we'll in fact, you might see those numbers or those comparisons change a bit.

In terms of capital spending, you're right.

Our capital spending year-to-date has been quite low.

It's only about $22 million year-to-date.

And for the year, for the year we still believe that we're on track, maybe a little bit lower than the 80 tore or $90 million that we talked about, it may be a bit lower than that but we still believe we'll be at about that number which is well below our historical levels.

And then just one last question.

Maybe if both John and Eric could comment on, obviously there was a significant slowdown of reorder business in a lot of categories over the past few quarters, and we've heard about some select pickups in reorders, and I was just hoping that you could comment on kind of your reorder business trends in both jeans and intimate apparel.

I think primarily some of that reorder business was in seasonal items, particular example in shorts, I think beginning the month of May, we thought we were going to get stuck with some shorts and then all of a sudden, it got hot, and we sold every short in DC, so I think a lot of what you're talking about is really on some seasonal items and we have seen a lot of pickup over the last four or five weeks especially in the shorts category.

Carol, similar situation in intimate apparel.

It seems to be item-driven, and it did pick up some for us here in the first half of the year, particularly upstairs, the department and chain stores, we have experienced some growth.

What that means for the second half of the year, I don't know.

I wish I did know that.

But there has been a little bit of a pickup?

Yes, there has.

Okay, thanks very much.

Thank you.

Our next question comes from Noelle Grainger of J.P. Morgan.

You may proceed.

Good morning.

Good morning.

A couple of questions on the sales line.

Obviously you're looking for a nice swing kind of second half versus first half, and I think you're really looking for all of your businesses to contribute to that, but I was hoping you might be able to give us a sense of what was, you know, a bigger factor versus a smaller factor in the kind of ten percent down to flat?

Well, Noelle, to your point, we do see improvement pretty much across the board.

I'll ask, John will comment specifically on jeans, but for the most part, for the most part the numbers, you're right on track.

We see the improvement spread fairly evenly across all of our businesses.

I think in jeanswear, Noelle, you're going to, we're going to see a bigger increase in the second half of the year with the Lee product, especially in Lee men's and Lee women's, both in denim and casual pants.

We're planning a larger increase in the second half than we experienced even in the first half.

If you're looking at the other businesses, some of the things I mentioned, Vanity Fair, Lily of France, Tommy Hilfiger all expect increased sales, licensed sports, our European jeans business, our outdoor businesses are all experiencing increase, so it's pretty broad-based.

Okay, on the jeans business, John, we've heard, been hearing a lot more recently about the young men's business, and I mean the brands that get mentioned most frequently, particularly on the denim side tend to be the, you know the more urban focused brands.

Can you comment specifically on your young men's business and what maybe you've got coming down the pike for back-to-school in spring of next year?

I'm glad you asked that question because we think we have one of the hottest brands in Lee dungarees.

That was started about five years ago and in the total business it's about 40% of the Lee young men's business and continuing to grow.

I believe this year it's going to grow in the double digit increases.

So right now, we're looking at Lee dungarees as our lead boss in the young men's.

Also, if you look at young men's, it's not a huge business in the mass channel, our Wrangler hERO Hero is doing extremely well and we have the Five Star Denim going out and we will be seeing in the Kmarts and Wal-Marts of the world in back-to-school and holidays so we have a two-pronged approach in the young men's and that's where the volume is right now.

Okay, great, and I know you had taken some selective price decreases for spring in jeans.

What's going on for fall when it comes to pricing, and is that part of the stabilization there?

Yeah, when you say price decrease, what we've done, in some cases we've put better product out there at similar prices to last year, giving a better value to the consumer and retailer and some other cases we had similar product at lower prices and other cases we actually reengineered the product and maybe with types of these goods and lower cost we've given lower prices so it's sort of been a combination of those three items in terms of giving a better value to the consumer and the retailer.

We see that hopefully stabilizing for back-to-school and holidays.

We feel really good in jeanswear, both with the Lee Hero, Rider Hero, the Rustler Hero that we have stabilized pricing going forward.

Okay, and on the marketing, you talked about given your execution on the restructuring initiatives and the profitability that you're going to be going to be increasing, ratcheting up the marketing spend a little bit, is the incremental spend that you just talked about today going towards any particular initiatives or is it just spread around?

Well, it is an increase in the jeans category as well as intimate category, particularly, and they are behind specific initiative in each Hero in jeanswear as well as intimates category.

The overall increase is 16% in jeans, and about 29% in the intimates business, so it's a substantial increase in particularly the consumer marketing area that is supporting these product launches, and it's been our approach and we feel like it's one of the things that's really differentiating the VF brands from some of our competition is we've always had a real product focus in bringing new products to market versus just doing Hero marketing, and we think this is a real winning strategy in today's market, and so most of this market will support specific product initiatives.

Great, one last question.

Just on the uniform contract that you announced with TSA, when does that kick in?

That's the new airport security program.

That has a very, very accelerated rollout, and they have aggressive plans in place to roll that out this year.

They certainly have a huge challenge when you think of hiring all of

Yup, the government has a lot to do, but we have plans in place to execute that program for them by November.

If they get the fiscal in place, we'll outfit them.

That's right.

Great, thank you very much.

Thank you, once again, ladies and gentlemen, if you have a question at this time, please press the one key on your touch tone telephone.

Our next question is a follow-up from Dennis Rosenberg of Credit Suisse First Boston.

You may proceed.

I just have a follow up on some of the financial things.

When you talk about a 200 basis point improvement in the second half gross margin, that would imply a sequential decline from the second quarter.

Is that what you're looking for?

Yes, again, Dennis, it's important to remember that in the second quarter in last year's second quarter, we had a fairly significant impact from the down time.

So as we look to the third quarter, we don't have the same impact in the prior year numbers.

So when you take out that factor, you're seeing relatively the same kind of improvement that we saw in the second quarter.

Is that much of a seasonality in the gross margin that you would go from a 37% gross margin in the second quarter to a 36% gross margin in the third and fourth quarters?

Well, 36 in the third quarter?

It would be 34% in the fourth quarter if you're talking about 200%.

There's some seasonality.

Yes, the second and third quarters are pretty close so there's some impact in seasonality in the business.

Could you be a little more specific?

I'm not clear really why you should have that big - if I look at the historic numbers, it doesn't show that.

So why should the third and fourth quarters have such a disparity versus the second quarter?

Are you talking about the improvement that we're talking about?

No, the second quarter gross margin was 37.3%.

Right.

All right, 37.3% in the third quarter would be up 300 basis points, and in the fourth quarter would be up 400 - 500 basis points.

But we're not, what we're saying is we're not going to see - the point is that we're not expecting to see the same gross margin.

We're expecting to see the same kind of improvement over last year.

That's the point of my question because if I look at historic numbers, if you take out last year, which was an unusual year, there wasn't that big a seasonality among all four quarters.

So you know, why is that, the 37% not a sustainable absolute number?

Well, there has been.

Historically there has been some seasonality in our numbers and we do expect that going forward.

Again, you have to look at last year and understand that there were a number of factors affecting last year's numbers, not the least of which was in fact the downtime.

So as it fluctuated quarter-to-quarter, it had some impact on what you saw last year, but still, again, looking at that and looking at the improvement, we expect to see similar kinds of improvements in the outquarters.

Okay, and when you talked about interest expense going down 2 to 3 million per quarter, are you talking sequentially?

Talking about gross, what was reported last year.

Okay, we'd expect to see the number about 2 to 3 million below what was reported last year.

So then, okay, is there a big working capital investment in the third quarter?

Because that would imply third quarter interest expense of about 19 to 20 million versus 14.7 million.

Again, it's a little bit like the prior discussion.

It's more related to what was in the number last year.

Last year, what we're doing now is we're anniversarying some of the debt reduction that occurred in the second half of that year.

So in the first half of this year, all of that came through in terms of lower interest expense compared to the prior year's quarter.

So you really have to look at what occurred in last year in terms of looking at the comparisons.

So it's going to be down, okay, because debt is down, but it won't be down as much as we saw in the first two quarters of the year.

Okay, again, where is the use of cash going to come in the third quarter?

For interest expense to go up as much as you're saying, it means that you're going to have a use of cash in the third quarter rather than generate cash in the third quarter.

What we're saying, interest expense won't go up in the third and fourth quarters.

It will still be below where we were last year.

This is the similar to the kind of discussion we just had.

Interest expense was 14 million in this latest quarter, 14.7 million.

You're saying that it's going to be up about 4 million versus that in the third quarter.

What, how much is your debt going to be up in the third?

There's some in the third quarter, for example, there's some seasonal borrowings that do take place.

Overall, the number would go up over where we were in the second quarter.

I guess that's what you're trying to get at.

Then again in the fourth quarter with the high cash generation, once again, we would be below where we were last year, and pretty close to where we were in the second quarter.

Okay.

Okay?

Very good.

Thank you.

Great.

Thank you.

Our next question comes from Margaret Major of Goldman Sachs.

You may proceed.

Hi, it's Margaret Major.

How are you?

A couple questions.

First of all, can you just talking about the jeans area, why is Lee going to be up in the second half?

Is that primarily because of the young men's initiatives, and can you reconcile that with the comments about, you know, the general price reductions in the denim area?

Well, Lee is going to be up in the second half of the year, primarily because of the Lee dungarees but we also have some new programs in Lee rivetted, which is our contemporary Mitsy line.

Also, we launched a Lee pipeline in boys and we're expecting to see some good results there, and initially with some of the retailers that we put out in June, some of the products we've put out in June we've had some good sell-through.

It's really based on product that we're putting out for the last half of the year.

Product and value for that consumer, that retailer and the promotions we have planned along with the retailer for the second half of the year.

So that's why Lee, we're expecting to be up in the second half of the year.

So Lee prices are not going to be down, Lee prices should be at least flat and main up a little because of the product programs?

Wrangler and can you describe what's going on with that business, is that going to be down in the second half in dollars and units?

Right.

When you look at Wrangler, you really have two components there, one is our westernwear business and right now we are seeing a slow down in our westernwear business.

The traffic in the westernwear specialty store is down for the first six months and we really don't see that picking up all that much in the second half of the year.

We do have some promotions planned for the second half of the year to bring in traffic to that western specialty store.

Right now, we're saying flat to down a little bit in Wrangler western for the last six monthsment.

If you look at Wrangler Hero in the mass channel, you have to really split it up into men's and women's.

We did see an increase in our Wrangler women's wear business for the first half of the year and we are expecting an increase in Wrangler women's wear in the second half of the year.

In men's and hERO product, it's up slightly in units down in dollars primarily because we've taken some price decreases in the second half of the year.

We have more of our price decreases in the second half of the year in Wrangler.

Um-hum, okay.

But again, I would like to say we are well positioned with the Five Star Denim program that we have going in the mass channel.

As Mackey was saying, we do have a TV that's product specific, and that's the first time we've had that in a long, long time.

So we're going to see some good results with that Five Star Denim program.

Yeah, I guess I just don't really completely understand why with the mass channel reporting same store sales increases that have just been consistently very strong and the department store channel being, you know, pretty weak, you know, why your sort of mass business isn't stronger than the department store's business, you know?

Yeah, I look at that in mass store channel, I don't know if apparel is as strong as some of the other product categories that they do sell, like food and hardware that are stronger than apparel even on the mass side.

The question on the margins when you were talking about, you have three kinds of price reductions, if you will.

Can you just talk about how the margins are, your gross margins are impacted by those price reductions?

Well, in some cases overall if you look at it, again, you have to look at product mix and the pricing, and if you look at it, it's probably a margin pointed to overall pricing, but again we've shifted a lot of production overshore this year and that's made up for some of that and actually our margins are up.

All right, good.

Can I shift the question over to Vassaret for a second.

Can you just help me understand why is Vassaret a challenge?

I didn't get to hear your lunch presentation, so you may have addressed it there but what's the issue with Vassaret?

The issue with Vassaret for this year from the beginning of the year has been a loss in force base with our biggest customer.

As we came into the year, we lost our force base, nd that's affected our business in the first half of the year.

What we're doing about that right now in the second half of the year is we have a couple new products that we're launching the biggest of which is a program called MB which we just shipped June 25th, a Mackey commented about our investment in media support to our new programs and that is a program we're spending a lot behind in the second half to try to recover some of this business.

So when you lost space, who did they give it to?

It got spread around the industry.

We picked up some of it in our other brands and some of it went to our other competitors.

All right, and then if I could, you know, go to a bigger picture question and toss it over to Mackey for a second.

Mackey, you talked about the apparel environment being anemic which you're encouraged because your VF brands are doing better on a relative basis certainly than the overall industry.

Can you talk about what is it going to take to improve the apparel business in your mind?

What are the issues?

Why is it anemic?

I think as John said, even the retailers such as the discount channel distribution that's doing well are not doing nearly as well in the apparel category.

I think that's just the spending habits of consumers today.

There are other priorities for their disposable income which relate to home.

It relates to travel.

It relates to services.

It relates to electronics, and I don't know that we're going to be able to change what consumers want to spend their money on.

I think the challenge that we have in the apparel industry is presenting new innovative product, which is the strategy we've pursued for some time.

I don't think this advertising brands gets you there today.

I think you have to have better products for consumers and then you have to tell them about them.

So that's why we're increasing our marketing span and we're increasing it behind specific product initiatives.

We think that's what it's going to take and we think we're going to be very successful with that.

We're doing more of that than we've ever done.

As I said we're spending 16% more in our jean's business, spending 29% more no our intimate as business to tell them about specific new products and that, we feel is a solution.

We think we will increase our market share a little bit more with these types of initiatives, as well we feel much better about the top line in the second half of the year on an ongoing basis.

That's a good segue into a couple of final questions that I have.

With regard to the increase in marketing, is coop. spending included in those increased budgets, things that you do in cooperation with your customers?

It is, yes, because we want our customers to also support these initiatives, but a lot of that increase is in our own media.

Much of the increase, that very high percentage of the increase would be in our own media spend.

Okay, can you just tell us, where do you put as far as the accounting for co.op., where does that go?

Is that part of SG and A or is that a reduction of sales?

That's an SG and A expense.

Okay and there hasn't been any change on that; has there?

In terms of the terms of the programs, no.

The accounting for it.

No, no, the account's been the same.

Okay, a question on markdown accounting.

Where do markdowns fall into your income statement?

Is that a reduction of sales or you know, where does that fall?

That's a reduction of sales.

Okay, can you talk about how the reduction of distressed inventory this year versus last year has played out in terms of the impact on the top line?

Actually on the top line it's

It's less than - in terms of the overall sales impact, it's less than 1%.

All right, and what does, you know, distressed inventory typically run in a company like VF?

I don't know if you aggregate it up to a full company perspective.

Actually, we don't, because it really does vary company by company, as you might imagine.

Yeah, I do.

So maybe you could tell us your two big pieces, jeans, intimate?

In distressed sales in total, if you look at closedown for regularrs, in terms of units, it's probably around 5 to 8%, something like that.

Intimate apparel, I don't have the number handy, but I'd guess it's in the 5% range.

I'll just conclude by asking about one of the topics du jour today in the Wall Street Journal, the SEC says everyone has to sign the same document with regard to their financial statements and I'm just wondering did VF sign theirs and what are your plans for that?

Well, we've been signing statements for years saying that we believe that any kind of accounting relates - I'm not sure I'm doing anything different than what I've always been doing.

I do know there is a different document that has to be signed and we do sign it more frequently related to more releases, but what we have in place at VF is a culture of financial controllers that have been there for many, many years.

We have some terrific people who stick behind those controls and live by those controls everyday.

So I feel fully confident in signing any statement anybody wants me to sign about our finances and our accounting.

So we don't have any problem there.

Well, we appreciate that very much.

Thank you, Mackey.

Okay.

Thank you for asking the question.

Thank you, our final question is a follow-up from Carol Murray of Salomon Smith Barney.

You may proceed.

Hi, I just have two quick follow-ups.

In terms of the marketing increase, you had said it was, you know, more on the media front.

Could you just give us, is it, are you expanding the number of books that you're doing prints in in terms of magazines?

Have you increased your TV presence?

I mean, what exactly, you know, as a consumer what would I expect to see in terms of, you know, a heightened presence?

Where would it be more noticeable?

In jeanswear in Wrangler and Lee, it would be more on the TV side, on the media side there.

In Riders it would be more on the print side.

Okay, and in intimates?

In intimates, you're going to see a lot more print in the second half.

In fact, it started in the books that came out this month in the MV launch from Vassaret that I mentioned earlier on in the call.

We also have some programs coming up this fall.

We're investing in some program that we've produced in the last couple of years to reinforce those programs, the illumination program, the Vanity Fair program and the X gra program, the Lily of France are both being invested in substantially in the second half of this year, all in print.

So does the marketing also include 00:59:12 things that might occur at point of sale or no? 00:59:17 >>ERIC WISEMAN: That's part of the overall 00:59:19 budget, yes. 00:59:22 >>JOHN SCHAMBERGER: Are you saying in terms of 00:59:23 fixturing, Carol, is that what you're saying? 00:59:26 >>ANALYST: Fixturing or signage, give-away, 00:59:29 whatever. 00:59:30 >>JOHN SCHAMBERGER: Yes, that is part of the 00:59:31 expenitentiary; that is right. 00:59:33 >>ANALYST: So point of sale is included in that 00:59:34 as well? 00:59:35 >>JOHN SCHAMBERGER: Yes. 00:59:35 >>ANALYST: Okay, and then I just want to Eric, 00:59:41 the new program at Vassaret is called Envy, 00:59:46 E-n-v-y? 00:59:47 >>ERIC WISEMAN: That's how it's pronounced.

It's 00:59:50 actually spelled NV.

It's pronounced envy.

We've 00:59:57 already got you interested. 00:59:58 >>ANALYST: You certainly did.

Okay, I'm glad I asked that otherwise I would have been embarrassed in print.

The last question, I think someone mentioned this, either Bob or Mackey about The North Face having such a good increase in fall pre-season bookings, and I just wanted to ask, because if I recall, is fall pre-season the same as your fall bookings?

I'm not - what exactly does pre-season mean?

All preseason means, Carol is some companies ask for those orders earlier, than others and in most cases there is some discounting obviously to the retailer for an earlier order.

Pre-season means that, it's just on an earlier basis.

But it's obviously, represents a very, very significant portion of the total bookings for the season, and so it's a great indication of what you expect obviously to ship and what you will ship.

So the orders are increased by 15%.

In other words, there's no hidden piece there.

That's what we expect to increase in terms of our shipping patterns.

Okay, right, so because at this point obviously you have all of your fall orders?

That's right, we began shipping the substantial quantities on July 10th.

Have you all seen any slowdown from this ongoing negotiation from the west coast with the dock workers?

We don't have a problem yet, but it's something that we're watching very closely.

Um-hum.

When is your next peak shipping period?

Well, would be in the spring.

Right now is our peak shipping period.

Right, but right now, I mean if they were to, you go through peak and valleys and the next big ship for the holiday what, October, November?

The next big season once again is related to spring and that's a much lower, less substantial season for us.

Outerwear or the company?

The North Face.

I thought you were talking about outdoor.

You're talking overall?

Yeah.

In jeanswear, holiday is a big shipping period and we start in September.

All righty.

Thank you very much.

You're welcome.

This concludes the question and answer session.

Mr. McDonald, please conclude with any closing remarks.

Okay, well, thank you.

I think we pretty well covered a very strong quarter

Ladies and gentlemen, thank you for participating in the VF Corporation conference call.

This concludes the program.

You may now disconnect.

Have a good day.