威富公司 (VFC) 2004 Q3 法說會逐字稿

Welcome to the VF Corporation third quarter 2004 conference call. (OPERATOR INSTRUCTIONS) At this time, I'd like to turn the presentation over to John McNamara with the Financial Relations Board.

Please go ahead, sir.

Thank you.

Good afternoon, everyone.

Apologies for the brief delay in getting started.

Thanks for participating in the VF Corporation third quarter conference call.

By now you should have all seen a copy of this morning's press release-- this afternoon's press release and if you did not, please call Samantha Alfonso at the Financial Relations Board at 212-445-8474 and she'll send you one immediately following the conference call and confirm your name on the fax or e-mail distribution lists.

Starting our call this afternoon is Mr. Mackey McDonald, Chairman and CEO of VF Corporation.

Before we begin, I'd just like to remind everyone 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 implied 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.

With that, I'd like to now turn the call over to Mackey.

Go ahead, Mackey.

OK, thank you, and good afternoon.

Thanks for joining us.

Of course, we're very pleased with the performance of all of our operating units this quarter.

Particularly given the softness in apparel sales reported by retailers over the past couple of months, our brands' performance is particularly outstanding.

I think it's a testament to the hard work that's being done behind the scenes here at VF to execute a very detailed, comprehensive growth plan and I'll speak to that in a moment.

In terms of the quarter, I think the most important point to make is that our great performance was very much balanced between our core businesses and our acquisitions.

We're in an extremely fortunate position.

Our core category-driven businesses are performing very well.

We have a number of very exciting new brands in our portfolio that are on or ahead of plan with strong growth prospects for the future.

Our balance sheet is in great shape, despite having absorbed three acquisitions this year.

We continue to generate very strong cash flow and we pay an outstanding dividend, which we just increased for the 14th consecutive year.

In the release we established a new, long-term sales growth target of 8 percent annually.

This goal is the outcome of a growth plan that we've been working on for nearly a year.

We've spent many months fine tuning our assumptions around that plan, putting together detailed work plans for literally dozens of initiatives within our core businesses, identifying new brands to add to our portfolio, creating a new customer team organization to strategically align ourselves and grow our business with leading retailers, working on plans to better leverage our supply chain and reduce cost and identifying the enablers and resources to make all of this happen.

Now this is a five-year plan and we're still in the early stages.

Clearly, not each and every initiative we've targeted will come to full fruition.

But our performance this year has validated our confidence in our direction and our ability to execute this plan.

Our operating committee and all of our coalitions and business units have built this plan from the bottom up and we've clearly defined responsibilities and ownership for each and every step along the way.

As we continue to execute our growth plan, here's what you can expect.

First, more consistent top-line growth, balanced between our core businesses and acquisitions.

We're continuing to seek acquisitions to fill white spaces in our portfolio.

We're confident in our ability to identify the right brands, integrate them in quickly and efficiently and to grow them.

Second, a more balanced and dynamic portfolio of businesses.

As we continue to build our outdoor and sportswear coalitions, they'll become an increasingly bigger part of our mix.

You'll also see a move to more lifestyle rather than category-driven brands.

These are businesses that typically carry higher gross margins due to the premium these brands command.

Third, you can expect that we will retain our traditional conservative financial and operating disciplines.

We're not going to significantly skew the risk profile of VF Corporation.

As we build these businesses, it will be applying the same conservative inventory management, financial controls and process that have served us well for so long.

We'll preserve our conservative financial structure, strong balance sheet and dividend policy.

And last, but certainly not least, we will continue to work towards our goal of a 14 percent operating margin.

By and large, our core businesses are at or close to those levels.

Additional improvements will come from volume gains, the integration of our acquired businesses and from cost reductions throughout our supply chain.

In fact, we also pointed out in our release that we're targeting $100 million in cost reductions throughout our supply chain over the next five years.

Cross-coalition projects are underway in such areas as inventory management, procurement, distribution and technology.

Some of these savings will be reinvested back into our brands to fuel their continued growth.

Those are decisions we will be making on an annual basis as our growth plan progresses.

Now I'm not going to spend time today reviewing all our business results as our coalition chairmen will be providing a detailed update of our growth plans to investors in a meeting tomorrow, which we'll be webcasting, but I felt the most productive use of our time today will be spent in helping you understand our performance in the quarter and our guidance.

I'll now turn it over to Bob Shearer.

Bob?

Thanks, Mackey.

Starting with sales, the 25 percent increase in the quarter is represented by three components.

First, as stated in the release, the acquisitions of Vans, Kipling and Napapijri accounted for $184 million in sales in the quarter.

Second, we had three full months of Nautica sales in the quarter versus only one month in the 2003 quarter.

Thirdly and very importantly, organic sales growth was 6 percent in the quarter, reflecting the strength of our core businesses.

Now related to earnings per share, you'll note a similar picture.

Our recent acquisitions contributed 12 cents per share and that was ahead of our expectations.

And the earnings per share contribution from organic businesses grew by 8 percent, including the Playwear loss and growth plan spending, and that outpaced the strong organic growth that we saw in sales.

Now that points to the very strong profitability from these businesses and a cost structure that's highly leverageable against top-line growth.

And I should also point out that our profitability improved, even with the higher levels of spending supporting our growth plans.

So we are really pleased with this progress.

Now in terms of our growth plan investments, we stated in the release that we invested $13 million in the third quarter and that we expect to spend up to $20 million in the fourth quarter.

Now that would indicate a total spend for the year of approximately $42 million.

As indicated in last quarter's conference call, roughly 40 percent of this investment is dedicated to brand building.

In the third and fourth quarters of 2004, our advertising spending will increase by approximately 33 percent over the second half of 2003, including a minimal impact from recent acquisitions.

Now back to the third quarter.

We saw a significant improvement in gross margins, which was driven by two factors.

First, the mix of our business continues to move toward higher margin lifestyle businesses, represented by our three recent acquisitions and the increases in our outdoor and sportswear businesses.

This mix change accounted for about two-thirds of the improvement.

And secondly, we realized that operating improvements in our core businesses resulting from higher overall efficiencies leveraging the sales increases and lower, cleaner inventories.

The increase in SG&A as a percent of sales reflects the mix issue, as well, which accounts for almost all of the total increase.

In addition, the spending against the growth plan cost us about 50 basis points in the quarter.

Actually the SG&A relationship in our businesses improved by almost 50 basis points.

Also on the P&L, the category of royalty income and other rose significantly again this quarter, reflecting the impact of having a full quarter of licensing income from Nautica versus just one month in last year's third quarter.

The loss from the disposal of our Playwear business, included in the quarter, which is about $15 million, primarily reflects the costs of exiting leased facilities that were still in use during the quarter.

You recall that an offsetting gain of $10 million on the sale of the Playwear business was recognized in the second quarter.

Any significant impact from the Playwear exit should now be behind us and, as a reminder, sales in 2004 from Playwear will approximate $84 million.

Obviously, we were pleased with our operating margin in the quarter, which, despite the growth plan spending and the Playwear charge, hit the 14 percent level.

The increase in interest expense reflects the higher level of average borrowings during the quarter resulting from acquisition activity and our tax for the quarter was at a rate that approximates our expected annual rate, which is about 33.5 percent.

OK, now let's turn to the balance sheet.

We continue to be pleased with our inventory levels.

As stated in the release, inventories were down from the prior year, despite the addition of $58 million from our three most recent acquisitions and this is contributing to another great year in cash flow from operations, now expected to approximate $550 million, which is at the high end of the range we indicated last quarter.

As you know, we target a debt-to-total-capital ratio of below 40 percent.

At the end of the quarter, our debt ratio was 31.9 percent.

Our strong cash generation enables us to maintain strong liquidity, despite our investment in acquisitions.

By year end, barring any additional acquisitions, this ratio should be down to about 30 percent.

In terms of our guidance for the fourth quarter, sales could be up 8 percent.

It's important to keep in mind that for our acquired companies, the third quarter is their seasonally strongest quarter.

So their sales contribution will be substantially less in the fourth quarter.

And, as to earnings, we again expect very healthy contributions from our core businesses.

The two factors that are contributing to our expectations for flat earnings per share are first, the growth spending of up to $20 million that we referenced earlier, and secondly, the favorable tax settlement that added 7 cents to last year's fourth quarter.

And finally, those of you who follow us know that we wouldn't normally provide 2005 guidance until February.

However, we thought it was important to provide you with an initial estimate as a sign of our confidence in our growth plan.

Accordingly, in our release we indicated that we could see high single percent growth in both sales and earnings next year.

We also expect to continue to invest in our growth plan in 2005 and we expect to maintain very healthy margins.

In 2005 we expect to see top-line gains as a result of our investments.

We should see improvements in profitability of our recently acquired businesses and we should begin to realize some of the benefits of our supply chain initiatives.

Of course, we'll be refining our 2005 guidance when we release full-year earnings in mid-February.

Mackey?

OK.

Thank you, Bob.

We'll now open it up for questions, but keep in mind the fact that we will have a meeting, a webcast, tomorrow in which our coalition chairmen will be providing more detailed updates of our growth plan.

But we'll open it up for any questions that you have at this time.

(OPERATOR INSTRUCTIONS) Ron Vellus (ph).

Hello, Banc of America Securities.

This is Reed (ph), actually, on for Ron.

We just had a couple questions about your denimwear segment and we were wondering how the performance was, if you could break it out between the mass channel and just overall and then maybe any thoughts on how that's your outlook for the rest of the year there?

Thank you.

This is Terry Lay and just to break things out for you, overall, as we indicated in the release, we were down about 1 percent globally in our denim business and about 3.5 percent in the U.S.

Frankly, there were two factors that drove that decrease.

One was less distressed inventory, which was very positive for our operating margins, which continue to be year-on-year, actually through every quarter this year.

So the absence of less distressed and the other factor was in the mass market and it was directly related to our K-Mart business, which was down in the quarter.

And then I believe on the last call you had mentioned how it had done, excluding K-Mart.

Could you comment on that?

Well, excluding K-Mart and the distressed-- less distressed inventory, which, again, we view as a positive, we were slightly up.

OK.

And then just lastly, I was wondering, the guidance-- the '05 guidance that you were talking about, if you could comment on, again, just the denim segment, what kind of assumptions you're using for that in terms of, I guess, revenue and unit growth.

Yeah, I'll tell you.

At this point, while we did give that early indication, we're really not prepared and wouldn't at this point in time, you know, respond to any kind of specifics related to the year '05 at this point.

More to come.

Bob Drbul.

Lehman Brothers.

I guess, Mackey, could you talk a little bit about-- within the intimate business and within the denim business, can you talk about how you see the inventories at retail today?

And I guess, just elaborate a little bit, in terms of the replenishment trends and the, you know, the fill-in business that you guys are seeing, how retailers are reacting in the environment that we're in right now?

Yes, sure, I'll be glad to, Bob.

We see a continuation of what we've been seeing for a good part of this year, which is a roller coaster year.

We see weeks where sales appear to pick up at retail and then we see real soft two and three week spurts.

So there just doesn't seem to be any real momentum at retail.

We look at the month of September as pretty weak.

October began to pick up some and then tailed off, so there's just no real momentum.

It's an up and down business.

But I will say that, both on the retail side and, I think, for the most part, on the supplier side, the retail-- or control of inventories has been very high on everyone's mind as a result of seeing this kind of-- type of volatile situation.

As a result, the inventories appear to be in pretty good shape.

I don't see much difference in denim or on the intimate side.

I think they're both in fairly good shape going forward and certainly our inventories are.

We have felt good about our performance of our brands at retail.

We think, for the most part, our brands on the intimate side are doing extremely well and on the jeans side doing well, comparatively speaking.

The softness at retail, certainly overall, having an impact on us, but we think not as significantly as, maybe, some of our competitors.

OK.

And I guess as a follow-up, can you talk a little bit about, you know, with the retailers being tough on their inventories and trying to keep things lean, on the-- you know, markdown support and maybe within the Nautica business and just throughout, you know, other azimuths of your business from retail?

Yes, one of the advantages that we've had as a company is our ability to manage inventories at retail extremely well.

We've got great replenishment programs.

We've got great planning systems.

As a result, we don't build up our inventories and so we have not been impacted that significantly with the markdown exposure, because we don't have these big load-ins at the beginning of season that some of our competitors do.

As a result, our exposure has not been as significant.

There is a continuing exposure, I certainly feel like, in the department store sportswear category.

There is that exposure, but we're working on new models there, as well, that we think ultimately will be good for both the retailer and for us in reducing that dependence on markdown money and depending a lot more on having inventories that are managed more like category inventories.

We think there's some strength that we have as a category company that we can take to the lifestyle brands, which have a higher growth rate potential.

So we have the advantage of having a higher growth rate, but also the efficiency of being a category manager that is going to really help us create a new model at retail.

OK.

And one more-- one question for Bob.

In terms of the operating cash flow expectations, have they changed at all for the full year?

What we said, Bob, was that the last time-- the last time out we gave a range and the top end of the range was about $550 million and now what we've said is, yes, we do expect to be right at about $550 million for the year.

David Griffith.

Yes, Tradition Asiel Securities.

In the past, Eric, you've talked through, you know, where Nautica was going to be in terms of sales reductions year-over-year.

Could you sort of comment on how that worked out in the third quarter and expectations for 4Q?

Sure.

First comment, David, is versus our-- you know, our plan for the business for the year as we put them together in Nautica.

The Nautica brand in the third quarter ran about 3 percent ahead of the sales forecast that we had for the business, which means we were pretty close to getting it right when we thought we would have low-double-digit decreases based on space reductions at retail.

We've talked about losing, you know, 15 to 20 percent of our space at retail, which we have lost and then performing better from an inventory turn and productivity standpoint in that space and we have performed better.

So we're a little bit ahead at Nautica on the revenue-- revenue side of where we wanted to be and moving along in the operating improvements, also.

And then expectation as you're heading into the fourth quarter.

We're operating out of the same retail space footprint.

There won't be any significant changes in those footprints during the fourth quarter, so we expect the same kind of trend.

That's what we've planned for and that's what we expect.

OK.

And then, Bob, could you just comment on, you know, where you see using the strong cash flow that you're generating this year?

Yeah, David.

You know, we've been pretty consistent and, obviously, we're at the same place, you know, that our priority is, in fact, on the acquisition side.

You know, we haven't been buying back shares at this point in time.

We're still pursuing opportunities from that standpoint.

So clearly-- clearly the priority remains with-- you know, on the acquisition side.

Jeffrey Edelman.

The first question has to do with the reorder business and replenishment.

I believe it was earlier in the last year where you were suffering from the fact that the discounters were kind of cutting back on you faster than their sales at retail.

Has that been occurring now or has it just been consistent with what's going on at retail?

We think it's pretty consistent right now.

We tend-- as you go through cycles, we tend to get impacted negatively early on, because-- because we are so tight on inventory, which is a good thing, and also we have a positive impact when things pick up, because we're able to get our customers back into stock in a hurry.

So we tend to be early on those cycles.

What we're seeing right now is not one long, either negative or positive, cycle.

It's basically a pretty sporadic up and down cycle and so I would say right now we're probably not being impacted more than our competitors are.

Right.

OK.

And then secondly, as we look at this great in the outdoor business, could you give us a sense whether or not that's still reflecting increased distribution, increased penetration or is it now pretty much commensurate with sell-through at retail?

Yes, I think there are three things driving that and three things we've been working hard on and I'm glad they're all coming good for us.

One is, in every single product category-- looking at North Face, we grew our sales in every single product category that we compete in.

So that says that our sell-through at retail will continue to be very strong.

Second, there has been some door distribution, but not as much as there has been in the last few years.

There is some door distribution and still some ahead of us.

And last, we've introduced new product categories over the last few years that we're kind of finding our footwear and I'll use footwear as an example where-- that those categories are beginning to take hold for us and we're beginning to see real big growth of those.

Noelle Grainger.

Hi.

J.P. Morgan.

A couple of questions.

First, Bob, the accretion from the acquisitions--

Right.

--12 cents in the third quarter was pretty significant.

I think you had indicated 5 cents for the full year previously.

Can you give us a sense of kind of what really came in ahead of your expectations?

And also, I guess I'm curious if you've bumped up your fourth quarter.

I guess it's implying you're assuming 2 cents accretion in the fourth quarter from the acquisitions.

Has that changed from last quarter?

Yes, hi, Noelle.

The-- yes, the estimates that we had were 5 to 7 cents for the quarter and, obviously, we exceeded that.

The two businesses that were substantially above-- above those estimates were both Vans and Kipling and the business was just a little bit stronger than we anticipated, particularly on the top-line and, to some extent, on the bottom line.

So those are the real drivers and, again, the Napapijri business was right on target.

So those were the factors.

I remember that there was a penny in the second quarter, as well, so it implies about a penny in the fourth quarter.

OK.

OK, great.

Thanks.

I'm not sure if you want to talk about this today or not, but I'll go ahead and give it a shot.

In terms of your operating margin goal of 14 percent, I'm curious if you can kind of qualitatively discuss how you see that shaking out over your five-year plan and I guess I'm looking at your general guidance for next year of high single digit top and bottom line, which would imply not a lot of margin-- operating margin expansion.

Presumably, is your investment going to be kind of front-loaded in terms of the five-year plan?

And kind of how do you see that flowing through?

Yes, you're right, Noelle.

I mean, at this point in time we'd like not to talk a lot about that and, again, we'll certainly, you know provide a lot more details about that when we detail out the '05.

But what I can tell you is there are a number of pieces.

I mean, for example, our mix is changing and that-- you know, that has an implication.

We do expect to see the acquisitions continue to improve, all the acquisitions, you know, that we've made over last year or so.

Those are significant-- those are significant factors, as well.

So, again, there are just a number of pieces that we expect to come together as we look out five years.

You know, we talked about the idea of some cost efficiency gains, as well, as we leverage the scale of VF Corporation and some of those come a little bit later, we anticipate.

So, again more to come on that, but, I mean, just generally, that's where some of the pieces-- where we see some of the pieces coming from.

OK.

And just lastly, on intimates, I'm hoping we can get a little bit more color on, you know, the drivers of growth.

A 12 percent in the quarter was really outstanding.

Maybe by brand?

Hi, Noelle.

This is George.

The good news is that we had a great quarter, as you indicated, in intimates and it really came across all pieces of the business.

Our mass market business was up very nicely.

Our chain and department store business was also up and our private label business, driven off the very successful of-- at Victoria's Secret of Body By Victoria, helped as well.

So the strength was pretty much across the board.

Virginia Genereux.

The 8 percent -- Bob and Mackey, I know you all don't want to get into lots of detail here -- but for next year, I presume that's all organic, right?

I mean it does not presume additional acquisitions.

Is that right?

It's a combination of organic growth and acquisitions.

Yes, and I would say not necessarily new acquisitions but, obviously, the annualization of the ones that we've just done.

Right, exactly, which should be about half of it or so?

Yes.

And, Bob, the rest of that is probably kind of a continuation of the trends we're seeing, maybe, with intimates and outdoor being better?

Yes, that's right.

I mean, some of the stronger businesses that we're seeing now, the stronger growth businesses we would expect to continue more into next year.

Sure.

OK.

That's great.

That's helpful.

And I know we'll more tomorrow from you guys on all this.

If I may, on the-- let me ask about the fourth quarter.

Bob, I-- if you're going to spend-- you know, you look at the SG&A increase this quarter.

You're going to spend a little more next quarter on some of these-- these initiatives, the $20 million and you're going up against a 7 cent compare.

I mean, I feel like-- I don't know how you get to last year's EPS number.

Can you help me a little bit with-- is there something-- are either the gross margins going to be better than they were this quarter in terms of the increase?

Or was this-- Can you talk a little bit about that?

Yes, we do expect to see a continuation in the gross margins, to be sure, you know, relative to the kind of improvements we've seen and maybe even just a bit stronger in terms of the improvement side.

And you're right, I mean, you know, the spending largely does fall in the SG&A area.

But we-- what we expect to see and really the piece behind this is exactly what we saw in the third quarter is that continuation of improvement in our core business margins and that's really what drives us.

OK, Bob, and to your point on the gross margin, I mean, I look back.

If you're-- can you help me with that?

Because I thought this quarter, you know, you were also anniversarying some downtime at the denim facilities last year.

You know, this quarter is 275.

What else is getting-- what gets better next quarter on the gross margin side?

We continue to-- and, again, we saw some of that in this quarter, as well, but we continue to keep our inventories very lean.

For example, you saw the-- at the end of the quarter that, you know, despite the addition of the acquisitions, our total inventories were actually down, you know, below last year.

And that's not just a good thing from a liquidity standpoint, but it's a great thing in terms of the overall efficiency of running the business and profitability.

It has strong implications.

So that is-- that is the other piece that we've been seeing, keeping those inventories very clean.

OK.

OK.

And then lastly, maybe Terry, could you-- on the K-Mart front, is anything-- I mean, I feel like that's been something that's surprised you guys in terms of continued declines in inventory there.

That's, you know, talked about a lot.

Are you seeing that-- any prospect of those guys replenishing somewhat that might-- that might, you know, have some positive implications for growth in domestic denim?

Well, I think based upon recent meetings we are seeing more adds for fourth quarter and, actually, our turn performance in the store has been pretty good.

We feel we've gained share within K-Mart overall.

So we don't think it's as much a product performance issue as a drive traffic issue.

And with their recent management change, I'm not sure what's that going to be hold, but I assure you in partnership we'll be discussing all that and working very hard to grow our brands in K-Mart.

That's important to us for the future.

Michael Ellmann.

Good afternoon.

I'm affiliated with GMO in Boston.

I just wanted to know what the currency impact in the quarter was on revenue at the operating income if you can offer that, too.

Yes, it was in the-- it was a little less significant on the top line.

I believe it was a point or two on the top line and on the-- in EPS it represented about 3 cents.

OK.

Not all that significant.

When you say a point or two, I mean, like 1.5 percent?

A percent.

Yeah, right, 1.5 percent.

(OPERATOR INSTRUCTIONS) Noelle Grainger.

J.P. Morgan.

Hi, again.

Bob, just a quick question on inventories.

What was the number if you take out the acquisitions?

Do you have that?

The acquisitions-- you know, we have to be careful with that.

The acquisitions added $58 million.

OK.

OK, so that'll get you to what you're asking.

(OPERATOR INSTRUCTIONS) Steven Long (ph).

It's Harvard Management (ph).

I apologize for such an open-ended question, but can you just give us a little more flavor on how you are planning your business with the elimination of quotas?

Yeah, we can.

We feel like we're in great shape with that particularly compared with some of our competitors, because we have such a good balance of manufacturing and sourcing within the company.

We do have a strong presence in Asia at a little over 30 percent of our product coming from there, but we're not dependent on Asia.

We have a very strong sourcing and manufacturing operation in the Caribbean that's extremely cost-competitive.

The labor costs are higher there, but our engineered manufacturing process there is much more efficient than Asia, so as a result we have actually lower costs.

So we're in a position to be able to move our production in whatever direction the changes in the quotas are going to dictate.

We think we can increase as the quota impact of Asia comes on stream.

We do think, at this point, that there will be some, probably around 10 percent, impact from some of the quota changes from the WTO that are coming into place for those goods that are coming out of the areas where quotas are being eliminated.

But we think, as a result of that, we'll be able to reposition some of our production there and still be very competitive with our production that's coming out of other parts of the world, as well.

So we don't see any industry-changing events related to this.

We see changes that will occur, but it's going to be more where you're sourcing from, what country you're sourcing from, rather than an increased flow of imports into this market.

All right.

Could you also just touch on the logistics issue, more related to the availability of the cargo ships and access to those ships?

We're not experiencing any difficulties as a result of any the issues out there.

All right.

Do you see any price increasing coming from the shippers?

Again, nothing that would impact us in any significant way.

Gentlemen, at this time we appear to have no additional audio questions.

Please continue with any further statements.

OK.

Thank you very much for joining us.

As you can tell, we're very excited about the quarter, but we also are much more excited about the strong cash flow, the strategy we have in place, our new growth program and what that's going to do for VF over the next five years as we implement this program.

We're very-- feel very good about the people we have in place to execute this throughout the company and the strategies they have in place that they will be executing.

So we look forward to discussing our next quarter's results with you.

Thanks for joining us.

And also, remember tomorrow we have our webcast tomorrow and coalition chairmen will take in more detail about the growth plan.

Thanks for joining us.

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