VFC: More Cons than Pros

No growth, peaky margins, above average portfolio, $5.25-$5.35 in EPS power next year, and a $78 stock (14.7x earnings). For VFC? I don’t get it.


This is one of those quarters that really makes me step back and scratch my head on VFC.


On one hand, it’s kinda tough to argue with the company’s financial management, portfolio strategy, and how they set expectations with the Street. We’re seeing improved profitability in Jeanswear and Outdoor – its two largest coalitions, and the sales/inventory spread took a meaningful turn up for the first time in 2-years. CFFO outlook went from $750mm to $800mm due to inventory reductions. And Nautica, the perennial doggie in the portfolio, actually rebounded – not bad at a time when there’s about $400-$500mm in LIZ business in department stores that’s up for grabs in the Spring.


But on the flip side, this company simply has no growth. The top line was down 5% -- no good. When we look at the underlying 2-yr run rate by stripping out FX, and acquisitions (from 2 yrs ago), we’re still looking at a 5% hit to revenue. When we look at Outdoor/Action Sports – VFC’s core growth driver – it was down 1%, and down 4% after we account for the fact that incremental growth is coming from company-owned retail. In addition, VFC has not conducted any acquisitions at a time when there are more undervalued assets than I’ve seen in years. If there was ever a time for a ‘deal company’ to do deals, wouldn’t this be it? This is concerning. It reinforces my view that business models that rely on acquisitions simply don’t fly relative to other quality growth businesses out there. I can't make a perma-bear statement there, but rather need to consistently ensure that the appropriate valuation gap exists between companies like VFC, and others that can grow.


What does that leave us with? No growth, peaky margins, above average portfolio, $5.25-$5.35 in EPS power next year, and a $78 stock (14.7x earnings). For VFC? I don’t get it.


VFC: More Cons than Pros - VFC OrgRev 10 09


VFC: More Cons than Pros - 10 26 2009 10 28 57 PM


VFC 3Q FY09 Earnings Call


Quarterly Highlights:

  • Jeanswear sales improving on 1yr & 2yr basis with sequential trends in margins improving
  • Outdoor sales lacking growth, but margins improving notably up 230bps yy;
  • Imagewear continues to struggle most of smaller coalitions
  • Raised lower end of guidance to $4.85-$5.00 up from $4.70-$5.00; and CFFO up to $800mm from $750mm
  • Increased expectation for stores to 80 up from 70 by FY09 year end


P&L Notables:

  • Gross margins down 5bps yy reflecting:
    • Improved margins in Outdoor and Action Sports business as well as Jeanswear
    • Greater % of full price retail sales
    • Expect GMs to exceed 45% in Q4
  • SG&A +68bps yy reflecting:
    • Higher pension expense (~100bps)
    • Retail growth
    • Offset in part by cost mgmt efforts
    • Expect SG&A margins to remain relatively flat to up slightly yy



  • Revs flat, up 3% in constant $$
  • Direct-to-Consumer up 17%
  • Expect even higher rev growth in Q4
  • Retail:
    • Stores: expect to end the year with 80 stores
    • Retail stores doing well



  • Revs down 10.5%, down 7% in constant $$ in 3Q
  • Domestic down 6%
    • Lee continues to gain share; revs down 1%
    • Wrangler strong at WMT with enhanced signage, but hurt in the mass market from loss of Riders brand programs (noted in Q2)
  • Int'l down 10% in constant $$ - partially offset by 17% growth in Asia jeans business
    • European Jeans business continues to be challenging
  • Op. margins expected to be nearly 2x Q4 F08 driven by higher gross margins (incl. 1x OMs were 8.4% in Q4 FY08)



  • Revs up 3%
  • Seven for All Mankind revs negative (mid-teen operating margins)
  • Direct-to-consumer and Asia were bright spots in the business, both had positive growth
    • YTD opened 13 stores and expect 20 by year-end



  • Revs down 15%
  • Uniform business struggling in current environment  - and poor attendance at sporting events hurting sales for licensed product



  • Revs up 4% - helped by a timing shift of shipments
  • Op. Margins up to 16% level and is expected to sustain DD in Q4
  • Kipling - agreed to distribute handbags on an exclusive basis to Macy's in U.S. starting in spring 2010 to 375 stores



  • International business down with revs down 6% in Europe in constant $$ (accounts for ~70% of Int'l sales)
    • Asia was a partial offset up 32% (~12% of sales)
    • Expect an increase in Int'l sales in Q4 on both constant $$ and reported basis
  • Retail: up 6% with 23 new stores opened in qtr (80% in full price format)
  • Buzz related to reorders due to lean retail inventories
    • Trend bodes well for NT margins



  • Inventories down ~$170mm (-13%) yy
  • CapEx $21mm
  • Repurchased 750,000shs in 3Q, expect similar amount in Q4


Outlook (Q4):

  • Revs
  • GMs above 45%
  • Expect SG&A margins to remain relatively flat to up slightly yy
  • Tax Rate of 26% for FY09 - implying 24% rate in 4Q
  • Repurchased 750,000shs in 3Q, expect similar amount in Q4






  • Seeing improvements from major rebranding
  • Chg in 2H of the year is the shift towards lower price points - more value focused product working much better
  • Reduction in off-price channel is ~15% yy


F2010 Fx & Pension Exp Outlook:

  • Fx could benefit the 1H of next year - Int'l stronger in Q1 and Q3 (assuming rates remain flat ~1.49 Euro, Fx would benefit revs by ~$110mm, or 3.5% and ~$0.15 in EPS benefit in 1H of F10 assuming 20% incremental margin)
  • Pension impact of $0.70 in EPS….all else being equal would equate to $15-$20mm favorable impact in FY10


Comp Store Trends:

  • Comps were flat to down slightly - expect to see improvement in Q4
  • Outdoor related stores were up mid-single digit


Retailers Short Inventory - Ability to Chase Demand:

  • Jeanswear has lots of capacity
  • Can go from purchase order to DC in 20 days
  • Most Outdoor related goods (i.e. tents, equipment) made in Asia could not be turned around in time to be realized in Q4
  • Believe they are better positioned than most to be able to chase demand in Q4
  • VFC lean in terms of inventory - rather chase sales


FY09 Outlook:

  • Some uncertainty related to 2H is past so brought up low end
  • Cautious to the upside due to uncertainty surrounding Q4 holiday season


TNF Spring Orders:

  • Spring orders positions stronger - up mid-single digit (in constant $$)
  • International might be even stronger
  • In U.S. ~80%-85% of business done off of pre-book business


SG&A Expense Control:

  • Less of a reduction compared to Q2 yy decline
  • Pension and retail driving SG&A higher offset in part by cost reduction efforts
  • Advertising spend was down 50-60bps, but still at relatively high level


Inventory Levels:

  • Have ~100 days of inventory - can supply 3mo+ with no further production


Shift Towards Lower Price Points - Brands/Segments Positioned to Benefit:

  • No specific call outs, but do believe they are gaining share in certain markets with weaker branded competitors


Retail Doors:

  • Now expect up to 80 stores in F09 up from 70 as of Q2
  • Roughly 80% full-price
  • Outlet openings only driven by capacity to move excess product
  • U.S. makes up greater % of growth ~75%+


Jeanswear - Regional Trends:

  • European business is still challenging
  • Eastern European business built over the last several years is struggling



  • Still busy and active, nothing to report at this time


Licensing Model:

  • Chance of moving any wholesale businesses to license model?
  • Have hired a new leader still in first 90-days on the job
  • Looking for new brands as well as evaluating ones in current portfolio


Gross Margin - View Above 45%:

  • Restructuring impacts of last year had no impact on GMs
  • Retail business will boost margins by ~100bps
  • Rest is primarily driven by operations
    • Both in U.S. and European businesses


Industry/Company Capacity:

  • Own ~25% of manufacturing
  • Roughly 50% of jeans are sourced


Pricing - Targeted Channels of Distribution:

  • In Lee AUR in mid-tier is actually up and its taking share
  • Claim to be taking share at KSS and JCP and Sears with higher AUR
  • Higher end of retail spectrum (Saks & Nieman Marcus) comps have been weaker than mass and mid-tier
  • Expect global revs to be down slightly Fx neutral - pleased with that


Product Costs:

  • Helping in 3Q and especially in 4Q - had been a drag in 1H of F09
  • Don't see any reason for these benefits to change significantly


Smaller Brand Call Outs:

  • Lucy - in a tough stop right now (LULU just preannounced better 3Q results AMC)
  • Kipling and Napapijri have had a great run internationally
  • Reef is stable, but has not grown the way they would have liked


Vans Trends/Outlook:

  • Hasn't lost momentum due to the recession
  • Terrific geographic opportunity - particularly in Asia
  • Still growing strong in US

 Casey Flavin


WMS's 1Q2010 results are better then they look at first glance. Although, given the lofty multiple and high expectations, in-line may not be good enough.


At first glance, it looks like WMS came in below expectations and guidance looked equally uninspiring. However, looking under the hood, results are not bad at all - at least not relative to our expectations. We think some investors were hoping for a raise in FY guidance.



  • Dynamics of the market are consistent with their expectations. However, meetings with casino operators since August have been positive
  • WMS has a 13% share of current slots on the markets, and with current ship share rates in the 24% range, they believe that they have a large opportunity
  • Think that replacements will increase moderately in CY2010, but that with entry into new Class II markets, Helios platform, and international growth, WMS's growth can outpace the market


Quarterly overview

  • WAP units are becoming a larger percentage of their participation base and contributes to better ROI and average daily fee earned per day
  • Realizing significant success on REEL 'EM IN, COMPETE TO WIN game, performance on par with WIZARD OF OZ
  • While new unit sales declined, ASPs increased, due to higher BB2 mix.
  • 550 units were due to new units, balance were replacements 2,400
  • Shipped to two Indian gaming casinos in 1Q2010
  • Shipped to Mexico this quarter
  • Are starting second field trial in Australia this quarter
  • Believe that they have plenty of room to grow margins
  • WC was a cash drain this quarter;  higher royalty expenses, higher stock comp, longer term financing options, and A/P timing all negatively impacted cash flow this quarter.


Financial highlights

  • Realized higher average daily fees and margins as a result of WAPs becoming an increasingly large part of their participation base
  • D&A was flat as they benefit from efficiencies, keeping participation games in the field longer and having more fully depreciated units in their install base
  • The tax rate was a little higher than they anticipated but they expect it to increase slightly in 2Q2010, and increase again in 2H201 as the tax credit expires and the rate goes to to 37%
  • Net cash balance of $120MM, subsequently, by quarter end another $25.7MM of the converts were converted to stock. Have 58.7MM shares outstanding and market cap of $2.8BN. Net net they will save 500k in CY2010



  • Guidance assumes lower play levels in line with usual seasonality
  • Continue to expect sequential growth in March & June quarters
  • Reiterated FY 2010 revenue guidance
  • Potential growth markets for beyond 2010:
    • CA, IL, Maryland, Ohio, Kentucky, MA
    • Singapore, Phillipines, Spain, Japan, Italy
  • WMS is uniquely positioned to benefit from networked gaming through software and systems
  • Working on several master purchase agreements and multi-year purchase arrangements



  • Some of the new competitor's products look similar to WMS's
    • Imitation is the highest form of flatterly - will continue to try and stay ahead of the market
  • Feel good about their guidance - things are progressing along with their expectations
    • Upside is possible, but will come from better replacement cycle/ market share gain
  • Change in competitive environment; re: financing/discounts?
    • Not really
  • Opportunity to improve margins ... goal of getting to 25% operating margin
    • They were up 300 bps in their seasonally slowest quarter, and as volumes ramp that should help them achieve that
  • How sustainable is the growth in their daily revenue per day?
    • As long as they keep delivering good content and increasing mix to more WAP it will help them
  • Have they starting thinking about the next version of Blue Bird cabinets?
    • Yes - can see BB3 at G2E
    • Think Helios will be important for markets where win per day is lower and cant afford a 16k machine
  • I really don't understand why people keep asking the same question about win per days and their success... their games perform well, hence they grow the footprint. WAP games earn over $125 perday (our guess is over $130 this Q) hence the more games they place here the higher the overall daily fee... what's confusing here???
  • Focus on the yield vs just growing the footprint should see over install base growth though throughout the balance of the year
  • Customers are very excited about the networked gaming applications and BB2
    • They are referring to a lot of the "networked features" like customer recognition and community gaming already in their games.  Wagenet will allow customers to put those features on banks of games
  • Australia?
    • Second phase of a 2 phase field trial - trial should finish by CY2009
  • Italy and Brazil are also exciting markets for them
  • ASPs internationally are similar to NA
  • Less than 10% of participation games are outside the US because many markets don't allow for that pricing model
  • Placements in Class II markets domestically
    • Pursing for sale model in these markets - literally just went live in the last few weeks - small shipments
    • Shipments to Mexico were all Class III (included in international)
  • Helios platform launch
    • Markets where that platform works well? Lots of international markets don't do more than $30-$40 per day so a 10k ASP makes a lot more sense
  • Are they underpricing their WAP product?
    • Kind of a redundant question since WAP gets % of coin in and the better the games do the more WMS earns... what am I missing?
  • How much of the ASP growth is due to mix vs price increases?
    • Last year 17% were BB2, so there is a big mix impact, think that by 2/3Q2010 mix will be over 70% of shipments
  • REEL EM IN, COMPETE TO WIN is performing at WIZARD OF OZ level or better




The Economic Data calendar for the remainder of the week is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.  


WEEK AHEAD - wk 10 27


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United Kingdom – Prognosis Negative

Research Edge Position: Short the British Pound via FXB


We’ve maintained a bearish view on the UK since we began publishing research early last year and the data out late last week continues to provide confirmation for our thesis. It is noteworthy that the UK reported a -0.4% contraction in GDP in Q3 quarter-over-quarter, surprising forecasters that expected a modestly positive growth rate, and calling into question the ability of substantial stimulus programs issued by the Central Bank and government over the last months to right the economy.


The UK has now underperformed both Germany and France for two consecutive quarters, as the Eurozone’s largest economies returned to growth (+0.3% Q/Q) in Q2.  Italy already released its Q3 GDP at 1.0% Q/Q and we’ll be waiting for other countries to release their GDP figures in the coming weeks. Clearly the inability of PM Gordon Brown and Co. to lead the economy out of recession bodes not only poorly for his party which is fighting for reelection next year, but puts into question the Bank of England’s latest decision to not increase its 175 Billion Pound program to further aid the economy.  


The lack of confidence in management along with burgeoning government debt has encouraged Pounding the Pound (see chart below).  Friday’s GDP announcement put monster downward pressure on the Pound, sending it down 2.2% versus the Euro and 2.3% versus the USD intraday. Fortuitously, we shorted the Pound via FXB (British Pound Sterling Trust) on 10/16 in our model portfolio, a position we’re comfortable holding for a TRADE.


 A separate report out on Friday from the Statistics Office showed that industrial production declined 0.7% Q/Q, manufacturing contracted 0.2%, and construction fell 1.1%, a cocktail of negative data to add to rising unemployment and a annual inflation rate (+1.1%)  that is running higher than in the Eurozone (-0.3%), a bearish point as the economy comes off its bottom. In aggregate, the FTSE has underperformed the DAX and SP500 by a measurable spread for most of the year, a trend we expect to continue.



Matthew Hedrick


United Kingdom – Prognosis Negative - Pound1


Guns & Ammo Meet 'Banker Bonanza'

Sales of guns and ammunition have been on a tear since the '08 Presidential election, but data suggests the trend is slowing and the industry is about to face the toughest comps in recent history. While it’s unclear if this trend will continue one thing is clear – Cerberus is joining in the 'Banker Bonanza' with an IPO of the Freedom Group.



The WSJ reported last week that Cerberus is in “advanced preparations” for an IPO of the Freedom Group, a rollup of firearm companies including Remington Arms Co., Bushmaster Firearms, and at least 5 others over the last 3-years. According to the S-1, the combined entity commands a dominant leadership position in shotguns, rifles, and ammunition (see table below). Smith & Wesson (SWHC), the better known public player in the space, is the market leader in handguns.


Guns & Ammo Meet 'Banker Bonanza' - FreedomGrpMktSh 10 09


The surge in industry sales has been driven by consumer fear that President Obama could back legislation banning gun sales and placing a hefty tax on ammunitions. If you aren’t an avid hunter, ask someone who is about the price of ammunition. Chances are they’ve been stockpiling it like the rest of country. The figures I’ve heard don’t suggest a 20% - 30% increase, or even a 50% hike, but rather a multiplier that could catapult the cost for a box of rounds from $8 on average to $20-$30 – that’s not a rounding error change. Anecdotally, during our visit with management at Dick’s Sporting Goods there was no indication that demand had slowed for ammunition and the industry generally remains in short supply.


As it relates to demand for guns, data suggests trends are indeed cooling. One of the most commonly used indicators of demand is the FBI's National Instant Criminal Background Check System (NICS), a federal database used by licensed firearms dealers who are required to run background checks on prospective buyers. The chart below says it all – while the number of background checks increase, the rate of growth is slowing on the margin and comps are about to get a whole lot harder.


A quick glance at the S-1 filing reveals that at $800mm+ in annual revenues, the Freedom Group is roughly twice the size of its next closest public competitor in Smith & Wesson and the most fitting ‘pure play’ on the “Obama Effect.” The company also boasts a more attractive margin profile with EBIT of 15% vs. SWHC at 10% over the LTM. While it remains unclear if these trends are going to continue, the road ahead is clearly more challenging. Taking these factors into consideration, I’d rather be selling the trend than an IPO into it.



Guns & Ammo Meet 'Banker Bonanza' - NICsTrends 10 09



Casey Flavin


Pity poor Paul – Volcker, that is.

Mr. Volcker, brought on board to great fanfare, turns out to be the Trophy Wife of the Obama economic team.  He gets trotted out whenever the President needs to show off, but clearly, Mr. Volcker is to be seen and not heard.


The former Fed Chairman appears to be the only member of the current economic team who Gets It – and the only one that no one is listening to.


Financial professionals are notoriously light on their grasp of the history of their own industry.  Those who shape the industry itself are often the promulgators of the fallacy that This Time It Will Be Different.  With leadership like this, can we expect the investing public to have a clue?


Volcker, a man who very much lived through the financial and political turbulence of dealing with the near destruction of the US economy, keeps repeating over and over, like a quietly inebriated man during a noisy cocktail party, “Bring back Glass Steagall. Bring back Glass Steagall.”  The other partygoers look at him, deem him not danger to himself or others, and step around him as they head back to the punchbowl for a refill. 


Volcker is anything but inebriated.  He sees clearly just how badly all this is likely to end.  But he has been the Daniel in the lions’ den of politics and has no illusions about his own power to remove the liquor.


“Mr. Volcker scoffs at the reports that he is losing clout,” reports the New York Times (20 October, “Volcker Fails To Sell A Bank Strategy”).  Asked about being sidelined in the current debate, Volcker responded, “I did not have influence to start with.”


Stay tuned for the next episode of the new reality show, “Desperate Fed Chairmen.”



Moshe Silver

Chief Compliance Officer


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