V.F. Corporation
Q2 2010 Earnings Call Transcript

Published: 22 Jul 2010

[Operator:]

Good day, and welcome to the VF Corporation Second Quarter 2010 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Jean Fontana with ICR. Please go ahead.

[Jean Fontana:]

Thank you. Good morning, everyone. Thank you for participating in VF Corporation's Second Quarter 2010 Conference Call. By now, you should have received today's earnings press release. If you have not, please call [phone], and we will send you a copy immediately following the call. First in the call today is Eric Wiseman, Chairman and CEO of VF. Before we begin, I would like to remind participants certain statements included in today's remarks and the Q&A 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 actual results, collaborations or financial conditions of the company to differ are discussed in the documents filed with the company and the SEC. I would now like to turn the call over to Eric Wiseman.

[Eric Wiseman:]

Thanks, Jean. Good morning, everyone, and thanks for joining us today. Following my opening comments, Bob Shearer's going to review the quarter's results in more details. We also have with us is by phone today Karl Heinz Salzburger, President of our International business, who's going to provide a recap of our results in Europe and Asia. It's obviously very gratifying to be here tonight today talking about a 47% increase in earnings per share, particularly following a first quarter where our earnings rose 60%. It's been an amazing first half for VF, delivered by a very talented global team that's focused on winning in any environment. While we did not provide revenue or earnings guidance for the second quarter, it's clear our results again surpassed both our and the Street's expectations. The good news is that the upside was broad-based with better-than-expected results across nearly all our businesses. Not only were revenues stronger than we anticipated, but, similar to what we've seen in the last couple of quarters, our gross margins expanded significantly, which in turn helped drive earnings per share to an all-time record high. Taking a quick snapshot of the quarter compared with last year, every coalition posted higher revenues and operating income, and nearly every coalition posted higher operating margins. We are especially pleased by the return to growth in our Jeanswear and Imagewear businesses. We recognize that these comparisons are against what was a very weak quarter last year, but I think it's clear to everyone that there's been some deceleration at retail since the first quarter, and yet our top line continued to gather momentum. Based on very strong first half results, we're pleased announce today increases in our full year guidance for both revenues and earnings per share. We've raised our target for top line growth by 100 basis points to 4% to 5% growth from 3% to 4% growth. Earnings per share are now expected to increase 18% to $6.10 versus our prior guidance of $5.90. As noted in the release, this includes a greater negative impact to foreign currency translation on both revenues and earnings than we previously anticipated. On a constant currency basis, revenues would otherwise be up 5% to 6%. The release touched on first half versus second half comparisons and pointed out that the investments that we've discussed with you in the past two calls are more heavily weighted towards the second half. Now the investments made to date are already paying off, which you can clearly see in today's results, and we are highly confident that we're spending against the right initiatives to sustain growth through the balance of this year and into next year. Also bear in mind that our second half results will include $0.10 negative impact from foreign currency translation. So on a constant currency basis, we're now expecting revenue growth of 7% in the second half with earnings per share rising by approximately 5%, and that includes the higher brand spending. You need to understand this spending is not just short-term advertising. It's also in longer-term brand and product development. For example, we continue to invest in new product innovation at The North Face, where we're on a winning streak of product innovation awards. In the past year, The North Face has received more than 25 product awards. These include things like the El Lobo Pack, which was voted as the most stable pack by Backpacker Magazine; and the Thunder Jacket, an ultra lightweight high-power down jacket chosen as the Editor's Pick for 2010 by Transworld Snowboarding; and the Single-Track lightweight training and racing shoe, which was voted the Best Debut in 2010 by Runner's World. More recently on July 15, The North Face won three additional outdoor industry awards at the OutDoor trade show in Friedrichschafen, Germany. Now I think it's important that I address a recurring question that is creating a lot of interest and concern across the industry. The question relates to product cost inflation and the potential impact on gross margins for both this year and next. Over the past couple months, we've been very consistent in our response to this question, so I just want to reiterate that response here. Our product costs will be down in 2010 versus 2009. They were down in the first half of the year and they will be down in the second half of the year as well, but by a lesser amount. Gross margins are expected to reach a record high this year. Gross margins were substantially higher in the first half of 2010 compared with 2009, and we expect positive gross margin comparisons in the second half of the year as well. The gross margin increase will be less in the second half than what we experienced in the first half, which is consistent with the expectations we laid out at the very beginning of this year. So cost inflation is really more of a question for us in 2011. And we're not immune to the cost pressures that are occurring, which stem primarily from the current imbalance between supply and demand. When demand dropped sharply beginning in late 2008, a lot of capacity

[Robert Shearer:]

Thanks, Eric, and I'll start at the top with revenue. We were obviously really pleased with the 7% increase achieved in the quarter, and as Eric noted, every coalition reported higher revenues. Also of note is that the 7% growth was negatively impacted by currency translation by one percentage point. Now as we saw in the first quarter, our gross margin performance continues to be exceptionally strong. Our gross margins topped 47% in the quarter with a 320 basis point improvement over last year's second quarter. And as noted in the release, the improvement was driven by three primary factors

[Eric Wiseman:]

Thanks, Bob. Now let's wrap up with some comments from Karl Heinz Salzburger, Vice President of VF International. Karl Heinz?

[Karl Salzburger:]

Yes, thank you, Eric. Just to remind the group, my comments will cover our international businesses in Europe, the Middle East and Asia, the markets for which I have responsibility. On a constant dollar basis, growth in revenues in these markets were up nearly 4% in the second quarter. We enjoyed solid growth in our Outdoor and Action Sports business, which is primarily The North Face and Vans; our Sportswear and Contemporary Brands business, which includes 7 For All Mankind, Napapijri and Kipling; and in our Asia businesses. During the quarter, we also continued to improve profitability with operating margins of our international businesses rising more than 200 basis points. Despite a lot of well-publicized concerns regarding the market trends in Europe, our major brands continued to perform strongly. Year-to-date, The North Face stores have achieved double-digit comp store growth and fall bookings are up 25%. Vans stores have also achieved double-digit comp store growth through the first half of the year with fall and holiday bookings also up 25%. We have been steadily increasing our investments behind both brands to drive growth and market share gains in Europe and are very encouraged by the results we are seeing to-date. Our 7 For All Mankind brand continues to expand in Europe with 24% revenue growth in the second quarter. Strong bookings and additional new stores should drive double-digit growth in the second half of the year as well. New stores opened in the quarter included Milan, Berlin and Antwerp, and we are looking forward to opening our second store in Paris this quarter. We remain on plan to open a combined total of about 15 owned and partnership retail stores in key European cities this year. Our Napapijri brand also continues to perform very well, with 7% revenue growth in constant dollars during the quarter, double-digit comp store growth in the first half and fall bookings up 15%. There were a couple bright spots in our European Jeanswear business in the quarter. Our Wrangler brand posted a moderate growth in constant dollar in the quarter. The brand's cutting edge marketing campaign continues to gain accolades, winning five awards at the prestigious Cannes International Advertising Festival. While the profitability of our Jeans business continues to improve, overall, this business continues to be our most challenging. The momentum continues in Asia with revenues up 26% in the quarter. We enjoyed exceptionally strong results in The North Face, Vans and Kipling businesses in China. While still a relatively small market for us currently, we're also making very good progress in India, where revenues grew by more than 50% in constant dollars during the quarter. As you have heard us discuss in past calls, we have committed to a substantial increase in marketing in China this year. We're on track to aggressively expand distribution in China. We have 40% targeted increase in door count by year end, or 1,400 stores, which should help drive our goal of 25% revenue increase across Asia in '10.

[Eric Wiseman:]

Thanks, Karl Heinz. That concludes our comments. We'd love to hear your questions. And, Stacey, could you open up the line for questions for us?

[Operator:]

[Operator Instructions] We'll take our first question from Kate McShane with Citi Investment Research.

[Kate McShane:]

Eric, you commented that for cotton, we may possibly see an easing of prices in the cost of this commodity if the crop is strong in August and September. Will you still be negotiating prices at this point for spring 2011? Or will you be locked in by that time?

[Eric Wiseman:]

We'll have some flexibility in later spring, kind of mid- to late spring pricing. That depends on how good the crop is too, Kate. There's a couple pieces that move there that make your question a hard one to answer precisely. We've certainly established our pricing agreements through this fall, and depending on when it feels like the crop might be good, that'll partially drive that, but what it would be by mid-spring at latest.

[Kate McShane:]

Okay, great. And just one more question on the cost front. I would expect that you would see more pricing pressure in your Jeanswear business just because of how much cotton composes of that category. Do you have any pricing power in your Jeanswear business, that 30% of your total sales? Or will we see more margin pressure in this category while you take price increases in other categories?

[Eric Wiseman:]

We absolutely have some pricing options in our Jeans business. One of the reasons we're so focused on the strategy of innovation is because we have learned over the past few years in particular, when we create innovative products that consumers really want, they helped us sustain some revenue momentum during the recession, and we've charged a fair price for this. In fact, our average unit price at Lee has gone up through the recession and it's because we've been innovative. So the combination of innovation and the strength of our brands gives us some flexibility. But you're right; that is where we have our biggest pressure point. We have plenty of product categories that between the fabrics that go into the products and the locations that they're made aren't really experiencing inflationary pressures right now. So you know how diverse we are in our business mix and we're as diverse in the inflationary pressures.

[Kate McShane:]

Okay, great. If I could squeeze one more in about SG&A and your spending in the back half of the year. I know you're not giving quarterly guidance, but can you give any kind of comments around how we should drive our model with SG&A spending Q3 and Q4? Will we see more in Q3 going into holiday? Or will we see more spending in Q4? Or will it be evenly distributed?

[Eric Wiseman:]

Kate, I can't answer that, but Bob would love to.

[Robert Shearer:]

For the second half of the year, the way to think SG&A is that the ratio, the percent of revenues will be up just a little over 100 basis points actually in each quarter. And the marketing spend actually, when you do the math, right, and the $65 million out of the $85 million, and that's obviously a little abnormally second half weighted. It's more weighted to the second half than we'd normally expect to see but the $65 million actually would drive about 150 basis points of increase over that period of time. So there are some offsets, a little lower pension expense as an example. But we'll net down to just a little over 100 basis points per quarter.

[Operator:]

We'll take our next question from Jim Duffy with Stifel, Nicolaus.

[Jim Duffy:]

Eric, so a little bit of history view here, if you look back historically, the relationship between cost at the border, say, and price at retail, has there been a linear relationship? Or in times when you see costs go up, has historically has it been difficult to pass that through at retail?

[Eric Wiseman:]

I have to think about that a little bit. We have not had problems in historically in addressing substantially all of the inflation we've seen coming at us, whether it was from labor or from other cost of goods. Over time, we have been able to address substantially all of it, and we expect that would be the case next year as well.

[Jim Duffy:]

Is that VF specific? Or based on your historical perspective, is that kind of an overall industry dynamic?

[Eric Wiseman:]

No, I can only speak to VF specific. I know that we have such strong brands that are in great demand by consumers. That helps us address some of that. And how efficient we are, I mentioned in the call, a third of our production comes from factories that we own and operate, and we are not having labor inflation there or were able to offset it by efficiencies based on how well we run factories. So we're just not seeing it there. So I understand there's a really big question out there, but we're pretty confident that we have work to do and the story is not yet fully told, but I'm real confident in our team's ability to address substantially all of this.

[Jim Duffy:]

Yes, given your sourcing base, it seems you're better insulated than many sounding so [ph]. You've begun the booking process with some of your brands for spring. Early days yet, but what are you hearing from the mindset of retailers as you have those discussions?

[Eric Wiseman:]

There's caution back in people's voices right now in general about the market. The slowdown that we've all seen happen since I guess the second week in May has had everybody ask, how confident should we be in placing spring orders? The good news for us, if you look at what happened during even the recession when there was more than just a little caution, there was widespread caution; we continued to get pretty good bookings for most of our business. You know that in 2008, we had a good revenue year. Last year, we were down 4% on a constant currency basis across our company, and we're pretty confident that we've got the right brands and the right products within our brands to do better than most in that. And in fact, as people are getting more selective about what they buy, they're looking to leading brands, if you're looking to leading brands, you're looking to brands like Wrangler and you're looking to brands like Vans and The North Face. So we're pretty confident about next year.

[Jim Duffy:]

Great, and then final question for Karl Heinz

[Eric Wiseman:]

Karl Heinz, you got it? Can you hear it?

[Karl Salzburger:]

Yes, I got it. You heard me saying that before, we had a very,very strong quarter with Vans in China, which nearly doubled the business. Vans, we see Vans as a big opportunity for us in China. We just started basically a couple of seasons ago. We have very talented management on the spot, management which knows about footwear, and it's one of the brands where we certainly will do better and become a big opportunity for us in China. We open a store, we have a big store's [ph] rollout and I can't quote what the company is [ph] longer term, but certainly it's one of the top opportunities we have.

[Operator:]

We'll take our next question from Bob Drbul with Barclays Capital.

[Robert Drbul:]

Eric, I just have some questions on the Mass Jeanswear business. There was recently a change of the U.S. business for one of your largest customers and I was wondering if you saw any major strategic changes that might positively or negatively impact your business. And some of the changes or the moves in your Riders and Wrangler Women's businesses, is that due to the change in strategy or anything that we should think about?

[Eric Wiseman:]

Well, Bob talked about the acceleration of our progress in our Mass Jeans business during his comments. And what's driving that, there are a couple things. We have been talking for a while about programs that we lost with one of our large Mass customers, and we are regaining some of those programs and permission I think to gain them all back. Some of them were in test. Some of them are further than test into full rollouts, so that's to our team's tenacity in not giving up on those programs because we believe they were the right things for that customer, and we're giving permission to, at a minimum, test them and, as a best case, roll them out. You've heard comments about one of our customers talking about returning to basics, and they've specifically mentioned things like jeans and tees. So any time we have a large customer on jeans, when we're their largest provider of national branded jeans, that creates an opportunity for us and we're working very closely with that customer to help them get back to the more basic apparel business. I think it's the right move for them, and they'll execute it really well. We're really confident they can execute that well, and we're happy to be a partner in that with them.

[Robert Drbul:]

Great, and, Bob, I have a question for you on product costs. I think Eric said that you would have lower product costs for the remainder of the year. I think in previous calls, you had mentioned that you thought you would have higher year-over-year costs beginning in the fourth quarter. What has changed from that perspective?

[Robert Shearer:]

Well, Eric's comment was for the second half. So the cost, as you might expect, Bob, increasing a little bit as each quarter goes on. So for the fourth quarter, what I've indicated in the past is that costs, or product costs, when you compare year-to-year, fourth quarter to fourth quarter of last year, right, that the costs will be up just a little bit over where they were last year in the third quarter; they'll still be below, and that nets to being just slightly below for the second half of the year. The reality is that costs year-to-year, when you look at the second half of 2010 versus the second half of 2009, again, down a little bit on a net basis, but fairly neutral.

[Robert Drbul:]

Okay, and then just one final question for Karl Heinz

[Eric Wiseman:]

Karl Heinz?

[Karl Salzburger:]

Yes, Bob. Historically, we have seen, especially on the brands I mentioned where we have the strong bookings, that the cancellation rate is pretty modest now. We haven't seen in the first semester a change of that cancellation rate. So honestly, we don't expect major surprises on the strong bookings even for the second semester.

[Operator:]

We'll take our next question from Omar Saad with Credit Suisse.

[Omar Saad:]

I wanted to ask a question on priorities for cash flow. It looks like you're buying back stock more aggressively than you have in the past. What are the key decision factors there? How are you thinking about buying your own brands versus going out in the M&A markets and picking up some brands? And I also have a question on the marketing and advertising spend. I thought you made an interesting comment, that you're seeing a nice pickup in the areas where you're spending on marketing and advertising dollars. Could you give us some more color there in how that makes you feel about where the consumer is?

[Robert Shearer:]

Omar, I'll start on the first part of the question relative to priorities for cash. We did. We expected to buy back 3 million shares in the first half of the year, and that was our communication. And when the market fell off a little bit, as the market fell off a little bit, we were seeing strengthening in our cash generation for the year and our cash position, the resulting cash position. So it felt like we could and should go out and buy an additional million shares. Having said that, our priority, as I said in my comments, our priority remains on the acquisition front. That is where we want to invest, and that's been pretty consistent over a period of years. So we saw the opportunity, we upped the buyback a little bit even in the second half the year. We could do a little more from that standpoint, but it's not a change in strategy or focus. Our focus remains on the acquisition front. Eric, do you want to take...

[Eric Wiseman:]

Yes, Omar. I'll deal with the second part of your question, which was about where we're seeing proven results from investments that we've made in the business this year. I'll give you a couple examples. One is the Nautica Father's Day TV campaign that we ran in partnership with Macy's. We did that in two markets as a test. We did that in New York, and we did it in Florida. I won't give you specific numbers because I'd rather keep that as internal information. But they were very encouraging, enough so that we're hoping to do more of that and increase that investment with Macy's later on this year. Another is Vans in Europe, where we in June I guess ran an outdoor campaign in several cities. I think we were in six or seven cities and, Karl Heinz, correct me if I get this wrong, we did in some cases just a lot of outdoor billboards, and I said [ph] we took a few markets and did big splashes of Vans awareness, talking about the history of the brand and the products that we sell. And we saw an immediate lift in both our sell-through at retail and in immediate bookings went up. Karl Heinz, do you have any color to add to that comment about Vans?

[Karl Salzburger:]

No, you said it all, Eric.

[Eric Wiseman:]

And the last example I'll give you is in the script, Omar, I talked about the product awards we're getting at The North Face. We are making substantial investments in both consumer insights to inform us about the products that we should be making; in our business model, around the activity-based model; and in people to help create really compelling product, and some of that shows up in awards. It also show up in momentum with your brand, and for us to keep a brand that big going, we have to continue to create amazing products. So we're investing in that, and that's a long-term investment. Is that enough examples?

[Omar Saad:]

No, that's great.

[Operator:]

We'll take our next question comes from Sean Naughton with Piper Jaffray.

[Sean Naughton:]

Vans, obviously a great quarter. Can you talk about the domestic growth? I think you said it was up 20%. Can you walk through like the combination of that growth, whether it's through new doors or the reintroduction of new doors to the brand or comp store growth? And how the comps were within your existing wholesale accounts for Vans domestically?

[Robert Shearer:]

Sean, this is Bob. Most of the growth by far, about 75% actually of the growth came from our wholesale business. So the remainder was primarily from opening new stores. So again, just a great story around Vans, just an incredible quarter and year so far, and especially in the fact that most of that growth has been driven by the wholesale side of things.

[Sean Naughton:]

Okay. And then has there been any change in the penetration of apparel and footwear? Or are you still tracking kind of that 7.25 [ph] range?

[Robert Shearer:]

It's still tracking pretty close to where it was on the wholesale side. A little bit more of that is in the apparel side of the business, so it's getting a little bit of strength. It is gaining some strength, but still overall for the brand, pretty close to where we've been.

[Eric Wiseman:]

Sean, the thing I would add to that is Karl Heinz just talk in answering another question about Vans' success in China, and I just mentioned our investment in Vans in Europe in select cities. The Vans brand we are highly confident can continue to grow, and we're investing in it to deliver that growth. It's a very strong brand.

[Sean Naughton:]

Great. Can you discuss any -- are there any delays or anything you're seeing within the supply chain right now where you guys are having trouble getting the goods that you've placed order for, for the fall or getting here domestically?

[Eric Wiseman:]

Yes, Sean, we don't have huge challenges there. There is a shortage of both ships and containers. But during non-peak times, just a normal kind of fall demand, we're having to scramble during really peak months where there's a lot of stuff coming at us, and that's true for back-to-school, so we're experiencing that now, and it'll be true for holiday. What our experience has been for back-to-school is that we've been able to work around it, and we're having minor delays, a week delay getting the stuff here, which doesn't affect our ability to get product to market. It's taken a whole lot more work from our supply chain team to get them here, but they are able to get them here reasonably on time.

[Sean Naughton:]

Okay. And is it just a change in mix in terms of how you're importing in terms of air freight or anything like that? Are you having to increase that percentage of the goods that you're bringing in?

[Eric Wiseman:]

Yes, a little bit more air freight for us this year. It's a surprising statistic. And I'm getting very granular here. In a normal year, about 2 million new containers go into service, and some go out of service, right. They need to removed from the chain. Last year, only 200,000 new containers went into service. So it was a 90% reduction in the introduction of new containers into the system, and that's what's creating a lot of this pressure right now. That industry is getting back and refueling that demand, but it's taking a while. But as I said, we're able to work around it pretty well.

[Operator:]

We'll take our next question from Michael Binetti with UBS.

[Michael Binetti:]

If I piece together a few of your comments from today, it sounds like you're fairly confident for some of the orders, at least in your key growth driver brands, that you're seeing in early-on discussions for 2011, and you think you have enough pricing power across the portfolio to help offset some cost inflation that everybody's starting to talk about. And you also pointed to the ongoing mix of the business. I know it's a little early to talk about 2011 at this point, but since you guys gave quite a bit of helpful detail, I'm looking at least into the early part of the year, is there any reason at this point that we shouldn't expect gross margins for VF Corp to keep expanding in the first part of 2011 in our models?

[Eric Wiseman:]

Michael, as you said, we did provide a lot of details and a lot of color around the numbers, but we just continue to believe it's just a little too early, right, it's just a little too early to comment on that. What we've tried to point out are all the pieces that we're looking at, all the areas of opportunities that we have, all the actions that we're taking to address that, but you'll hear a lot more about 2011 in the very near future.

[Michael Binetti:]

All right. Then maybe I can just ask a question about North Face, and I'm looking at the U.S. business for North Face. Obviously, it's very back-weighted for the profitably of that brand. Could you help us look at how the total -- how your order book looks for the U.S. for North Face? And then maybe in particular how ASPs look on a year-over-year basis in the orders that you guys have on the books right now?

[Robert Shearer:]

Well, the last time we got together, actually, we talked about our order positions being actually globally up 20%, and that obviously is we haven't seen any falloff from that, so that business, as you said, continues to perform really well, and the order position that we're seeing for fall shipments remains quite strong.

[Michael Binetti:]

Any comments on ASPs?

[Eric Wiseman:]

I know we're not under any pressure. My guess is -- I don't know the answer to that. I won't guess at it.

[Operator:]

We'll take our next question from Todd Slater with Lazard Capital.

[Todd Slater:]

Could you tell us what the -- just how much Europe was up overall and maybe provide a little bit of color on some of the specific countries? And then just back to the ASP question, I'm just trying to get my arms around it. It sounds like you're planning to offset some if not all of the sourcing and other cost increases with some pricing increases, and you talked about innovation and ways in which you could achieve that. And I'm just wondering in the fourth quarter and maybe in 2011, should we expect your average ASPs or unit prices to move up roughly in line with the sourcing inflation that exists? And if so, what would be a sort of good starting point? And then lastly, you said that the retailers are getting a little more cautious, and I'm just wondering if you'd seen if any of the big department stores have indicated that they might want to be a little more conservative on the back half deliveries.

[Robert Shearer:]

I'll start on a couple of those. We were both writing down as you're asking your questions, Todd. First of all, the international business, I made a comment that our total international business on a constant dollar basis increased by 6% in the quarter. It was impacted by translation. So that pulled it down to about 3%. In terms of ASPs, yes, I think it is fair to assume that as we've indicated, we clearly see pricing increase potential for our brands as we move into next year. So again, all things being equal, yes, we will see some price increases next year clearly across our businesses.

[Eric Wiseman:]

On the question about are retailers getting cautious and how are we seeing that, we've had some very few instances of kind of cancellations and delays in terms of materiality to overall VF. So we have seen it's been very spotty, but it has not been a big issue or material issue in terms of a discussion we would have.

[Todd Slater:]

Okay, and the question on international, I was curious about Europe specifically. I got the overall international and I think you mentioned Asia up 26% and India up 50%. Could you give us the European numbers? And maybe talk a little bit about some of the specific countries and what you're seeing there?

[Eric Wiseman:]

Bob and I are looking at each other; neither of us have the specific numbers for Europe. Karl Heinz, do you want to talk about the BRIC countries and what's going on there and how important or unimportant they are to our overall mix?

[Karl Salzburger:]

Yes. Clearly, it's publicized a lot, the BRIC countries are not in the best shape, to come to the point. The good news is it's a relatively modest business for us, so our exposure is relatively thin there. We haven't released a number for Europe, so what I can say, we have three coalitions, I mean three big businesses

[Eric Wiseman:]

Todd, does that help you?

[Robert Shearer:]

Yes, Todd, I can give you a little bit more on that. In constant dollars, our growth in Outdoor and Action Sports was high single-digit kind of growth. However, in our Jeans business, that pulled that down. And so again, that business is still -- it's more stable than it was, but it's still declining a bit even in constant dollars. So those are the two significant factors. But the point is by far, our largest business and fastest-growing business there, which is our Outdoor and Action Sports, that continues to grow at a nice pace.

[Todd Slater:]

Great, that's very helpful. And just, are you going to -- when do we cycle that change in the Mass piece? Can you just remind us when that is?

[Robert Shearer:]

Yes, it was about an $8 million impact to the quarter, so not so big, not so big anymore. And on the second half, just to carry through with that in the second half, last year, we had about $20 million of revenues associated with that Mass Jeans business that we've now exited. So $8 million in the second quarter and $20 million for the last part of the year, and then that will be done.

[Operator:]

We'll take our next question from David Glick with Buckingham Research Group.

[David Glick:]

Just a follow-up on Todd's question

[Karl Salzburger:]

The first question, David, we clearly stay very cautious because a lot of rumors and a lot of facts are going around Europe. The economy of certain countries are not in the best shape. So we do remain cautious. Especially in our stronger brands, we have not seen negative stigmas. Our cancellation rate has not changed, and I would say that the strong brands are doing well. While we stay cautious, we're pretty confident and don't expect negative effects happening the second semester.

[Eric Wiseman:]

David, this is Eric. I'll deal with the Nautica turnaround. We're obviously thrilled that Nautica has had a really strong wholesale business in the first half. The team there has worked very hard over the last 18 months to get the right product assortment together, to get the right marketing communication message together and to get the right -- to get that to come to life that retail with our retail partners in the right way, and that's kind of firing on all cylinders right now. So they've had a good the first half, and the business is turning more pure into their traditional wholesale department store channels, so that's all really, really good for us. The outlet stores there, I will tell you, have not done as well, nor have they been our focus. Our priority was rebuild the platform for the wholesale business. Once done, leverage that into our outlet store model, so we're working on the second phase of that and I would expect to see improvement in our outlet store business there next year.

[David Glick:]

I mean, are retailers now, given the turnaround this spring, certain to chase product for fall and increase their bookings on a relative basis for spring?

[Eric Wiseman:]

Well, I would say that our fall bookings, which are the ones that -- fall and holiday, which are the ones we have in hand, are significantly higher than -- what we assume today would be back in January and February before we began to get some momentum in the business. So our customers are increasing their support of the brand based on the performance this spring for fall and holiday. We don't have spring bookings yet, so I can't comment on that.

[Operator:]

We'll take our next question from Robbie Ohmes with Bank of America Merrill Lynch.

[Robert Ohmes:]

I was wondering if you guys could give a little more detail on the growth driver outlook for North Face the way you did with Vans, meaning can you give us a little color on how wholesale versus retail looks for The North Face in apparel versus footwear versus accessories sort of aligned by U.S. versus Europe versus Asia, just to give us a flavor if anything's changing in terms of what the growth drivers look like for the overall brand?

[Robert Shearer:]

Robbie, I'll start on that. I gave some numbers for Vans relative to the breakout of retail versus wholesale, and it's very much a similar story for The North Face. As a matter fact, even more so; nearly all of the growth in The North Face that we've been seeing is due to the wholesale side of the business, not so much driven by new stores. And also, from an international versus U.S. standpoint, as we've been seeing and as we've been saying and as we look forward as well, the brand is strong. The brand is strong here in the U.S., it's strong Europe and it's also strong in Asia as well. So we're seeing really equal strength, equal growth. We said previously that order positions for the fall business being up, the 20% area again, that was, we saw consistency across the globe relative to those positions. So that's again, it's good news from all angles.

[Robert Ohmes:]

And any sort of category color as footwear is starting to really accelerate, or is it sort of apparel and footwear and accessories all moving together?

[Eric Wiseman:]

I'd say mostly moving together. Our footwear business is still -- the resurgence, I guess I'd say of our footwear business is still in some early stages as we've talked about in the past, but the areas that have shown strength and particularly on the apparel side continue to show strength. Not a big change there.

[Operator:]

And our next question from Ken Stumphauzer with Sterne Agee.

[Kenneth Stumphauzer:]

Just briefly on the direct-to-consumer segment, there was a pretty noticeable deceleration in the year-over-year growth rate. What's causing that? Is it slower year-over-year increase in stores?

[Eric Wiseman:]

Well, two things really. First, our comp store growth rate for the first quarter was 10%, and when that happened, we said in our first quarter call we did not expect to see that going forward. What we learned in the second quarter was that it was slightly worse than we thought it was going to be. We knew it would slow down from that kind of rate. In fact, in the second quarter, our comp store growth rate was about flat, and it just tailed off in the last six weeks of the quarter. Our outlook for the year also came down by about 100 basis points in terms of our assumption about comp store growth. which we said would be mid-single digits, and we're down about 100 basis points from what we thought sooner. We've been opening new stores and closing stores. I'm getting our mix to a position where we have a much more effective retail portfolio and it's showing up in improved profitability in our stores. So while we have some comp store pressure from consumer spending, which I think we're not alone with, the profitably of our direct-to-consumer model continues to improve because we're getting the store mix right and exiting the underperforming stores and investing in new stores, and are still on track to open about 80 new stores this year.

[Kenneth Stumphauzer:]

Okay. Secondly, Bob, in the past, you've disclosed kind of the order of magnitude of the different gross profit margin puts and takes. Can you do that again? What comprised that 370 basis point expansion?

[Robert Shearer:]

Yes, in the second quarter, and as we've been talking about here, a different story than what we expect to see for the rest of the year because of the comparisons of the second half of the year against the second half of last year. So product costs, the reduction in product costs added about 200 basis points to the 320. Eric just talked about, and this is on gross margins, Eric just talked about our retail performance, and that has improved, and that contributed about 70 basis points. And just operating the business really cleanly and other mix factors and all those other kinds of things made up the difference.

[Kenneth Stumphauzer:]

Okay. I know you can't talk in specifics, but as far as the M&A environment goes, we've obviously seen a lot of volatility in the equity markets and perhaps some concerns in the credit markets. I'm just wondering if you're seeing perhaps valuations come down to more reasonable levels yet.

[Eric Wiseman:]

I wish I could say that was the case. I think that has not been -- we have not gotten an acquisition done this year, so that's blinding flash of the obvious. Having said that, one of the reasons has been price. We have not been able to come to terms with the price that the sellers expect, and we don't have anything that I have as a reference point. But clearly, the markets have come down, and that might suggest a different kind of valuation. We remain focused as we have been on the Outdoor and Action Sports sectors as our primary focus for acquisitions, and we're still very active.

[Operator:]

We'll take our next question from Mitch Kummetz with Robert Baird.

[Mitchel Kummetz:]

First on the gross margins, when you look at your outlook for the back half of the year, you guys are saying gross margins are up and product costs down. But, Bob, you made a comment that you should actually see some product cost increases in the fourth quarter. So do you expect gross margins to be up in the fourth quarter? Or is it more just the third quarter? Or how should we be thinking about between the two quarters?

[Robert Shearer:]

Yes, it a little bit more improvement just as you expect, Mitch, with costs, what's happening with costs. And again, it's not a huge impact here, but yes, we see expect to see the comparison a little stronger in the third quarter than the fourth quarter -- versus the fourth quarter last year that was really an extraordinary quarter for us. So yes, clearly a little more improvement, yes, in the third than the fourth.

[Mitchel Kummetz:]

But you still think gross margin could be up in the fourth quarter even within...

[Robert Shearer:]

Possibly yes, slightly, but flat to up very slightly.

[Mitchel Kummetz:]

Okay. And then on the SG&A, Bob, you mentioned that if you strip out your higher investments in the back half, you actually expect leverage on that line item, which is pretty impressive I think given that what's happening with mix, particularly as you build out your retail business. So I guess the question is on a longer-term basis, how should we be thinking about that SG&A line? I mean, is that something where you can get leverage over the next few years? Is that how you're thinking about the business on a go-forward basis?

[Robert Shearer:]

Yes, I'd say relative to SG&A, Mitch, that a lot does depend on our spending, on the marketing spend. And you're right; what we're seeing this year is that the big factor is, in fact, the higher and the incremental marketing spend. Now to be fair, one of the points of leverage, you could say, but our lower pension expense is helping us there. So that accounts for some of the difference, but still otherwise, relatively flat. So I think a lot of that will depend on the marketing spend, and that's yet to be seen. If our marketing continues to -- the higher spend continues to produce the results that we're seeing, we may continue to accelerate the spend.

[Operator:]

We'll take our next question from Chris Svezia with Susquehanna Financial Group.

[Christopher Svezia:]

I guess one of my questions is just on if you can talk about 7 for a moment and just, Eric, your comment about just kind of what you're seeing in that business. Maybe talk about retail and the wholesale pieces and just in terms of what you're seeing there in terms of the business.

[Eric Wiseman:]

That one shifted on us a little bit here in the quarter. We had a really strong first quarter with 7. We had a strong second quarter with 7 as well. We have seen a slowdown in the premium denim space in the last few weeks -- in the last eight weeks, really, since May. That segment in particular has been a soft spot, so our stores are still working for us, and we're continuing to invest in our stores, but there clearly has been a slowdown. How long that lasts, I wish I knew the answer to that. The answer for us is to make sure we create compelling product, which obviously we're working on that, and we're increasing our investment in the brand. In fact, we're just about doubling our marketing spend behind 7 For All Mankind right now because we think it's a great brand. And even though it's under pressure right now, we're going to spend on it to make sure that we connect with consumers in the right way. We underspent on it a bit in the last few years, so we're going to reinvest in it and hope we have the right products at the time and that the fall gets better than the last eight weeks have been.

[Operator:]

We'll take our next question from Dana Telsey with Telsey Advisory Group.

[Dana Telsey:]

As you think about the Contemporary business, even beyond 7, what are you seeing in terms of price points, department store contribution for in-store shops? How is that moving along and their ordering trends? And just lastly, not just to beat the dead horse in terms of product costs, as you think about 2011, do you see price points to consumers changing?

[Eric Wiseman:]

Sure. In the contemporary space, in terms of price points, there was a significant reduction in price points during the course of the recession over a two-year period. The average price point for a pair of premium jeans, regardless of brand, came down. It didn't mean that we didn't still offer the high end of the range, but the consumers bought more at the lower end of the range, so we saw a reduction in AURs. That stabilized in the first four months of this year, and I think it's under question right now, Dana, because there's been a change that really has just happened, and as you know, we're also at a period of year, it's been a very warm June and July across the United States, and I'm not sure if people are waking up thinking I'm going to go buy a pair of long jeans, long bottom jeans right now because that's what I want to wear today. In fact, I'm pretty sure they aren't. The question will be during back-to-school

[Operator:]

And we'll take our last question today from Kevin Boler [ph] with Morgan Stanley.

[Unidentified Analyst:]

Bob, you've taken a couple questions today on M&A and I think in particular, you're saying that some of the targets are maybe asking too much here. So I think in March, you'd mentioned that you'd be willing to make $1 billion-plus acquisition if you could find the right target. I'm curious if you're still thinking that $1 billion-plus is a good number and just what your constraints are. I mean, how do you think about your capital structure? Is leverage now close to one turn? Is three or four turns too much leverage for the right acquisition, for a $2 billion or $3 billion or $4 billion acquisition? I'm just curious, what are the constraints to how you think about capital structure? And how low do you want to keep leverage? And how do you think about the big pictures cap structure questions as you think about M&A?

[Robert Shearer:]

Yes, Kevin [ph], we do talk about a billion-dollar deal because we could clearly afford to do that, and that's really where the comments are coming from, so we often get the question would you, could you do a billion-dollar deal, and we say, well, we certainly could. And we would for the right brand. All the risk factors would have to be appropriate to do the billion-dollar deal, but we would do a billion-dollar deal. So when you look at our debt ratios right now and our cash position as well, it obviously gives us a lot of flexibility. We talked a little bit earlier, don't know if you heard it, there was a question relative to the buyback program. We upped the buyback a bit here in the quarter over what was expected. We bought back 4 million shares versus the 3 million expected, said we could increase that a bit as our cash continues to strengthen. So I think the bottom line, Kevin [ph], is we just have a lot of flexibility in our balance sheet right now from a cash, from a debt standpoint, and the priority remains on acquisition. And we could do a larger acquisition. If you looked at our history, it would say that that's not as likely as one that's below that billion-dollar mark.

[Operator:]

And that was our last question. I'd like to turn the conference back over to Eric Wiseman for any additional or closing remarks.

[Eric Wiseman:]

Yes, thanks, everyone, for joining us. We're obviously pleased with the second quarter. That is history now. More importantly, we're confident we can navigate the challenges ahead of us, and we look forward to keeping you updated as we do just that. Thanks so much. Bye-bye.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude our presentation. We appreciate your participation. You may now disconnect.