Earnings Call Transcript - VFC Q4 2020

Operator, Operator

Greetings and welcome to the V.F. Corporation Fourth Quarter and Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Operator Instructions: As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Alkire. Please go ahead, sir.

Joe Alkire, Head of Investor Relations

Good morning, and welcome to V.F. Corporation’s Fourth Quarter Fiscal 2020 Conference Call. Participants on today’s call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC. Unless otherwise noted, amounts referred to on today’s call will be on an adjusted constant dollar basis, which we defined in the press release that was issued this morning. We use adjusted constant dollar amounts as lead numbers in our discussion because we believe they more accurately represent the true operational performance and underlying results of our business. You may also hear us refer to reported amounts, which are in accordance with U.S. GAAP. Reconciliations of GAAP measures to adjusted amounts can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide management’s view of why this information is useful to investors. During the fourth quarter of 2020, the company determined that the occupational workwear business met the held-for-sale and discontinued operations accounting criteria. Accordingly, the company has reported the related assets and liabilities of the occupational workwear business as held for sale and discontinued operations as of the date noted above and included the operating results of this business in discontinued operations for all periods presented. During the first quarter of fiscal 2020 the company completed the spin-off of its jeans business into an independent publicly traded company under the name Kontoor Brands. Accordingly, the company has removed the assets and liabilities of the jeans business as of the date noted above and included the operating results of this business in discontinued operations for all periods presented. Unless otherwise noted, results presented on today's call are based on continuing operations. Joining me on today's call will be VF's Chairman, President and Chief Executive Officer, Steve Rendle and Chief Financial Officer, Scott Roe. Following our prepared remarks, we'll open the call for questions. Steve?

Steve Rendle, Chairman, President and Chief Executive Officer

Thank you, Joe. And welcome, everyone. I hope my comments this morning find you and your family safe and healthy. Please bear with us today because we are all working from separate locations. It is remarkable how quickly the world has changed since our last call just a few months ago. Through the first 10 months of the year, VF had powerful momentum tracking ahead of our long-range plan and now COVID has profoundly impacted the world as well as our business for the last two months of our fiscal year. I've never been more confident in our people, our brands and our future. It's times like these that serve as a purifying fire, separating the best companies from the rest. We've prepared ourselves well for a time such as this. Our strong brands, our financial and supply chain disciplines coupled with our fortress balance sheet allows us to weather almost any storm. I'm confident that VF will emerge from this crisis in a position of strength, prepared to accelerate at a time when many are under tremendous financial strain and unable to adequately invest in their business. And while COVID has appropriately been a dominant theme recently, let's not forget that 2020 has been a year of significant accomplishments for VF. To name just a few, the move to Denver, the release of science-based targets in line with our commitment to sustainability, the successful spin-off of Kontoor Brands and the announcement of our intent to sell the occupational workwear business. Even with this exceptional activity, we were managing our way to a strong year. Through the first three quarters of fiscal 2020, we had delivered 9% organic revenue growth, more than 100 basis points of gross margin expansion and 19% organic earnings growth. Vans and The North Face, our two largest properties were growing 17% and 9% respectively. And our global D2C platform was growing at a double-digit rate, led by 20% digital growth. So what's giving me confidence about our future? First and foremost, our incredible community of associates, from our experienced leadership team actively managing this crisis to our distribution center associates working tirelessly to enable our brands to continue serving their consumers. Words cannot fully express how thankful I am for the entire VF family and their infallible commitment to each other and our business. Next, the nimbleness of our enterprise, which has demonstrated once again the ability to adapt and act with agility to protect our people, protect our enterprise, and preserve liquidity and quickly pivot to those priorities which position us to emerge in an advantaged position. And I'm thankful that we have been aggressively transforming VF into a consumer-led, retail-centric, digitally focused enterprise. This transformation, coupled with a renewed focus on the three-lens approach to managing the portfolio has honed our organizational focus and simplified our business model. Our ability to pivot in light of changing consumer and distribution environments through portfolio actions has been and will continue to be both a catalyst for growth as well as a hedge against risk. Our movement away from challenged distribution channels while focusing more deeply on the most attractive addressable markets gives us a real advantage in an uncertain and fast-evolving world. Finally, for the commitment across our organization to act as a purpose-led, performance-driven enterprise during this time of crisis. In addition to providing pay continuity to retail associates during the global lockdown and increasing hourly wages for distribution center associates, VF has committed nearly $7 million in financial support and product donations across more than 20 different branded initiatives. And we're in the process of producing up to 3.5 million pieces of urgently needed PPE for COVID-19 relief efforts. Our most recent COVID-related actions are in addition to the ongoing efforts around Made for Change initiatives, leading with science-based targets focused on improving people's lives and planet. Using the considerable scale and resources of VF for the betterment of both people and the planet are not just the right thing to do. It's good business as we forge even deeper connections with our consumers during this time of crisis. Collectively, these characteristics positioned VF to not only weather this storm, but to emerge as an even stronger, leaner, digitally oriented enterprise on the other side of the current pandemic. In light of the current environment, in the new world we find ourselves operating within, I'd like to spend a few minutes highlighting the key elements of how VF is managing the now, how we are approaching emergence from this crisis and how we intend to capitalize on the next. Regarding the now, from the early days of the outbreak in China, we've taken a people-first approach in our COVID-19 response, prioritizing the health and safety of our people, while also protecting their financial well-being. As my good friend and North Face athlete Jimmy Chin told me, 'All storms pass, it's how you weather them that matters.' We have a bias for action and decisiveness to effectively manage this crisis and I'm proud of the actions we've taken guided by our values. As we've implemented measures to care for and protect our people, we've also taken several key actions to advance our enterprise protection strategy. These prudent actions have helped us preserve and enhance liquidity and given us more flexibility to manage our operations through a prolonged crisis. These actions have included reducing discretionary spending and compensation across the VF senior leadership team and our board, proactively executing a $3 billion bond offering to establish a significant cash buffer and ensure over $5 billion of near-term liquidity, implementing a thorough and rigorous review of current inventory and forward inventory commitments, suspending our share repurchase program, collaborating closely with our most important strategic partners across the value chain and finally proceeding with our previously announced divestiture of VF's occupational workwear business as a potential source of additional cash. One of VF's greatest assets has always been our operational discipline and the rigor with which we manage our balance sheet. Today that discipline and know-how are coming together to create a range of options for how we maintain and further bolster our position of strength, which Scott will cover shortly. Turning to our brands, all of which remain focused on driving consumer connectivity and brand-new engagement during these unprecedented times. Our brand teams are more than ever using this unique opportunity to share best practices, key insights and learnings among our marketing and digital leaders to accelerate impact and efficiency. We've made a purposeful shift in our consumer engagement actions to employ greater empathy and compassion connecting with consumers in the unique stay-at-home environment we all find ourselves in. This strategic shift has resulted in stronger engagement and affinity leading to higher consideration and conversion. I encourage you to explore our brand websites and social platforms to see this come to life, demonstrated in The North Face 'Healthcare Workers in First Responders' initiative, coupled with 'United to Move the World' program, along with Vans 'Bouncing Off the Walls' campaign, 'Shoe Box Challenge' activation and 'Foot the Bill' program; or Altra's 'Embrace Space' virtual workouts; and Timberland 'Stay Strong' campaign. I'm proud of our brands' ability to maintain strong emotional connectivity with our consumers despite this disruption in the world around us. None of us knows exactly how the COVID-19 outbreak will change our world. But we're already beginning to see signs of what's to come. Fortunately, our brands and businesses are uniquely positioned to address certain evolutions in consumer behaviors and value systems. For example, we believe people will place greater value on exploring outdoors after spending so much time in their homes. We believe there will be an increased commitment to personal well-being and active lifestyles with health becoming a major new priority. We believe people will have a greater appreciation for the frontline workers who keep others safe, and the tradespeople who keep our world running. We believe there'll be an elevated focus on environmental sustainability that will lead to a sharper focus on combating global climate change and with online shopping serving as a lifeline for so many consumers around the world during the pandemic; we believe the proliferation of e-commerce will be significant. Regardless of whether these changes are subtle or seismic, our brand teams are already working to connect even more intimately and meaningfully with consumers in a post-COVID world. Today, we're preparing for this new future and positioning our brands to set the standard for what's next. The long-term strategy we introduced in 2017 has repeatedly proven that we're activating a powerful plan capable of delivering sustainable, high-quality growth and top-quartile returns. I strongly believe that our strategy will be even more relevant in the years ahead. We've evolved and focused our strategy since it was introduced, but the key choices at the heart of it remain the same: driving and optimizing the portfolio, directing investments toward Asia with a heightened focus on China, elevating D2C and digital, and finally, underpinning our strategy is the steady transformation of our business model to make VF more consumer-minded, retail-centric and hyper-digital in everything we do. As we prepare for the next, our work is focused, amongst other things, on evolving our systems landscape and building better capabilities and tools to power our brands forward. We're focused on leveraging enterprise data and analytics with an emphasis on critical end-to-end data and digital capabilities to drive consumer engagement and loyalty. This will take on a new level of importance as digital activity and engagement continues to rise in a post-COVID world. We're also working to become increasingly agile in how our teams work together, enabling us to move faster to seize opportunities whenever and wherever they exist. It will result in a more agile and efficient operating model, an organization designed through the lens of our consumer-minded, retail-centric, hyper-digital transformation. Before passing the call over to Scott, I want to reiterate the deep gratitude I have for the incredible effort each of our 50,000 associates put in during this past year. Fiscal '20 was an unprecedented year for many of our teams, even before the pandemic hit: spinning off the jeans business, relocating associates and their families to different cities and countries and now managing through the disruption of COVID-19 has been an extraordinary ask. Our associates have been tested to the extreme, and they've responded with determination and a sharp focus on getting the job done, but they did more than that. I'm so proud of the way our associates have rallied to help others in this time of great need, living out our purpose in a very real and meaningful way. It's been truly humbling to see our teams answer the call in our communities and it gives me great hope in our collective ability to overcome this moment together, driven by the power of the human spirit. It also gives me even greater confidence that VF Corporation will be better on the other side of the COVID-19 crisis. I believe that truly purpose-led brands and companies will fare better than others when the situation's over because their decisions will be principled and based on values that consumers share, continuing to foster a sense of community with our consumers during these trying times. We're positioning VF and our brands for a bright future. And with that, I'll turn it over to Scott.

Scott Roe, Chief Financial Officer

Thanks, Steve, and good morning, everyone. I'd like to start by echoing Steve's comments as I too share a deep sense of gratitude for the leadership team and community of associates around the globe. Both Steve and I have been part of the VF family for more than 20 years. And while I have a deep understanding of the depth and unique capabilities resident within VF, I am nonetheless humbled by the commitment and excellence that I've witnessed as this great company continues to rise to the occasion. This exceptional group of people is taking actions to position VF to accelerate upon emergence from the crisis. The individual and collective efforts throughout every region, brand and function are nothing short of amazing. A sincere thank you to each one of you. It's not just what you're doing, but how you're doing it that inspires me personally. The commitment of our associates to each other and to the broader communities in which they work while continuing to drive our business forward embodies the core DNA of VF as a purpose-led, performance-driven enterprise. Last fall at our Investor Day, in Beaver Creek, we introduced the topic of portfolio resiliency and specifically highlighted balance sheet and supply chain flexibility, fiscal discipline, diversification and investment optionality as core tenets. That received less focus at the time given the growth trajectory of our business and the economic backdrop at large. However, portfolio resiliency could not be more relevant for where we are today as we manage through what Steve referred to as the now. So, I'd like to spend a few minutes providing insight and context for how we're navigating the current environment. Let's start with balance sheet flexibility and fiscal discipline, bedrock of VF's 121-year-old legacy. VF entered this crisis with a fortress balance sheet and strong liquidity. Prior to the outbreak, our leverage was below 2x. We were on track to return close to $2 billion to shareholders in fiscal 2020 through share repurchases and dividends, and we had significant dry powder to execute our M&A agenda. In year one of our long-range plan, we were tracking well against the goal to generate more than $8 billion of free cash flow over the next five years. Just a handful of months later, the whole world changed. Revenue across our sector froze overnight, resulting in higher rates of cash burn and disruption across the retail landscape. The capital markets remained open, but there were growing concerns about the ability for even high-quality companies such as VF to access lines of credit. These are uncertain times. But in this moment of turmoil, we demonstrated both our willingness and our ability to tangibly build excess liquidity to weather the disruption caused by COVID for a prolonged period. With this in mind, we elected to raise $3 billion of longer-dated debt last month and fully repay our revolver, providing VF with more than $5 billion of immediate liquidity. While our recent actions may ultimately prove conservative, given the current uncertainty surrounding the retail sector, our actions are a clear testament to VF's balance sheet flexibility and financial strength. Moving to the second dimension of our portfolio resiliency, supply chain flexibility and operational rigor. The sophistication and scale of our global supply chain coupled with our operational discipline are hallmarks of VF and a source of competitive advantage, particularly during times of uncertainty and marketplace disruption. As the pandemic scaled globally, our operational leaders mobilized quickly to thoroughly assess inventory on hand and in process, assess inventory positions of key retail partners, and meaningfully reduce forward inventory purchase commitments through a rigorous and thoughtful demand-supply matching process. We maintain an active and transparent dialogue with our key partners and strategic suppliers as we work together to unfold purchase commitments and product assortments. We also remain in active conversations with our key retail partners as we collaborate on a thoughtful plan to clear excess inventory moving forward, and the appropriate level of future inventory purchases considering the current environment. Throughout these conversations, our focus is undeniably on the long-term health and sustainability of VF, our brands and our partners. And while many of these conversations are difficult, we have not strayed from our core values, approaching each discussion with honesty, transparency and integrity. Yet another example of how our enterprise-scale supply chain flexibility, fiscal discipline and financial capacity, coupled with our deep-rooted history of treating each stakeholder ethically, positioned VF to emerge from this crisis in an advantaged position. Turning to the third dimension of portfolio resiliency, investment optionality. Optionality applies to both capital allocation as well as investment spending, both capital and expense. Our short-term capital allocation priorities have changed. While share repurchases remain a key element of our long-term plan, we are taking actions to preserve liquidity and have decided to suspend our share repurchase programs for the time being. We remain committed to our dividend, of course subject to board approval. Our dividend has and will remain an integral part of our TSR algorithm over the long term. And the recent actions we've taken to shore up liquidity give testament to our ability to continue to support the dividend. Regarding investment spending, we have selectively reduced discretionary spending and CapEx in light of the current environment. We have focused our remaining investments on the aspects of our strategy that we believe will be even more important growth drivers in a post-COVID world. Specifically D2C and digital including digitally focused demand creation and technology. And while it's still very early days, our April results support the general belief that digital commerce will only increase in importance. And finally, we are reexamining all structural overhead in light of a rapidly changing world. Historical analog support structures are being reimagined in a hyper-digital future. These actions will simplify the business model and increase agility — necessary traits in this fast-evolving marketplace. So wrapping up the concept of optionality, I will front-run a topic I know is on many of your minds. First, with regard to our occupational workwear business proceeding with our sale process. As I'm sure you've noticed in our release, this business has qualified for held-for-sale, discontinued operations accounting treatment. We remain in active conversations with prospective buyers and are confident we will have a transaction completed during this fiscal year. We will keep you apprised as the process unfolds in the coming months. With that said, while the strategic rationale for the divestiture is unchanged, there is no urgency to sell these assets from a financial standpoint. As is always the case, a material deterioration in market conditions could impact the ultimate timing of a transaction. As it relates to potential acquisitions, we continue to actively assess strategic opportunities and believe the disruption caused by COVID could lead to an increase in M&A activity and the availability of attractive assets. While our first priority remains stabilizing our organic business, we are well positioned from a liquidity standpoint to pivot to an offensive posture when prudent. M&A remains our top capital allocation and strategic priority on a medium to long-term basis. The disruption underway across our sector will undoubtedly provide ample opportunities for strong companies with demonstrated M&A capabilities to create significant shareholder value through inorganic growth. The final element of portfolio resiliency I'd like to highlight is that of diversification. As companies across the globe report earnings, we are reminded of the advantage of running a global enterprise during this crisis. The ability to extract learnings from reopening protocols, traffic trends, and consumer behaviors in our APAC region allows us to be more informed and planning for the ensuing recovery across other regions. It also gives us several months' head start compared to mono-geography companies. Our diversified channel footprint has also been critical, most notably our digital business. While our own D2C digital platform is about 12% of revenue today, our total digital footprint, including digital wholesale, is closer to 20% of the business. The ability to keep these channels open during this lockdown period has been critical in our ability to continually engage with our consumers. And recent trends suggest significant growth in the digital channels is likely to mitigate some of the brick-and-mortar shortfalls, although it's too early to understand fully how this will evolve. I want to conclude my comments on diversification by directly addressing our wholesale footprint in light of the heightened disruption we see underway in certain segments of the distribution landscape. Considering our D2C, digital wholesale and international partnership stores, roughly half of our business today is D2C and consumer-facing. Of the remaining wholesale business, roughly half is through international wholesale, which was healthy and growing heading into the crisis and remains well positioned. In U.S. wholesale, which represents about 25% of total revenue, we have dramatically reduced exposure to the more structurally challenged mid-tier and department store channels, which now represent less than 5% of VF revenue in fiscal '20. The largest portion of our U.S. brick-and-mortar wholesale business fits in what we call specialty, which is primarily comprised of differentiated, healthy outdoor, active and athletic retailers. Most of these retailers are healthy and growing digital businesses of their own. Our key accounts entered this crisis strong and we are actively working with our partners to emerge from this crisis stronger together. So to summarize, I'm confident that our balance sheet and liquidity positioning, investment optionality, supply chain flexibility and portfolio diversification position VF with the capacity to navigate the current environment and provide us with the ammunition to run with accelerated growth and returns as we begin to emerge from COVID. Our diversified TSR model with a strong commitment to the dividend, coupled with both organic and inorganic optionality delivers a unique and balanced value-creation model. So now moving on to our fundamentals and recent business performance. Our business was showing strong momentum heading into the final months of our fiscal year as evidenced by 9% organic revenue growth and 19% organic earnings growth during the first three quarters of fiscal 2020. The fourth quarter, however, marked a profound change in conditions. Our APAC business was essentially shut down for two weeks, our European business was closed anywhere from two to three weeks, and our North American business was closed the final two weeks of the quarter. Unsurprisingly, our results for the fourth quarter reflect the operational impacts of the disruption just outlined. Despite this disruption, we're encouraged by the trends we experienced in our digital business during the quarter, which remained operational in all three regions. On a global basis, Vans, The North Face, Dickies and our emerging brands all grew double digits. EMEA generated low-teen digital growth led by more than 40% growth at The North Face. EMEA's digital business declined over 20% in the month of March, but reaccelerated to high-teens growth in April led by triple-digit growth in The North Face. The APAC region generated 19% digital growth led by more than 20% growth in China, driven by strength at Vans and Dickies. Our digital trends in APAC were essentially a month ahead of EMEA, with a significant decline in February followed by a sharp rebound in March, with growth of more than 30% led by Vans and Dickies. In April, digital normalized somewhat with growth in the high-teens. The digital business in Americas grew at a low single-digit rate during Q4 as strength in Vans was offset by softer trends at The North Face. Following modest declines in February and March, we've experienced a sharp recovery in April, which has continued into May with triple-digit growth driven by broad-based strength across the Big Four brands. And while it's too early to draw strong conclusions from our quarter-to-date performance, we are encouraged by the relatively consistent phasing of the recovery curves across regions today. As you saw in the release this morning, due to the current marketplace uncertainties, we're not providing a formal fiscal 2021 outlook at this time. However, I can share with you how we expect our business to evolve over the course of the coming year across our three geographic regions, and the approach we're taking to planning our business. Through the remainder of the first quarter, we expect North America and EMEA to begin to reopen, and we expect continued steady improvement in the APAC region. We anticipate disruption across the distribution landscape, resulting in a highly promotional marketplace. We expect high-teen inventory growth in the first quarter, followed by lower inventory levels on a year-over-year basis as we move through the balance of the year. Moving into our second quarter, we expect to see sequential improvement in North America and EMEA but expect both regions to decline significantly on a year-over-year basis. We expect our APAC region to continue to accelerate. We believe promotional activity will likely remain elevated and expect disruption across the distribution landscape to continue. By the third quarter, we believe our APAC business will begin to return to more normalized growth alongside stabilizing North America and European marketplaces as we enter the fall holiday season. We believe continued promotional activity is likely. We expect our North America and EMEA businesses to return to modest growth by the end of our fiscal year with APAC returning to more normalized growth. We believe that promotional environment will begin to moderate as the impacts of excess inventory and retail consolidation begin to stabilize. Underlying the expected evolution of our business just outlined is an acceleration of our hyper-digital transformation. As we look ahead, digital will become even more central to VF's growth and success. Our fiscal '21 investments in digital transformation, which represent about 80% of all planned strategic investment for the fiscal year, offer a springboard of how we will leap into a more advantaged future. I look forward to sharing more details as the year unfolds. Given the recovery expectations just outlined and the visibility we have into the current quarter, we expect revenue in the first quarter of fiscal 2021 to be down slightly more than 50%. For the full year, we expect to deliver at least $600 million of free cash flow through a combination of operating earnings, working capital management and lower CapEx. We believe this supports a year-end liquidity position of at least $5 billion with over $3 billion of cash on hand and a net leverage ratio below 3x. These numbers exclude the potential proceeds from our occupational workwear divestiture, which could provide an additional source of liquidity. So, in closing, VF has navigated many crises over our 121-year history and has demonstrated willingness and ability to evolve our portfolio and strategy to stay relevant as consumer behaviors and the marketplace evolve. There is no question that the COVID-19 disruption will have lasting impacts on our sector. There will be retail casualties, this will accelerate industry consolidation. This will likely excel in the category of trends, which we believe will benefit from activity-based lifestyle brands. We are witnessing the acceleration of digital commerce and the critical importance of direct consumer engagement. We also believe this environment will shine an even brighter light on corporate values and highlight the importance of purpose-led enterprises. Ultimately, we believe what we're witnessing right now is an acceleration of underlying trends which were forming before the crisis hit, further supporting our consumer-minded, retail-centric, hyper-digital strategy. Further supporting our portfolio reshaping efforts from the past three years, and further supporting our portfolio's focus towards activity-based lifestyle brands in large, growing and structurally attractive addressable markets. The building blocks of our long-term strategic plan are unchanged, but the pace of market and consumer evolution will undoubtedly accelerate. Fortunately, we've been moving down a path to transform to this new reality for several years using portfolio moves as a catalyst. We will continue to focus our key strategic choices around the transformation to a retail-centric, digitally-led enterprise. The combination of all these levers coupled with a diversified TSR model will place VF in an advantaged position. So, with that, we'll turn the call back to the operator and take your questions.

Operator, Operator

Operator Instructions: Our first question today is coming from Robert Drbul from Guggenheim Securities. Your line is now live.

Robert Drbul, Analyst (Guggenheim Securities)

Hi, good morning, everybody. Hope you guys are well. Thanks for the detail. I guess just - I was wondering if you could spend a little more time on inventory levels, I guess by brand, and I was just wondering if you could maybe explain a little better in terms of your plans through the promotional environment, whether you would pack stuff away, maybe use of off-price, just the different approaches you might take in terms of the level of promotion to sort of get the supply-demand imbalance in the coming quarter?

Scott Roe, Chief Financial Officer

Sure. Bob, Scott speaking, I'll take that one. So, we've gone through, as you can imagine, a really rigorous demand-supply match. And as we looked at forward demand signals and order books, this varies a bit depending on the brand and the geography, but in general, we're seeing forward order books for fall and winter that are down in that 20% to 30% range, excluding APAC which of course is ahead from a recovery standpoint. And so what we've done is we've even from a buyer standpoint been a little more aggressive than that because our goal here, Bob, is to both make sure we have the right assortments and enough newness on the floor as we go through fiscal '21. But more importantly, we want to exit this at a point of equilibrium from a target inventory standpoint which means that our on-hand inventory and inventory at retail are in balance. As a result, what we're doing is we're looking at the inventory that we own, we're aggressively taking market-appropriate discounting to try to clear excess inventory and we expect that to continue through the balance of the year. But we're also looking at building the assortments that ensure we have enough newness and at the same time being a little more aggressive on the carryover side of the business in order to make sure that as we exit this year, our inventories are back in line. That varies by brand, and if you take our largest brand, Vans, the relative amount of last-seasonal goods as you think about The North Face was relatively low. So, in some cases, we're looking at holding inventory and building those assortments and replacing forward buys. This is also where our outlets really come into play. When we reduce our forward buys, we can supply outlets with the goods that we have on hand from a merchandising standpoint. So I hope that gives you some shape of our thinking about inventory and the situation.

Operator, Operator

Our next question today is coming from Omar Saad with Evercore ISI. Your line is now live.

Omar Saad, Analyst (Evercore ISI)

Thanks. Good morning. Appreciate all the information. I would love more detail on the digital platform you're building and you're talking a lot about e-commerce and digital and the information you've provided around penetration rates, which is also really helpful. But specifically, where are you on apps, loyalty programs, data analytical capabilities, and also on omnichannel purpose. If we remain even if stores are open, if we remain in a subdued traffic environment, being able to offer the consumer inventory across their channels and touchpoints that maybe they don't want to go and spend the time in-store shopping, where are you on your capabilities for kind of omnichannel inventory management? In general, broadly speaking on digital, I know it's a focus but dive in a little bit deeper there for us. Thank you.

Steve Rendle, Chairman, President and Chief Executive Officer

Yes. Good morning, Omar, this is Steve. I'll start. One of the things we're most happy about is this transformation that we've been putting in place for the last two years in really increasing our focus on our digital platform, our digital capabilities, and our consumer-facing information around our data platform. You know where we are: it is a strong position, and we're continuing to invest in our digital platform specifically around ease of shopping, different purchase and checkout capabilities, doubling down on our mobile presence, and to your point on apps. It's an area of great opportunity for us and you can see both Vans and The North Face do use apps to some degree, but that's an area where we're going to double down and invest. Our loyalty programs: Vans' program is now up over 12 million members, and The North Face program is somewhere in the 7 million to 8 million range, and it's that level of information that gives us insights into where our consumers are, what they're expecting and how we should be engaging with them. We'll continue to build our consumer data platform and analytics capability to really get closer and build greater engagement and affinity. We've pivoted quite a bit on our buy-online, pick-up-in-store strategy, how we're thinking about buy-online return-in-store, and then there is a new notion of buy-online, pick-up-at-curb. That was not something we had in our toolkit a month ago, and in the next two weeks, we'll be standing that up not only here in North America, but in Europe. The agility that our organization is showing — our digital and technology teams, where we've made significant investments in people and capabilities — is strengthening us in this time where consumers have pivoted so strongly towards engaging with brands online, not just on the content but in significant growth in our online sales in April and month-to-date. We're in a really good position and I couldn't be happier with our decision three years ago to make this pivot to be more consumer-minded, retail-centric and hyper-digital in everything we do.

Scott Roe, Chief Financial Officer

Real quick, Omar. I just wanted to reiterate what Steve said: we talked about focused investments. This is an area where we're not pulling back. We're continuing to prioritize investments in digital. Could we see more short-term profitability by cutting such investments? Yes. But this is an area where we're maintaining our investments because we believe that's the right long-term decision.

Omar Saad, Analyst (Evercore ISI)

And — so thanks, Scott. One quick follow-up: have you said where you see that kind of 20% overall digital penetration could go? And then, is your digital capability important when you're in discussion with potential acquisition candidates — the digital prowess you can bring to their brand franchises? Thanks.

Steve Rendle, Chairman, President and Chief Executive Officer

Remind me, Joe, I don't think we've stated where we think it will go. That 20% is both our own D2C as well as our wholesale digital partners. But that is where all of the energy is certainly pivoting from a consumer standpoint, and we see that becoming a much more significant part of our go-to-market strategy. And we think about acquisitions: certainly brands that have digital capability within the addressable markets that we've talked about would be an advantage that we would be looking for, but we're also looking at partnerships that would bring enhanced skills and capabilities in the area of data and different parts of the analytics toolkit to get quicker time to value.

Operator, Operator

Our next question today comes from Michael Binetti from Credit Suisse. Your line is now live.

Michael Binetti, Analyst (Credit Suisse)

Hi guys. Thanks for all the detail and for the help on the questions here. I want to ask a little bit of detail on Vans and D2C trends and how D2C translates across the business in total. On the Americas D2C number in February — I know the month was warm and you have a lot of cold-weather businesses — could you speak to how much of the D2C comps you saw there were due to mix of The North Face and Timberland? And then maybe just a little bit of color on how Vans D2C is trending in the Americas as we start to emerge here in this quarter?

Scott Roe, Chief Financial Officer

Yes. So the trends in April have been really strong and we laid them out in some of the commentary in the release: you're seeing a big surge in our online business. In fact, we're seeing triple-digit growth across several of our brands and in different regions. As for Vans specifically, remember that multiple-year stacks are large and you're up against massive numbers a year ago, and we also noted a softer landing event. So while still impressive, Vans' growth has moderated more toward a level that's in line with long-term expectations. Colder-weather brands saw a bit of a drag. Coming into the fall and holiday, we were a little late and not as deep from a promotional standpoint, and our intention was to address that, which we did. We saw trends in a pre-COVID basis start to accelerate as we became more competitive and moved inventory. Once COVID hit, numbers got more difficult, but the encouraging thing is all brands — cold-weather brands, Vans, all of them — have seen material acceleration in April and so far into May. Again, early days, but the green shoots we're seeing are encouraging.

Steve Rendle, Chairman, President and Chief Executive Officer

Hey Michael, I would add real quick: Vans had a good quarter, but what's really giving us greater confidence is where we stand in April and May. We've spent a lot of time shifting our message to consumers, getting much more empathetic and meeting consumers where they are in this stay-at-home environment, really changing our messaging to be more purpose-led. In Vans' case, the content around creativity and the Shoe Box Challenge has driven strong user-generated content and connectivity. Our April and May digital results are up really strong and give us confidence that digital will continue to be a growth vector for Vans as we wait for stores to come back online in the coming months.

Mark Bianchi, Analyst

I guess if I could just get one more in there. I know we've talked about before COVID; Vans' margins were very good, lower mid-20s I think based on historical commentary. How does e-commerce margin compare to the overall brand margin since that's going to be a bigger focus going forward and maybe how do the lower volumes impact Vans' D2C EBIT margins?

Scott Roe, Chief Financial Officer

Yes. As we've said fairly consistently, gross margins in our D2C channel are similar to what we see in the brand overall. Our D2C is our most profitable channel, so as we see the move toward digital, that's positive from a mix and profitability standpoint. Lower volumes can create some dilution, but overall D2C remains attractive from a margin perspective.

Operator, Operator

The next question is coming from Jonathan Komp from Baird, your line is now live.

Jonathan Komp, Analyst (Baird)

Hi, thank you. A bit of a follow-up question. I want to understand the detail of how you see the geographies evolving, which was very helpful. I'm curious, directionally, how you think about that across your brands. Are there differences by brand in recovery potential — for example a brand with lots of momentum versus a brand like Timberland which has been the opposite side of the spectrum? Any thoughts you're willing to share looking forward on a relative basis?

Scott Roe, Chief Financial Officer

I was just going to clarify your question. You're talking about differences by brand by geography and whether anything is unique across them?

Jonathan Komp, Analyst (Baird)

Yes, exactly. Trying to understand the ability for various brands to recover in the scenario you laid out.

Steve Rendle, Chairman, President and Chief Executive Officer

I'll start. Our APAC business is back up and running; stores and partner stores are open and digital is performing extremely well. We're seeing consumer traffic improve week over week though still down versus last year. The results we're seeing are that across our brands they're finding unique ways to connect with consumers online. We are doing virtual shopping events; Dickies has been innovative in connecting virtual to the store. Those learnings help us understand how to activate in Europe and the Americas as those markets come back online. About 40% of our stores in Europe are open today; our digital wholesale partners have been working with us since the onset and continue to show solid growth across the portfolio. The North Face business is probably the strongest in online connectivity in the Americas; we're preparing to open stores in five states next week and DTC brands — specifically Vans and The North Face, Timberland to a lesser degree — will benefit. Timberland has seen exceptional online growth through April month-to-date and that's a positive sign. We're seeing universal growth across our portfolio as we collaborate and share what worked first in China across other regions.

Scott Roe, Chief Financial Officer

As you think about China, we had a couple months' head start to see how consumers reacted and what emergence looks like. Our China business returned to growth very broadly in April, which is encouraging and serves as a basis for how we think about progression in Europe and North America.

Jonathan Komp, Analyst (Baird)

Okay, thanks. And then maybe one follow-up on the expense side and protecting margin: with significant top-line pressure expected over the next several quarters, any thoughts on how downside might flow through to EBIT relative to the March quarter?

Scott Roe, Chief Financial Officer

We're not giving specific guidance, but a couple of things to note: gross margin will experience pressure from elevated promotional activity as we work to move inventory in the channel. Some factors are episodic rather than structural. From the earnings side, we provided some shape on cash: we expect more than $600 million of free cash flow for the year, reduced CapEx, maintenance CapEx in the ~2% of sales range, aggressive inventory management which should benefit working capital, and the remainder will come from earnings. Use those as reference points as you model flow-through.

Operator, Operator

Thank you. Next question is coming from Jim Duffy from Stifel. Your line is now live.

Jim Duffy, Analyst (Stifel)

Thank you, good morning. Difficult times no doubt, but clearly the strategy from eight months ago seems even more relevant today. I have a few questions on the digital business. First, can you speak about the changing economics you're seeing with digital demand creation? What are the changes you're seeing in ad rates and conversion rates with stores closed? And then the triple-digit North American digital growth seems to be outpacing the digital growth in other regions. Are there things that are more evolved in the North American digital business that can be accelerated in EMEA and APAC?

Steve Rendle, Chairman, President and Chief Executive Officer

I don't have specific ad rate numbers for you, Jim, but high level: we've pivoted our marketing and used a zero-based approach to how we deploy ad dollars and shifted toward more digital tactics. That's having significant benefits for e-commerce trends. We've seen traffic up and, more importantly, conversion increasing as we engage consumers with better content and programs. Vans' Shoe Box Challenge is an example where people come online to create custom shoes and participate in the program. The North Face program to support frontline medical workers has brought a tremendous increase in traffic and new consumers, particularly many female consumers, which expands the brand's audience. We're focused on building engagement and affinity rather than just driving immediate transactions. Growth in the U.S. is stronger right now, but growth in Europe and APAC is in line with expectations and we are deploying similar tactics there and seeing strong engagement.

Operator, Operator

Thank you. Our next question is coming from Erinn Murphy from Piper Sandler. Your line is now live.

Erinn Murphy, Analyst (Piper Sandler)

Great, thanks. Good morning. Just two for me: if you reopen stores, is there an added cost that you need within your own stores to ensure the shopping experience is safe? And how do you expect your staffing requirements to change within stores? Second, around product launches for fiscal 2021, have you had to make any shifts this year given the current environment and inventory considerations?

Steve Rendle, Chairman, President and Chief Executive Officer

Erinn, we are ready to begin reopening stores. Our playbook developed in China gives us a good understanding of what we need to do to assure consumers are comfortable and for our staff to feel safe. There are increased costs associated with proper sanitation, PPE for staff, and re-merchandising stores to enable social distancing. Traffic is not what it normally is, so staffing levels are adjusted to ensure the right level of service and one-to-one engagement. Feedback from consumers as we reopen has been very positive. On product launches, we haven't broadly changed our product-release cadence; in fact, this situation has heightened the need to be retail-centric. Newness and the frequency of new reasons to engage — in-store and online — remain important. We're managing forward buys thoughtfully to ensure we have open-to-buy available for the right level of newness flowing into each brand, both to our D2C channels and wholesale partners as they reopen.

Erinn Murphy, Analyst (Piper Sandler)

Thank you.

Scott Roe, Chief Financial Officer

One addendum, Erinn: Steve asks every day, 'Do we have enough newness?' There's an intense focus on newness. Another positive byproduct of this process is a reduction in SKUs and tighter assortments for our own retail and digital channels and for our wholesale partners. That added discipline helps in the constrained environment.

Operator, Operator

Thank you. Our next question today is coming from Adrienne Yih from Barclays. Your line is now live.

Adrienne Yih, Analyst (Barclays)

Great. I hope everybody is doing well. Steve, my first question is more big picture: outside the obvious shift to digital, what other secular consumer behaviors are you seeing or foresee emerging post-COVID? And how does each of the four pillar brands stand to gain in that environment? Scott, my follow-up will be on gross margin.

Steve Rendle, Chairman, President and Chief Executive Officer

Great question, Adrienne. In addition to the immediate uptick in digital, we're seeing an appreciation for the outdoors as people spend more time close to home. There's increased interest in health and wellbeing, and a renewed respect for frontline workers and tradespeople. We see heightened focus on environmental sustainability. Our portfolio is well-aligned with these trends; the reshaping we've done over the last three years and our purpose-led focus supports these shifts. Our brands are positioned to benefit from outdoor, health-focused and sustainability-oriented consumer priorities.

Adrienne Yih, Analyst (Barclays)

Great. Scott, digging in on gross margin: which quarter do you see the deepest hit to gross margin from promotions and channel liquidations? Is it the September quarter? And what formats will the markdowns take — vendor allowances, lower costs on forward buys, or other approaches?

Scott Roe, Chief Financial Officer

In terms of shaping, you'll see more pressure on gross margin in the first half of the year and then moderation as you move through the year, though elevated for the full year. Tactically, we'll use a range of options and generally focus on partnering with key accounts and discounting approaches such as gross-to-net markdowns rather than broad wholesale returns. One of our best weapons is our outlet network; we learned lessons about dumping goods into third-party off-price channels, and we won't do that at scale. We'll use outlets in a brand-appropriate way to clear inventory without causing channel conflict. The majority of the work will be with key accounts, our own digital channels, and our outlets.

Operator, Operator

In the interest of time, our final question today comes from Camilo Lyon from BTIG. Your line is now live.

Camilo Lyon, Analyst (BTIG)

Thanks. Good morning everyone. Two questions: first, you mentioned in the press release that you had some supply chain impacts. Could you delve deeper into which brands were affected and where that stands today? Have those been resolved? Second, what's your view on the right store-base size going forward? Are you anticipating closing doors as leases roll off or as mall traffic changes?

Steve Rendle, Chairman, President and Chief Executive Officer

Camilo, there are no material ongoing impacts to our supply chain. The connectivity with our supply partners for garment and footwear production and materials has allowed us to right-size forward purchases and align open-to-buy against current demand. Those partnerships let us quickly pivot and position to reduce on-hand inventory over the course of the year while ensuring appropriate newness. On store base size: one trend from China and Europe is that a local, community-based retail footprint — people shopping closer to home — is proving extremely valuable. Our exposure to malls is not significant; about 80% of our footprint is in A malls, tapering to B and a small tail in C and D. We're well positioned where we are located. Consumer behavior change will be interesting to watch: are consumers comfortable coming into stores? Do they prefer buy-online, pick-up-at-curb? We're ready for this. Our IT and store teams have prepared, and the local, convenient store footprint seems to be increasingly important.

Scott Roe, Chief Financial Officer

I'll add that we actively manage our lease terms and at any point in time roughly 25% of the fleet is up for renewal each year, which gives us significant optionality to refine the footprint as retail evolves. We can turn the fleet relatively quickly.

Operator, Operator

We reached the end of our question-and-answer session; I'd like to turn the floor back over to Steve for any further or closing comments.

Steve Rendle, Chairman, President and Chief Executive Officer

Great. Thank you everybody for joining us and putting up with our conversation-from-home model here. I just like to leave you with a couple of thoughts. VF, with the strong history that we have, is absolutely built for and prepared to navigate the times we are in today. The strengths that we have — both operational and financial disciplines that have guided us over our 121-year history — have put us in a very strong position to manage the foundational elements of our business. Our iconic brands and the reshaping of our portfolio that we've taken over the last three years put us in a very strong position to connect with consumers in evolving consumer and market trends. Our investments over the past two years to transform VF to be more consumer-minded, retail-centric and hyper-digital, and our deep commitment to elevating our D2C, digital and consumer engagement through our data platforms are all proof points that the strategy we've been working on and the actions we've taken position us extremely well to navigate and accelerate on the other side of this crisis. I encourage you to stay connected with our brands, watch what we're doing online and the engagement strategies we're putting in place to reinforce confidence in the work we are doing to drive our business and be prepared for acceleration on the other side. Again, thank you for joining us. We look forward to talking to you in July.

Operator, Operator

That does conclude today's teleconference. You may disconnect your line at this time. Have a wonderful day. We thank you for your participation today.