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VF Corporation (VFC)

Q3 FY07 Earnings Call

October 18, 2007, 4:30 PM ET

Executives

David E. Griffith - Integrated Corporate Relations

Mackey J. McDonald - Chairman and CEO

Eric C. Wiseman - President and COO

Robert K. Shearer - Sr. VP and CFO

Analysts

Brian McGough - Morgan Stanley

Omar Saad - Credit Suisse First Boston

Robert S. Drbul - Lehman Brothers

Virginia Genereux - Merrill Lynch

Jeffrey Edelman - UBS Warburg L.L.C.

Brad Stephens - Morgan Keegan

Robert F. Ohmes - Banc of America Securities LLC

Kate McShane - Citigroup

Robert Samuels - J.P. Morgan

Eric Tracy - BB&T Capital Markets

Presentation

Operator

Welcome to the VF Corporation Third Quarter 2007 Earnings Conference Call. Please be aware this call is being recorded. Now at this time, I would like to turn the conference over to David Griffith of ICR. Please go ahead.

David E. Griffith - Integrated Corporate Relations

Good afternoon. By now you should have received today's earnings press release. If not, please call my office at 203-682-8213 and we'll get you a copy immediately following the conference call.

Hosting our call today is Mr. Mackey McDonald, Chairman and CEO of VF.

Before we begin, we would like to remind participants that certain statements included in today's remarks and in the Q&A session may constitute forward-looking statements within the meaning of federal securities laws. Forward-looking statements are not guarantees and actual results may differ materially from those expressed or implied in the forward-looking statements. Important factors that could cause the actual results of operations or financial condition of the company to differ are discussed in documents filed by the company with the SEC.

At this time, I'd like to turn the call over to Mackey McDonald.

Mackey J. McDonald - Chairman and Chief Executive Officer

Okay, thank you David. Good afternoon. Thanks for joining us as we review the highlights of another record quarter of both revenues and earnings. In fact, not only did we exceed the guidance we provided in July, but we have raised our full year outlook and expect a very good fourth quarter with revenues and earnings per share up 18% and 13% respectively.

We feel especially good about our strong results, given the concern in the market about the health of the consumer and apparel spending at retail. I will give a few more comments on this topic.

First, we have consistently said that we expect a fairly choppy retail environment. Good months will continue to alternate with weaker ones. Certainly, the most recent retail sales reports were largely disappointing, fuelling fears about inventory build ups and markdowns. And weather certainly isn't helping and was cited as a factor by several retailers coming in on weak September sales.

But while these current marketing conditions are far from robust, if history is any indication, consumers will still be buying apparel, footwear and accessories this following holiday season. The National Retail Federation has forecast holiday resales growth this year of 4%, which is below the 10 year average of 4.8%, but hardly a disaster. We believe that the consumer will be fairly resilient, but certainly more selective in the apparel choices they make, and that's why we feel good about our brands, our strategies and our outlook.

Our third quarter results are a testament of the fact that strong companies and strong brands can continue to perform despite short-term market pressures. We exceeded our guidance for the third quarter and expect equally strong comparisons in the fourth quarter because the changes we've made within VF over the past several years have resulted in a business model that is unique within the apparel industry.

As I think about what sets VF apart, there are four things that are apparent. First, we have powerful brands that resonate with consumers. They provide us with tremendous opportunities for future growth via multiple fronts, including international expansion, extension into new products, retail sales growth and e-commerce. Second, we have an outstanding track record of execution. We define and deliver on our goals. Our acquisition track record is providing excellent returns to our shareholders. We have true expertise in managing the art and science of apparel and we operate an amazingly diverse and complex business model that spans multiple channels of distribution, geographies and product categories. Third, our business is extremely diversified. We are not overly dependent on any particular brand, product category or channel of distribution. More than a quarter of our revenues are international, providing us with tremendous geographical diversity, and we have a growing retail business, accounting for $1 billion in revenue, which is providing an important balance to our wholesale business. And fourth, we have a unique culture within VF that enables success. We are rarely satisfied with the status quo. Rather, we constantly challenge ourselves to set the bar higher and exceed our goals. As a management team, we are very focused on total shareholders returns and ensuring that our business decisions are shareholders return driven. These are the things that set VF apart, and which will help us ensure our future success.

Now let's get some more color on our coalition's performance from Eric Wiseman. As you know, we recently announced that Eric will be assuming the title of Chief Executive Officer on January the 1st. Eric?

Eric C. Wiseman - President and Chief Operating Officer

Thanks Mackey. This really was a quarter of tremendous achievement by our brands and coalition. And we feel truly fortunate to have such talented leaders and associates across VF who are so passionately committed to successfully executing their growth plans and who manage to do so day in and day out despite some pretty strong headwinds.

And right now, the concern seems to be most concentrated on the mass market and department store channels of distribution. I would remind you that these channels combined account for about 20% of our total revenue base. Diversification is a terrific thing, and VF's got it in spades as Mackey just mentioned. We have diversity in our brands, in our products, in our customers, in channels of distribution and in geographies.

I will start the discussion of the third quarter with Jeanswear. Our Jeanswear business in total had another quarter of both top and bottom line growth. We are continuing to see good momentum internationally where revenues increased 13%. About half that increase was from currency translations, but excellent performance nonetheless particularly in our Wrangler business in Europe and in international markets such as China, India, Mexico and Russia. Domestically, our business was down slightly.

On the positive side, we saw a robust increase in our Wrangler men's business which was up over 5%. And in our Lee women's business and in our women's Western business. We also started to ship our new Wrangler outdoor line and have expanded our genuine and vintage Wrangler programs in mid tier stores. However, the macroeconomic environment... macro environment offset these positives and many of our large retail customers posted weak traffic and comp store sales results. In addition, the warmer start to the fall season is impacting the early sales of seasonal items. We remain cautious about overall macro trends, but we expect a good fourth quarter for both our domestic and international jeans business.

I know a question many of you have relates to inventories, both ours and at retail. Retail inventories are a bit high at the moment, but not at a level that is causing us undue concern. With our Retail Floor Space Management and Vendor Managed Inventory capabilities, we have been able to manage inventories appropriately and are in line with our customers' expectations.

In terms of markdown exposure in the fourth quarter, generally speaking, we have much less markdown exposure on fall goods as many of the items are core and run all year long. The overall jeans market has been generally flat in terms of units all year. But our data indicates that we continue to gain share in men's and women's in mid tier stores and in boys and girls. In mass stores, we are gaining share in both men's and women's. In mid tier, that is Lee, we are growing our share modestly in women; again, a testament to our strong brand and a Jeanswear management team that really understands how to keep our brands relevant to our consumers and to our customers.

In terms of operating margins, we saw a nice pick up in the quarter with Jeanswear operating margins reaching nearly 18%.

Turning now to our Outdoor coalition, which posted another amazing quarter of top and bottom line growth. As we indicated in our release, both our domestic and international outdoor businesses posted revenue gains above 20%. Also, as stated in the release, the increase was driven by exceptional growth across our major brands with double-digit revenue gains in The North Face, Vans, JanSport, Kipling and Napapijri. We are seeing strong growth in The North Face in both its retail and wholesale businesses domestically and internationally and across its outerwear, sportswear and footwear product categories, which truly is a testament to the scope and strength of this brand. And you may recall in April we acquired The North Face business in China, and this business is seeing tremendous growth.

Vans continued to grow in every segment, internationally and domestically, both its wholesale and owned retail business.

We continue to see double-digit comp store sales growth, fuelled by the core vulcanized shoe business. We are seeing a sales shift from the iconic classics clip on to other iconic styles like the Authentics, the Era, and the Scape High [ph], which we see as a positive since it broadens our brand presence in stores and reduces our reliance on any one style. Our Kipling and Napapijri businesses are also having a traffic year with rapid growth in both Europe and Asia, fueled by a positive reaction to our new product launches and new retail store openings.

Operating income rose 16%, slightly less than sales because we continue to invest heavily behind the future growth initiatives in Outdoor, but margins remain very strong at about 20%.

In terms of our Sportswear business, we are seeing the twin effects of the weak and very promotional department store environment and warmer weather impacting Nautica brand revenues in the quarter. Also, as we have pointed out in the release, Nautica revenues were impacted by the change in shipping days by the brand's primary customers. Now the last week of September is the first shipment of holiday products, so moving that into October did affect the balance of sales between the third and fourth quarters. If you look at the total 10% decline in Nautica brand revenues in the quarter, about half of that is due to macro factors and about half is due to the change in shipping dates. So in terms of the fourth quarter, we expect to see year-over-year growth in revenues and more stability in operating margins.

Our Kipling business in the U.S. is part of our Sportswear coalition and continues to grow rapidly. The brand's wholesale and retail businesses were both up significantly in the quarter with a lot of positive buzz created by our Fergie for Kipling line of handbags that was launched this fall. Our John Varvatos business continues to have great momentum, both at wholesale and retail with much of it coming from the John Varvatos Start USA line.

We are obviously not pleased with the sharp drop in Sportswear operating income in the quarter. But that's largely related to the Nautica line decline and higher promotional activity. But as previously stated, we expect better comparisons in the coming quarters.

And now turning to our new coalition, Contemporary Brands. We only owned the 7 For All Mankind and lucy businesses since late August. So there is not a lot of commentary here. The two brands combined generated revenues of $33 million and operating income of about $5 million. 7 For All Mankind is doing particularly well with its denim business performing strongly and good response continuing to its newer sportswear lines. Our European leadership is now actively engaged in working to enable and support the brand's growth in Europe. Owned retail is also a part of the brand's strategy and we are on track to open the first 7 For All Mankind store. It will be on Robertson Boulevard in Los Angeles. It opens in November, followed by a second store that will be opening in Dallas.

We continue to be excited by the opportunities for the lucy brand. Lucy marks VF's first pure direct-to-consumer acquisition and we see great potential for the brand by expanding its retail store base. In November, lucy will be opening six new stores, bringing the total number of lucy stores to 60 by year end. Over the next five years, we see the potential for 100 new stores.

Now I'll wrap up my coalition comments on a very strong note: Imagewear, which posted excellent results in the quarter. Revenues and operating income rose 24 and 23% respectively. While in the last two quarters, Imagewear's top line growth resulted from the Majestic acquisition, in the third quarter, Imagewear generated healthy organic growth of 4%, right in line with our long-term growth targets for the business. The growth came from our licensed sports apparel business, which posted a 12% increase in revenues excluding Majestic with the successful start to the NFL season and strong Major League Baseball play off. The integration of Majestic has gone very well and that brand's financial results are exceeding our initial expectations.

Now let's hear more on the financial picture from Bob Shearer.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Thanks Eric. I will start with the financial highlights of the quarter. Revenues and earnings per share from continuing operations were up 15% and 13% respectively, hitting new records for our third quarter and coming in above our prior guidance.

We are also pleased to announce a 5% increase in our quarterly dividend to $0.58 per share from $0.55 per share. We remain committed to maintaining a dividend payout ratio at the 40% or above level.

In terms of the overall P&L, total revenues grew 15% in the quarter. The combined contribution to revenues from acquisitions, that is Eagle Creek, Majestic, The North Face, China, 7 For All Mankind and lucy was $100 million. If you exclude acquisitions, our organic growth rate for the quarter was a very strong 9%. You will recall that previously, we indicated that the 7 For All Mankind and lucy acquisitions could be slightly dilutive in the quarter, but in fact they were slightly positive.

Gross margins were up 10 basis points to 43.9% from 43.8% with operating margins also up by 10 basis points to 16%. A favorable mix impacted gross margins from stronger growth in our higher margin businesses of 30 basis points was partly offset by an accounting reclass that reduced gross margins by 20 basis points. And keep in mind that, as expected, our acquisitions had a slight negative impact on operating margins in the quarter, which includes the amortization associated with intangible assets.

Now moving down the P&L. Interest expense increased by 19%, reflecting acquisition financing and our tax rate in the quarter was higher than in the prior year's quarter when we reported a favorable impact from NOL utilization. The most recent rate is more indicative of what we expect for the full year.

And one other point related to the quarter, while foreign currency translation positively impacted the quarter by $0.05 per share, the EPS comparisons were negatively affected by the tax credits that helped last year's third quarter as I just mentioned.

Now looking at the balance sheet and cash flow. The trend towards higher accounts receivable continued in the current quarter, partly due to the same reason that we have seen in recent quarters, and that is higher growth in our European businesses where payment terms are substantially longer than in our domestic businesses and also strong sales in our U.S. Outdoor businesses where payment terms are somewhat longer than VF averages. Now our European sales during the quarter increased by 20%. Also, our recent acquisitions had some impact on the AR comparison as we had only one month of sales from these businesses; however, their balance includes sales from periods prior to the date of acquisition.

Inventories rose 25% in the quarter, which is higher than the 18% revenue increase we expect for the fourth quarter. The factors here include once again the recent acquisitions where days in these early periods of ownership are higher than average VF days and also, as we saw in prior quarters, Outdoor inventory days are somewhat higher to ensure shipping performance. In addition, Sportswear days are also somewhat higher due to their difficult sales comparisons.

Now also as you can see, we ended the quarter with about $1 billion in short-term borrowings, which relates to the 7 For All Mankind and lucy acquisitions. Recently, we concluded the placement of $600 million in long-term debt, represented by 10 and 30 year notes with an average coupon rate of just under 6.25%. Now the proceeds have been used to pay down a substantial portion of the outstanding short-term borrowings. At the end of the quarter, our debt to total capital ratio was 33.7%. However, with our strong cash generation during the fourth quarter, we should get our ratio back down to the mid-20% area by the end of the year.

And now turning to our guidance. With another strong quarter behind us, we raised our revenue and EPS targets for the full year. In the third quarter, we exceeded our prior guidance by $0.06 per share and we are raising our full year EPS guidance by that amount. So we now anticipate EPS to rise slightly more than 13% for the year versus our previous guidance of 12%. And in terms of revenues, we are raising our guidance to 15%, reflecting our strong quarter just completed. Now for the fourth quarter, that implies revenues and EPSS growth of 18% and 13% respectively, which I hope you will agree, are strong comparisons, especially when considering the current environment. Operating margins in the quarter should expand by about 130 basis points. Now you'll recall that last year's operating margin was impacted by approximately $15 million of expenses related to restructuring. That was worth 90 basis points to our operating margins at that time. So even on a comparable basis, in other words, taking into consideration the expenses in last year's fourth quarter, operating margins should improve.

Mackey J. McDonald - Chairman and Chief Executive Officer

Thanks Bob. We usually get a question about acquisitions during these calls, so I will close with a quick comment on this. We are very pleased by both the quality and quantity of acquisitions made this year, which should add approximately $360 million to '07 revenue and $0.07 to '07 earnings per share. While the acquisition environment has been somewhat challenging in terms of pricing and availability all year, we have been... we have demonstrated our ability to add great brands and people. 7 For All Mankind, Majestic, Eagle Creek, lucy and The North Face business in China.

Looking forward, we will continue to actively seek additional brands with our very disciplined acquisition process and criteria that are designed to ensure that our acquisitions provide good top and bottom line growth potential and contribute positively to total shareholder return. The good news is even without acquisitions, we are experiencing very positive organic growth. We can continue to take a disciplined view of the opportunities that come before us and only choose the strongest brands with the strongest growth at the most attractive prices.

At this time, we'd like to take your questions.

Question And Answer

Operator

Very good. [Operator Instructions]. And our first question will come from Brian McGough with Morgan Stanley.

Brian McGough - Morgan Stanley

Thanks guys. Agreed with your comments. Certainly, nice to see a company beat numbers in this kind of date [ph] and also congratulations to you, Eric, as well. I hope Mackey, we will still hear you on the calls.

Mackey J. McDonald - Chairman and Chief Executive Officer

Oh yes, I'll be here.

Brian McGough - Morgan Stanley

I was hoping you guys could just give a little bit of color on the overall environment out there. I mean with your portfolio overall, both on a geographic basis as also as well by category, you just have a pretty good view, I would think, as to what's going on out there. And everyone's wondering is it whether? Is it a weak consumer? I don't know if anyone really knows. But you guys probably have a better read than most. What do you think?

Mackey J. McDonald - Chairman and Chief Executive Officer

I'll make a overall comment, and then I sure Eric will add to it. But what we are seeing is what we have been seeing now for a number of quarters and actually for several years. The consumer continues to be very resilient. They continue to buy apparel when the weather is hot, later in the season when the economic conditions are tough. But they are changing the way they buy it. They are being selective, they are buying either very special brands and products that make a strong statement about their lifestyle or they buy products of great value. And fortunately, our brands, as we've moved into lifestyle brands, have fallen primarily into these categories of strong lifestyle statements for consumers. So they are buying our products. Or we have products obviously of great value as well and those are doing well even in these choppy waters.

Eric C. Wiseman - President and Chief Operating Officer

Brain, the other comment that, as more of a corporate comment around that is, one of the things that Mackey and I both mentioned during our earlier comments is the diversity of our portfolio puts us in a position of strength we think. And it's because we own some of our own retail stores and it's because over a quarter of our business is done outside of the U.S. There are a lot of things that we have going for us that from an overall business standpoint help us perform at this high level during these challenging times. And we certainly do have pockets of our business that are most... more effective than other pieces by the current challenging environment out there. But overall, as you can see in our numbers and in our forecast for the year, we'll do just fine through this.

Brian McGough - Morgan Stanley

And then I guess just another question more specifically on the portfolio in the context of the environment, but when you look at other brands out there outside of VF and then when you look at your own brands, what kind of businesses are holding up and what's not in this kind of climate. I am wondering if that changes your thinking in any way from the overall, I guess, just a standpoint of what type of businesses you want to own, what type you want to buy and even are there any that you currently own that perhaps you might want to divest?

Eric C. Wiseman - President and Chief Operating Officer

We have identified Brian that we want to own kind of leading lifestyle brands, and that's the kind of businesses that we have been investing in and that's the kind of businesses that we'd like to continue to invest in. Having said that, and we have talked about this, we have different expectations of different parts of VF. Some of our businesses, their contribution to the Corporation is slower sales growth, but they are profitable and contribute a lot of cash. Others are much faster growing and we are investing more in them. And what we try to do is run the portfolio in a way that delivers the best return for our shareholders.

Brian McGough - Morgan Stanley

Okay. I think that's clear. And then I guess just lastly, a specific question on North Face. It's the one business that I was surprised to see do as well as it did in light of everything now we are seeing out there. And I was wondering if that was more growth indoors or is it that you are just getting better sales out of existing doors as you add new categories like footwear.

Eric C. Wiseman - President and Chief Operating Officer

Ye have little faith, Brian.

Brian McGough - Morgan Stanley

Sorry about that.

Eric C. Wiseman - President and Chief Operating Officer

We have... the team at The North Face has delivered that brand in a great way quarter after quarter, year after year for a long time now. And that brand continues to post double-digit growth rates both in the U.S. and internationally. And it's because... it's part of the diversity thing again. They've made that more than an outerwear brand. It's got an important sportswear business both men's and women's, and the outerwear business has developed beyond almost exclusively heavy outerwear to all different weights of outerwear. So our sell throughs in that brand have been strong and we are expecting a great fall season with The North Face.

Brian McGough - Morgan Stanley

Okay. Thanks very much.

Operator

Our next question is from Omar Saad with Credit Suisse.

Omar Saad - Credit Suisse First Boston

Thank you. I wanted to ask a quick question around if you think about the different channels. I mean you guys are obviously diverse in terms of your brand portfolio, but also the channels that you operate and sell into. Could you talk about kind of the mass channel versus department store channel versus kind of some of the sporting good channels? Which of these, in your wholesale business, which of these channels in terms of inventory positioning, execution, the health of the consumer in those different channels, which ones do you feel most comfortable with in this environment and which ones are you going to watch a little bit more closely?

Eric C. Wiseman - President and Chief Operating Officer

You are kind of asking us to pick a favorite customer, and I am not going to do that. I will tell you that they have different challenges right now, and that's kind of public knowledge. We have a strong and growing mass business. Our business in the mass channel is good. And our biggest customer in that channel has struggled in their apparel business, and we are trying to be a part of that solution with them. At the other end of the spectrum, there is a big department store that's going through an enormous transformation right now. And they are working hard to make that work for them and we'd like to part of that with them as well. But all of our channels have different challenges and we try to just engage with them and help them grow.

Omar Saad - Credit Suisse First Boston

Okay. And kind of following on on the mass channel comment, you look at your Jeanswear numbers this quarter, I mean the profitability there was phenomenal. Can you elaborate a little bit on that? What really allowed you to drive some of the profit improvement? Obviously, the 3% sales growth in Jeanswear was great, but expand as well in terms of the profit growth there?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Omar, this is Bob. There were a couple of things. One was actually last year, we had some expenses that I'd call in the nature of some restructuring that we did. I think we called them aligning capacity. But as much, if not more than that, we just... we ran the business more efficiently. We last year were caught with inventories that were a little bit higher than they should have been. We needed to provide for those inventories, and we just didn't have that issue this year. So, overall, it was just running the business and the quality of the sales were improved over what we saw last year in the quarter.

Omar Saad - Credit Suisse First Boston

And Bob, quickly, on the other hand, if you look at the outerwear business, obviously extremely profitable this quarter, but still down a little bit there. Is there anything we should read into that?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

No, there really isn't. I mean it was down just slightly. And in any one quarter, we are continuing to invest behind those businesses both in terms of some new product initiatives and that kind of thing. And in any one quarter, they might stand out a little bit more than another. So, no, there is nothing at all in terms of the fundamental profitability of these businesses. They remain very, very strong.

Omar Saad - Credit Suisse First Boston

Okay. Great job. Great job you guys. Really nice to see these kind of results in this environment. Congratulations.

Mackey J. McDonald - Chairman and Chief Executive Officer

Thanks Omar.

Operator

Our next question is from Robert Drbul with Lehman Brothers.

Robert S. Drbul - Lehman Brothers

Hi, good afternoon.

Mackey J. McDonald - Chairman and Chief Executive Officer

Hey Bob.

Eric C. Wiseman - President and Chief Operating Officer

Hey Bob.

Robert S. Drbul - Lehman Brothers

A couple of questions. I guess Bob or Eric, can we start on inventories? Can you drill down a little bit more when you like what was the dollar number in the inventories that was attributed to the acquisitions and can you maybe just elaborate in each segment if you are comfortable in all segments in terms of the inventories?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Let me start with that Bob. A little bit more on the inventory. The increase was, as we said in the comments, was up 25%. And again, as we look to the fourth quarter, we are anticipating sales growth of 18%, very strong 18%. Now, they are not exactly in line, the higher days of the newly acquired companies. And that's very, very typical when we make acquisitions; the days that we bring in are normally a little higher than the average VF days. So that impacted... the recent acquisitions impacted that comparison by about 3 percentage points, all right. So you start with 18 as a comparison and that's another 3. And then the Outdoor business, we did build some inventories there to service the business and we felt we were a little bit short last year, so we wanted to make sure that we service that business properly. So the days there were up a bit, but again, we were very comfortable doing that. And then the other piece, it was a little bit smaller piece, but Sportswear as well, softer sales there had also contributed to the increase. So overall, we continue to feel very, very good about the overall quality of the inventories. There is not any one piece that we are concerned about.

Robert S. Drbul - Lehman Brothers

Okay. And when you look at the overall retail business, your retail business, what was the blended overall comp of your retail business? Is it a fair way to look at that and can you give us that number?

Unidentified Company Representative

Give us just a minute here.

Unidentified Company Representative

We are looking for... see if we have that for the quarter.

Robert S. Drbul - Lehman Brothers

Okay. And I guess I'd throw another one out, as you look for, overall, for the Nautica business, how much of that business is now done on replenishment and what sort of expectations do you have for the promotional activity in Nautica for the fourth quarter versus what you had experienced in the third quarter?

Eric C. Wiseman - President and Chief Operating Officer

Yes, I actually don't know the exact replenishment number, Bob. But it's a smaller percentage of the business, and most of that business is run in the traditional sportswear mode of having a line that's into these stores over time. I will say that there is going to be more promotions in the next 90 days because the season got off to a slow start. We have reflected that in our forecast for the year and we don't expect any additional requirement for that from budgeting purposes. But it's going to be a promotional October, November, December is my guess because we got off to such a slow start. And I am not sure we are going to get the comp store sales number for our owned stores. We would only have it for our domestic stores when we get it, but we can talk to you about that later.

Robert S. Drbul - Lehman Brothers

Okay, sounds good. Thank you very much.

Eric C. Wiseman - President and Chief Operating Officer

Thanks Bob.

Robert S. Drbul - Lehman Brothers

Good luck.

Operator

Our next question is from Virginia Genereux with Merrill Lynch.

Virginia Genereux - Merrill Lynch

Thank you and congratulations Eric Wiseman.

Eric C. Wiseman - President and Chief Operating Officer

Well thank you very much.

Virginia Genereux - Merrill Lynch

That's exciting. Okay, a couple of questions. Your organic growth, the fourth quarter guidance implies a little faster organic growth, Bob, if you've sort of been running up. I think year-to-date you are organically growing, approaching 10%. And by my math, you are closer to 12 organically in the fourth quarter, and maybe and retail is a part of that, but can you talk about a little bit what's driving that?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Actually, in the fourth quarter at the 18%, Virginia, the organic phase would be right in the 9 to 10% range. Okay, 9 to 10%. And what's driving that are the same pieces. Now remember that last year was a more challenged quarter for the Jeanswear business after a very, very strong September. You'll recall things slowed down a bit in October. So that's a factor. Across most of the other businesses, there was no one piece that stands out. The same where we are seeing strength today, we should continue to see in this next quarter. And again, the overall organic growth rate is very comparable to what we saw in the third quarter.

Virginia Genereux - Merrill Lynch

Thank you. And sort of a follow on to that, you gave a lot of good color on the retail environment and the back half year. As you look out to spring of '08, there has been feedback that retailers are ordering with teaspoons. Would you expect to be able to maintain sort of these magnitudes of organic growth into the first half of '08?

Mackey J. McDonald - Chairman and Chief Executive Officer

Well, as we look at retail going forward, as I said earlier, we feel this is going to continue to be a somewhat choppy situation, will extend on for a while. But we do feel that there are going to be clear cut winners in brands and in categories. And that's why we feel very positive not only for fourth quarter, but as we go into next year. We feel very positive of our ability to sustain strong growth levels. But we do expect overall retail to continue to have choppy performance as it has for sometime now.

Virginia Genereux - Merrill Lynch

Thank you, Mackey. And then on the mix, just quickly, you guys, you mentioned, Eric, that you are... that 20% of the business is mass and department stores. I don't know if that includes national chains. But if we are just thinking about the sort of pro forma mix maybe for next year, it looks like owned retail is going to be 14% this year, you said it was $1 billion, so maybe that grows a little bit international, and I guess owned retail, some of that is owned retailed. But that's high 20s altogether.

Unidentified Company Representative

Correct.

Virginia Genereux - Merrill Lynch

Can you just sort of segment the business as it stands kind of now by channel and geography maybe?

Eric C. Wiseman - President and Chief Operating Officer

It's a little... actually, the answer is I can't do that accurately, because it is complex, because the way we look at the business how much is retail, how much is international, there is overlap. It's a fair question and we can get... we can do that calculation.

Virginia Genereux - Merrill Lynch

Okay, I can do that offline. That's great. Last one, if I may. Are you all seeing any impact from the weaker dollar? Either, and more specifically I guess in your kind of cost to manufacture, kind of input cost, are you seeing any negative impact there that could be an issue at some point?

Mackey J. McDonald - Chairman and Chief Executive Officer

Well, we see both benefit and some issues with it from our standpoint. So it pretty well evens out. I mean we obviously see some higher costs in buying materials, but we also see greater revenue coming in from our growing international operation. So this growth in international operations is a real strength. It's one of a number of things I mentioned earlier that had changed VF to a very different type company. And that's why in this environment, as we look at our international operations, our owned retail, the strong brands we have across all these different categories, we just feel very positive with how these factors are coming together to allow us to continue to perform in a choppy environment.

Virginia Genereux - Merrill Lynch

That's great. Thank you all so much.

Mackey J. McDonald - Chairman and Chief Executive Officer

Okay.

Eric C. Wiseman - President and Chief Operating Officer

Thank you.

Operator

Our next question is from Jeffrey Edelman, UBS.

Jeffrey Edelman - UBS Warburg L.L.C.

Thank you. And Eric, my congratulations to you also, and look forward to the next five years very similar to the past five years?

Eric C. Wiseman - President and Chief Operating Officer

As do us [ph]. They are going to get better, probably.

Virginia Genereux - Merrill Lynch

Seriously, in that same vein, it looks as if you pretty much hit the... your target 14% operating margin next year. And obviously we can look at the faster growing more profitable businesses and Nautica showing some improvement. As we think over the next few years, is there room to expand the margin, be above that or are you going to focused more on investing to drive the top line? Strategically, how should we look at the parts going forward?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Hey Jeff, this is Bob. You've actually... I mean you've hit on all the points. And I'll tell you we are in the process right now of looking at our five year plan. And what I can tell you is that clearly is an opportunity. Just as we've been seeing margin expansion over the last several years, as you mentioned over the last five years, we see that kind of opportunity to continue for sure. The question is always the balance, the balance in terms of growing the top line, which we have seen very, very strong growth over the past several years. And the question there is the investments that we need to make to continue that top line growth. So that's exactly what we'll be taking a really hard look at and we'll have more to comment on that when we talk... and we lay out our five year plans.

Virginia Genereux - Merrill Lynch

Fair enough, thanks, and good luck Eric.

Eric C. Wiseman - President and Chief Operating Officer

Thanks Jeff.

Operator

We'll next go to Brad Stephens of Morgan Keegan.

Brad Stephens - Morgan Keegan

Hey, good afternoon and congrats on a great quarter. A question for you in the Sportswear line. When we look at Nautica, I think you've had a falling out with one of your retail partners. Is that substantial impact going forward? And then just looking at the coalition as a whole, operating margins have been under pressure for probably the last eight quarters or so. When should we see a reacceleration in the operating margins and then what is Nautica's growth rate from here?

Eric C. Wiseman - President and Chief Operating Officer

We have... on the operating margin question, when we acquired Nautica, it was a kind of mid to high single-digit operating margin, and we rather quickly got it up over 15 to almost 16%. Following that, we've decided to reduce that margin, make some investments in programs like our women's sportswear business, which has been an investment track for us. Absent that, absent investments like that, the men's sportswear business at Nautica operates at or above the 14% level right now, which is our target for Nautica and target for VF. And we are confident that we can run Nautica at the 14% operating margin level again. We are making some investments in it right now. We also need to get it on a better growth track than it's been on the last year. And we are working very hard to align with our customers in a better way and bring them better product, and we have got a team assembled at Nautica that we think can do that.

Brad Stephens - Morgan Keegan

Could you talk to the top line given the relationship with Dillard's [ph] and how we should think about Nautica long term and then over the course of the next 12 months? Is that a big impact or minimal, etcetera?

Eric C. Wiseman - President and Chief Operating Officer

You are catching us in the middle of a planning cycle in understanding what 2008 is going to look like. And I am not going to disclose the 2008 growth targets for any of our brands right now including Nautica, sorry.

Brad Stephens - Morgan Keegan

Okay. A question for Bob. You mentioned the accounting impacted you 20 basis points. Is that something that goes on forward or what was that?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

It will go forward. Again, it was just some expenses that actually came out of SG&A and went up into the gross margins. So, again, it was worth... it was only 20 basis points. I just felt that I should point it out given the overall gross margins because we have seeing about 30 basis points almost per quarter of mix improvement. And once again, we saw that in this quarter.

Brad Stephens - Morgan Keegan

All right, thank you very much.

Operator

We'll next go to Robbie Ohmes, Banc of America Securities.

Robert F. Ohmes - Banc of America Securities LLC

Thanks. Just a quick follow-up question. Can you... I guess this is sort of for Bob. Can you just give us some help with how we should think about the fourth quarter? It would seem like with the 18% revenue growth that you can grow earnings maybe fast as 18% or faster. Could you give us the line items that bring you back down to that lower earnings growth in your guidance? Is it gross margin is a little tougher because of Nautica or is it the interest expense from the acquisitions, or, a little help there would be great. Thanks.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Okay, Robbie. Actually, from a gross margin standpoint in the fourth quarter, we expect to see... we'll see some improvement. Now, again, last year's numbers included in the gross margin as well as in the SG&A area included some expenses, some restructuring expenses. So they won't repeat. So we are helped a bit by that. But outside of that, we expect to see about 50 basis points of improvement in the gross margins for the quarter. So, again, all in, more like 150 basis points of improvement, right. But again, that's helped by the expenses that won't recur. So once again about... actually, I am sorry, about a full point coming from actual improvements. The expenses last year were worth about a half a point, were worth 50 basis points. Again, let me make sure that's clear. 150 basis points in total, 50 basis points of that due to the lack of restructuring that was in last year and then a 1 point improvement. That's gross margins.

On the SG&A side, once again, last year was impacted by some restructuring costs that won't recur. That's 40 basis points. And there, just as we have been seeing, the mix as well as some impact from the acquisitions will pretty much offset that. At the bottom line, what's happening there is why the 13% is last year, actually, we had the tax credit, a significant tax credit overall. Now again, even net of the restructuring, the tax credit was positive to the EPS numbers by about $0.03 worth. So if you take that out of the equation, we are closer to a 16% improvement in EPS, which is pretty close to the 18%. Why isn't it exactly on, because part of the top line improvement does come from acquisitions. And in these very early stages of those new acquisitions, again, not a lot of EPS contribution coming from them.

Robert F. Ohmes - Banc of America Securities LLC

Got it. That was very helpful. Thanks so much.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Good. You bet.

Operator

Our next question is from Kate McShane of Citigroup.

Kate McShane - Citigroup

Hi, thank you. Can you talk a little bit about the backlog for spring for The North Face? And on an unrelated question, can you talk a little bit more about what seasonality we should expect from the new Contemporary business segment?

Eric C. Wiseman - President and Chief Operating Officer

Yes, hi Kate, it's Eric. I'll deal with the bookings. You asked about the bookings for The North Face for spring, was that your question?

Kate McShane - Citigroup

That's right.

Eric C. Wiseman - President and Chief Operating Officer

Yes. In the kind of vocabulary that we have normally talked about that proudly is that we have double-digit bookings increase. We have had in the past, and I will tell you we continue to have for this spring of '08 a double-digit bookings increase for The North Face.

Kate McShane - Citigroup

Okay. And is there any... is that mostly from one particular category or is it across the board, sportswear --

Eric C. Wiseman - President and Chief Operating Officer

That's... the business is kind of trying to cooking on all cylinders right now. We are getting growth in our footwear business, in our sportswear business, in our equipment business and in our outerwear business.

Kate McShane - Citigroup

Okay. And then just, can you talk through the seasonality of the new Contemporary business at all?

Eric C. Wiseman - President and Chief Operating Officer

Kate, we don't expect that there are going to be significant variations quarter-to-quarter. But with the growth on the international side, we expect to see in sportswear, what I'd really like to do is defer that question till we have... till we take a little bit closer look at the '08 plans and we'll speak more to it at that point.

Kate McShane - Citigroup

Okay, thank you very much.

Eric C. Wiseman - President and Chief Operating Officer

Sure.

Operator

Next question is from Robert Samuels, J.P. Morgan.

Robert Samuels - J.P. Morgan

Hi, good afternoon. Can you comment a little bit more about your... on your international strength, any particular markets stronger than others?

Eric C. Wiseman - President and Chief Operating Officer

Yes, this is Eric. We have a lot of good things going on internationally. The bulk of our momentum right now is in Europe and in Asia. That's not to say that we don't have traction in Mexico and other places. But the big dollar growth is coming out of those places. Some of that is new business. You may be call that I guess 13 months ago, we established a joint venture in India which is moving along, so that's a new business for us. We also just acquired in the spring of this year The North Face brand in China. And that's a small business, but growing rapidly. And we have recently moved some leadership to China to coordinate our growth across VF in that region, and that team is kind of getting built and settled now. In Western Europe, our Jeanswear business has been particularly strong. We talked earlier they were up 13% in the quarter. As well our Outdoor business and our Vans business and our Reef business is all growing very, very nicely in Europe.

Robert Samuels - J.P. Morgan

Great. And then just quickly, just a quick comment on Reef. Did you see any pressure there during the quarter from things like crocs [ph]?

Eric C. Wiseman - President and Chief Operating Officer

Almost 80% of Reef's business happens in the first six months of the year, currently from a shipment standpoint. So the year is kind of over by the end of June from a wholesale shipment standpoint. And we are having a decent year at Reef and we are expecting growth next year.

Robert Samuels - J.P. Morgan

Thanks.

Operator

Next question sis from Eric Tracy, BB&T Capital Markets.

Eric Tracy - BB&T Capital Markets

Good afternoon. If we can just touch on the Contemporary profitability, by my math, it comes in at roughly 15% on an EBIT basis. Just wondering if you could kind of elaborate on that. That seems... is that seasonally strong for that quarter or is that sort of a base that we can expect to work off of?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Well, again, the Contemporary brands, we only owned the brands for a month. So we only had one month of operations in the quarter, Eric, so it's a little hard to draw conclusions from just a quarter. Although from an operating margin standpoint, yes, they were actually a little bit lower than which might expect going forward.

Eric Tracy - BB&T Capital Markets

Okay, fair enough. And then maybe just a clarifying point. I think Mackey mentioned on the acquisitions, did he... $0.07 accretive for '08 is now expected? Was that what I heard kind of in his summarizing comments, add roughly 360 in revenues and $0.07?

Mackey J. McDonald - Chairman and Chief Executive Officer

That's in '07.

Eric Tracy - BB&T Capital Markets

That's in '07?

Mackey J. McDonald - Chairman and Chief Executive Officer

Yes, not '08.

Eric Tracy - BB&T Capital Markets

Okay. So $0.07 accretive as opposed to kind of neutral what we thought previously?

Mackey J. McDonald - Chairman and Chief Executive Officer

I am sorry, what was the question?

Eric Tracy - BB&T Capital Markets

Can you... I guess maybe --

Mackey J. McDonald - Chairman and Chief Executive Officer

That's all acquisitions made during this year.

Eric Tracy - BB&T Capital Markets

The entire year.

Mackey J. McDonald - Chairman and Chief Executive Officer

It's all of the '07 acquisitions, not just the recent ones.

Eric Tracy - BB&T Capital Markets

Not just lucy and --

Mackey J. McDonald - Chairman and Chief Executive Officer

Right.

Eric Tracy - BB&T Capital Markets

Fair enough. Great. Thanks guys.

Operator

Next question is Linda Donnelly [ph], Franklin Management Group, Wachovia.

Unidentified Analyst

Thank you. Just one quick question. Prior guidance for depreciation and amortization for '07 was $125 million. Do you think at this point it will be slightly higher than that?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Actually, the number right now... you said 125?

Unidentified Analyst

Yes.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Yes, we are right on that number.

Unidentified Analyst

All right, great. Thank you.

Mackey J. McDonald - Chairman and Chief Executive Officer

Any more questions?

Operator

[Operator Instructions]. Our next is now from Christian Buss [ph] with Thomas Weisel.

Unidentified Analyst

Yes, hi guys, congratulations on a nice quarter.

Eric C. Wiseman - President and Chief Operating Officer

Thank you.

Unidentified Analyst

Wondering if you could provide a little bit of perspective on The North Face, China opportunity sort of if you can provide any color on what kind of phase that comes on, what kind of opportunity you see.

Eric C. Wiseman - President and Chief Operating Officer

You are coming through a little soft. I think your question was about The North Face, China opportunity. And that's a brand new business for us. It's a very difficult market to predict. What we know is that we have a really good brand for that market. There is some cold weather in that market, and we think it can be important. But it really is too early for me to give you any kind of direction about how big it might be. We just think it's an important place for us to have the brand.

Unidentified Analyst

All right, thanks a lot. And then one other question I had, which is on the 7 For All Mankind brand, what's the mix there between domestic and international right now if you could remind me?

Eric C. Wiseman - President and Chief Operating Officer

Right now, between 25 and 30% is international and the balance is in the U.S.

Unidentified Analyst

All right, thanks a lot.

Eric C. Wiseman - President and Chief Operating Officer

You're very welcome.

Operator

And we do have a follow up from Virginia Genereux with Merrill Lynch.

Virginia Genereux - Merrill Lynch

Thank you. Bob, what about CapEx for this year? It looks like under 80 year-to-date.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Yes, it should be right around 140, Virginia.

Virginia Genereux - Merrill Lynch

So you are going to spend 60 in the fourth quarter?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

It's a little higher spending.

Virginia Genereux - Merrill Lynch

Okay, okay. And can you quantify, Bob, the intangibles amortization associated with the 7 and lucy acquisitions and when that... and what portion of it falls off and when?

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Yes, in the early years, it's about, I believe it's about $13 million or $14 million. And it's heaviest obviously during the first three to four years. I can get back to you with some more specifics on that.

Virginia Genereux - Merrill Lynch

Okay. All righty. Thank you all.

Robert K. Shearer - Senior Vice President and Chief Financial Officer

Okay.

Operator

And with that, there are no further questions. I would like to turn the call to Mackey McDonald for a closing comment.

Mackey J. McDonald - Chairman and Chief Executive Officer

Okay, thanks for joining us. We hope that you've gotten a very clear perspective of why VF has performed differently in this type of environment and also why we feel comfortable that we can continue to outperform the market going forward with the transformation we have made in the company. Thanks for being with us.

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