Corporate Presentation 2020

Nov 10, 2020

Good afternoon, everyone. I'm Kimberly Greenberger, Morgan Stanley's branded apparel and footwear and soft lines retail analyst. We're very pleased to host Levi's at our Life After COVID Conference. This is their first participation at a Morgan Stanley Retail Conference. As many of you know, Levi's is one of the world's largest brand name apparel companies and global leader in jeanswear, with nearly 6,000,000,000 in sales in the latest year and over 6,000,000,000 in market cap. Today, we're joined by Harmit Singh, Executive Vice President and Chief Financial Officer Chris Ogle and Ida Orphan representing Investor Relations. Harmit joined Levi in 2013, continuing a successful career across various industries. Prior to his current role, Harmit held a number of Chief Financial Officer positions at multiple global companies, including Hyatt Hotels, Pizza Hut and Yum Restaurants International. Harmit, welcome, and thanks again for being here. Thank you, Kim, for having us. And we're looking forward to our first retail conference with Morgan Stanley and your team. Thank you so much. Today, we plan to discuss Levi's broader direct to consumer and e commerce strategies as well as how COVID-nineteen may have changed Levi's business and strategies. We'll start today's session with a moderated question and answer format followed by audience questions. For those of you joining us via the webcast, please click the Ask a Question button on the webcast to submit your questions and there can be a slight delay here, so we encourage you to submit those questions early. Before we dive in, I need to remind everyone that you can find important disclosures on the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. Additionally, Levi's comments today may contain forward looking statements and non GAAP metrics subject to the Safe Harbor statements and reconciliations in Levi's SEC filings. Please note in our discussion today, Levi's will not be discussing the current quarter trends or any updates to their outlook for the Q4 and beyond, as provided in the recent Q3 earnings call. With that, I'm happy to get started with our first question for the day. Harmit, COVID-nineteen has altered the way many global brands seek to connect with consumers. Can you start by sharing with us how you are seeing COVID-nineteen change consumer behavior and how Levi has altered its strategies for a post COVID world? Thank you, Kim. And thanks, everybody, for participating and attending today's meeting. This is my 5th recession. My first recession was in Asia in the late 1990s, but it's my first in the apparel industry. And so as you think through the different crises that we have faced, the pandemic being one of them, we have a playbook. The playbook is all about managing through the crisis, but emerging stronger. To your question about how our consumer behavior is changing, I think it starts with the orientation of the consumers towards strong brands. We believe the work place is casualizing and casualizing at a faster pace. The digitization or the consumer experience has accelerated. What would have taken probably years is happening very quickly. And importantly, we believe the consumers are becoming a lot more conscious. They're moving from conspicuous consumption to conscious consumption, which really plays to our strengths. It's all about brands that not only focus on value, but values. It's about driving sustainability, keeping safety of the consumers at the forefront. As you know, in quarter 3, we announced the launch of a re commerce program. It's a $28,000,000,000 $30,000,000,000 market, and it's our first entry into it. Levi's is one of the few brands that are sold and resold. People collect and resell it, so we thought we might as well lead from the front. In terms of your question on strategies, we are pivoting to focus on 3 important priorities for us going forward. One is, we have great brands. We're going to be brand led. And that's all about ensuring that we're able to generate and drive trust of our consumers as well as reach out to the younger consumers. The second is we are going to be a DTC led company. This company grew up as a wholesale company. But we think DTC is the way to go. DTC direct to consumer business has grown double digit pre COVID and it allows us to connect directly with our consumer. It also has higher gross margin as well as allows us to build more of a lifestyle style orientation for our product. And the 3rd focus is about diversification, diversifying geographically, diversifying our product categories, diversifying our channel and diversifying our brand portfolio. All this is underpinned by a couple of things. One is what we call digitization of our consumer, employee and customer experience. The second is a real focus on financial discipline and growing margins, improving our ROI, etcetera, driving working capital management, etcetera. And the 3rd is all about operations excellence. So that's how we're thinking about it. And we're using this time, as I talked about, emerging stronger to accelerate our transformation that began 7, 8 years ago. Wonderful. Okay, excellent. That's a great introduction. Maybe we can just talk about the past year and build on that. As you mentioned, Levi is redirecting its efforts to growing its direct to consumer business and sort of shifting a little bit the strategic focus organization. Since the onset of COVID, we've obviously seen a marked acceleration in your e commerce growth already. And it's been really exciting to see. I think during your Q3 call, you mentioned that you expect higher growth rates in the channel post COVID. So the growth rate at a higher rate to be sustained and that your e commerce business could double in size within a 5 year timeframe. Do you think COVID has actually enhanced in some ways Levi's long term direct to consumer revenue opportunity? And how do you see COVID altering the e commerce opportunity, both on your own website and on some of your partner brand websites? Yes. No, it starts and ends with the consumer. And the puck was already headed there. COVID basically accelerated the way the consumer shops, and we are focused on riding that wave. So let me talk a little bit about the business. About 10 years ago, our direct to consumer business, and I include our franchise business, which is reported in wholesale part, we have over 2,000 franchised doors around the world. So if you take the 2, it was about 26% of our total revenue. In 2019, it was close to 44%. It's higher today. And what we have talked in our Q3 earnings is, it's going to be north of 50% of our business. The gross margins on our direct to consumer business are higher than wholesale. For example, our e commerce gross margins are 20 percentage points higher than wholesale. Brick and motor EBIT margins are accretive to the company operating margins. And more importantly, it allows us to engage and connect directly with our consumer. Our global digital footprint and in this site, Kim, I include not only our levi.com and doctors.com sites, I include our Peopler players like the Zalando's, the Amazons, the Dmalls and the dot com of our wholesale customers. That digital footprint is expected to grow over time. It is, I think, a little over 20% in quarter 3. It was about half tagged pre COVID. We think over time, it gets to a third of our business and allows us to directly engage. What we're doing at our end is accelerating our omnichannel capabilities, buy online, pick up at store. We've launched an app. I mean, this morning, there was excitement at the same family because my daughter discovered we just relaunched our collaboration, New Balance sneakers. And people and she went to the app. We didn't have an app. She went to the app, tried to order it. It was already sold out. So I'm trying to figure out a way to get her some shoes. But I mean, I think that's the advantage. We didn't have an app. We were testing it pre COVID. We've accelerated that. We have a loyalty program today. We have a million over a 1000000 consumers. And it's great it's exciting because the stats that I'd like to see now, revenue and EBIT is great, but I want to see the new consumers that are signing up. I want to see repeat. I want to understand what lifetime value is. And that only can come with direct engagement of our consumers. And we're seeing great repeat. Repeat is close to 40%. And we are able to market programs on a more digitized way. We're also using AI. And our algorithms are geared towards people who are spending more. People who are not spending is geared to trying to drive them to the brand, etcetera. So I think a lot to come, but really excited about where DDC can take us over time. And it's all about great engagement with our consumer, which you can then bring back to our wholesale customers and say, this is how we are doing it. Why don't you do it this way? And I think the magic of the 2 is music, right? Absolutely. Absolutely. That's an excellent segue into the next question here, which is just about your wholesale strategy. Obviously, wholesale remains of critical importance to Levi. Can you run through your U. S. Wholesale strategy and how you see this channel evolving in the next year or even the next 5 years? Yes. Many years ago, when DDC was 26% of our business, U. S. Wholesale was over 50% of our business. It's down to about 30%. I think over time, it settles in the mid to high 20s. But the component of it and we have some great wholesale customers, the component of it is healthier. And over time, we'll grow, right? And the reason we feel good about it, if you take our quarter 3, the non digital business with our largest traditional brick and mortar department stores was less than 10% of our total revenues. It used to be much higher years ago. So our focus with the traditional retailers is all about driving more business in the productive doors. Underperforming doors will close. We've kind of built that into our algorithm and our model, but we're already focused on the productive doors and building more of a lifestyle orientation in the productive doors with higher AURs. The in terms of why I believe U. S. Wholesale will be healthier. You heard about our expansion opportunity with Target. That's a healthier business. We are focused on driving more of a premium distribution so that the AURs go up. We are focused on driving value with our Signature and Denizen brands and driving new distribution where it makes sense as well as growing our digital piece, which is with pure players as well as the dotcom business because we think that's where the puck is headed. And so that's our focus on U. S. Wholesale. So I would say healthier than it was pre COVID as we emerge from the crisis. Fantastic. Okay, excellent. And that sort of brings us to the international strategy. Maybe you could compare and contrast how international differs from the domestic business. And how do you think about international expansion opportunities and category expansion opportunities? Sure. So 75% of the apparel market is outside the U. S. International today is about 60% of our business. 7, 8 years ago, international was in the minority. The business was skewed to the U. S. So over the last 7 to 10 years, we have changed the structure of the business. International, if you think about product categories in good, better, best, international is more of a better and best product category or what we call Tier 1 and Tier 2. The U. S. Is still a large primarily a good market having grown up in the wholesale business, which we're trying to over time diversify. The areas of focus internationally, Europe remains a strongest region. It was the strongest region in quarter 3. The brand is really, really strong. And we believe it's got the right balance between direct to consumer and wholesale. It's fifty-fifty between direct to consumer and wholesale. And if you take the franchise business out of wholesale, our direct to consumer plus franchise is clearly on the majority. Asia has been rocky for us, but it's our greatest opportunity. We have a wonderful track record in India and in Japan. China, our business is still small. It's about 3% of our total business, and we think we can grow that over a are becoming a larger share of the business and continue to be under penetrated. As we establish more of a lifestyle orientation, I think you'll see outsized growth as we saw pre COVID from these categories. Our M and A focus, which is inorganic M and A, not that we need it because we believe we can grow this business organically in the mid single digit growth that our growth algorithm has. Our M and A focuses around categories of accelerating tops, women's, outerwear and potentially entering athleisure because it's a consumer segment. It's no longer a trend, it's a consumer segment. And with the casualization of the workforce, it's something that we'd be open to look at. Great. Fantastic. Okay. That takes us to margins and the margin opportunity at Lean Vi. You've talked about several factors that will continue to benefit gross margin over the long run, obviously one of them being the growth in direct to consumer. And you also on your recent conference call talked about increasing average unit prices. You mentioned today more profitable wholesale partnerships. How do you think all of these things in aggregate shape gross margin going forward? Yes. I mean, Kanji, we're confident we can expand gross margins for the reasons you talked about. Our geographic growth international is higher gross margins. Our channel growth driven by DTC, higher gross margin. We premiumize the brand, higher AURs. We continue to negotiate fairly well with our vendors. And we take price increases in we took we increased our women's styles in the U. S. By $10 that is ticking. We took a price increase in quarter 3 in Mexico, that's ticking. So wherever the brand is strong, which we think is in large parts of the world, expect us to take pricing because I think as we introduce new innovation in the product, as we introduce new styles, I think that will probably help. So gross margin has been a point of strength. Even during COVID, we've continued to expand it. We talked about ending the year with higher gross margins than in 2019, which means we managed our inventory really well. So and then if you think about an ongoing growth algorithm in the post COVID world, it does call for a 40 to 50 basis points increase in gross margins annually. Fantastic. That is excellent. Okay. Next item on the P and L, SG and A. And are there meaningful differences or important differences in SG and A between the channels? And how should we think about the impact to operating margin, for example, as your e commerce business scales? Yes. The it's a great question. It's the change in structural economics, we figured out as the puck was headed more towards DDC, we had to get ahead of it. Because as you know, brick and mortar has cost that wholesale doesn't, both people cost, capital cost as you open stores, etcetera. And e commerce has cost which are different from wholesale, the higher digital advertising costs and this constant upgrade in technology. We just upgraded our websites in Europe and the U. S. And that led to higher conversion rates and everything else, but the higher costs. As we think about it, we believe that our EBIT margins do leverage on brick and mortar, so higher gross margin, higher SG and A, but even EBIT margins. E commerce, which used to be a drag on the P and L, which is losing money because we were investing in e commerce people and technology over the last couple of years, actually has turned profitable this year. And it's in the black a year prior to schedule. So as the business continues to grow, and that's why we talked about doubling the business, we think that only drives higher profitability. Our view is if e commerce business doubles, it would be accretive operating margins of a business that's doubled the sizes today would be at par or accretive to the business from that perspective. As you know, we talk about a company that generates high returns, return on invested capital is important. Our brick and mortar stores on an average, and we do this exercise annually where we look at 3 year return on invested not on a cash basis, but after capitalizing the lease. And that's in the mid to high teens. And so our assets are returning and returning well. So that's how we think about both operating margins, gross margins and returns. Fantastic. Okay. So thinking about operating margin targets, if I reflect back on the Q3 call, you mentioned Levi is on track to deliver a 12% adjusted operating margin when you get back to pre COVID revenue levels. And this represents obviously a nice level of improvement from what you actually saw in 2019 at 10.6%. So what are the key factors that you see supporting this higher margin in the future on what would be similar revenue to 2019? Yes. If you go down the P and L, I'd say higher gross margins, as we talked about, given every all the initiatives that we mentioned. On the SG and A, during COVID, we accelerated the structural realignment of our cost base. We took our headcount. We have cut travel. We have renegotiated every contract out there with 3rd parties. And we have are renegotiating every rent on for a big brick and mortar stores. I mean, I'm talking to all quite a few landlords directly, especially the big ones in the U. S. And my team around the world and our region presidents are doing similar stuff. So a combination of all this, we think structurally eliminates about $200,000,000 We need to reallocate half of that towards higher advertising as we scale up AI. We are upgrading our ERP. We call it Project Solar. It's part of something that I look at. And like most of the companies, it's about digitizing and automating the foundational piece. We are accelerating omni and e commerce. So that's where the costs will be or the savings, half of that will be reinvested. And that's why we think once we get back to pre COVID revenue levels, our operating margins will be will get to 12% or over that. And that's where we are confident that we can get there. Fantastic. And you mentioned there that you in addition to running finance also oversee IT. Can you talk to us about Levi's top IT initiatives and your CapEx plans? You've also mentioned progress on liquidity and working capital initiatives beyond CapEx. What are your capital allocation priorities, including any potential M and A? Sure. So when I entered a company about 7.5 years ago, we were spending about 2.5% of our revenues on capital. And most of the technology investment was geared towards maintenance CapEx. So we were fixing things that were broken. And what we've done over the last couple of years as we develop the turnaround strategy for the company, we developed a mindset that technology is a true enabler of growth and profitable growth over time. So if you take our $160,000,000 of capital that we have guided, we spend this year, 2 thirds of that is towards technology. And it's being spent on omnichannel capabilities, it's being spent on the ERP upgrade, it's being spent on AI and other initiatives, etcetera, etcetera. So a lot of work on the digitization, omni capabilities, etcetera, all of which would drive growth. The remaining third is largely spent on new stores. We're opening we opened 60 doors. We signaled we'll open on a gross basis 100 doors. So we're spending money against that, spending money on remodel of our doors. We're digitizing our store footprint. So the consumer interaction is a lot more engaging. We have tailor shops and you can go into the store, order online, so the associate ordering, etcetera. So there's a lot of that, that's currently going on. To your question about other capital allocation, we are a dividend paying company. That's what we said when we did an IPO. We've been paying dividends for many, many years. We actually suspended it given the lack of visibility and the fact that we were not very sure where the COVID crisis would take us. We do declare dividends every quarter, so we will on a quarterly basis. As you know, in quarter 3, we generated positive cash flow, probably a little earlier than we thought, largely because I took the opportunity to drive working capital efficiency, which is about collecting our bills. It's about making sure we pay our vendors to pay as per market practices and importantly, turn and churn our inventory. So our investment in inventory is at reasonable levels. So I would say, I think the we'll review dividends on a quarterly basis when we report earnings. We just need to see a little bit more visibility into the future. Our we have a very strong balance sheet. We have over $2,000,000,000 of liquidity between cash on hand as well as access to our revolver, which is untapped largely. Our leverage ratios have gone up largely because EBITDA, thanks to quarter 2 and quarter 3 declined dramatically. And as things come back, we think our leverage ratios improve. I've been asked whether we want to be an investment grade company, and my view is that being 1 notch below investment grade is a good place because we can access capital as we demonstrated. We raised $500,000,000 I think in April or so, and we did it at very competitive rates. To your question about M and A, we are a disciplined group. And as I said, we believe there is a long runway organically. Having said that, we have a small M and A team now, a team of 2, small and mighty. And we look at things, but our focus is largely going to be on free filters. It's something that culturally fits in. Sustainability is important. So that should be of paramount importance. Strategically, it should be focused on the categories I talked about and allow us to leverage our scale, plus allow us access to younger consumers and allow us to accelerate our direct to consumer business. And then there is a financial criteria, which is all about driving accretive earnings as well as decent ROI. So that's how we think about it. Fantastic. And it looks like we probably got time for one more question. You referenced, Harmit, in just some of the changes that you're seeing among your consumer base here through COVID that you are seeing an increase in consumers' focus on sustainability. Here at Morgan Stanley, we're also very much focused on the investment allocation process that involves ES and ESG Lens. And it sounds like there are a number of ESG initiatives at Levi. Maybe you could talk about those and have any of them changed or altered as we've gone through the pandemic? Sure. ESG has been in our DNA. And I thank Levi Strauss himself because he donated to a charity from the first profit he made way back. In the Haas family has done a phenomenal job. So when we joined the company, we started with a real strong foundation. One of our working philosophies is profit through principles, which means that it's not only important what we make, but how we make it. I was speaking at an ESG conference yesterday, and I said in my view, ESG should be expanded to add another E, which is employees, environment, social and governance. In terms of our initiatives, a lot of our initiatives start with sustainability, but quickly become innovative. So I'll talk to you about our FLX or future finish program, which is all about reducing chemicals, but it turned out to be laser technology that allows us to now finish product faster and without a lot of chemicals and at lower cost because it allows us to churn inventory a lot faster. During the crisis, as we have taken initiatives, our actions have been guided by our values. We increased vendor we increased the we extended the payment terms for our vendors, but we set up a supplier financing program with IFC so to ensure that our vendors were able to access a lower price supply of financing. When because we had to unfortunately lay off people, we took salary cuts, Even though dividends could be paid because of a wonderful liquidity situation, we decided that we managed all our stakeholders. We took the we kept the dividend suspended in quarter 3, as an example. We continue to donate against social causes as a company. We have stood up for social justice and equality for many, many years. We have spent over $30 plus 1,000,000 on driving the right causes. We have taken stands. As you know, we came up with giving people. Along with Patriconia, we teamed up with Time Forward And after the or around the midterm elections in 2018, we came up with a coalition that expanded to about 1800 companies and people who have given time to work, time to volunteer, etcetera, etcetera. We've just released our diversity stats, and we have been very vocal in the fact that we will be very transparent with our diversity stats. We have announced that we will we are under recruitment drive to add a black person to our Board. We're going to increase the representation of our leadership group so that it better represents the profile of the country. So really focus on things like that. In my group, for example, in finance, I've established a mentorship program for diverse candidates. We just started. So there's a lot that we do. Obviously, it's not enough. And it's incumbent in all of us to collect together and drive this around the world. And that's what we are focused on. But we think it's a core piece of our DNA and our strategy and is what differentiates us from a lot of others. Well, what a nice note that is to end our session today on. Harmit, I want to thank you on behalf of Morgan Stanley for joining us today. And for all of you who tuned into today's session, thank you very much for your kind attention. Have a great rest of the day. And thank you, Kim. Thanks for inviting us. And a shout out to Aida and Chris, who helped me behind the scenes. So thank you all of you. Have a nice day. Have a good conference. Thank you. That concludes today's session. Thank you. Bye bye. Bye bye.