Ending February 28th, 2016. All parties will be in a listen-only mode until the question and answer session, at which time instructions will follow. This conference is being recorded and may not be reproduced in whole or in part without written permission from the company. A telephone replay will be available two hours after the completion of this call through April 18th, 2016, by calling 855-859-2056 in the U.S. and Canada, and 404-537-3406 for all other locations. Please use conference ID 81204858. This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for one month on the company's website, levistrauss.com. I would now like to turn the call over to Chris Ogle, Vice President, Treasury and Investor Relations at Levi Strauss & Co.
Thank you. Good afternoon, everyone, and welcome to our quarterly conference call. I'm pleased to introduce members of the Levi Strauss & Co. management team. With us here today are Chip Bergh, our President and CEO, and Harmit Singh, our Executive Vice President and Chief Financial Officer. Before we begin, let me briefly remind you of a few items. Our discussion today may include forward-looking statements, including statements regarding our strategies and expected financial and operating performance. Although these statements reflect the best judgments of our senior management, they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the statements, as more fully described in our quarterly report on Form 10-Q, our registration statements, today's earnings press release, and our other filings with the Securities and Exchange Commission, all of which are available on our website at levistrauss.com.
We expressly disclaim any responsibility to update our forward-looking statements. Other unknown or unpredictable factors also could have a material adverse effect on our future results, performance, or achievements. We provide information on our website about how we compile various measures used to describe our business performance. Participants on today's call may discuss non-GAAP financial measures. You'll find the appropriate reconciliations and descriptions of our non-GAAP financial measures at the earnings webcast page in the investors section of our website, as well as in today's earnings press release. Finally, today we filed our quarterly financial report on Form 10-Q with the SEC, and it's available on our website. I'll turn the call over to Chip Bergh.
Thanks, Chris. Good afternoon, everyone. Thank you for joining us today. We got off to a good start in our first quarter of 2016. Revenues were flat and gross and adjusted EBIT margins grew on a reported basis despite notable currency headwinds. On a constant currency basis, revenue grew 5% and profits were up double digits. We continued to execute on our long-term strategies to drive sustainable, profitable growth. The Levi's brand grew men's and women's tops and bottoms. Key international markets grew revenues, and our expanding direct-to-consumer channel continued to perform well. Harmit will now walk us through the financial details for the quarter. Harmit?
Thank you, Chip. Welcome to everyone joining our call. My comments today will reference first quarter comparisons on a year-over-year basis in US dollars, unless I indicate otherwise. First quarter net revenues of $1.1 billion were flat on a reported basis and grew 5%, excluding $46 million in unfavorable currency translation effects. Global revenues from our direct-to-consumer channel grew low double digit on a constant currency basis, driven both by improved performance of existing stores as well as ongoing expansion of the network internationally. In our wholesale channel, global revenues grew 1% on a constant currency basis. Global men's revenues grew low single digits, and global women's revenue grew in the mid-teens. Gross profit for the quarter grew 4% on a reported basis to $560 million as compared to $537 million last year. Despite unfavorable currency translation effects of approximately $24 million.
Reported gross margin grew more than 200 basis points to 53%. The improvement primarily reflected lower negotiated sourcing costs and growth in our higher margin international and retail businesses. The strong margin improvement was despite increased sales of discounted Levi's units in the U.S. as we began to manage high inventory levels of inventory we've seen in the quarter, and the impact this quarter incorporated of the Dockers transition. First quarter SG&A expense of $441 million was up from $425 million on a reported basis. Currency favorably impacted SG&A by $15 million. Excluding currency, higher SG&A reflected the ongoing expansion of our retail network and e-commerce business. We had 86 more company-operated stores at the end of the first quarter than we did a year ago.
Higher SG&A in the first quarter also included higher advertising investment, primarily associated with the activation of Super Bowl, as Chip discussed on our last earnings call. Of the 150 basis points increase in SG&A as a percentage of revenues, 130 basis points related to direct-to-consumer and advertising investments. Adjusted EBIT of $124 million grew 4% from the prior year on a reported basis and grew 12% without $9 million in unfavorable currency effects. As a percentage of net revenues, adjusted EBIT improved to 12% as compared to 11% last year, as a higher gross margin more than offset our increased direct-to-consumer and advertising investments. A detailed reconciliation of adjusted EBIT is attached to our press release. First quarter net income grew to $66 million as compared to $38 million last year. Higher adjusted EBIT, lower foreign currency transaction losses, and lower interest expense drove the increase.
I'll share more detail on the first quarter results of our three regions. Net revenues in the Americas declined 1% on a reported basis, but grew 2%, excluding $11 million in unfavorable currency effects. For the region, direct-to-consumer and wholesale revenues grew, primarily in Mexico. Traffic in our company-operated stores continued to decline, but we more than offset the impact through strong conversion and modest growth in e-commerce. Our U.S. wholesale business declined, primarily reflecting the Dockers transition. Adjusted EBIT for the Americas declined 18%, excluding $2 million in negative currency impacts, mainly reflecting Dockers transition costs and higher advertising expenses, as we expected. In Europe, net revenues grew 8% without $22 million in unfavorable currency effects, and on a reported basis were roughly flat to last year. Growth was driven by direct-to-consumer expansion and performance, concentrated in the U.K., Germany, and France.
Adjusted EBIT in Europe grew 15%, excluding $4 million in negative currency impacts, reflecting the revenue growth and a higher gross margin. In Asia, net revenues were up 10% without $13 million in unfavorable currency effects and were up 3% on a reported basis, primarily in our direct-to-consumer and traditional wholesale channels. China, India, and Japan comprise the majority of the region's growth in the quarter. Adjusted EBIT in Asia grew 6%, excluding $4 million in negative currency impacts, reflecting the region's higher net revenues. Turning to the balance sheet and cash flows. Inventory dollars and units are up, both from November and from a year ago. Nearly half the increase during the quarter relates to earlier timing of receipts, normal seasonal build, and expansion of our direct-to-consumer channel. We anticipated some inventory build given the tepid retail environment in our wholesale channel in the U.S.
The increase in inventory is largely comprised of core products that will continue into future seasons. We are proactively managing inventory down. It will take some time, and we expect to return to normal levels by year-end. While this will pressure gross margin, we still expect to achieve our full-year margin target of 51%. First quarter free cash flow was $28 million, up from $12 million last year and despite $8 million more CapEx this year. Total available liquidity at quarter end exceeded $1 billion, comprised of cash of $271 million and $740 million available under our credit facility. Net debt was $810 million, a modest decrease from $834 million at year-end, and our leverage declined slightly to 1.9 from 2.0 a year ago. Additionally, during the second quarter, we paid the $60 million dividend that we announced in February. With that, I'll turn it back over to Chip.
Thanks, Harmit. As you heard, a very solid start to the year. While it won't be easy in light of the fragile macroeconomic factors globally, we remain optimistic to deliver our full-year constant currency financial objectives of profitably growing revenues and gross margins. Meanwhile, we remain focused on our fiscal 2016 priorities to return the U.S. business and the Dockers brand to growth and to sustain growth in direct-to-consumer and our international businesses. In the first quarter, beyond the impact of the Dockers transition, our U.S. business trended somewhat better than we anticipated. Levi's brand revenues grew in men's and women's. Our direct-to-consumer channel offset lower foot traffic with conversion, expansion, and e-commerce. Consumer reception to our Levi's women's denim collection in our stores remains strong, and our Denizen and Signature products continue to perform well.
Our biggest challenge remains our U.S. wholesale business, which we expect will decline in the second quarter, reflecting the continuing soft conditions in this channel. Timing of some seasonal shipments as compared to last year, and the Dockers transition that we have referenced will also contribute to a softer second quarter. The Dockers turnaround is underway as we position for growth in the second half of this year. As I mentioned last quarter, we're taking the opportunity during this 30th anniversary year to begin to reposition the brand and migrate the product assortment toward more casual styles while simplifying the consumer shopping experience. During the first quarter of 2016, the decline in Dockers revenue from the transitioning product lines was partially offset by revenue growth in the brand's on-trend casual pants segment.
Toward the end of the second quarter, you will start to see on floors our revamped Signature khakis in a stretch fabrication. In fact, the product is now online, and based on early results, we are optimistic that as we move into the third quarter, we will pivot the brand to growth and deliver overall growth for the full year. As Harmit outlined, international direct-to-consumer momentum continued in the first quarter through our investment in stores and improved execution at retail. Several international markets were key to our growth, and we grew direct-to-consumer revenues through improved performance of our existing store base, as well as from the stores we've added since last year. Our retail footprint expansion continued in the first quarter, and we remain committed to opening more than 70 company-operated stores in 2016.
Looking forward, we expect the second quarter to be much softer than the first quarter performance suggests. Revenue growth is expected to be more muted, driven by the performance in U.S. wholesale. Adjusted EBIT is projected to decline year-over-year as we reduce inventory and spend more on advertising. In addition, we will also lap last year's gain on selling the facility in Turkey. With that, operator, we can open up the lines, and we'll take your questions.
Thank you. The floor is now open for questions. If you have a question, please press star, then number 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound sign. Because of difficulty hearing questions asked on a speakerphone or headset, we ask that you please use your handset. I will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jenna Giannelli with Citigroup.
Questions, good afternoon. First question, just on the gross margin expansion in the quarter. I think it was a little bit better than what we were expecting, but you seem to have a little bit more of a cautious tone for the rest of the year. Is that just kind of related to the elevated inventory levels, or is there anything else that you're seeing that the reasons why we shouldn't be bullish post the first quarter?
Yeah, Jenna. Thanks for the question. Gross margins have grown over the last couple of quarters.
Yeah.
Let's talk about the drivers of gross margin relative to a year ago for the quarter. I'd say close to 75%-80% of gross margin increases, thanks largely to us negotiating a lower cost with our vendors, combined with the fact that we've been able to, largely thanks to the global productivity initiative that we initiated in 2014, do things like simplify fabrics, et cetera. The other piece is structural. As we grow our international and retail businesses, that helps grow gross margin. To offset some of the currency issues, we've also taken pricing. Those factors are the key contributors. The other piece is as you model gross margin in our business, quarter two seasonally is probably our softest quarter.
As we project the year, the fact that we will be promoting a little bit more to manage our inventory down as well as just the seasonal effect is what drives us to project getting close to the 51% gross margin number that we reflected.
Okay, great. Thanks. Just a follow-up back, kind of going back to the inventories being up about, I guess, 25% year-over-year. Can you give us a sense of kind of where that is? Is it kind of more Americas, international, men's versus women's? How much of that was sort of planned versus just maybe more leftover product that we should think about you working through the rest of the year?
Sure. Basically, I'd say half of the increase during the quarter relates to three things. The earlier timing of receipts during the first quarter, planned seasonal build.
An expansion of our direct-to-consumer channel as well as our international businesses. The other half is largely driven by the tepid retail environment in our U.S. wholesale channel. Just something for you to be aware of, that in our business, the lead times are slightly longer. For example, as the environment slowed down, we were building inventory based on demand signals we received in the front half of 2015. As the demand signals slowed down, inventory built up. We've already begun to proactively manage it down. In quarter one, for example, we sold more incentive units than we'd originally planned for. It will take some time. We're doing a couple of things. We are reducing orders for core products. We're, as I mentioned earlier when I talked margins, we're promoting a little bit more. We're clearing inventory through off-price channels.
In terms of geographic mix, and in terms of the health of the inventory, the inventory is largely our core products, largely driven by men's. That's where we think we can manage it down over time without a dramatic impact to margins. Is largely based in the U.S. There's been some build internationally, but that's largely driven by the fact we're growing at a very fast pace and adding a whole bunch of stores. Hopefully this responds to your question.
No, it's very helpful. Thank you. Just one final one, if I may. The mid-teens growth that we're seeing in women's, how long can we expect that type of growth to continue? Is there anything kind of new or incremental from a product pipeline standpoint that we should think about for the rest of the year on top of what you guys have already done? Thanks.
Well, I'd like to be able to say that we can continue to grow double-digit for a long, long time. Of course, we'll soon be lapping the relaunch of the women's line. If you recall, that hit the floors kind of the end of the summer last year. We've got about another quarter or two of lower base, then pretty soon we're going to be up against the launch. Obviously, we've thought about that and planned it. We're continuing to innovate on our women's business, and we'll continue to bring some excitement to that business as we do begin to lap it. I don't know if we'll continue to grow at double-digit. I don't want to promise that.
We're really focused on accelerating the growth on our women's business, both tops and bottoms, and feel very confident based on the first three quarters since we relaunched it.
Okay. Excellent. Thanks so much.
Your next question comes from the line of William Reuter with Bank of America Merrill Lynch.
Hey, Bill.
Good afternoon, guys.
Hey. The changes in negotiated sourcing levels, which it sounded like contributed a lot to the gross margin expansion, when did those kind of changes get made, or when were those, I don't know, contracts or agreements or lower prices, when did those start?
We negotiate annually. You're seeing the impact of negotiations that took place last year for 2016. It's a constant process. We've been able to leverage our scale a lot better than we have in the past. That's largely thanks to the fact that we're really focused on the products we're introducing, as well as we're simplifying things like fabrics that I talked to you earlier.
Okay. With regard to the commentary about the second quarter getting softer, did you guys see a material change in the cadence of, I guess, the number of shoppers or the traffic in your stores, I guess, in the beginning of March relative to what you'd seen in the previous quarter?
No. Nothing significant in our stores. The revenue being a little muted is a combination of, I would say, the continuation of softer traffic trends we've seen in the wholesale channel, as well as some timing. Some spring shipments were shipped in Q1 as compared to Q2, as well as we see the orders for the second half of the year, we expect probably a lower replenishment of orders in anticipation of our fall products. That's really driving what we're signaling our revenue change in trends for quarter two. Plus, there's the Dockers transition.
Okay. Just lastly from me, you talked about weak traffic, and then you also talked about better conversion. I don't know if you can give us any context to what types of declines in traffic and what types of improvements in conversion we're seeing. Kind of related to that, what you are doing such that your conversion rate is improving. Thanks.
In terms of, Bill, traffic declines, going back a year, thanks to the currency pressures, we probably saw in our tourist locations traffic declines starting in quarter two, we'll probably start lapping that. We've been driving conversion now for a long, long time. Despite a traffic decline, our sales have largely been positive. A couple of things that are really driving that. We've been focusing on pushing the products that are really working. We've got better execution happening at the store level. That is a combination of product training, selling training, et cetera. As well as we've focused on building Levi's into more of a lifestyle brand and the focus on introducing the tees and growing the top business, our unit per transaction has also improved. That's why conversion overall, followed by UPT, are big drivers of it.
Okay. Thank you very much.
Thank you.
Your next question comes from the line of Carla Casella with JPMorgan.
Hi. I have a question about advertising spending. It was a little bit higher than we expected this quarter. I'm wondering, should the cadence of advertising spend be similar to last year for the rest of the year or is there any more shift as it goes with the quarters?
We spent, Carla, about 5.4% in quarter one. As we mentioned in our last call, we expect to be spending on a full year basis, probably 50 basis points more in advertising. On a full year basis, it's driven by the fact that we did activate the Super Bowl this year, as well as our businesses, especially in international expand. We're spending a little bit more in businesses overseas. Going back to quarter two, I'll just try and help you with the bridge for quarter two. We expect quarter two advertising to also pick up relative to last year. That's largely driven by the fact we're spending more money on TV advertising, for example, in the U.S., as well as more money in international. Most of the 50 basis points increase for the full year is projected to happen in the first half.
Okay. On the inventory side, you mentioned that you'll be able to manage down inventory. Should that be done by 2Q, or do you think some of that could be carryover into three or four?
I think a large part of it will actually happen in the second half, in Q3 and four. I think you'll see modest improvement in quarter two, but a lot more happening in quarter three. As we close the year, getting to year-over-year levels, which are a lot more modest in terms of increase than you've seen so far.
Okay. I would've thought with this cold April and the snow we've had, it might have helped some of the jeans over the spring merchandise. Another question on the Dockers side of the business. Can you just give us a little more commentary on the wholesale? When you talked about wholesale weakness, can you talk about Dockers relative to Levi's? How should we look at that as we go forward in the next couple of quarters?
Sure. I guess, the way to think about, they're interconnected, obviously, right? Dockers is predominantly a U.S. business and almost exclusively a wholesale business here in the U.S. Dockers has struggled over the last 18 months or so in wholesale, and that has brought our wholesale numbers down. Relatively speaking, Levi's is performing better in wholesale than Dockers. Dockers, we're trying to reposition this business for growth, which will begin happening kind of in the second half as we bring in new product that's really more market relevant. I talked about the Signature stretch product, which is now available online. That makes up a big part of the Dockers business here in the U.S., 40% of the business roughly. That'll be hitting wholesale floors kind of late second quarter.
As we've been trying to get ready to bring in this new product, we've been working with our wholesale partners to flush the old product. Obviously, investing in discounting that product to move it out of the stores to make room for the new product as it comes in. We invested a fair amount of money in that this past quarter, and it has negatively impacted our sales. It's all to set us up for what's to come in the second half. Not too different than what we did on the women's business, honestly, a year ago, where we had to get rid of old product on the floor in order to position us to launch more exciting market relevant product, which in the case of Dockers, will come in the second half of this fiscal year.
Okay, great. Then one housekeeping item. On your cash balance, how much of that is tied up overseas versus accessible in the U.S.?
Yeah. I'd say the way to think about it, Carla, is a third is tied up, a third is permanently invested. It's a third is tied up, but we can bring it back in through treasury and tax strategy, we do. A third is permanently invested, and about a third is in the U.S. Broadly speaking, that's how you should think about our cash at any point in time.
That's great. Okay, no change. Okay, thanks.
Your next question comes from the line of Grant Jordan with Wells Fargo.
Hey, good afternoon. This is David Aller on for Grant. You talked a couple of times about performance in Europe and Asia, with the store growth helping out there, but then you also called out strong performance. Could you maybe dive into what exactly went well, whether it be products or men's versus women's?
Yeah. I think you're referring to the fact that we've said that our direct-to-consumer business was driven both by strong performance of existing stores and strong performance in terms of opening new stores, and that is fact. Our business outside the U.S. is primarily retail. The way to think about is Europe is 50% wholesale, 50% retail. Asia is 70%, I would say, majority retail with a growing wholesale business. Both factors did contribute. In terms of what drove it, clearly, our women's products have had a major factor internationally. Largely because we are seeing good growth in our businesses that we run, which is our retail doors, and that's across the world, including the U.S. Internationally, the retail business is a stronger component. The other fact that's driving our direct-to-consumer business overseas is also e-commerce.
We've seen good e-commerce growth both in Europe as well as Asia. We talked about execution at retail stores. Conversion as well as UPT across our retail businesses internationally has also been fairly strong.
I guess I would just add one other thing, Grant. Execution has been really, really important. Harmit mentioned a minute ago that we're investing a little bit more money in marketing support, both in Europe and Asia, because we've got pretty compelling evidence that it's working. If you were to talk to Seth Ellison, our president of the European business, he would say the Levi's brand is really strong right now and on a roll. We're growing share. We feel really, really good about the growth that we're seeing on our business. The women's business in both Europe and in Asia, since we've relaunched it, has been growing really strongly in both regions. We're just trying to go from success to success. We are investing behind that, given the really strong results that we're seeing in what you guys know is a very difficult environment.
Great. Then, turning to just kind of the depth of the M&A market. The number of deals that maybe you've seen or looked at over the last couple of years, how does that compare to the pipeline you're looking at right now? If you could update us on your appetite for either bolt-on M&A or more transformational deals.
Yeah. David, difficult to comment on the pipeline, but I'd say that our balance sheet is a lot stronger. I'd also say that, given the growth we have seen over the last couple of quarters and what we think about our business long term, we believe we can grow this business organically at a steady clip. In terms of M&A activity, it's probably going to be opportunistic, if at all. If something comes along that we think complements our brands and the strategic direction of the company, we'll take a look at it.
Okay. Last question from us. On the Dockers transition, I think you said maybe in Q2, you'll kind of be phasing out of the discounting and clearing the old product. Is that correct? You said you expect to grow for the full year. I'm guessing that was kind of the sales number, not the profit number. Is that accurate?
Yep, that's accurate. I don't want to promise that all discounting will be done by the second quarter. A lot's going to be based on what's still left in the doors. By the end of the second quarter, we will have the new Signature stretch. Signature is 40+% of the Dockers business at wholesale here in the U.S. That new product will be on the floor along with some new signage. We'll probably still have some carryover product trickling into the third and fourth quarter. The casual part of our business is growing right now as we speak. A lot of that product has stretch in it already. By resetting this other 40%, we do expect the second half will grow and that we will grow for the year.
Said differently, the growth in the second half is going to offset the decline in the first half. That's the expectation.
Okay, great. Thanks for taking the questions.
Yep, good talking to you.
Your next question comes from the line of Hale Holden with Barclays.
Hi, thank you for taking the call. Just a couple of questions. I'm wondering, what is the conversation like between you and your retail customer? Do you see sort of retail buying less from you as a function of them being a little bit more cautious than you expected?
Well, I guess probably the best way to answer that is to say that we view our relationship with every single one of our customers as a real partnership, and that we're focused on each other's best interest. Some of their customers are growing and it's working, and our business is working inside their stores. In a couple of other instances, we're a little bit more challenged, and they're a little bit more challenged. That's just an opportunity to continue to work on getting things right. I really don't want to comment on whether they're cutting back orders or they're open to buy budgets. You can ask Ben that question. We're focused on partnering with each one of our customers to try to build our business and build our brands in their stores.
Got it. Given the recent outperformance, I guess, from your women's line, are you seeing a little bit more floor space, wholesale floor space from your customer?
At this point, no.
Got it. Another one, just quickly on SG&A. Can you maybe break down the incremental investment in SG&A? Is it related to maybe a spike in store opening in 2Q, or is some other major project you're working on your DTC department, and can you just comment on that?
Sure. Let me try and break it up because I heard SG&A, and I also heard a reference to quarter two. Let me try and help you on both. Let's start up with quarter one. SG&A as a percentage of revenue was 41.8%, and it was 150 basis points higher than a year ago. 70 basis points was largely driven by higher selling expenses, which is primarily our investments in e-commerce, and to the question you asked, the 86 store increase that we've seen year-over-year. That's one piece of it. The 60 basis points increase was driven by higher advertising investments, and that's again, primarily associated with the Super Bowl activation.
That's the first piece of it, which means our organic SG&A is largely in check and in fact, in control, and is largely driven by the fact that we are focused on managing our cost, especially as we implement our Global Productivity Initiatives. Talking about quarter two, because we did say that in quarter two, besides the revenue being muted, EBIT will also decline year-over-year. That's really driven by a couple of factors. One is the higher spending in advertising, and if you heard my comments to Carla, we are spending 50 basis points more in advertising for the year. A large part of that is in the first half. The second piece is, last year in quarter two, we actually recorded an $8 million gain through the sale of our finishing and distribution facility in Turkey.
That's something that will not be offset this year. The other piece is with revenues a little bit more muted than quarter one, and expenses a little higher. The SG&A percentage will be higher, and that's why adjusted EBIT as a percentage in quarter two, we expect will be lower.
Great. Thank you very much. That's all my questions.
Thanks, Hale.
Your next question comes from the line of Paul Trussell with Deutsche Bank.
Just following up on Carla's advertising question. I mean, a high 6% of sales range?
Yes, that's right.
Yep.
A year ago, it was 6%, with a 50% increase in basis points, we're talking six and a half.
Okay. When we think about repositioning Dockers, once we get through the older inventory, will we see this roll out uniformly? Will this be more to your stores at first and then wholesale? What's going to be really different about Dockers today versus Dockers when it's repositioned?
Well, it's really fundamentally a wholesale business here in the U.S. It's going to be what you see in wholesale. I think what you're going to see that's different, I should say that we've obviously shared this with all of our key customers, They're genuinely excited about it too, is a dramatic simplification of the shopping experience for the consumer. We're moving to essentially four pillars, which really reflects the casualization trend that's happening, along with a move towards more stretch fabrication. You'll see different in-store signage and the way the brand shows up, different way it's merchandised, much more focus on casual looks and more focus on more innovative stretch fabrics.
Okay. When you guys-
It's a pretty significant change versus what you would see in the store today, which is a little bit of a collection of multiple years of trying different things on this business that makes the shopping experience more challenging for the consumer. It cleans it all up, it simplifies it dramatically. It moves towards looks and silhouettes that the consumers are looking for today with fabrications that they want.
Okay. When we look at your, you mentioned annually renegotiating sourcing costs. When we look at cotton costs out on the market today at long-term lows, is that something that we can capture this year or is that more of a benefit into 2017?
More 2017, [Karu], because largely through our negotiations for this year. Cotton, for example, the latest cotton prices are probably 10% down from the lows we have seen.
To be clear, we don't buy cotton.
Yeah. Most of our sourcing is to third parties. Cotton is just one input component that goes into our manufacture. The other costs, which are largely wage inflation, we expect part of that to be offset with costs like higher wages, et cetera.
Okay. Just lastly, you guys have a small stub piece of those yen bonds still outstanding. They're a bullet to November, I think, 2016 here. What's the thought process for those?
November is not very far. We expect when November comes, we'll probably pay the bonds down at that point of time.
Thank you very much, guys. Appreciate it.
Okay, Karu.
Your last question comes from the line of Kevin Coyne with Goldman Sachs.
Hi, good afternoon. Thanks for taking the questions. Most have been asked and answered, but just a couple of follow-ups. Harmit, I think it was you who mentioned that the excess inventory or the inventory build was in the core product and mostly men's. Would you say that that excess inventory was more due to just weaker consumer trends, or was there anything to do with fashion as to why it was kind of left on hand?
It's basically the weaker retail environment, some seasonal builds earlier than we thought, and some timing of receipts earlier than we thought. That's why we think the health of the inventory is solid. The question is, do we mark the product down and sell and bank the cash, or do we sell it over time? That's the commercial equation that we grapple with. We're committed, given the amount of cash we have tied up in inventory, we're committed to manage the levels down through the rest of the year.
Okay. That's helpful. Thank you. Just one final one. When thinking about wholesale and your guidance for 2Q, you mentioned, I believe that you think you've held your own or held steady the shelf space. With a lot of wholesale partners closing stores, would you say that or can you quantify the % of, let's say, shelf space or square footage you would be down this year versus last year as a result of some of these door closures?
Kevin, what we said earlier is that we don't think it's going to be material for two reasons. One, the stores that are closing are low volume stores. The impact on that in our total business is not dramatic. The second is, given our past history, where some of our customers have closed stores, we've been able to remap that either through our own stores or through other wholesale retailers.
Okay. Thank you.
Yeah.
Thank you. All right. Thank you all for joining us. We're pleased with the start to the year that we've had. Pretty broad-based and balanced growth on a currency-neutral basis, we remain optimistic that we'll deliver on our commitments for the year. Thanks a lot for joining us. Thanks for your questions, we look forward to talking with you next quarter.