To the Levi Strauss & Co.'s first quarter and fiscal year 2015 earnings conference call. 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 21st, 2015, calling 800-585-8367 in the U.S. and Canada, and 404-537-3406 for all other locations. Please use conference ID 13108371. 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'd now like to turn the call over to Chris Ogle, Vice President, Investor Relations, and Assistant Treasurer at Levi Strauss & Co..
Good afternoon, everyone. Welcome to our conference call. I'm pleased to introduce the Levi Strauss management team today. Chip Bergh, our President and CEO, Harmit Singh, our Executive Vice President and Chief Financial Officer. Let me remind you of a few items. Our discussion may include forward-looking statements concerning matters such as our expected financial and operational performance, including guidance for fiscal 2015, our strategic plans, expectations for economy and currency headwinds to both reported revenues and earnings, anticipated full year A&P spend, future investment in retail and e-commerce, reduction of controllable costs, and long-term estimated savings from our global productivity initiative. These are based on our current assumptions, expectations, and projections about future events. Although they reflect the best judgments of senior management, they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the statements.
This is more fully described in our annual report on Form 10-K, our registration statements, and the other filings we make with the Securities and Exchange Commission. We expressly disclaim any responsibility to update these forward-looking statements. Other unknown or unpredictable factors could also have material adverse effects on 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 refer to non-GAAP financial measures, and you'll find the appropriate reconciliations at the earnings webcast page in the investors section of our website, as well as in our earnings press release announcing first quarter 2015 financial results, which was furnished with the SEC today on Form 8-K.
Finally, today, we filed our quarterly financial report on Form 10-Q with the SEC, and you can link to our SEC filings from our website. Now I'll turn it over to Chip Bergh.
Thank you, Chris, and good afternoon, everyone. Thanks for joining us today. As expected, the first quarter presented some challenges, not least of which were currency headwinds, which significantly impacted our reported results. However, by executing our strategies, we grew our global direct-to-consumer business, capitalized on trend right product offerings, grew the Levi's women's business, and delivered cost savings from the Global Productivity Initiative we launched last year. Looking beyond the impacts from currency and other one-off items, the business continues to perform well in line with our expectations. We are offsetting wholesale declines with direct-to-consumer growth. We are combating traffic declines with better conversion and improved product offerings. Our gross margin is improving, and base overhead costs are declining. We believe that the continued execution of our strategic blueprint will yield sustainable, profitable growth in the years to come. Harmit will now walk you through the financial details.
Over to you, Harmit.
Thanks, Chip. Welcome to everyone joining our call. My comments today will reference first quarter comparisons on a year-over-year basis in U.S. dollars unless I indicate otherwise. Net revenues of $1.1 billion declined 7% on a reported basis. Excluding unfavorable currency translation effects of more than 500 basis points, net revenues declined 1%, as a 3% decline in wholesale revenue offset direct-to-consumer revenue growth of 4%. We achieved these results despite losing the benefit of the Black Friday week, shifting our women's Dockers business to a licensed model, and working through slowdowns at the ports. Excluding these impacts, total consolidated net revenues in constant currency would have been up low single digits. Gross profit for the quarter declined 7% to $537 million on a reported basis, in line with the revenue decline.
Excluding the unfavorable currency translation effect, gross margin of 51% was up 30 basis points, reflecting lower negotiated product costs and continued savings from streamlining our supply chain as part of our Global Productivity Initiative. First quarter SG&A expense of $425 million was flat to the prior year on a reported basis. Favorable currency effects of $22 million offset a timing-related increase in A&P spending. Ongoing savings from our Global Productivity Initiative offset $11 million increase in expenses related to the expansion of our direct-to-consumer business. As a reminder, we anticipate full-year A&P spending as a percentage of revenue to be in line with prior year, at around 6%. The nature of our marketing program this year will result in a more balanced allocation of A&P dollars across the four quarters of 2015. Adjusted EBIT of $120 million, decline $39 million from the prior year.
The decline was primarily driven by unfavorable currency effects of $13 million and the timing of the A&P expenditure. As a percentage of net revenues, Adjusted EBIT was 11%, down from 14% last year. A detailed reconciliation of Adjusted EBIT is attached to our press release. First quarter net income of $38 million, declined $12 million from last year. Foreign currency transaction net losses and the A&P timing offset lower interest expense and restructuring charges. Now I'll share more detail on the first quarter results of our three regions. Net revenues in the Americas declined 7% in constant currency and 8% on a reported basis. The decline reflected our decision to license women's Dockers and the fiscal calendar shift, which hurt both retail and wholesale. On top of this, we had the well-publicized port issues to navigate.
The region's Adjusted EBIT declined 8%, reflecting increased advertising investment and the lower net revenues, partially offset by a higher gross margin. Net revenues grew 9% without the impact of currency, but fell 8% on a reported basis. Adjusted EBIT was down just 2% on a currency-neutral basis, but with the negative impact of currency declined 19%. These significant swings dimensionalize the softness of European currencies relative to the dollar. On a constant currency basis, revenue growth was driven by strong retail performance and expansion, and the slight Adjusted EBIT decline reflected higher selling and advertising expenses, which offset the higher net revenues. In Asia, net revenues were up 5% without the effect of currency, but flat on a reported basis. Direct-to-consumer revenues grew in a promotional environment. China, India, and Japan all grew again. Adjusted EBIT grew 4% without negative currency effects owing to the revenue growth.
Turning to the balance sheet and cash flows. Excluding the effects of currency, inventory dollars and units are up from November, reflecting our normal seasonal build. Compared to a year ago, inventory dollars and units declined, reflecting improved inventory management. Free cash flow for the first quarter of 2015 was $12 million, and capital expenditures were $21 million. During the first quarter of 2015, on a gross basis, we opened nearly 20 of the 60 stores we plan to open this year. Liquidity remains strong. Total available liquidity at quarter end was $920 million, comprised of cash of $203 million and $717 million available under our credit facility. Net debt of $923 million was flat to year-end, and leverage as we define it was 2.0 compared to 2.7 a year ago. Lower leverage primarily reflected the redemption of our Euro notes last year.
Before I close, I wanted to spend another moment on the impact of the strong dollar. As anticipated, currency headwinds are indeed having a significant impact on our reported results. We are taking appropriate actions to mitigate as much of the impact as possible, but we expect it to remain a stiff headwind for the rest of 2015. Based on current rates, we now believe that the negative impact to full-year revenue will be in the range of 500 to 600 basis points, and the negative impact to Adjusted EBIT in basis points will be roughly twice that. With that, I turn it back over to Chip.
As Harmit discussed, currency and several unusual impacts affected the reported results for the quarter. Looking past those items, however, we continue to experience solid momentum as we maintained our focus on driving sustainable, profitable growth. We grew our direct-to-consumer business globally, driven by performance and expansion abroad. In Europe, we saw particular strength in the U.K., Spain, and Russia, while in Asia, sales around Chinese New Year were strong. You will see us continue to invest in these regions to maintain the momentum. In the Americas, underlying performance in our company-operated stores remained solid. We continue to drive conversion in our outlet stores and to grow e-commerce. From a product standpoint, around the globe and across channels, we're seeing strength in slim and tapered styles.
The slim-fitting Levi's 511 jean remains one of our best performers, we've expanded the Levi's assortment to include offerings like the 541 athletic fit and the tapered 501 CT, both of which are selling well. Demand remains strong for our slimmer Dockers offerings, including the Alpha series. Our global Levi's women's business grew again, driven by a positive response to on-trend spring seasonal assortments, as well as ongoing consumer response to the softer, stretchier products we introduced last summer. The Levi's 501 CT for women is showing encouragingly early results in the market. We believe the full reset of the Levi's women's business ahead of fall will provide us with even better positioning and will drive results in the second half. We also benefited from lower expenses related to the global productivity initiative we launched last year.
These savings helped to offset the negative currency impact to our earnings this quarter and will help fund our direct-to-consumer business expansion and the investment behind our brands to support our long-term growth objectives. In 2015, we will continue to execute the productivity initiative, setting the stage for a more agile company. We anticipate the benefits of this program to become even more evident as we move through the year. With that, we'll take your questions.
Thank you. The floor is now open for questions. If you have a question, please press star, then the number one 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. Your first question is going to come from the line of William Reuter with Bank of America Merrill Lynch.
Good afternoon, guys.
Hey, Bill.
I was wondering if there was any way you could quantify what you achieved due to the Global Productivity Initiative during the quarter and what may have been reinvested in the business in other places.
Bill, as I referenced in the prepared remarks, we invested in the business approximately $11 million in terms of expanding the direct-to-consumer business, and that was broadly offset by the Global Productivity Initiative savings. That's one piece of the savings. The Global Productivity Initiative actually also helps reduce the cost of goods sold. Our gross margin performance, as you probably observed in the quarter, was pretty good relative to a year ago, despite currency headwinds. Essentially, we're offsetting currency downside through the margin expansion by reducing cost of goods sold, and that impact is about 30 basis points.
Okay. That's very helpful. My second question is on your inventory, which looked low and down on a year-over-year basis. How much of this may have been due to the impacts of the West Coast port delays, can you talk a little bit about how you feel about your inventory position?
Overall, we're feeling good about our inventory position. I think the year-over-year decline has partly to do with the fact that we had a buildup in inventory last year for a whole bunch of reasons. In terms of the impact because of the port strike in terms of inventory being down, I think it's largely minimal. The way to look at our inventory, because the currency headwind also impacts currency. If you just equalize for that and just look at inventory on a unit basis, the units also declined relative to last year. Relative to where we ended the year last year, which is in quarter four, inventory dollars and units were up a little, that is normal seasonal buildup.
Okay. That's very helpful. It sounds like the women's reset. I guess, can you give us a little more specificity about what month you expect that to launch into? I guess, in anticipation of that, will we see any sales slow down as maybe the legacy products are not purchased?
Bill, it's Chip. The women's reset should start hitting the floors around August, in advance of the fall season. Late July, early August, we'll see it. We are anticipating a little bit of a drawdown. It's built into our plan. As we head into the women's reset, I think that's going to be normal. We'll see product going on sale as retailers try to clear out the old product and make room for the new product coming in. Our ability to execute through this and execute it brilliantly will, in the end, have a pretty strong determining factor on how our women's business performs for the full year. What I can say, just to reinforce it, is we have tested the new women's line globally. Been around the world a couple of times qualifying it with consumers.
We actually have it in a few of our own stores right now to get early pre-market learning on it, which will further guide us in terms of how we show up, in terms of in-store navigation and things like that. The early results from that are also pretty positive. Late summer is when it'll be on floor, and a little bit of a slowdown leading into that as retailers, wholesalers naturally draw down the inventory.
Great. Thank you very much.
Your next question will come from the line of Karru Martinson with Deutsche Bank.
Good afternoon. Just to circle back on the guidance here with the FX. If I look at the first quarter, Adjusted EBIT was down 24%, a little over that. What gives you the confidence that the impact would be double the sales impact, that 10%-12% range?
Good question, Karru. The Adjusted EBIT being down, a part of that is because of the shift in timing of advertising. I think if you look at advertising quarter-over-quarter in pure dollars, the increased dollar spending is about $20 million. I would normalize that for the year. I think the best way to look at the quarter in terms of actual performance, in quarter one, our EBIT percentage and percent of the revenue is approximately 11%. That's what we ended last year as a percentage to revenue. During the first half of the year, a couple of things are going to happen that will depress our earnings for the first half versus the second half. First is the normalization of advertising, and second is just the shift in the fiscal calendar that will have an impact on revenue.
The other thing, as Chip talked about, transition of the women's product. That also happens in the first half of the year. I think there's a couple of things that will probably depress our earnings for the first half. I hope that answers your question on foreign currency.
Karru, this is Chris, and I just want to make sure that I understood your question because it would be relevant to the audience, which is to say our discussion around the impact of currencies to Adjusted EBIT was not to say that we project EBIT will be down 10%-12%. What we're saying is that the impact of currency will cause a 10- to 12-point difference between our reported earnings and our constant currency earnings. In our Q1, where you see we posted a 24% decline on a reported basis, but a 17% decline, that's the 700 basis points that we're comparing to the numbers that Harmit gave you. We definitely want people to walk away understanding that that's the basis points impact between reported and constant currency.
Great. Thank you. Appreciate that clarification. On gross margin, when we look at the second half of the year, what's the potential upswing here from the lower cotton pricing, and how will that flow through?
There is a benefit. That benefit probably gets offset with the impact of the currency headwinds. I think the way to look at our gross margin is, we have said in the prior call, and we're reinforcing it again today. I think we expect our gross margins to be approximately in the 50% range for the year. The way we're thinking about it is, any adverse impacts on currency get offset by positive improvement or impact because of lower cotton, as well as all the initiatives on the supply chain side that we're implementing across the system.
Just lastly, a big picture view. We heard a lot from last year on how athleisure was siphoning off dollars, particularly on the women's side. What are the trends looking like for the 2015 season?
Athleisure is still there as a factor, but what we're seeing in denim, and you're probably seeing this as you walk the streets, is two things. Soft, stretchy, super stretch, super tight, more comfortable denim is still in favor with consumers, with women. The other thing that's starting to happen that is definitely becoming a trend is more of the boyfriend jean. We'd like to think that we may be leading some of that because the 501 CT, which we introduced for women, is more of a boyfriend-type cut. Destructive denim is also definitely a trend on both men's and women's, and we've got product to match those trends. Athleisure's still there and growing. It is a dynamic for sure, it, last year, did have an impact on overall denim sales.
We're seeing that impact start to slow as we've got more product that meets that consumer need for comfort.
Thank you very much, guys. Appreciate it.
Your next question will come from the line of Grant Jordan with Wells Fargo.
Great. Thanks. I'm on the wrong line, I'm going to answer. Maybe just give us, one, if you can tell us as we look out over the quarters of this year, is there a particular quarter that, based on the FX, you think is gonna be worse? It sounds like maybe Q2 is gonna show a lot of the brunt of the decline.
I'd say it's probably evenly spread. It probably depends what happens to the dollar relative to the other currencies. I'd say generally speaking, our quarter two is weaker than most quarters. So you'll probably see a bigger impact in quarter two relative to the other quarters.
Okay. That's helpful. Then second question. Has the wholesale environment changed from a big picture perspective from your standpoint, and any read-through on consumer spending?
No, it's still a pretty challenging environment. You heard it in the overall comments. Wholesale was down in the U.S. Partially offset by growth of our own retail. It's still a tough environment out there.
Okay, great. Thank you.
Your next question will come from the line of Carla Casella with J.P. Morgan.
Hi, I'm just wondering if you can give us some sense for, this wholesale, you think it remains weak through second quarter and spring, now that we're kind of through the winter heavier jean season?
Yeah. Carla, I think, as Chip referenced, our anticipation is wholesale remains weak. As earlier mentioned, in quarter two or the first half of the year, we are transiting, especially as we launch the new women's product in the second half of the year. I think you'll see modest softness. We're pleased with how our retail stores are performing. We expect over time, both within the U.S. as well as globally. Outside the U.S. is largely a retail business, and that continues to perform as you've seen from the numbers in Europe and Asia. We think globally, we're able to offset some of the softness in the wholesale channel during the year. Longer term, with new product introduction, I think that's where we see wholesale over time picking up.
I guess I would add just, part of the reason there was that long pregnant pause after you asked the question, we were all sitting here looking at each other is we're obviously in the middle of the second quarter and can't really comment on actual results. Obviously, wholesale is such a big part of our business here in the U.S. that we're working with our partners and doing all that we can to get these trends reversed. I think there may be some dynamics that are gonna come into play over the course of this year with the stronger U.S. dollar. There's gonna be less tourism. What kind of impact is that gonna have on the wholesale business, particularly when you start thinking about the location of some of the doors of some of our bigger retailers or wholesale partners?
I guess our attitude is to focus on the things that are within our control. I say that all the time. Plan for the worst and hope for the best and continue to work hard to get that wholesale business back on track and growing again.
Okay. I guess I'm trying to get a sense for, though, wholesale overall, is it just traffic to those retailers where you're selling into or have they started allocating space away from the category?
No, we haven't seen any of the latter. In fact, we're always going out there trying to get more than our fair share of space. There hasn't been a reduction in space amongst our key customers. I think it's a combination. Weather thing was definitely an issue again in the first quarter. We were lapping. The denim was on a down cycle. That was certainly a dynamic. All of these retailers have also had a pretty tough year or two years when you look at their overall results. For the most part, most of them have had some challenging quarters.
Okay, great. Then in your prepared remarks, you mentioned there were some timing issues in the A&P spending. I'm just wondering the magnitude of that and what month was it shifted from and to?
Yeah. Overall, Carla, we still expect to spend as a percentage of revenue, about 6% for the year. In the past at least two years, that spending has skewed towards the second half of the year. This year, given that we have a fairly successful campaign in Live in Levi's, given that we're introducing new products, like the 501 CT as an example, and with our women's reset happening, we expect to normalize the spending. For example, in the quarter, as a percentage, advertising was 4.8%, which is up by about two percentage points from the last quarter. Still within the 6%, but up quarter-over-quarter. Our sense is you'll probably see a similar lift in quarter two, and then that gets normalized in the second half.
Just to build on this, the other reason last year, we knew we were coming with Live in Levi's in the second half, we were kind of trying to keep our powder dry so that we had the maximum amount of money to put against the new campaign because we had a great deal of confidence in it. Now that campaign has proved itself in the marketplace, we're committed to trying to smooth our advertising spending across the full year because advertising should drive revenue growth. We feel confident that this campaign will do that.
Okay, great. Just one housekeeping. The restricted payment basket
Yep. It's 800-
It's important if he doesn't ask.
$800,000. $800 million. I keep saying thousand.
$800 million.
$800 million.
Okay, thanks.
That's right.
Your next question will come from the line of Jayne Hale with Barclays.
Keep waiting for you guys to use the RP basket and get a different number for Carla. I had two questions. You mentioned you've kind of got the design locked for women's jeans coming out in the summer, it would require, I think in your words, a brilliant executional launch. I was wondering what some of the components that would go along with that that maybe we could watch for from home to see if you're on track.
I think what it's going to look like is transitioning out of the old product pretty smoothly and getting the new product on the floor in a way that there isn't massive confusion to the consumer. Remember, what the women's reset is all about is a clear navigation, a simpler shopping experience for the consumer. Helping her to find the fit and the product that she's really looking for. We're testing a lot of these navigation and in-store signage propositions in a couple of our stores around the world right now and getting some good learnings from it. Success will look like, when you walk into one of our wholesale customers, and you walk into the women's section, you see clear navigation. You see the breadth and depth of the new line on floor.
Hopefully, you see a lot of consumers standing there buying product as well.
Are you seeing an increase in orders from your wholesale customers ahead of that launch, or are they kind of keeping everything close to the vest?
There's clear interest. We look at it differently across the world. There's clear interest, and that's why we're confident about it.
It's gotten really good reception. I think it's probably premature to talk about the orders. We typically don't talk about customer orders and things like that. What I think it is very fair to characterize the response from our customers has been very enthusiastic.
Great. I think you said that there was an $11 million offset to restructuring savings that got invested in direct sales, and I was wondering what kind of the components of that was. Was that an expense or a capital charge, or?
No, it's expense. It's largely direct-to-consumer business, it's towards e-commerce initiatives as well as we're growing our retail store base, as we open new stores, that makes a difference. Only other thing I'd say on the e-commerce business, we are investing behind technology. That's in a part of it.
All right, great. Thank you very much. I appreciate the time.
Thanks.
Your next question will come from Todd Harkrider with UBS.
Yes. If I look at the Americas on a two-year basis, revenues are down around 10%, but of course, there's a lot of moving parts with Black Friday timing shift, weather issues, and you licensing some businesses. Can you talk about maybe what organic revenues were over the two-year period?
We don't have that number off the top of our head. There's been a lot of calendar movement in the Americas business. I'd say the one pleasing part of the Americas business has been our performance in retail. Despite traffic declines, we've continually demonstrated growth in retail largely through better conversion and higher units per transaction. On the wholesale side, introduction of shop-in-shops, for example, has made a difference.
That's good to hear. In Asia, despite the promotional environment, operating income grew at a similar rate as revenues. Can you talk about if that was due to your global cost reduction efforts there or any additional color on the bottom line in Asia would be helpful. Thanks.
I think costs continue to play a part. I think our margins are a little better as we navigate through the promotional environment in Asia, as well as the strengths of our core business. We talked about China, India, for example, growing again. Those are big businesses for Asia and a growing middle class. As those businesses tend to improve, that makes a difference in terms of overall Asia performance.
Yeah, I appreciate it. Good luck with the rest of the year. Thank you.
Thanks. Thanks, Todd.
At this time, I'd like to turn the floor back over to the company for any closing remarks.
Okay. Well, thank you all very much for joining us, and for your great questions. We'll look forward to talking with you again at close of next quarter. Thanks very much.
Thank you. This concludes today's conference call. Please disconnect your lines at this time.