Earnings Call: Q1 2015

Apr 14, 2015

Welcome to The Levi Strauss and Company's First Quarter and Fiscal Year 20 15 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 2 hours after the completion of this call through April 21, 2015, calling 800-585-8367 in the United States 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 1 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 and Company. Good afternoon, everyone. Welcome to our conference call. I'm pleased to introduce the Levi Strauss management team today Chip Berg, 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 and P spend, future investments 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. And 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 ks, our registration statements and the other filings we make with the Securities and Exchange Commission and 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. And 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 Q1 2015 financial results, which was furnished with the SEC today on Form 8 ks. 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 Berg. Thank you, Chris, and good afternoon, everyone. Thanks for joining us today. As expected, the Q1 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 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 Q1 comparisons on a year over year basis in U. S. Dollars unless I indicate otherwise. Net revenues of $1,100,000,000 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 doctors 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 $537,000,000 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 and A expense of $425,000,000 was flat to the prior year on a reported basis. Favorable currency effects of $22,000,000 offset a timing related increase in A and P spending. And ongoing savings from our global productivity initiative offset $11,000,000 increase in expenses related to the expansion of our direct to consumer business. As a reminder, we anticipate full year A and P spending as a percentage of revenue to be in line with prior year at around 6%. But the nature of our marketing program this year will result in a more balanced allocation of A and P dollars across the 4 quarters of 2015. Adjusted EBITDA of 1 $120,000,000 declined $39,000,000 from the prior year. The decline was primarily driven by unfavorable currency effect of $13,000,000 and the timing of the A and 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 $38,000,000 declined $12,000,000 from last year. Foreign currency transaction net losses and the A and P timing offset lower interest expense and restructuring charges. Now I'll share more detail on the Q1 results of our 3 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. And adjusted EBIT was down just 2% on a currency neutral basis, but with the negative impact of currency decline 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 slide 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 Q1 of 2015 was $12,000,000 and capital expenditures were 21,000,000 dollars During the Q1 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 $920,000,000 comprised of cash of $203,000,000 $717,000,000 available under our credit facility. Net debt of $923,000,000 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'll 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 5.11 jean remains one of our best performers and we've expanded the Levi's assortment to include offerings like the 541 athletic fit and the tapered 501CT both of which are selling well. And 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. And the Levi's 501CT 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. Questions. And 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 initiatives during the quarter and what may have been reinvested in the business and other places? Bill, as I referenced in the prepared remarks, we invested in the business approximately $11,000,000 in terms of expanding the direct to consumer business and that was broadly offset by the global productivity initiative savings. So that's one piece of the savings. The global productivity initiative actually also helps reduce the cost of goods sold. And our gross margin performance as you probably observed in the quarter was pretty good relative to a year ago despite currency headwinds. So 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? And 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 of inventory last year for a whole bunch of reasons. In terms of the impact because of the post strike in terms of inventory being done, I think it's largely minimal. The way to look at our inventory because the currency headwind also impacts currency. So if you just equalize for that the 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 4, inventory dollars in units were up a little and that is normal seasonal buildup. Okay. That's very helpful. And then it sounds like the women's reset will come. I guess, can you give us a little more specificity about what month you expect that to launch into? And I guess, in anticipation of that, will we see any sales slowdown as maybe the legacy products are not purchased? So Bill, it's Chip. The women's resets 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. And the early results from that are also pretty positive. So late summer is when it will 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. And 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 Q1, adjusted EBIT was down kind of 24%, a little over that. What gives you the confidence that the impact would be kind of double the sales impact in kind of that 10% to 12% range? Good question, Kevin. The adjusted EBIT being down is 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 $20,000,000 So I would normalize that for the year. I think the best way to look at the quarter in terms of actual performance in quarter 1, our EBIT percentage as a percent of the revenue is approximately 11%. That's what we ended last year as a percentage to revenue. And 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. So I think there are a couple of things that will probably depress our earnings for the first half. I hope that answers your question on foreign currency. Yes. And 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% to 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. So 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. So we definitely want people to walk away understanding that that's the basis point 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? Yes. So I mean there is a benefit. That benefit probably gets offset with the impact of the currency headwinds. I think the way to look at it, 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. So the way we're thinking about it is any adverse impacts on currency get offset by positive improvement or impact because of lower quartant as well as all the initiatives on the supply chain side that we're implementing across the system. Okay. And just lastly kind of a big picture view. We heard a lot from last year on how athlete leisure was kind of siphoning off dollars particularly on the women's side. What are the trends looking like for the 2015 season? So, I mean, 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 2 things, soft stretchy, super stretch, super tight, more comfortable denim is still in favor with consumers with women. And then the other thing that's starting to happen that is definitely becoming a trend is more of the boyfriend gene. We'd like to think that we may be leading some of that because the 501CT 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 is still there and growing. It is a dynamic for sure and last year did have an impact on overall denim sales, but 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. And your next question will come from the line of Grant Jordan with Wells Fargo. Great. Thanks. I'm a little bit of an answer. But 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 going to be worse? I mean, it sounds like maybe Q2 is going to show a lot of the brunt of the decline? I'd say it's probably even the spread. It probably depends what happens to the dollar relative to the other currencies. I'd say generally speaking our quarter 2 is weaker than most quarters. And so you'd probably see a bigger impact in quarter 2 relative to the other quarters. Okay. That's helpful. And then second question, has the wholesale environment changed from a big picture perspective from your standpoint? 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. But it's still a tough environment out there. Okay. Great. Thank you. And your next question will come from the line of Carla Casella with JPMorgan. Hi. I'm just wondering if you can give us some sense for I mean, this wholesale, you think it remains weak through through Q2 and spring? I mean, now that we're kind of through the winter heavier jeans season? Yes. Carl, I think, as Chip referenced, our anticipation is wholesale remains weak. We are and as earlier mentioned in quarter 2, for 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. So I think you'll see modest softness. We are pleased with how our retail stores are performing. And 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. So we think globally we're able to offset some of the softness in the wholesale channel during the year. And then longer term with new products introduction, I think that's where we see wholesale over time picking up. I guess I would add just I mean 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. But 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 going to come into play over the course of this year with the stronger U. S. Dollar. There's going to be less tourism. What kind of impact is that going to 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. So, 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. So I guess I'm trying to get a sense for those. Is it wholesale overall 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. And in fact, we're always going out there trying to get more than our fair share of space. So 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 Q1. We were lapping the denim was on a down cycle. That was certainly a dynamic. But all of these retailers have also had a pretty tough year or 2 years when you look at their overall results. For the most part, most of them have had some challenging quarters. Okay. Great. And then in your prepared remarks, you mentioned there were some timing issues in the A and P spending. And I'm just wondering how the magnitude of that and what month was it shifted from into? Yes. So overall, Carla, we still expect to spend as a percentage of revenue about 6% for the year. In the past at least 2 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 CD as an example and with our women's reset happening, we expect to normalize the spending. So for example in the quarter as a percentage advertising was 4.8%, which is up by about 2 percentage points from the last quarter. So still within the 6%, but up quarter over quarter. Our sense is you'll probably see a similar lift in quarter 2 and then that gets normalized in the second half. The other just to build on this, the other reason last year we knew we were coming with Livent Levis in the second half and 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. So we're committed to trying to smooth our advertising spending across the full year because advertising should drive revenue growth. And we feel confident that this campaign will do that. Okay. Great. And then just one housekeeping. The restricted payment basket? Yes. It's $800,000 $800,000 $800,000,000 $800,000,000 $800,000,000 $800,000,000 Okay. Thanks. That's right. And your next question will come from the line of Hale Holden with Barclays. Keep waiting for you guys to use the RP basket and get a different number for Carla. For I had two questions. You mentioned you kind of got the design lock for women's jeans coming out in the summer, but 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? Well, 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 clear navigation, a simpler shopping experience for the consumer, helping her to find the fit and the product that she's really looking for. And 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 learning from it. So successful look like when you walk into a and do one of our wholesale customers and you walk into the women's section, you see clear navigation, you see the breadth and depth of this of the new line on floor. And hopefully, you see a lot of consumers standing there buying product as well. And 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 and 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. But and we typically don't talk about customer orders and things like that. But what I think it is very fair to characterize the response from our customers has been very enthusiastic. Great. And then I think you said that there was an $11,000,000 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? No, it's expense. And it's largely direct to consumer business and 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 on the the only other thing I'd say on the e commerce business we are investing behind technology. So that's a part of it. Great. Thank you very much. Appreciate the time. Thanks. And your next question will come from Todd Farkreiter with UBS. Yes. If I look at the Americas on a 2 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 2 year period? I mean, I don't have we don't have the number at 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 a better conversion and higher units per transaction. And on the wholesale side, introduction of shop in shops, for example, has made a difference. That's good to hear. And then 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. And those are big businesses for Asia and growing middle class. So as those businesses tend to improve that makes a difference in terms of overall Asia performance. I appreciate it. Good luck with the rest of the year. Thank you. 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. And 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.