Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co.'s fourth quarter and fiscal year 2014 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 February 19, 2015, by calling 1-800-585-8367 in the U.S. and Canada, and 404-537-3406 for all other locations. Please use conference ID 72233474. 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, Investor Relations, and Assistant Treasurer at Levi Strauss & Co.
Thank you very much. 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 concerning matters such as our expected financial and operational performance, including our guidance for fiscal 2015, our strategic plans, our expectations for the economy and currency headwinds in general, future investment in retail and e-commerce operations, reduction of controllable costs, and long-term estimated savings from our global productivity initiative that are based on our current assumptions, expectations, and projections about future events.
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 annual report on Form 10-K, our registration statements, and other filings with the Securities and Exchange Commission. We expressly disclaim any responsibility to update forward-looking statements. Other unknown or unpredictable factors also could have material adverse effects 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 will 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 the fourth quarter and fiscal year 2014 financial results, which was furnished with the SEC today on Form 8-K. We also filed our annual financial report on Form 10-K with the SEC today. As you know, we pushed this call back a couple of days for administrative reasons. Today, we had a technical issue with one of the exhibits attached to the 10-K, and that's why the 10-K was not filed sooner. As a result of not being able to attach that exhibit, we will be filing a 10-KA either later today or tomorrow, including the exhibit. I want to thank you for your understanding on both these points. You can link to our SEC filings from our website.
Now I'd like to turn the call over to Chip Bergh.
Thank you, Chris. Good afternoon. Thank you all for joining us today. We faced a challenging global environment in 2014. We are pleased to have grown full year reported net revenues 2% and Adjusted EBIT 8%. We focused on the controllable aspects of our business, counteracting soft retail traffic by driving conversion and productivity in our stores, ensuring product availability across all channels, and investing behind our brands with marketing initiatives to drive awareness and traffic in the key selling seasons. We also initiated a global program to improve the structural economics of our business, establishing the foundation for a more agile and profitable future. We believe this initiative will provide the capital to fuel sustainable, profitable growth and strengthen our financial position. Before I discuss our strategic focus for 2015, I'll turn it over to Harmit to walk you through the fourth quarter financial results. Harmit?
Thanks, Chip. Welcome to everyone joining our call. My comments today will focus on the results of the fourth quarter of 2014 and will reference comparisons on a year-over-year basis in U.S. dollars unless I indicate otherwise. Also, please recall that our fourth quarter 2014 contained an extra week due to our fiscal calendar. Net revenues of $1.4 billion grew 7% on a reported basis and 10% in constant currency. Two-thirds of the growth reflected the additional week in 2014. Levi's men's increased in both tops and bottoms. Levi's women's was up modestly, while Dockers men's and women's declined. Without the extra week, wholesale revenues were up slightly, while direct-to-consumer revenue was up more than 3%, reflecting store expansion, strong conversion, and e-commerce growth. Gross profit for the quarter was up 7% to $680 million due to the revenue growth.
Gross margin of 49% was down 20 basis points, mainly due to the promotional environment and our efforts to normalize inventory levels. Supply chain benefits from a global productivity initiative partially offset higher input costs. Fourth quarter SG&A expense rose $10 million to $581 million, including a $31 million non-cash pension settlement charge, as well as the impact of the 53rd week. Excluding these, SG&A declined, reflecting savings from our global productivity initiative. Adjusted EBIT of $134 million, nearly double as compared to the fourth quarter of last year, driven by the higher revenues and lower SG&A. Adjusted EBIT as a percentage of net revenue was 10%, up from 6% last year. A detailed reconciliation of Adjusted EBIT is attached to our press release.
Fourth quarter net loss of $6 million was down from net income of $17 million last year, as the increase in Adjusted EBIT was offset by $53 million in restructuring and other charges related to the global productivity initiative and the $31 million non-cash pension settlement charge. Now I'll share more detail on the fourth quarter results of our three regions. Net revenue in the Americas were up 8% on a reported basis and 9% in constant currency, driven by the extra week. The region's retail business grew in a promotional environment, and Levi's womens at wholesale was roughly flat, reflecting the performance of the new products we introduced last summer and the extra week. Adjusted EBIT was up due to the extra week and lower SG&A. In Europe, net revenues grew 7% on a reported basis and 15% without the impact of currency.
About a third of the growth reflected the extra week in the fourth quarter. The remainder was driven by retail productivity and improved product availability, as well as taking over stores formerly run by third parties. Adjusted EBIT grew as a result of the higher sales. In Asia, revenues grew 4% on a reported basis and 7% without the effect of currency. Revenue grew in direct-to-consumer and traditional wholesale channels. China, India, and Japan all grew again, though the overall environment remained promotional, putting pressure on margins. As a result, Adjusted EBIT was down slightly from the prior year. As expected, by the end of the fourth quarter, we brought inventory in line with prior year. While this resulted in margin pressure, we are pleased to begin 2015 with lower inventory levels. Free cash flow for 2014 was $123 million.
Capital expenditure of $73 million included opening more than 50 company-operated stores during the year. The company's liquidity position remains solid as we continue on the path to build a stronger balance sheet. At quarter end, we had cash of $298 million and $665 million available under our credit facility, resulting in total available liquidity of nearly $1 billion. Net debt was $926 million as compared to $1.1 billion a year ago. Our leverage, as defined by our gross debt to Adjusted EBITDA ratio, was 2.0 compared to 2.7 last year. Lower leverage primarily reflected the redemption of our euro notes during the year. With that, I'll turn it back over to Chip to discuss progress against our strategies and our priorities for 2015.
Thanks, Harmit. As expected, we faced a challenging environment in 2014. Amidst the backdrop of global economic and geopolitical uncertainty, the industry remained pressured by soft consumer traffic and aggressive promotions at retail, as well as competition from other spending categories such as consumer electronics and durable goods. Despite these conditions, we made progress during 2014. We grew both revenue and Adjusted EBIT for the second consecutive year. We initiated a program to improve the availability of many of our best-selling products, driving productivity across channels. We delivered strong returns on our marketing investments during the year with the launch of the global Live in Levi's campaign and the unveiling of Levi's Stadium, while at the same time holding full-year A&P spending flat. We continue to expand our direct-to-consumer business while driving strong conversion at retail and improving the effectiveness of our e-commerce promotions and site experience.
We grew revenue in both Europe and Asia for the first time in three years, despite difficult macroeconomic trends in many of the key markets in those regions. We began investing in new capabilities that will help drive continued long-term growth. We also improved the structural economics of the business with our global productivity initiative. The actions we took in 2014 are expected to deliver net annualized savings of more than $125 million, and we're confident that we will reach our ultimate objective of $175 million to $200 million in savings. The benefits of the initiative can already be seen in our improved profitability. Full-year Adjusted EBIT as a percentage of net revenues improved 60 basis points as compared to prior year. Looking ahead, we expect 2015 to present its own set of unique challenges.
Slow global economic recovery, mounting currency headwinds, uneven consumer spending, and potential further disruption at West Coast ports will require us to maintain our focus. We will work to mitigate the impacts of these pressures by focusing on what's within our control, and in so doing, we will not lose sight of our long-term objectives. In 2015, we will expand our direct-to-consumer business by opening new stores, continuing to improve productivity, and driving online traffic and conversion. We will reset the global Levi's women's offering with an exciting product slate, which we'll launch later this year. We will delight consumers with fresh interpretations of our iconic products, such as the new tapered Levi's 501 CT, and a focus on innovation, including an expanded Levi's Commuter collection later this spring. We will engage consumers globally by building upon the marketing momentum generated by the Live in Levi's campaign.
We will complete the transition of the Dockers women's business to a license model, which will allow us to focus on execution for the Dockers men's business as we work to expand our successful Alpha line while striving to maintain share with the traditional consumer. We will continue to improve the economics of our business through our global productivity initiative. Harmit will now outline the financial outlook for 2015.
In 2015, we expect to profitably grow full-year revenue on a constant currency basis, even with one less sales week. First quarter comparisons will be tough given the inclusion of Black Friday sales week in the prior year, but we expect stronger performance in the second half. Given recent strengthening of the dollar, full-year revenues may be unfavorably impacted by as much as 500 basis points. Excluding currency effects, our expectations for margin and expenses are as follows. We expect gross margin of 50% or better. Margins will benefit from some of the structural cost improvements we've made and lower cotton prices in the second half of the year. We have planned A&P investment of 6% of sales again, though spending will be more balanced throughout the year. Retail expansion will continue to raise selling expenses.
We expect SG&A to be roughly flat as a percentage of revenue owing to the benefits of our productivity initiative. Accordingly, we expect Adjusted EBIT to be weaker in the first half and stronger in the second half. Strengthening our balance sheet remains a top priority. Debt reduction will be an ongoing focus, though at a more modest pace than in 2014. We expect strong free cash flow again in 2015, despite higher CapEx in the range of $110 million to $120 million to fuel long-term growth. The higher capital expenditure in 2015 is driven by more than 60 store openings, investments in retail technology and e-commerce, and in other IT systems to drive productivity. We also, earlier this week, announced a higher dividend of $50 million, reflecting our confidence in the financial health of the company. 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 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. Your first question will come from Grant Jordan with Wells Fargo. Please go ahead with your question.
Good afternoon. This is David Alarcon for Grant Jordan. You briefly mentioned in your prepared remarks the ongoing situation on the West Coast ports, and I wonder if you could expand on that a bit about what you're doing to address that situation.
As you know, the port situation on the West Coast has been tenuous for about the last half year, with notable delays of delivery. Just like all other importers, we've been experiencing delays and longer lead times. However, up till this point, we've been able to mitigate the impact to the business and have not experienced any material impact to date. As you know, and as probably just about everybody has read in today's The New York Times, the situation has deteriorated. It's gotten worse over the last couple of weeks. The delays are now more volatile and unpredictable, which makes it harder for us to manage and plan our business. Any prolonged disruption at these West Coast ports could adversely impact our supply chain and product availability. We're continuing to monitor the situation.
We've got contingency plans in place, such as air freight, diverting shipments, and/or transiting product for earlier deliveries. All of these obviously come with a higher cost and the risk for some service delays. As I said, up till this point, we really haven't had any material impact on the business. The next two months are pretty critical, and the situation has worsened over the last two weeks or so.
Great. Moving back to the restructuring program, the second phase that you announced after the end of the last quarter. I wonder if you could just walk us through expectations for this year. I think the plan was to reduce headcount by something like 500 jobs. If you could just talk about the financial implications and when we could expect the timing of those actions to take place.
Sure, David. As you know, we announced the Productivity Initiative in quarter two of 2014, and we said that it's a program that we'll execute over 18 to 24 months. In November of last year, we announced the next phase, which is primarily around outsourcing global business services so that we could drive some resource efficiency and allow us to focus on our core business activities. We're going to spend a large part of 2015 actually transitioning. With every transition, especially with outsourcing, in the short term, you'd probably need to basically source up your resource base. The actual impact in terms of savings, we'll probably start seeing towards the end of 2015, but the full impact is largely going to be seen in 2016 and beyond.
We ended this year, excluding restructuring and other charges, we ended 2014 with an improvement of about 140 basis points, which already demonstrates we're beginning to see savings. We still stand committed at the end of the program to see savings and achieve anywhere between $175 million to $200 million on a net basis. In 2015, overall, we expect, again, in constant currency, SG&A to be largely flat as a percentage to revenue.
Turning to your guidance on revenue, you talked about expecting to grow revenue on a constant currency basis, even with the extra week. Could you talk us through your expectations geographically, if you expect areas that grew in 2014 to continue in 2015, or any major reversals that you're looking for?
Again, we don't necessarily forecast or guide revenue growth by region. I'd say, as we think about the world on a constant currency basis, Europe and Asia will see growth along with the U.S., and that will basically, essentially drive our revenue growth overall. Now, I did say that the numbers that we mentioned was largely constant currency. On a reported basis, given the currency headwind, and especially given the fact that about 40% of our revenue is generated outside the Americas region, we'll probably see a translation impact of about up to 500 basis points.
Great. That's it from me, guys. Thanks for taking the questions.
Thanks, David.
Your next question will come from Karru Martinson with Deutsche Bank.
Good afternoon. Just on the port delays, as you mentioned, starting the year with lower inventory levels. Is this going to impact as we come into the spring selling season, or are those orders kind of already through the system and now it's really more about getting in line and ready for back to school?
No. The deliveries that we're watching like a hawk right now, Karru, it's spring deliveries. It's shorts, it's a lot of the seasonal items that are due to deliver late February through late March. That's what we're watching because obviously, if it shows up a couple of months late, that's a problem. That's what we're most concerned about right now, and I think we're probably not much different than most other apparel manufacturers.
No, certainly. When you guys talked about the-
Karru, just one point of reflection or correction. I think our inventory levels at the end of 2014 are normalized levels. What we began a year ago was on the higher side.
Okay, perfect. Thank you. In terms of the new store openings, could you give us a little bit of a sense in terms of the cadence of those openings on a quarter-to-quarter basis and your feeling on whether we'll do more here in the U.S., more in Europe or Asia?
Yeah. The openings are largely company-operated retail stores, and with our focus on retail and expanding that business as a percentage, we are opening stores. Largely, these stores are outside the Americas region, largely in Asia and Europe. In terms of timing of these store openings, again, as we've planned for the stores largely towards the second half of the year as against the first half.
When we look at the women's product, this has been an area that we've put resources behind and relaunched many times. What makes this relaunch different? Is it the breadth of the relaunch, the design, the product?
It's a little bit of everything. You're right. I kind of smiled as you asked the question because I don't know how many times we've done this. We've spent probably about 18 months now working to get this right. A big part, what makes this a little bit different, is we've really focused on simplifying our women's lineup. Today, globally, we have about 65 different fit blocks that we sell. Effectively have three different women's lines around the world. Arguably even four, if you consider some of the specific product that we do in Asia. 65 fit blocks, it's more than double the number of fit blocks that we have on the men's business, which is dramatically bigger than the women's business. We're focused on simplifying it. We get it down to about 30, 31 fit blocks globally.
It's a much tighter assortment, easier to shop from a consumer standpoint. Well-differentiated between wholesale and retail. We've got a good focus on soft, stretchy product, which is where the consumer has gone here recently. The product that I've talked about before that we rushed to market here in the U.S., which has stabilized our women's business and wholesale, is that soft, stretchy, super soft, super stretchy denim. That represents a pretty significant part of the line, but we also have very traditional denim cuts as well. We're very excited about, we've done a ton of research on this. It's been very well received, done a couple of global tours with this product. Customers are excited, and we feel pretty good about it.
Okay. Just lastly, from a big picture perspective, there's certainly been a lot more denim on the runways, kind of people feeling that it's swinging back that way on a styles perspective. When you think about denim versus kind of athleisure or bigger trends, where do you see the fashion cycle going here for jeans?
If you're gonna ask me that question, you know what I'm gonna say. You're right. The observation that you've made is right. Denim seems to be back into a kind of an upswing. We need it. The category is very, very soft the last two years or so, and we've managed to build share. The stronger brands tend to do better in soft categories. As the category comes back, we expect that will float more boats, and our business should benefit as a result of it. We're also trying to bring a lot of innovation at the same time. The thing that we've launched here recently, which we're really excited about, is the 501 CT. It's a new interpretation on the 501, which is our most iconic item. Basically what it does is it taps into the consumer insight.
Consumers were customizing and tapering their 501s, and it was the most tailored item, as people would buy the 501 and then take it to a tailor shop and taper it. We've kind of tapped into that consumer insight, and we're now offering it as a separate item in our line. We're pretty excited about that. Innovation drives the category and drives category growth. We're gonna try to bring a lot of innovation this year between both men's and women's. I talked about the women's stuff just a minute ago. That, combined with the fact that denim is getting a lot of play on the runways, we're pretty bullish about the category and about our prospects for it.
Thank you very much, guys. Appreciate it.
Your next question will come from the line of Carla Casella with J.P. Morgan.
Hi. Thanks for taking the question. I can vouch for the stretchy women's jeans since I bought a pair this year and have been selling it to friends.
Only one, Carla? You can buy more.
I'm broke. I don't get to wear my jeans every day, J.P. Morgan.
Thank you for supporting our brand.
On the sales, the Black Friday shift, I had down and we only expected that to be about 1% of sales. I'm just wondering why it ended up being so much greater, or was that just a piece of the sales in the growth in the U.S.?
Yeah, it was 1%, Carla. Our expectation was 1% for the year. The extra week fell during the holiday season, so it generated a lot more interest from consumers. That's why the quantification of that was a little higher.
Great. Okay. The gross margin was a little bit lower in the fourth quarter than what you're forecasting for 2015. Is that partly just because you were still clearing out inventory? Is it the seasonal nature of it, or the fourth quarter promotions?
Yeah. You answered the question yourself. It's a combination of both. It was a combination of clearing inventory as we're committed to do and getting our inventory levels to a stronger and a healthier position, as well as the promotional cadence in the market, which we haven't seen abate during the holiday period.
Okay. I have to always ask their RP basket. After you pay the $50 million dividend, and I'm assuming that's first quarter, what will the RP basket be?
About $800 million.
Okay. On currency, you do a great job of breaking out all the detail for us in your Qs and Ks, and we really appreciate that. Have you changed the way you either buy or hedge, given the dramatic movements in the currencies this year?
Yeah. Carla, the headwind is strong, as we all know. We don't necessarily hedge for translation. On the transactional front, we employ a cash flow hedging strategy. The only thing I'd like to point out, we don't apply hedge accounting. You do see a little bit of volatility in our gross margins and gross profits. To your question about have we changed anything, we don't hedge 100%. We hedge our key currencies. We're looking at
- seeing if we need to expand that basket. The other thing we're looking to see if we can help mitigate the situation, we're looking at a couple of things. We're looking at pricing initiatives that don't hurt the brand long term. We're looking at different sourcing alternatives. Most of our vendor contracts are in US dollars. The question is there a different way of buying, et cetera? We're thinking through a whole bunch of things. Plus, we did a pretty good job last year on cost curtailment, and we'd like to continue that as we move into the phase 2 or the phase 3 of the Productivity Initiative.
Okay, great. Thank you for taking the questions.
Thanks, Carla.
Your next question will come from the line of William Reuter with Bank of America Merrill Lynch.
Good afternoon, guys.
Hello.
Following up on the question there about the impact of the extra week. You guys did not talk about how it may have impacted Adjusted EBIT in the quarter. Can you talk about how the profitability or the margins in that week would differ from maybe the rest of the quarter?
Good question. I'd say approximately about a third of the EBIT lift that we reflected in the quarter was because of the 53rd week.
Okay. That's useful. Your inventory levels look good relative to where they were last year. Can you talk about how you feel about the currency of them, whether either the aging of them is better or worse relative to where they would've been last year?
Yeah. Overall, both the quantity of inventory as well as the health of the inventory, we feel we're in a better spot than a year ago. Just to reflect on what happened in 2014, basically, it was caused by two factors. We over-corrected for lower service levels in 2013. The Americas region had a softer year than expected. We spent most of the second half of the year clearing inventory, which while hurting margins, brought us down to a level where we think is more normalized.
Okay. My last question here, I'm looking at your cash flow statement and the employee benefit plan amortization from accumulated other comprehensive loss for the year of $46 million. Did that show up anywhere in your calculation of Adjusted EBIT?
We are-
add back
Chris, do you know?
No, I don't think so, Bill. I think that's a standard reconciling item that we have. If it's a non-cash item, it wouldn't be in our Adjusted EBIT.
Okay.
Is it the OCI schedule that you're looking at?
No. Well, I was just looking at your press release, but I was trying to make sure essentially that we should add back that if we were trying to calculate Adjusted EBITDA, that we wouldn't be double counting any of the adjustments that you guys would've already added back in your calculation of Adjusted EBIT.
Yeah, we can look at that, Bill, when I take you through the financials, if you want. I think that the way that we look at Adjusted EBIT, we back out the non-cash item for the pension settlement charge. Everything else, on a year-over-year basis, is treated the same. The amortization number is just the same number it's always been.
Okay. I'll follow up with you later. Thank you.
Thanks, Bill.
Once again, if you would like to ask a question, press *1 on your telephone keypad. Again, that's *1 for questions. Your next question will come from the line of Todd Harkrider, UBS.
Yes. Congratulations on the good quarter. Regarding Europe growing partially due to taking over some third-party stores, can you let us know how much you benefited from that, what country that was in, and if you see any other short-term opportunities to take over more third-party stores?
Todd, I think the best way to break up the growth that we saw in the quarter in Europe is to say that about a third was driven by the extra week, about a third was driven by what we call business model changes, and a third was more organic. Again, the business model changes, I think largely geographically were a couple of countries. To your question about will we see a similar impact going forward, I'd say in one country, we actually acquired some franchise stores, and that was done earlier part of 2014, so we're not going to see that impact. As we look at business opportunities in a longer term, again, we look at this opportunistically. As and when we either take over stores and run them ourselves or take over franchise stores, we will disclose it on a quarterly basis.
Okay. I know you took over the Russian stores a while ago. Can you talk about how those are performing? Then also it's great to see that you're ramping up new store growth. Can you give us an estimate on what kind of returns you're seeing on the new store openings? Thank you.
Sure. Russia, given what's happened to the ruble, is going through a bit of an economic spin. Our business in Russia is actually doing reasonably well. We have taken some pricing action to offset some cost pressures in Russia. Overall, we still believe, from a long-term basis, Russia is a good business and has potentially quite a bit of growth left. In terms of your second question, which was, Chris, what was the second question?
Profitability on store openings.
Yeah. Again, we don't disclose that. Principally, every store has to pass a return on invested capital threshold, which is determined using a cost of capital plus risk profile in the particular country. Generally speaking, as a portfolio, our stores have performed reasonably well.
That's good to hear. Good luck navigating through the West Coast issue. Thanks.
At this time, I'd like to turn the floor back over to the company for any closing remarks.
Okay. That'd be me. I just want to thank everyone again for calling in. It's good to put 2014 behind us. Last year's 2014 becomes this year's base period. As we move into 2015, as we've talked today, we're focused on balancing our objective of continuing to drive near-term execution, while at the same time setting the stage for a more prosperous, profitable, long-term future. Thanks for joining us, and we'll be talking with you again here in a few weeks in April. Thanks very much.
Thank you. This concludes today's conference call. You may disconnect your lines at this time.