Levi Strauss & Co (LEVI) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company third quarter 2010 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 through October 18, 2010, by calling 800-642-1687 in the United States or Canada. From outside these countries, call 706-645-9291. For either number, please input the ID code of 13879010, followed by the pound key. This conference call is also 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 Roger Fleischmann, Vice President and Treasurer of Levi Strauss & Company.

Good afternoon, and welcome to our conference call. I'm pleased to introduce members of the Levi Strauss & Company management team. With us here today are John Anderson, our President and Chief Executive Officer. Robert Hansen, President of the Global Levi's Brand, and Blake Jorgensen, our Chief Financial Officer.

Before we begin, let me briefly remind you of a few items. Our discussion today may include forward-looking statements that are based on our current assumptions, expectations, and projections about future events. Although these statements reflect the best judgment 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. 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. Finally, today we filed our quarterly report on Form 10-Q with the SEC. You can link to our SEC filings from our website. Now I would like to turn the call over to John Anderson.

Good afternoon, everyone, and thank you for joining us. We're pleased to report another quarter of positive growth, led by our Levi's brand. The retail environment in the third quarter was more challenging than we anticipated. US and European unemployment remained high, and consumer spending continued to be weak. A combination of lack of consumer confidence and unseasonably warm weather in parts of Europe and the United States negatively impacted retail sales. Despite these conditions, third quarter net revenues grew 7%, and we achieved several key milestones in our strategy to grow our business around the world.

Revenues were up in all three regions on a constant currency basis. Growth was driven by the strength of our Levi's brand in the Americas, our acquisitions in 2009, and the expansion of our dedicated store network worldwide. The growing contribution of revenues from our retail stores has improved our gross margin. As we indicated on prior calls, our operating income and net income are showing the effects of the continued expansion of our retail network and increased advertising to support our key brand initiatives. We continue to generate healthy cash flow and maintain strong liquidity, while building inventory to support our growth.

As I have mentioned before, we are focused on several growth strategies. These are capitalizing on our global presence, diversifying and transforming our wholesale business, accelerating growth through dedicated retail stores, driving productivity, and building our brand leadership in jeans and khakis. I'm pleased to share some important milestones we have recently achieved to advance these goals.

First, we appointed Global Brand Presidents to support each of our major brands around the world. Robert Hanson, who you will hear from in a few minutes, is now leading our Levi's brand as the global Levi's brand President. Aaron Boey, who has been leading the operation in Asia Pacific was appointed the Global dENiZEN Brand President. And Jim Calhoun, who has been heading up the Dockers revitalization, was appointed the Global Dockers Brand President. We believe having Global Brand Presidents will help us promote consistency in how consumers experience our brands around the globe. Ultimately we will expect these changes to deepen our relationships with consumers and drive growth and efficiency.

A major milestone in our strategy to reengage with women was a successful rollout of Levi's Curve ID jeans, which introduces a revolutionary fit system. We launched this new approach this fall exclusively in our retail stores, and we'll roll out the line to wholesale customers, beginning in spring 2011. This initiative leveraged our innovative product and marketing talent around the world, and was our first global program targeted at women.

Another major milestone was the introduction of the dENiZEN brand in our Asia Pacific markets. This is our first brand to debut outside the United States. I will say more about dENiZEN when we talk about Asia Pacific. We believe these strategic actions will position us to capitalize on the growth opportunities in our markets when the global economy truly recovers.

I'll turn things over to Robert, who will now review results for the Americas.

Thanks, John, and good afternoon, everybody. We made strong progress in the Americas during the third quarter with revenues up 9% on both a reported and a constant currency basis. The Levi's brand delivered solid results in the wholesale channel, which complemented the contribution from the outlet stores we acquired last year. We're seeing our continued investments in Levi's brand pay off in the marketplace. We're leading fashion trends, including Levi's skinny jeans and leggings.

We've collaborated around exclusive product for Brooks Brothers, J. Crew, Filson, and a few others. We have improved the product assortments and consumer experience in our outlet stores. We launched the third phase of our Go Forth campaign, which features our workwear collection, focused on product craftsmanship. We successfully launched our Levi's Curve ID consumer experience, as John mentioned, and we've redesigned our on floor presentation in the wholesale channel for our Levi's men's and juniors lines.

Turning to Dockers, we continued our efforts to reenergize the brand as part of our long-term commitment to rebuild the product line and the category. Although Dockers revenues declined in the quarter on reduced sales of excess inventory, we continue to believe that our commitment to product excellence and innovative marketing will drive growth for the brand. Overall, we're moving forward on our plans to improve our products and extend our retail network. We're growing in a challenging market, and we are pleased with the progress we're making to become more consumer focused.

Now back to John to review the results for Europe and Asia.

Thanks, Robert. Turning to Europe, the business environment continued to be challenging this summer. Revenues in the region declined 3% on a reported basis. Excluding the currency impact, net revenue increased 6% over last year, due to the growth of our retail network and our footwear and accessory acquisition of 2009. We also saw positive trends in Dockers, and in our premium businesses, Made and Crafted and Levi's Vintage Clothing. Our wholesale operations continue to be adversely impacted by the regional economic conditions and weak consumer spending.

In our Asia Pacific region, net revenues were up 11% on a reported basis, and up 5% on a constant currency basis. We saw mixed results across the region, with tough conditions in Japan, but strong performance in India and China driven by the continued expansion of our retail network.

As I mentioned at the beginning of the call, we were proud to introduce the dENiZEN brand. dENiZEN is a new aspirational brand for consumers in our emerging markets, targeting 18 to 28-year-olds who seek high quality fashion at affordable prices. The collection includes a variety of jeans, tops, and accessories for men and women, designed with the standards of craftsmanship that have made Levi Strauss & Co. famous around the world. We launched the brand in growth markets including China and India, and we're very pleased with the early response.

Now, Blake will discuss the details behind our third quarter financial results.

Thanks John, and good afternoon, everyone. Our third quarter of 2010 represents another period of solid growth. Despite persistent global economic challenges, all three regions generated increased constant currency net revenues. Our performance in recent quarters reflects the strength of the Levi's brand and our continued investment in the business. We maintained our focus on working capital management and ended the quarter with a solid liquidity position.

Throughout today's call, I will reference performance comparisons on a year-over-year basis, unless I indicate otherwise. Total reported net revenue for the third quarter were $1.1 billion, up 7%, reflecting the strength of our Levi's brand in the Americas, our acquisitions in 2009, and the expansion of our dedicated store network worldwide. Unlike the first half of the year, the euro negatively impacted results in the quarter. On a constant currency basis, total Company revenues were up 8%. Our gross margin improved from 48% to 49%, driven by the increased contributions from Company-operated stores.

Total SG&A expense for the quarter was $457 million, an increase of 16%. SG&A increased primarily due to costs associated with our additional retail stores, advertising and promotion activities in support of our brands, and expenses related to our ongoing transition to a brand-led organization. The higher SG&A expense offset higher gross profit during the quarter, resulting in operating income of $86 million, a decrease of 12%. These higher operating expenses will continue, as we've previously discussed, our selling expense will increase due to our growing Company-operated retail network, and we will spend on A&P in support of our brands.

Below operating income, interest expense was $32 million in the quarter, down $6 million from last year, as a result of our refinancing activities in the second quarter and a decline in interest expense on our deferred compensation plans. Net income was $28 million in the quarter, negatively impacted by a higher effective tax rate. The higher tax rate is an ongoing consequence of our inability to benefit from losses in Japan.

Now I would like the turn to the balance sheet and cash flow. Cash provided by operating activities was $96 million for the nine-month period as compared to $174 million for the same period in 2009. As a reminder, the third quarter is typically one of seasonal investment in working capital. However, last year, we aggressively lowered inventory levels in response to difficult market conditions. This quarter, we were back to a more traditional seasonal investment cycle.

While higher net revenues have led to an increase in cash collections from customers, this was offset by the investment in strategic initiatives and our inventory build. We continue to focus on maintaining an appropriate level of core replenishment product to meet customer needs. Capital expenditures were $108 million in the nine-month period, up from $46 million last year, and on track with the forecast we provided at the beginning of the year.

The increase in the current quarter was primarily due to investments in our European SAP implementation, our headquarters remodeling, and our Company-operated store expansion. We have been executing on our plans to open new stores in outlet malls in the United States as well as new main line stores around the world. We now have 456 Company-operated stores worldwide.

Our liquidity is strong. We ended the quarter with cash of $261 million, and we had $283 million available under our credit facility. We are comfortable that our current liquidity and cash flow are sufficient to fund our strategic objectives. Our long-term financial strategy remains focused on reducing our debt level over time, as we invest in the business. We aspire to be in a position to pay a dividend to our shareholders in 2011, possibly as early as the first quarter.

To summarize, we are delivering on our commitment to invest behind strategic initiatives that we believe will deliver long-term growth. As we have discussed in the past, these actions will put near-term pressure on the bottom line. Now we will take your questions.

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Emily Shanks with Barclays Capital.

Good afternoon. Thanks for hosting the call.

Hi, Emily.

Hi. I had a couple of questions about the performance of your Company-owned stores. I think if I have it correct, you've got a good subset that's been open for more than 12 months. Is that right?

That is correct.

How are those comparable store sales tracking?

We don't break out comparable store sales as a reminder. Wholesale is still a dominant portion of our revenue, and so breaking out same-store sales growth may not really show truly how the revenues are performing. What I can say, though, is the stores, particularly the outlet stores we acquired last year in the US, are comping extremely well, and we're very excited about that because we've been investing and remodeling those stores, bringing them up to date, the and we're seeing clearly performance there. Our other stores continue to comp well around the world, but are obviously impacted by a difficult economic environment that John spoke to in his comments.

Okay. And on the base of stores that have been open for 12 months, can you tell us what percent are four-wall EBITDA negative? Is that a tiny number or how should we think about that?

We don't disclose that. I think you can assume that our store profitability profile is very similar to other retailers that are like us in terms of product. We're constantly reviewing the profitability of the stores. We're choosing to close some stores every year, anywhere between 5% to 10% of our portfolio will get reviewed, and we'll decide if we need to take actions on those stores on a yearly basis, which is consistent with other players in the retail business.

Great. And then just my last question, and I'll get back in queue. You had mentioned in your prepared remarks that we could potentially see a dividend as early as the first quarter. Can we assume that it will be in the $20 million-ish range, or should we prepare for a different number than that?

No, you should assume, I think we've said in the past that we would pay a dividend consistent with our level of profitability. So that $20 million level we paid in 2010 earlier this year is a good number to use. The comment around the first part of 2011 is really to be clear with people that since our fiscal year end is November, we are reviewing the options of paying our 2011 dividend in our first quarter, ahead of potential changes in the tax law.

Okay. Thank you for the detail.

Thanks.

Your next question comes from the line of Carla Casella with JPMorgan.

Hi. On this store expansion front, can you just talk about any key openings this year, and how many you expect total for this year, domestically and internationally?

Carla, -- this is Blake, as you know, we don't forecast store openings, but -- and I'll let Robert give you some highlights of the store footprint, particularly here in the US, some of the exciting things that are going on. But you should assume that you will continue to see store growth internationally, particularly on the franchise side to support the new dENiZEN brand in both China and India, and main line stores in core markets around the world and outlet stores where outlet stores make sense, particularly here in the US, and some parts of Latin America.

And, Carla, it's Robert. We are going to be opening three new main line doors here in the United States over the next couple of months. One in Malibu, one in the meat packing district in New York, and one on Newbury Street in Boston. They are more premium neighborhood boutique stores that we are very much looking forward to piloting that format, the smaller footprint, a more premium product assortment, and we'll keep our eyes posted on how those stores do. The major focus, as Blake has mentioned, and John in the past, has been in expanding our outlet business after we made the acquisition. We really did an analysis of where we were present and where we weren't present in outlet malls throughout the country, and have been doing targeted openings of outlets for the year, and that's been the major effort, not only in the US but as Blake mentioned, across the region and around the world.

When we look at dENiZEN in China and India, I'm trying to get a sense of how quickly franchisees can open doors. Is that something where you could see 100 doors in a year? Is that something where it's 10 to 20 doors in a year?

I think, Carla, it's John. We could definitely look at 100 doors in a year, and it would be a franchise driven model.

Does a typical franchisee pay $50,000 up front and a 4% royalty? Or have you disclosed?

We have not but it's a franchise model that we have explored with the Levi's brand in the past and works well for us.

Okay, and then the dividend color that you gave to Emily was very helpful, but can we also understand where the restricted payment basket stands today?

Yes. The restricted payment basket, as you know, is based on 50% of the cumulative net income beginning with the first quarter of fiscal 2005. So prior to the dividend paid in the second quarter of this year, the $20 million, the basket was roughly $500 million.

Okay. Thanks. That's all I had.

Thanks.

Next question?

Next question comes from the line of Grant Jordan with Wells Fargo.

Hey this is Mike Ciulis in for Grant. I was wondering if you could comment on the Curve ID concept, how that's tracking, and if the consumer response has been what you expected there?

Sure. As John mentioned, we're pleased with the rollout. We successfully rolled out the program across the Americas division, Europe, and Asia. As he also mentioned, we rolled that program out, the Levi's Curve ID sets in the United States in our own stores, and in Europe and Asia and the balance of the Americas region across both our owned stores and wholesale customers.

The launch has been successful. We're pleased with the level of engagements that the new program has generated, but it's early days yet, and we need to be somewhat cautious to respond to performance. We do believe that women have engaged in the concept of the program. It's about shape, not size. We're offering three shapes and multiple leg openings, and really fashion-right finishes. Up to this point, again, we're pleased with the results thus far.

Great, thanks.

Yes.

(Operator Instructions). Your next question comes from the line of Karru Martinson with Deutsche Bank.

Good afternoon. In terms of the expenses you referenced for building a brand centric company and SG&A, how much were they, and how should we back those out of the numbers?

This is Blake. Thanks for the question. We don't provide level of detail beyond what's in the financial statements. But what you should assume is that some portion of that is driven by A&P spending associated with not just the Curve ID program, which you may have seen some of the advertisements, but also by the dENiZEN program outside of the US, as well as the continuation of the Levi's brand advertising globally. We started a relatively healthy program last year and moved into this year, and we've gotten now have a new version of that Go Forth campaign that's been running broadly in the US, and that's driving some of the A&P spending.

In addition, a large portion of A&P spending is also on-floor merchandising. So if you were to go to any of our major wholesale customers, Macy's or Kohl's or others, you'll see a very strong view and improved positioning for both Levi's and Dockers on floor. And so that's driving some portion of the SG&A expense. Then the third component of that is really the building out of the retail operations, particularly in the early days where you're bearing more costs than you have revenue up tick, as the stores get going, and so you're seeing some of that early on.

And in terms of the Dockers brand, now that we had reduced sales of excess inventory. Are we clean on inventory position, or do we believe we're clean on inventory position at retailers, and how do you see that brand going, given the repositioning push behind it?

To answer the first part of your question, I would say that we are where we want to be on inventory at this stage. Last year we were doing some inventory builds in floor sets for new programs as a part of our product revitalization strategy, and that obviously had an impact on the comparable numbers for this quarter. But we've spent a lot of time and effort investing behind bringing the right fits and finishes to market, and we've supported it by the new more innovative marketing campaign we're running, wear the pants.

We have gotten inventories into a better position. It's resulted in lower sell-off of excess inventory in the year to date period. We believe the combination is working, but it's going to take some time to work the new products into the market to get them fully displayed and obviously particularly in this economic environment, we're being cautious to make sure that we balance the inventory to the demand from the consumer.

And just lastly, I know you guys aren't buying cotton directly, but the impact on denim prices, how do you see that flowing through your results as we go forward?

Well, clearly, the price of cotton has increased dramatically, and we will be looking at our future programs and passing on some of those costs. These cost increases are significant. We've already had some price increases this year, and we'll continue to monitor the price, and if need be, see how much we can pass on to the consumer.

All right, thank you very much, guys.

Thanks.

Thank you.

Your next question comes from the line of Jeff Kobylarz with Stone Harbor Investments.

Just following up on Karru's last question, can you say how much of a price increase you have put through so far?

It's not as simple as that. We brought out a combination of new products, repositioned the price on some existing products, but suffice to say that year to date, as we look through 2010, the cotton issue hasn't impacted us. It's more looking forward where we're going to have to review the impact of that on some of our future lines.

Okay. Can you say if you have a sense that your peer group are going to be raising prices similarly to your price increase?

All I can say is that everybody is going to be paying a higher price for cotton.

Okay, fine. About the women's product, I wasn't clear, Robert, if this ID product, if it's -- is it just in your corporate stores right now, or is it -- are you selling it wholesale yet?

Sure, I think -- sorry for not being clear about it. I think the easiest way to look at it, is in the United States it is in our owned stores. So the Levi's stores. Throughout the rest of the world, it's in a combination of our owned stores and our wholesale customers. In the United States, we wanted to roll it out initially in our owned stores and then scale it to the our wholesale customers, which will start with spring deliveries and culminate as we move into the back-to-school period next year.

Okay. And are there tops that go along with the women's product? Anything different there? Or is this just focused on just the women's products? I mean, just the bottoms product for women?

Yes, sure. The whole program around Levi's Curve ID is really centered around a lot of work we've done with women to understand their fit frustrations with denim jeans, and there's a number of interesting statistics, but I think the most interesting is that 86% of women would say that they are wearing a pair of jeans that doesn't optimally fit their body. So we developed this as a bottoms initiative. It's about communicating to women that they should buy jeans based on the shape of their body, not their size. So it's about shape, not size. We've developed a three fit. The slight curve, the demi curve, and the bold curve.

We'll be introducing a fourth fit as we launch 2011. Then we're offering it in skinny, straight, and boot cut leg openings, as well as fashion finishes. It is a bottoms initiative, but to complement that, we've been working on a very focused set of tops categories that we believe the Levi's brand is famous for. Obviously, tracker jackets, wovens, work shirts, tunic tops, feminine lived-in T-shirts, graphic tees, tops of that nature, and I think you can see those beginning to show up with much greater effectiveness in our own stores, and our intention is to build on those as they start getting acceptance from the consumer, and roll them out more broadly to our wholesale customer base.

Thanks very much for that clarification. Good luck with everything.

Thanks a lot.

Thanks, Jeff.

Your next question comes from the line of Phyllis Camara with Pax World Fund.

Hi, thank you. I know you guys have moved some of your manufacturing, because of higher costs in China, to Mexico, is there any potential for moving more of your operations closer to the United States or closer to -- because of high cotton prices and that type of thing, closer to where you're selling your goods?

Remember, we manufacture 43 countries as it is. China was never the predominant sourcing base for us. So, we have a very flexible footprint around the world. It's not just cotton that impacts where we manufacture. As you know, the apparel industry has many trades and many barriers. So we constantly look to moving things around. At this stage, we're very confident with the mix we have and where we're manufacturing our product.

Okay. And then also I'm looking at inventory, and your inventories are up, and you were saying you were building inventory. How does it work through for your franchise stores? Do you build inventory, keep that on your balance sheet, until you ship it?

We sell to our franchise stores like we would sell to a wholesale customer, so we're selling off the inventory, and they would hold it. We're obviously very conscious of inventory levels in the channel and we make sure we help all of our customers manage that appropriately, but we sell to them just as we would sell to a Macy's or a Kohl's.

Okay. And then is there anything -- you've already started, or already gotten everything ready for the Christmas selling season, and stuff like that. Have you, is there anything different than what would you normally do, because of the economy or anything like that? Are you starting to see from your retailers that they are holding more and more inventory, or are they still wanting you guys to hold more inventory for them?

Well, we haven't seen anything change. As we look toward the holiday Christmas period, clearly there is a lot of interest on what the consumer response is going to be, but our plans are set with our retailers. We are holding what we think is appropriate level of inventories, and we will anxiously await and see what happens in the next couple of months.

Okay, great. Thank you. Good luck with the Christmas season.

Thank you.

You have a follow-up question from the line of Emily Shanks with Barclays Capital.

Thanks for taking the question. I wanted to ask a follow-up around the cotton fund and actually wanted to expand it away from specifically just cotton, but also just your overall cost pressures that you are seeing on a go forward basis. Can you give us a sense of what that magnitude is for the next six to nine months?

For us, clearly cotton is the major area we're focusing on. The rest is not a major challenge for us at this stage. So it really is just cotton.

Okay.

I'd say, Emily, that the areas of pressure that we're seeing and that we know others are seeing are clearly around continued shipping cost pressures, a lot of capacity has been removed from the marketplace. Labor costs around the world, depending on where you operate, and how flexible your manufacturing is also can be issues. We've been managing around both of those effectively by having such a large footprint of manufacturing partners globally, we can move product manufacturing, but those are clearly the biggest components of the cost increases that we're seeing.

Once you take into account all of those levers that you can pull, what do you think the net impact is going to be to you?

It would be hard for us to boil that down, just because of our product mix, and our ability to move cotton or move production, so I couldn't give you an exact number.

Okay. And then my final question was around capital expenditure expectations as we look into 2011. Should we assume sort of this elevated fiscal year 2010 run rate of the $166 million-ish type number, or--?

As a reminder there, about $45 million of that $166 million number was associated with our remodeling of our headquarters building in San Francisco. That remodeling is almost complete, all of our employees have moved into their new office spaces, and we're just finishing up the lobby right now. We invite everyone to come look at it. We're very proud of it, and employees are very excited. That will not occur next year. We'll have essentially paid for the remodeling component. We are in the process of setting our capital budgets now and we'll provide some guidance during our next quarter's earnings call around what we expect for the year, but for a rough estimate today, I would strip the $45 million out of your 2010 model and start with that number, but we'll give you an update in the next quarter.

That's helpful. Thanks very much. Good luck.

Thanks.

Your next question comes from the line of Janet Clay with Liberty Mutual.

Hi, I was wondering if you could just talk a little more about your strategy with the stores in terms of, right now you're running around 15% for year-to-date of sales, and I find this part of the business a little hard to model because you're reluctant to give out the basic metrics that most people that run retail stores do, so can you tell us when you think you'd be able to give us those metrics, or a little more detail into the strategy there?

Yes, let me talk about the metrics and then John and Robert can weigh in a little more on the broader strategy. So on the metric side, I'm not sure -- I think our goal is to maintain a good balance of wholesale and retail. Our wholesale customers will always be the dominant part of our revenue, just because they're so large around the world. It depends, obviously, on where you are.

But here particularly in the US, the wholesale channel is very large. So we don't settle in on a percentage, but I think in the near term, between 15% and 20% of our revenue coming from our retail network is probably a fairly good number, and at that level, we think it's misleading to provide same-store sales data, and I think others that are similar, like Polo or some of the other players out there that have that kind of mix are following that same path.

In terms of strategy, we view that retail is a key component of our way that we approach customers. We want to make sure customers understand the full breadth of our product line, and they can see our product both tops, bottoms, and accessories in our retail format, as well as in our wholesale format, and it's a great way to exhibit that to customers.

So do you view the stores more of a promotional brand building tool, or do you view it as something where you think the margins will be greater than your wholesale side?

Well, we clearly have been able to boost our gross margins with the presence of our retail stores, and our goal is to develop a profitable business and maintain a profitable business for returns to our shareholders. And retail is equally as important as wholesale in that mix.

And so, at what point do you think you will have saturated the market in terms of stores? How many more stores do you think you can open?

I wouldn't want to speculate.

Thank you.

Thanks.

And your final question comes from the line of Ron [Village] with FBR Capital.

Hi, no questions at this time. Thank you.

At this time, I would turn the floor back over to the presenters for any closing remarks.

Well, to sum up, our revenue growth and improved gross margins demonstrate progress despite the challenging operating environment. We're executing against the strategies we outlined for you at the beginning of the year. Our recent significant achievements include the introduction of our Levi's Curve ID for women, the launch of the dENiZEN brand, and the appointment of new Global Brand Presidents. Thanks for joining us, and we look forward to talking to you on our year-end call. Thank you.

Thank you. This concludes today's conference call. Please disconnect your lines at this time.