Levi Strauss & Co (LEVI) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company's first-quarter earnings conference call. All parties will be in a listen-only mode until the question-and-answer session. At that 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 April 16, 2012 by calling 800-585-8367. Please input the ID code of 6859-3147 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, www.levistrauss.com.

I would now like to turn the call over to Kris Marubio, Director of Corporate Affairs at 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 Chip Bergh, our President and CEO, 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 statement, 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.

And now, I would like to turn the call over to Chip Bergh.

Good afternoon, and thanks for joining us today. During the first quarter, we continued to focus on balancing top-line growth while improving our profitability and cash flow. I am pleased to report that net revenue grew 4% on a reported basis, and net income improved 21%. Our revenue increase reflects the commodity-based price increases we have implemented, and the benefit of mix. We also continue to feel the impact of cotton prices on margins. Cost of goods sold during the first quarter reflected higher-priced cotton, and as we have previously discussed, our price increases have not fully offset these higher costs, which continue to impact gross margin.

Before Blake walks you through our financial results, I'd like to discuss the performance of our brands, and the progress we're making to drive profitable growth throughout the Company. Our brands continue to put the consumer at the forefront of everything we do. This spring, the Levi's brand built on its strong heritage, adding a modern take on its classic styles with innovative new products and finishing techniques. Levi's leveraged a technology it developed in the 1960s, Sta-Prest, and is using it in a new brightly colored slim-fitting pant for men. The brand also rolled out new Curve ID styles for women, as well as dresses and feminine tops. And we expanded Commuter series to global markets. In February, Levi's captured the attention of the fashion world, making its first appearance at New York fashion week. We got a positive response to our products, and we are looking forward to the fall season.

Turning to Dockers, sales were down again this quarter, and the team is focused on stabilizing the business. We are concentrating on our core product mix, and we are designing and marketing to appeal to a broader consumer base. The Alpha Khaki is offering modern fits, colors, and styles for the spring. The reintroduced D4 Khaki and the Wearever series offer versatile styles for the more traditional consumer. During the quarter, the brand launched the next iteration of its Wear the Pants marketing campaign, featuring popular personality, Bear Grylls. Our Denizen launch continues, and here in the United States, we are pleased with our progress at Target.

We are continuing to invest in our retail network. Our Company-operated retail stores performed well in the first quarter, and grew on a comparable-store basis. During the first quarter, we opened several new Levi's stores, including in Amsterdam and St. Petersburg, and we are about to open a flagship store on the Champs-Elysees in Paris.

In refining our global operating model and organization structure to build greater synergies between our brands, to be closer to consumers in the market, and deliver products that meet local consumer demand. Focusing on these improvements should also help drive productivity, and reduce our operating expenses. That I'm encouraged by our performance during the first quarter.

With that, I'd like to hand it over to Blake.

Thanks, Chip, and good afternoon, everyone. Throughout today's call, I will reference performance comparisons on a year-over-year basis, unless I indicate otherwise.

Total reported net revenues for the first quarter of 2012 were $1.2 billion, a 4% increase over last year. On a constant-currency basis, revenues were up 5%. Growth was primarily driven by our Levi's brand, and the performance of our dedicated store network worldwide. Our business continues to be impacted by the challenging global economic environment, particularly in Europe. Net revenues grew in our Americas and Asia-Pacific regions, but revenues declined in Europe.

Gross profit was $549 million, down 2% from 2011, reflecting a lower gross margin and unfavorable currency effects. Our gross margin was 47% this quarter, a decline from 50% last year. As we discussed in February, we exited 2011 with a relatively clean inventory position, and accordingly, sales to the discount channels were much lower than a year ago. However, peak cotton prices were flowing through our P&L this quarter. And as expected, higher product prices only partially offset those costs.

Turning to operating expenses, our SG&A declined to $439 million, a 4% decrease from 2011. This was driven by various factors, including a reduction in A&P spending, which was partially due to timing of campaigns as compared to last year. In addition, we had lower pension costs due to some changes in our pension plan structure, as well as lower long-term incentive expenses. Going forward, we remain focused on reducing SG&A spending.

Our higher net revenues and lower SG&A outpaced the impact of the gross margin compression, resulting in operating income of $110 million, up 11% over first-quarter 2011. Our net income for the quarter was $49 million, up from the $41 million last year.

Now I will share more detail on the first quarter regional revenue results. First, for the Americas region, we reported net revenues up 9%, primarily driven by the Levi's brand at both wholesale and retail. Higher net revenues also reflected the Denizen brand, which was not in Target at this time last year. As Chip mentioned, our Dockers business declined slightly, however, Dockers grew its full priced men's bottoms business as a result of the pricing and product strategies we discussed with you last quarter, which is encouraging.

In Europe, net revenues were down 7% on a reported basis, and 3% on a constant-currency basis. Our business continues to be adversely impacted by difficult economic conditions, particularly in the southern markets. Growth continued in our Asia-Pacific region, although economic growth and consumer spending slowed in key markets such as China and India. Net revenues increased 5% on both a reported and constant-currency basis, reflecting the strength of our brand-dedicated retail network.

Now, turning to cash flow and the balance sheet. Operating cash flow for the quarter was $105 million, as compared to $46 million last year. Inventory values remained elevated due to higher-priced cotton, but our inventory turns have improved as compared to last year. We remain focused on managing inventory unit levels appropriate to support our business.

Capital expenditures were $17 million, down from $40 million last year, reflecting a decline in our information technology systems investment due to the launch of SAP last July. We continue to invest in the expansion of our Company-operated retail network during the quarter.

At the end of the quarter, our cash balance was $238 million, and we had $555 million available under our credit facility. New debt -- or net debt was $1.7 billion. We are comfortable with our liquidity position, which is supported by our increased operating cash flow, and significant availability under our credit facility.

In 2011, we made our dividend payment during the first quarter due to pending tax law changes. In 2012, our plan is to pay a dividend in our second quarter, subject to Board approval. We are pleased with our first-quarter results; however, we are cautious as we move forward due to the ongoing difficult economic environment, the impact of which is increasing in some of our emerging markets. While we remain focused on delivering improved operating margins along with revenue growth, we will continue to be pressured by high cotton costs through at least the second quarter, and over the next few quarters we will incur organizational transition costs as we position the Company for long-term profitable growth.

With that, we will now take your questions.

Thank you. The floor is now open for questions. (Operator Instructions)

Your first question comes from William Reuter with Banc of America Merrill Lynch.

Blake, in your prepared remarks regarding the higher cotton costs that are going to be flowing through in the second quarter, you just noted that we should see some relief in the second half of the year. Should we expect that margins will stay around the level that they are here, or should we actually see some year-over-year increases in the back half?

Bill, thanks for the question. I think you should assume that we will still be in the high 40%s for gross margin going forward. That is the guidance I think we'd given in the first quarter. While cotton costs have come down, due to the length of our supply chain, it doesn't turn itself off immediately. And so, it will bleed into the third and fourth quarters, and slowly help us improve our gross margin back up into the levels that we saw a year or two ago. So, I would moderate your forecast for gross margin to stay in the high 40%s, and we will obviously see the seasonality trends that we have seen in the past.

Okay, that is useful. And you are advertising that was down, you noted that it was due to a timing issue. Should we anticipate that, for the year, ad spend will be pretty similar to last year? And should -- will we see a pick up all at once here in the second quarter, or will that be blended across the remaining three quarters of the year?

I think there is a -- I would go ahead and maintain the same model that you have in the past with general levels of ad spending consistent with our past performance. We tend not to have really lumpy ad spending, but there is some timing that goes between quarters. So, don't assume that there's going to be one quarter where it is all dumped into the quarter, but assume some smoothness consistent with how it was last year.

Okay, and then lastly, you noted that the second half of the year is going to have some organizational transitional costs. I was wondering if you could -- I'm not sure how you might be able to guide us or help us understand the magnitude of these, whether you can even talk qualitatively. Is there anything you could help us to think about how big some of these could be?

I can't give you any guidance there. All I would do is say that our focus will primarily be on our organizational costs in general, and somewhat consistent with some of the actions that we've taken in the past. But I think as we've talked about, we are going to be very focused on continuing to bring down our overall SG&A levels to get closer -- or to allow us to start driving the margins more aggressively.

Your next question comes from Karru Martinson with Deutsche Bank.

To follow-up on the organizational shifts here, what are you guys looking at? It sounds like we are going to be taking some headcount out. Is it a wholesale rationalization of the business, or is it just more tinkering around the edges?

Let me start, and then Chip might want to add in here. As Chip talked about in our last quarterly call, we've been working on improving our organizational effectiveness, and that is a combination of focusing on both brands and our commercial operations in all of our markets. I would call it an evolutionary process versus an overnight process. It is something that comes through controlling our spending as much as it is actively reducing spending. And so, it is a combination of those two. And you'll see it I think over the next 12-plus months versus all at one time, because of the complexity and the geographic diversity of our business.

I guess, Karru, I would just add that we are very focused on the notion of balanced growth, and we recognize that we need to grow the bottom line faster than the top line. And one of the things that is within our control are our own internal cost structures. So, we are looking for -- how do we drive productivity, get more efficient, and work the structure so that we get the most productivity out of the organization that we've got? And as Blake said, I think it is going to come over a period of time; it is not going to be one fell swoop. We are going to try to do this in a smart way.

Okay, and I thought I heard you say that the full-priced Dockers had gotten some traction. And I was wondering, how did that fit in with the reintroduction of some of the lower price points, more traditional styles that you guys carry in that product line?

That is definitely working; it is contributing. We walked away from a couple of core fits back about a year ago. We reintroduced them this past fall, and it's representing close to 20% of the total Dockers business. It is mostly selling at full price. Now, full price at lower price points, but it is definitely contributing to some of the traction that we are getting on the men's bottoms business on Dockers.

Okay, and just from a housekeeping perspective, what should we be thinking about for CapEx this year, as you walk back the IT investments?

Yes, so, our target that we set last quarter, and I think we are still consistent in the view is around $100 million. And the bulk of the decline year-over-year has been from the IT investment and our SAP rollout in Europe, as well as some of the general infrastructure cost that we have had over the last couple of years.

Your next question is from Grant Jordan with Wells Fargo.

My first question, you touched on this a little bit, but it sounds like the reduction you saw in SG&A in the quarter, that was not due to the result -- the efforts you've been making to reduce SG&A costs at this point?

I would say that it is the start of that process, but more of it was due to timing associated with A&P spending, as well as some of the costs associated with our deferred comp and our long-term compensation structures. So, all of those are a result of us focusing on more effective A&P spending, more targeted, as well as a continual effort to keep focused on the overall organizational costs. But I would say, if you are thinking about your models for the year, I would continue to keep your A&P spending levels fairly consistent with what you've had in the past. But yet, continue to expect more focus on SG&A each quarter, as we roll forward over the next three to six quarters.

Okay, that is helpful. And then my next question, you talked a little bit about, I think you said the economic impact in some of your regions was increasing as you moved into this quarter. Can you expand on that a little bit?

Yes, I think where we saw the biggest impact continues to be Europe, and that is in countries like Spain, Italy, Greece, Turkey, the countries where you would expect to see the biggest economic impact, the highest level of unemployment, the greatest level of consumer pain in the market. So, those are the places where we see immediate impact. We have seen less impact in the northern countries, but all of Europe is in an economic doldrum in many ways. And I think as you probably saw with China and India during the quarter, we've seen some slowing of the rapid growth there. We are seeing that show up as well in some of the consumer spending patterns of our consumer base in our stores and in our partner stores.

Your next question comes from Todd Harkrider with UBS.

Congratulations on a good quarter. To get my hands around SG&A a little bit better, can you break out A&P a little bit better, because you said to run it consistent with what we had in the models in the past, but you used to run like 6.4%, 6.5%, then it ticked up to 7.4%, then back down to 6.6%. I assume you're talking about around 6.6% or -- ?

I would say in that range. Obviously, we are focused on it. It is clearly a huge strength from Chip's background around marketing and advertising, and we are rethinking a lot of our programs and our ways that we operate around the world. We haven't traditionally operated on a fixed percentage of revenue, but I think if you keep it in that 6%, 6.5% range, that is probably good for your models.

So, it is being a little bit more strategic, as well, as [the shift] away from southern Europe, I assume.

Yes, that's exactly right.

The where and how we spend it, and how do we get more for -- more bang for the buck and how we spend it, is where a lot of our attention is going right now, and spending our money much more strategically. So, all of the advertising in the world may not bring back the consumer in southern Europe right now, so we are shifting our spending and trying to be smart about how we spend the money. But I think Blake said it from a guidance standpoint, you should be figuring somewhere between 6% and 6.5%. And this quarter is really just a -- it's a timing, phasing thing more than anything else.

That is understandable. And then, I missed the part on the SAP cost. Was that a benefit for the quarter as you complete the ERP implementation in Europe, or was most of the rest due to the timing shift in the pension plan structure? And maybe what you expect to maybe benefit from the change in the structure for the year, if possible?

So, most of it was from the latter. There was some small benefits from IT expenses, but the bulk of the SAP fell into capitalized software, and that you can see in the real decline in CapEx during the quarter. Down dramatically from first quarter last year when we were right in the middle of the height of the implementation. We went live, as a reminder, in July of last year, and so the bulk of the spending was in the tail end of 2010 and the first half of 2011.

That sounds good. And then, lastly on the -- can you talk about the slight reduction in your store count, since it seems like your total count has plateaued recently. In your opening remarks, it sounds like you're still committed to rolling out the dedicated stores.

Yes, we are definitely still committed to rolling out stores. At the same time, like any other retailer out there, we are constantly looking for opportunities to upgrade our network, which means closing unproductive stores or less productive stores, and either finding new locations or exiting a specific area. The bulk of the growth during the quarter was in the Asian markets where we've had quite a bit of growth, and we ended up closing some stores in the Americas markets when with the leases had come due and it was the appropriate time to do it.

But in no way does that indicate any lack of focus. It is a critical part of our business, and as you can see, the overall revenues coming from our store base has gone up as a percentage of total revenues during the quarter. And we -- while it will always be a smaller part of our business due to the strength of our wholesale side of our business, we do want to continue to focus on growing that.

In fact, just picking up on a point, I think the fact that we are negative net down stores quarter-to-quarter is because of the focus. We are much more focused on return on investment out of each store. And just like a garden, we're going to be constantly weeding and feeding to get stronger stores, more profitable stores, and stores that return. So, we are totally committed to the retail space.

Your next question comes from Emily Shanks with Barclays.

Hello, this is John Connor in for Emily today. I wanted to ask -- regarding the unsecured term loan, is that something you would be proactive in looking to refinance? Or can you give us a sense on how you would approach that decision?

I'm sorry, can you repeat that?

I'm sorry, with respect to the unsecured term loan, is that something you would be proactive in looking to refinance, or if you could just give us an idea of how you would approach that decision?

Yes, so, thanks. In general, we tend not to comment on refinancings, but obviously, the 2014 term loan is at a very favorable rate. And so, we are not in a rush to be able -- or to focus on refinancing that anytime soon, but we are going to always keep our eyes open and watch what is going on in the capital market.

(Operator Instructions)

Do we have another question?

Your last question comes from the line Kevin Coyne with Goldman Sachs.

Just in terms of -- I know the guidance is more or less high 40%s for gross margin, but I was wondering if you could give us a sense, is this more or less the trough for the year, or should we -- could it -- could things potentially trough in the second quarter? And as things improve, as cotton goes down in the back half, is getting back to a 50% area margin possible in the fourth quarter?

So, clearly, the second quarter will be a challenge because we are still in the midst of our highest-priced cotton. As a reminder, we put product into the supply chain anywhere between 6 and 12 months in advance because of our large volumes. And so, when we were putting product into that supply chain, we were doing it at the highest prices of cotton as they rolled through the commodity cycle.

But the other piece of the puzzle that really impacts gross margin is the demand and supply mix, and if we can align our demand and supply better, it eliminates the need to liquidate product to keep your inventories clean. I think we have a better sense today, as to the impact of the pricing increases, where a year ago we really didn't have as good a sense of what might happen. And so, in this quarter, it helped minimize the amount of sales through the discount channels, and we would hope that we can continue to do that during the year, help keep the gross margins on an upward trend back toward that 50% mark that you referenced and that we've seen in the past.

Great, thanks. And just as a follow-up to that, was the use of the discount channel on a year-over-year basis up?

We don't call out those sales, but as you can assume that the gross margins improved over the fourth quarter, you should assume that much of that might have been driven -- or was driven by sales through third-party discount channels.

Okay, and then just -- I know you mentioned the dividend. Just in terms of thinking about it, should we think about it in the same general size of prior dividends, or is there any potential where that would increase?

Yes, good question. We don't have a formal dividend policy, but what I've stated in the past has been -- we will try to pay a dividend that aligns with our profitability. And if you look back at the profitability over the last few years, the $20 million dividend is fairly consistent, and you should expect something in that range as well, if the Board, obviously, approves it.

I called out in my script that just a reminder that the first quarter cash flows, year-over-year, were slightly different because we paid our dividend last year in December of 2010, primarily due to the fact that there was a potential tax law change that ultimately didn't result in a real change, but we chose to pay our dividend anyway. Normally, we pay it in the late April, early May time frame. And this year, that should be your expectation as well.

Great, and just one housekeeping, I apologize if I missed this. But I know you mentioned some pension changes, but do you have an update, or can you give us what the pension cash contributions will be this year?

I called out in the 10-K last quarter the $65 million level. I think that is still the right level for you to think about from a cash side. The changes I referred to were really changes we made last year on combining some plans, but we are obviously seeing some of the -- either expense changes or cash changes already flowing through the income statement and the balance sheet. But I would stay consistent with $65 million number we used in the K.

Another question?

Your next question comes from the line of [Rishi Pari] with Sterne, Agee.

In terms of the challenges that you're expecting in Q2 on margins, would you say that the cotton costs flowing through Q2 are similar to Q1, or were they higher or lower?

I would say they are similar. In some areas or products, we might have seen slightly higher cost, but in general, I think the peak cotton was really coming through in the winter and spring seasons for us or Q1 and Q2.

And the price increases that you implemented, should we anticipate, at least in Q2, to see some level of improvement, since you probably implemented them a while back?

Yes, I would say that the price increases that you have seen and the coverage of the costs in Q1 will be pretty similar in Q2. In other words, we pushed prices fairly aggressively during 2011, and still haven't been able to fully cover all the cotton price increases, but we are probably to the end of our ability to push pricing much further.

Can you give us any idea how volumes were in the first quarter?

I think volumes are similar to what we saw in the fourth quarter. They remain challenged in the lower ends of the business where the consumer is the most challenged, where unemployment is high, or where they are getting hit with increased fuel costs or other inflationary cost.

On the higher end, we haven't seen as much impact, and thus volumes haven't been impacted. And it is primarily because those consumers aren't seeing the same impact. So, I think the trend is pretty consistent with where it's been, where we are seeing, obviously, some revenue increase because of pricing, but in some sectors, obviously because of volume increases as well.

And as a percentage of total revenue, what was licensing revenue?

It is a very small number. It is under 5%. It is really closer to 2%, and we have actually removed the formal call out in our financial statement because it was getting so small that -- the licensing business is important to us, but as our overall sales have grown, it has become less and less important to call it out.

And you said going into Q1, your inventory was pretty clean. Going into Q2, should we anticipate the same? And I assume on a year-over-year basis, given our assumptions on unit costs -- or sorry, input pricing, that units are down year-over-year?

We tend not to try to give too much guidance on units or quarterly inventory. All I will say is -- I would expect similar trends to continue during the year.

Any other questions?

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

Okay, well, the closing remarks are going to be really brief. Thanks very much for calling in today. Thanks for your questions, and we look forward to speaking with you again next quarter. Thank you.

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