Levi Strauss & Co (LEVI) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co.'s second-quarter 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 recognition from the Company. A telephone replay will be available through July 16, 2012 by calling 800-585-8367. Please input the ID code of 95091283 followed by the pound key.

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 Kris Marubio, Director of Corporate Affairs at Levi Strauss & Co.

Good afternoon, and welcome to our conference call. I am pleased to introduce members of the Levi Strauss & Co. 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. Our second-quarter results reflect the intensifying macroeconomic headwinds around the world. As many multinational apparel and consumer goods companies have indicated, growth markets, particularly those in Asia, have begun to exhibit a broad slowing trend, and conditions in Southern Europe worsened.

In this environment total Company net revenues for the second quarter declined 4% on a reported basis, and net income declined 37%. While revenues were down in Asia and Europe, revenues grew modestly in the Americas, driven by our retail stores. As we anticipated, high cotton costs continued to put pressure on margins, although our pricing actions and expense management partially offset the impact to the bottom line.

As we told you last quarter, we have begun taking steps to manage our controllable costs. The deteriorating conditions now underscore how important it is to address the underlying structural economics of our business and make tough choices to improve operating margin while focusing our investments. Let me walk you through what we are doing in greater detail.

First, we are executing on a multiyear commitment to reduce costs and strengthen our operating model. We are focused on driving sustainable organization savings in order to reduce our SG&A. For example, we are managing our business to get better scale. You have seen us moving to a global matrix operating model through the appointments of new executive positions, including our commercial operation leads and a global head of retail and e-commerce. Also, as you know, we announced the new Levi's brand leader.

This reflects the three pillars of our new organizational structure -- our global brands, global retail and commercial operations. During the second quarter we continued to reorganize our teams behind this model. We are making our commercial operations pan-brand in order to serve our wholesale customers more efficiently and gain greater economies of scale across our brands.

We are also consolidating country operations and reducing layers of management. We expect to activate this leaner operating model toward the end of this fiscal year.

Second, we are focused on being a best-in-class global retailer. Retail is an important pillar in our new operating model. Across the regions our store network continued to drive sales growth in the second quarter, and we see opportunities to grow our retail business profitably.

In order to achieve this goal we are focusing on service and the brand experience, as well as closing underperforming stores, moving to locations with better foot traffic, and where it makes sense, opening stores that effectively showcase our brands. During the quarter we opened a Levi's store on the Champs-Elysees, and last month we moved our successful Levi SOHO store to an even better location.

In addition, we are building a global e-commerce platform that will deliver a consistent experience for consumers around the world. Our own e-Commerce will complement the e-Commerce efforts of our wholesale partners.

And, third, as always, we will put the consumer at the center of everything we do, driving innovation and a great consumer experience. We are working with our wholesale customers to enhance the consumer shopping experience in a variety of ways, such as training sales associates on our fit system, and improving on floor displays.

The Levi's brand continues to focus on offering products with craftsmanship and innovation. Our more modern slim fitting 511 continues to gain traction. We are expanding our innovative performance wear this fall with a limited capsule skateboard collection with Nike and the next global rollout of our own Commuter series.

We are working to capture consumers' attention through engaging marketing and social media programs. Though we have selectively scaled back advertising during the quarter, we remain committed to supporting our brands with marketing programs that have a high return. For example, we connected with consumers on Facebook for a denims birthday celebration on May 1 for 501.

Turning to Dockers, the Alpha Khaki with its slimmer, modern fit is resonating well with younger audience, particularly in Europe, and our Wearever series is also gaining traction. The core of the brand, men's bottoms, grew slightly in the quarter. We are stabilizing the business by rightsizing the brand's cost structure, licensing where it makes more financial sense, and streamlining our product mix.

With that I will turn it over to Blake, who will walk you through our financials in more detail.

Thanks, Chip, and good afternoon everyone. Total reported net revenues for the second quarter of 2012 were $1 billion, a 4% decline from last year. On a constant currency basis revenues were down 1%, as declines in Europe and Asia offset the modest growth in the Americas, reflecting the increasingly challenging global economic environment.

Gross profit was $481 million, down 11% from 2011, reflecting higher cost of goods sold and unfavorable currency effects. As expected, our gross margin declined notably in the quarter to 46% from 49% a year ago.

Our spring season represents the tail end of the peak cotton prices in the products we sourced last year. And while our price increases have partially offset these costs, we determined that additional price increases in this economic environment would not benefit our results.

Turning to operating expenses. Our SG&A declined to $435 million, down from $476 million in 2011. This was primarily a combination of favorable currency effects and lower A&P spending, which we are now actively managing down given the challenging market conditions. While we remain committed to supporting our brands, we are focusing on carefully managing expenses and investing where we believe we can drive profitable growth.

Our lower SG&A did not sufficiently offset the impact of lower net revenues and the gross margin compression, and accordingly our operating income declined to $46 million as compared to $65 million last year.

Below operating income our results were impacted by our refinancing activities during the quarter. In May we successfully refinanced our $350 million senior notes due 2016, extending the maturity of that portion of our debt to 2022, and locking in a 200 basis point interest rate reduction. In addition, we also were able to repurchase more than half of our outstanding 2016 yen eurobonds at a discount.

Our 2016 maturities now solely consist of the remaining $50 million balance of yen bonds. The net impact of the refinancing activities during the quarter was an $8 million charge.

Our net income for the quarter, inclusive of the refinancing charge, was $13 million, down from $21 million last year.

Now I will share more detail on the second-quarter regional revenue results. The Americas grew net revenue a modest 1%. Increased Levi's brand sales at retail and Denizen brand sales at Target were offset by lower sales to certain major wholesale customers. Sales to lower-margin channels also declined.

In Europe net revenues were down 10% on a reported basis and 2% on a constant currency basis. While net revenues have increased in our own stories, sales to franchises and traditional wholesale customers continued to decline, reflecting the ongoing difficult economic conditions in Europe.

In Asia-Pacific we experienced the first overall business decline in two years, as net revenues were down 12% on a reported basis and 9% on a constant currency basis. Growth continued in China, but has slowed significantly, and this more tempered growth was offset by declines in other markets in the region. This was especially true in India where we saw a substantial drop in consumer demand.

We are concerned about the economic factors in Asia-Pacific and we are looking at ways to address the situation as the region has been a growth engine for some time.

Now turning to cash flow and the balance sheet. Operating cash flow for the first-half of 2012 was $328 million as compared to $85 million during the first-half of last year. The increase in cash flow reflects our tighter inventory position and the timing of Accounts Receivable collection.

As we move into the third quarter, traditionally a period of higher working capital usage, we are beginning to see the benefits from the decline in the cost of cotton in our upcoming product. We will also remain focused on managing inventory units to appropriate levels.

Capital expenditures for the first six months of 2012 were $37 million, down from $76 million we spent last year, which included the deployment of our SAP system in Europe. We continued to invest in the expansion of our Company-operated retail network, but we will be prudent in our capital spending, prioritizing profitability over growth.

We also paid a $20 million dividend to shareholders during the quarter, an amount consistent with the last few years. At the end of the quarter our cash balance was $278 million, and we had $587 million available under our credit facility.

Net debt declined to $1.5 billion from $1.8 billion at year-end. We are comfortable with our liquidity position, which is supported by our increased operating cash flow and significant availability under our credit facility.

Looking ahead we continue to be cautious due to the ongoing troubled economic environment. While the high cost of cotton will abate during the third quarter, the increasingly global economic challenges may continue to put pressure on our margins.

As Chip discussed, we will focus on reducing operating expenses and will make necessary changes in order to move towards our historical profitability level. These actions will result in some near-term costs, such as severance and other one-time charges associated with corporate reorganization and streamlining efforts.

In our future quarterly earnings call we will help you understand the nature of any of those charges. With that we will now take your questions.

(Operator Instructions). Wells Fargo.

Hey, it is Grant Jordan at Wells Fargo. Thanks for taking the question. I guess, maybe just give us a little more commentary on your cautious comments on Asia. What do you think is driving that? Is it macro economic conditions in those countries?

It seems to be a combination of a number of factors, but clearly GDP is slowing down in the big markets in Asia. So GDP growth rates have dropped by a couple of points in both China and India here recently -- a little bit of an inflation effect. And the consumer is pulling back. I mean, that is really simply what we are seeing, particularly true in China and India where we have decent sized businesses.

Okay. Has there been any competitive response there or do you feel like it is strictly related to the consumer overall?

I think big picture -- and I think you're going to hear it from other companies as well, I mean, we are already hearing it from some companies -- I think big picture it is a consumer dynamic more than anything.

Okay. In terms of just how you're planning the business going into the fall, it sounds like you're going to be cautious with your outlook, but what are you hearing from retailers on back-to-school?

You know, I think everyone is cautious, both our competitors that we are hearing, at least in their public comments, and what we are hearing from retailers. At the same time, they want to make sure their stores look good and the product mix looks good. Obviously, you have got the buildout going on at JCPenney's, which will continue to roll out through the back-to-school season, so it will be interesting to see how that looks.

But I would say overall it is a cautious view due to the economy in any of the local markets. And as Chip said, it is all really driven by the consumer not stepping up to spend.

Yes, I think if you go region by region, here in the US I think there is -- we are on shaky grounds a little bit right now. I think retailers are going to play it pretty safe in the second-half of the year. We will see that from an inventory -- how they manage their inventory and open-to-buys. Particularly true in Southern Europe, and I think we're going to see more of it with our partners in Asia as well.

My last question, just kind of dovetailing on that, how do you feel about your inventory position, and do you expect to have any clearance activities going into the next quarter?

We are feeling very good about the position, and in some portions of the world we are actually wishing we had a little bit more where certain products are working.

But clearly if you look at our cash flow you can see that the inventory levels have come down dramatically, and we are trying to operate with as lean an inventory position as we can to eliminate compression that we saw in the fourth quarter around our gross margin. So we are feeling good now, and we will continue to maintain that posture.

I will just pile on to say, I think we learned the hard way in the fourth quarter last year, and so we're going into the fourth quarter this year, into the second-half of the year this year, trying to manage our inventories pretty preciously.

Okay, great. Thank you very much.

Bank of America.

This is Bill Reuter. Following up on that question a little bit about your inventory levels, you have said you feel good. And I think also the cotton costs you mentioned are going to abate in the third quarter. But then you made cautious comments on margins.

I guess it would have seemed to me that if inventory is in good shape and cotton is lower that margins could expand. Maybe you can help me make sense of that.

Yes, so clearly our gross margin is well below what it was this time last year. Last year we were at 49.5%. We are at 46% this quarter. The negatives in that gross margin are obviously the price of cotton and the inability to continue to keep driving price up. We have been improving the quality of our product over time, but that plus the price of cotton hasn't allowed us to fully cover all that in our pricing.

We have -- in an effort to maintain lean inventories around the world we have discounted in some local markets and so that also has impacted our gross margins.

I think the positives are -- and the reasons we will see some gross margin increases, obviously the cotton costs will come down in the third and fourth quarters. And if we can continue to maintain low inventory levels we won't need to liquidate inventory or sell more inventory through the discount channel.

I think our caution is really driven around the overall economic situation globally. And while I think historically we have guided into the low 50%s in the back-half of the year, or for the full year, as I have said earlier, this year I think we will probably be still in the high 40%s.

So you should see some improvement in gross margin, but we are cautious as to how fast that improvement will occur and how quickly we will be able to see some of the benefits of the pricing that we have taken historically due to the fact that the economy is still slow.

Okay, that is very helpful. And then your advertising expenses, which were down pretty considerably in the quarter, I think last quarter you had made some kind of qualitative comments that you would expect they would be relatively similar for the year. Have you changed your strategy and are you guys going to -- should we see a large year-over-year increase in the back-half of the year to offset the first-half or is that not the way you're thinking about it?

I think what you are seeing, some of that is going to translate to real cuts. I mean, frankly, we couldn't back-load all of that right now I think even if we wanted to. So given the worsening conditions -- you know, we have pulled back some marketing support in some markets and that is going to translate into a real cut.

Now the second-half we are still planning to support our business. We do have plans. The business is seasonal and the second-half of the year going into the holiday season is really important for us. And we will be supporting the brands in the second-half about in-line with what we did a year ago.

And I think, Bill, you know, as both Chip and I commented, our focus is on bringing the overall level of SG&A spending down. We have obviously -- we want to maintain an appropriate level of A&P. We are going to cut back where it doesn't make sense this year, but going forward we want to maintain that as an important expense for us.

What we will really start to see in the back-half of the year and into next year is more non-A&P spending cuts around the overall operations of the Company. We are really focused on trying to drive organizational change, which should start to yield SG&A improvements over time.

Okay. And then, just lastly, do you have a sense for how your minimum pension contribution in 2013 could be impacted by the new legislation that increases the discount rate?

Yes, that is a good question. So, first off, the IRS has not yet released what the 25 year average rates are going to be. They will publish those in August. But our early view is that if we continue to use long-term averaging in our pension plans we would most likely see some benefit.

We have already seen some benefit this year just due to structuring. As you remember, in our 10-K we had said that we were roughly looking at $65 million in 2012 and $65 million again in 2013. 2012 will clearly be below that level. Most of our funding has already happened to date roughly $40 million. And we would see some reduction in the last piece of funding for the year, but that is only a few million dollars left in that funding.

Next year is still too early to say. We will obviously tell you that at the start of the year, but I would assume that it will most likely be below the $65 million level that we had disclosed in our 10-K for 2013.

Okay, that is all for me. Thank you.

Deutsche Bank.

This is Karru Martinson. Just so I am clear -- just to confirm, I guess, you are still looking at a high 40%s type gross margin for the full year, correct?

Yes, and we think we would still be in the high 40%s, but, obviously, lower than what the average was last year, primarily because of the impact in the first two quarters this year.

Okay. And then when you look at -- you guys talked about the reset going on with JCPenney's and there is a lot of noise here about the store within a store concept, are there any kind of upfront vendor payments or commitments that you guys need to make to pursue that strategy?

No, essentially what we are doing with JCPenney is redirecting the historical spending that we have done with them for on-floor, and that is spread out over time, so no upfront spending. That is really being the responsibility of JCPenney. And we will see how the business performs over time and that could ultimately impact how much we spend with them going forward, similar to how we did historically. But it is probably too early for us to give a real insight until we start to see how the shop-in-shops look as they rollout.

They're excited about it. We are very supportive of JCPenney as a key customer. But we are -- we will wait and see, but we will know in the next couple of months as we start to see the shop-in-shops rollout.

Okay. And recognizing the slowdown in Asia and then the consumer dynamic going on there is part of the shift though kind of these tough comparisons given the sell-in and the creation of Denizen last year, and when will we anniversary that feed-in?

Yes, it is good --.

We have -- actually we have anniversaried Denizen in Asia. And the comparisons here really are fundamentally reflecting what is happening from a consumer dynamic standpoint. So Denizen is down year-over-year, that is part of the Asia issue, but we are also seeing softness on our core Levi's brand as well.

Yes, as a reminder, Denizen is a very small business in Asia, so while we are anniversarying it, it doesn't have as big of an impact. It is actually larger in Target in the US, and we're getting some benefit of that now in our numbers. But still it is a relatively small portion of the US overall -- or the Americas' overall business.

Okay. And perhaps I missed it, but could you provide an update on what is going on in Japan? I know it has been a tough market, and what the outlook is there?

Obviously, last year, a very difficult year with the tsunami. It appears that while the economy has not returned to normal it has certainly stabilized to some extent, and our business has also stabilized. But we obviously continue to be cautious there, no different than we are in any market around the world.

We are working very hard to improve our business and improve the channels in which our business goes through, as well as our own retail stores there. And we think we are seeing some benefit, but it is still real early to tell.

Thank you very much, guys. I appreciate it.

JPMorgan.

This is Paul Simenauer on for Carla Casella. I just have a few questions for you guys. First, how is Dockers doing, and have you guys gained any doors there?

Dockers, our strategy has been to really refocus back on the core men's pants business here in the US. And the good news is that business is growing. The second thing that we have done on Dockers is get our cost structure right for the size of business that we have today, and so we are making good profit progress on that business.

The third thing I would say is that our business in Europe, which is a slightly different business than the business here in the US -- you know, in the US we are basically a pants business, in Europe we have got really a real head-to-toe collections business -- is doing pretty good all things considered with the tough economic environment in Europe.

So we're feeling pretty good about the progress that we're making on Dockers. There is still clearly a lot of work to do, but I am confident that this brand can grow and be a significant part of our portfolio again over time.

Got it, great. And that is a good segue into the next question. Levi's Europe, obviously, economic weakness you are saying. Can you discuss how performance varies by country?

I will give you a high-level response, and if Blake wants to go deeper he can. But think about Europe as North Europe and South Europe. And if you draw the line where -- about where that line would be, North Europe we are doing well and growing, and in some markets growing quite strongly. Southern Europe is pretty weak -- declining in most markets in Southern Europe.

Yes. And the only thing I would add is to the extent that you think about Eastern Europe, Russia -- our business in Russia has done well. It is obviously still small there, but as the economy has improved in Russia our business has improved.

And we have done well in the Middle East. Even though once again that is a small business, I think they haven't seen as much of the broader economic -- that it is a more social impact there, but our business has sustained pretty well.

But as Chip said, our overall worry is the broad economy in Europe. And while the south is bearing the brunt of a lot of the unemployment, the consumer is cautious almost everywhere in that market, including big markets like France and Germany. And that is why you're seeing a fairly flat business for us there that then gets impacted by the weakness in the euro as well.

I think that is a great point. Just, I guess, one other comment. So our business is modestly down in Germany right now, and Germany has got one of the strongest economies in Europe. And it is fundamentally, again, it is a consumer thing. The consumer -- the German consumer is a fairly conservative consumer anyway. They are being very conservative with their shopping dollars and they're just postponing things -- postponing purchases.

Yes, interesting, very interesting. Moving on, non-denim seems to be growing. Are you seeing any replacement of denim space at retail with non-denim or any loss of floor space there?

We haven't really seen any loss of floor space. We have been introducing non-denim products of our own in Levi's. There was a fairly -- very successful line called Sta-Prest in the early spring, which essentially was a denim or a jean cut using a non-denim material or a blended denim material. And I think we tend to see most of the denim players extending and so keeping their same floor space just with different product mixes.

Great, great, and one final question. This is about the JCPenney shop-in-shops. I don't know if you have said exactly when it is going to debut, precisely, like the exact dates, or if you have that, but that will be really helpful. And will it constitute a larger offering than what you had in JCPenney previously? And will Dockers also go in?

So that is a multipart question. I think you can expect to see the Levi's shop-in-shops up and fully operational -- I think their target will be back-to-school timing, so they are kind of going in pretty much as we speak right now. And I think we will have several hundred stores up and running by back-to-school on Levi's.

It will represent -- we will get some increased space and some increased inventory as a result of it. I have seen what the shops are going to look like. I think they're going to be really strong. It is going to definitely elevate the consumer shopping experience and make a meaningful impression. And I think it will be good overall for our business.

Dockers is still in the TVD column. We are working with them to try to seal the deal on Dockers shop-in-shops as well, but that will be on later timing. So they are focused on their big brands first. You have read what many of them are. We are delighted that Levi's is going to be one of the first brands up and running.

Got it. One last thing. I don't mean to ask too many questions, but I just want to clarify a point. There was actually something out today in regards to the potential slight change in the SG&A sharing agreement with JCPenney. I am not sure if you answered that question earlier or not. I just want to make sure that -- if there has been any changes what are they, or if they are material, or if you can talk about that at all?

Yes, what we said earlier -- I'm not sure what was announced today -- we -- obviously we didn't announce anything, other than to say that our spending with JCP will be consistent with how it has been in the past and will be over a period of time, not up front. And so our view is we have supported their on-floor investments historically, and our continued support will be over time as they build out their stores and as we operate those stores.

Very helpful. Thank you, guys.

Stone Harbor.

It is Jeff Kobylarz. I was just curious about -- I think you said about the inventory, I think you said it was -- most of the decline in inventory was in units. Is that correct?

Actually, I'm not sure if I said that or not. But we did see both a unit decline as well as a dollar value decline as we are starting to build lower-priced cotton inventory. But our bulk of it was in units coming down over the last quarter.

Okay. And then I think I heard you say, Blake, that in the US the retail stores were positive, and Denizen in Target was a positive contributor to sales, but then the wholesale business was down in the second quarter and is that -- did I hear that right?

Yes, that is correct.

Okay. And what is the reason for that? Is there -- do your wholesale customers want less weeks of inventory or what can you elaborate?

I think it is a combination. Obviously, you have got one major wholesale customer that is going through a transition. It is impacting their general business and you should assume it has impacted our business. But at the same time I think wholesalers are, as Chip mentioned, being very cautious about inventory. And they are seeing the slowdown in consumer demand and so they're being careful, and we're seeing some of that in our business, obviously.

Okay, so then is it, I guess, like a few weeks of inventory that are being held by these -- by retailers in general in the US?

You know, it is hard for me to say. I think with us, obviously, they tend -- each retailer has a different inventory policy. And in some of our products we operate with automatic inventory replenishment. So it is hard to tell exactly how much they are carrying at any one time.

Right. Okay. And then, I guess lastly, about the pricing, just given with cotton coming down it sounds like you're not changing prices for the second-half of this year. Is that correct? (multiple speakers).

That is correct.

Okay.

Yes, in fact, just to -- I guess, the other thing I would say, and Blake alluded to this or mentioned it earlier, we did -- we have been investing in the product quality that kind of unfortunately hit right at about the same time that cotton pricing went up. So we have invested in make, and it shows in the product itself. And so we're planning to hold pricing to offset that cost.

Sure, all right. Good luck. Thank you.

At this time there are no further questions.

Okay, great. Well, I want to thank you all for joining us today, and thank you for your questions. I just want to close by saying we are taking the necessary steps during this tough economic environment to make our business more competitive and drive long-term profitable growth. We look forward to talking with you next quarter. Thanks a lot.

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