Levi Strauss & Co (LEVI) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company's third-quarter 2013 earnings conference call.

(Operator Instructions)

This conference is being recorded, and may not be reproduced in whole or in part without written permission from the Company.

A telephone replay will be available two hours after the completion of this call through October 11, 2013, by calling 1-800-633-8284 in the United States and Canada, and 402-977-9140 for international. Please use reservation number 21673675. This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for one month on the Company's website, levistrauss.com.

I would now like to turn the call over to Chris Ogle, Vice President, SEC Reporting and Investor Relations at Levi Strauss & Company. Please go ahead.

Good afternoon, and welcome to our conference call. I am pleased to introduce members of the Levi Strauss & Company management team. With us here today are Chip Bergh, our President and CEO, and Harmit Singh, our Executive Vice President and Chief Financial Officer.

Before we begin, let me briefly remind you of a few items. Our discussion today may include forward-looking statements 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. Participants on today's call may discuss non-GAAP financial measures. You will find the appropriate reconciliations at the earnings webcast page in the investor section of our website.

Finally, today we filed our quarterly financial report on Form 10-Q with the SEC. You can link to our SEC filings from our website.

Now I'd like to turn the call over to Chip Bergh.

Thanks, Chris. Good afternoon, and thanks for calling in late on a Friday afternoon. We had a good third quarter. Total Company net revenues were up 4%, and net income more than doubled. And we achieved these results despite ongoing economic challenges that are impacting retail around the globe.

Before I discuss our strategies for driving profitable growth and our focus going forward, I'd like to turn it over to Harmit, who will walk you through the financial results in greater detail.

Thank you, Chip. Welcome to everyone joining our call. My comments today will focus on the results of the third quarter, and will reference comparisons on a year-over-year basis in US dollars, unless I indicate otherwise.

Total consolidated net revenues for the third quarter of 2013 were $1.1 billion, up 4% from prior year on a reported basis. Excluding currency effects, net revenues were up 3%. The increase was driven by higher revenues in the Americas at both wholesale and retail. On a global basis, Company-operated retail revenues grew 5%, and wholesale grew 3%.

Third-quarter operating income of $118 million was 36% higher than last year, and operating margin was 10% compared to 8% last year. Higher operating income was driven by a better gross margin again this quarter, offset by slightly higher SG&A. This, along with a $14-million income tax benefit, drove third-quarter net income up to $57 million, more than double last year's $28 million. The tax benefit resulted from the settlement of our US federal tax audits for fiscal year through 2008.

I will now review key factors that caused our margins and costs to increase this quarter, as well as discuss the impact of a few choices that were made in the third quarter last year. Gross profit for the quarter grew 10% to $573 million, mainly due to higher gross margin. We are pleased with the progress and focus on margin improvement this year. Gross margins for the quarter improved 290 basis points.

Factors that impacted the growth this quarter versus 2012 were approximately 160 basis points caused by the one-time impact of the dENiZEN shutdown in 2012, and a 100-basis-point improvement due to currency benefits. Efficiencies in our supply chain drove the balance. With only a quarter to go, we now expect that our full-year gross margin will end above 50%.

SG&A expense increased 5% to $455 million, mainly due to the timing and funding rate of our incentive compensation accrual, and an increase in A&P spend. A&P grew 17%, reflecting brand campaigns and products we launched in the third quarter, such as our Levi's Modern Frontier Campaign and our launch of Revel for women. While year-to-date A&P spend is less than 5% of revenues, we expect to spend at a higher rate next quarter, largely driven by the timing of our campaigns. And as a result, we continue to expect 2013 full-year A&P to end in the mid-5% range.

High incentive accruals in the quarter reflect that our Business in 2013 is performing better than projected at the beginning of the year. This was partially offset by a decline in impairment charges. As a reminder, last year we took a $19-million charge when we outsourced distribution in Japan.

Although third-quarter SG&A is up, our continued focus on cost and productivity has led to year-to-date SG&A being [70] basis points lower than last year at 38.8% of revenue compared to 39.5% last year. We also expect full-year SG&A as a percentage of revenues to be lower than last year, which would make this the third consecutive year where the percentage has declined year over year.

Now I'll share more detail on the third-quarter results for our three regions. Net revenues in the Americas of $710 million were up nearly 5% from prior year, both on a reported and constant-currency basis. Our Levi's direct-to-consumer business grew again this quarter, driven by our outlet stores and eCommerce sites. Our Levi's and Dockers brand revenues grew at key wholesale accounts. Wholesale sales also benefited from the expansion of Signature and dENiZEN with existing accounts.

In Europe, net revenues were up 3% on a reported basis. Without the impact of currency, revenues declined 1%. Revenues grew in our owned stores, especially in Russia. Sales to franchisees declined again, most notably in southern markets, which remained weak. We have a new regional leader in Europe, and have a renewed focus on our key markets in the region.

In Asia-Pacific, revenues were flat on a reported basis, and were 6% higher without the impact of currency. Constant-currency revenues are higher because of the charge we took when we exited dENiZEN last year. Excluding dENiZEN, revenues declined in Asia again this quarter, reflecting the ongoing challenges we face in several markets, including China.

Operating income declined in the Americas and Europe, mainly due to higher advertising and selling costs, and incentive-comp accruals. In Asia-Pacific, higher operating income was substantially due to the dENiZEN brand phase-out charges incurred last year.

We continue to focus on strengthening our balance sheet, as reflected by our overall liquidity position, lower net debt, and reduced leverage. Cash flow remains solid. Free cash flow for the first nine months of 2013 was $183 million, as compared to $345 million in the same period last year. We define free cash flow as operating cash flow, less CapEx, dividends, and payments on our foreign-exchange contracts. The decline in free cash flow as compared to last year was driven by an increase in cash used for inventory, owing to our inventory build and the lower accounts receivable balance we started off with this year.

Digging a bit deeper into working capital, which overall has improved, receivables continues to be an area of focus for us, and we have seen year-over-year improvement in collection trends. And payables have improved as well. Inventory balances are, however, 12% higher than they were a year ago. Approximately half of this year-over-year increase reflects the lower inventory balance from last year, and about half represents the inventory needed to support the volume growth that is driving our top-line performance. ¶ Capital expenditures in the first nine months of 2013 were $63 million, as compared to $54 million last year, reflecting facilities improvements and increasing technology investment, and our distribution center retrofit projects. As a reminder, we expect full-year CapEx will be in the range of $80 million to $100 million.

At the end of the third quarter, we had available liquidity of $904 million. Net debt was less than $1.2 billion, as compared to more than $1.4 billion a year ago, which, when compared with our better operating income, has substantially improved our leverage.

Heading into the fourth quarter, we are cautious in light of sluggish traffic at retail through the back-to-school season. Additionally, as we said in our last call with you, our retail network will not benefit from the Black Friday sales week this year. These factors, along with the timing of costs I mentioned earlier, will narrow our operating margins relative to the year-to-date trend. Still, we expect full-year operating margins will be notably improved over last year.

With that, I'll turn it back over to Chip to discuss our progress against our strategies.

Thanks, Harmit. So, as you heard, a good third quarter. This in spite of the economic challenges impacting the retail industry. But despite our challenges, the leadership we now have in place in key local and regional levels is committed to driving profitable growth by executing against the following strategic areas. First, driving our profitable core businesses and brands. Second, expanding beyond the core to build a more balanced portfolio. And third, becoming a world-class omnichannel retailer.

In the third quarter, we continued to drive our core businesses, which include men's bottoms for the Levi's brand globally, and for the Dockers brand in the United States, as well as key wholesale accounts around the world. Our wholesale business grew, with sales to our top-10 accounts up 7% for the quarter. We're upgrading our brand expression at key wholesale customers. At the end of August, we added new fixtures and presentation to stores in key markets, and we will continue to expand this during the fourth quarter.

On the Levi's brand, the team is keenly focused on winning a larger share of consumers' closets through innovative product and experiences. The Fall collection, anchored on modern interpretations of iconic pieces, such as the Levi's 501 jean. Growth in the men's bottom's business was driven by the Americas, where we observed strong sell-through of the 501 jean at both retail and wholesale. Growth in the Americas offset softness in Europe and Asia-Pacific.

To connect with consumers, the brand launched a global Fall marketing campaign, Modern Frontier, featuring a mix of established and up-and-coming pioneers in art, film, and design. The comprehensive campaign blended traditional elements, such as media, print, digital and outdoor, in key markets around the globe, as well as a modern consumer engagement program called Station to Station. Through this 10-stop train tour, the brand connected with fans across America, as well as online.

For the Dockers brand, US sales of men's bottoms were up for a third consecutive quarter, due to strong response from both the traditional and modern consumer. Signature Khaki sales grew double digits versus prior year. Sales of the more modern Alpha Khaki grew, due to an expanded collection.

The Dockers brand is also connecting with consumers through unique marketing and retail experiences. The team began testing a few pop-up shops in the key cities of Berlin, New York and Mexico City to engage and win the millennial consumer.

Our second strategy is to expand beyond the profitable core. This includes opportunities in men's tops and outerwear, in women's generally, and in key emerging markets around the globe such as Russia, India and China.

On a global basis, our tops business grew during the quarter. The Levi's Fall collection augmented its iconic 501 jeans with modern interpretations of the Western shirt and trucker jacket. The Dockers team is showing men how to put whole looks together with their khakis, and this is driving improved performance.

Our women's business was down slightly overall, but it remains a critical growth opportunity, and we're focused on improving our performance. In August we began rolling out a new collection, Revel, which features body-shaping technology that we believe will help women look and feel their best. This premium-price product is built off of the Curve ID platform.

We're investing behind the launch with advertising and marketing events in the Americas, Europe and Asia. It's mainly available in select Levi's retail stores and online. And while it's still early days, women are responding enthusiastically.

Turning to the emerging markets, Russia and India grew this quarter. Russia, which is comprised of Company-operated stores, grew revenue strong double digits while improving margins. India's a healthier business, thanks to the actions we took last year. We've started to improve performance in India by consolidating our franchisee base, shutting down dENiZEN, and focusing on the Levi's brand.

We're working in a similar manner to improve the Business in China. It will take some time. As we and our competitors have previously discussed, the industry is working through high inventories there. We have operational challenges to address as well. Our new Asia-Pacific leaders are focused on the Levi's brand, re-engaging consumers through product and marketing, working with our franchisee base to improve store locations and experiences, and building out our eCommerce presence.

Our third strategy is to become a world-class omnichannel retailer. During the third quarter, our global Company-operated retail business grew 5%, despite the traffic pressures the industry is facing. Our focus on driving productivity, and converting foot traffic into sales through outstanding service, is paying off. Growth mainly came from our outlets in the Americas, from our Russia business, and from eCommerce globally. Although eCommerce sales were only 2% of Company sales this quarter, they represented about 8% of Company-operated retail revenues.

In summary, it was a good third quarter, despite the industry challenges we're all facing. We've made substantial progress this year, building the foundation for long-term sustainable growth. Our leaders around the world are focused on executing against our strategies to not only navigate this tough environment, but also win in the market and build share.

Now we'll take your questions.

Thank you. The floor is now opened for questions.

(Operator Instructions)

And the first question comes from the line of William Reuter with Bank of America Merrill Lynn. Please go ahead.

Good afternoon, guys.

Hi, Bill.

In your 10-Q, in regard to your commentary regarding your gross margin improvement year over year, you highlight the $25 million due to the markdowns in Asia-Pacific. What were -- is there any sort of a breakdown to think about the remaining, maybe $20 million or $25 million of gross profit improvement?

Sure. So overall, as I mentioned, Bill, gross margins were up about 290 basis points. About 160 which is, a little over half of that is thanks to dENiZEN. 100 basis points, which is close to 35% of, is driven by what I call currency benefit, and the remaining is efficiencies in our supply chain. So that's the break up of the [competence] of gross margin.

And then your administrative expenses in SG&A, they increased. And you talk about it mostly being incentive compensation. Was this the accrual kind of for the first nine months that you guys kind of had a catch-up in this quarter, or was the year-over-year improvement the way we should think about -- the year-over-year increase the way we should think about the fourth quarter as well?

Yeah, it's largely in quarter three. A bit of catch-up, because as you know, accruals are linked to business performance. As we start thinking about business performance for the year, the catch-up is based on an annualized number. That's what I would say. The only other thing I would mention, Bill, is if you reflect on what happened in quarter three of 2012, we reversed incentive accrual. The problem was just reversed. At that point, our business performance was below trends that we expected in 2012, so there was a bit of a reversal there. And so a combination of higher accruals this year for this year's performance and a reversal of last year is really what caused the spike in quarter three. On a year-to-date basis, the incentive number is less dramatic.

Okay. And then just lastly, there are a lot of anecdotal reports out there that traffic in retail stores, particularly in apparel, are weak. I guess I'm curious what you guys would say about that, and maybe how you think you're doing relative to the industry. That's it from me. Thanks.

So I'll take that one. We talk about it a little bit in the prepared remarks. What we saw in the third quarter was very, very choppy, inconsistent traffic, and traffic being down for the full quarter. And I would say that trend has continued through the early parts of the fourth quarter. It's a real issue. It's out there. It's public. Everybody's talking about it. Our focus is to do what we can to get more traffic into our store, but then just as importantly, maybe more importantly, doing a better job of converting once we've got a consumer in the store. So -- and that's a big part of what's driven our results last quarter.

Thank you.

Our next question is from the line of Grant Jordan with Wells Fargo. Please proceed.

Hey, good afternoon. Thanks for taking the questions. Just a follow-up there on Bill's, a little bit in terms of what you're seeing from the consumer. Anything you can call out as it relates to the US consumer? If you're seeing any particular weakness at the mid-tier versus more of an upper tier consumer?

Well, Grant, the way I think about this is I see this as an opportunity, actually, for our brands. The Levi's brand is maybe one of the most democratic brands in the industry. We play at a price point from below $20 for Signature by Levi Strauss at Walmart to hundreds of dollars in our main line and flagship stores, with a pretty broad portfolio, and our sweet spot is still kind of Middle America. It's in the $50 range. So I would say that the one thing that is a concern, and as of the last time I checked the news about a half an hour ago, the government is still shut down. The longer that drags out, the more of an impact that could really have on the balance of this year. So if that is a prolonged thing, that is going to have a market impact, I think, on everyone's business as we cruise into the holiday season.

Sure. No, that's helpful. As it relates to your retail partners, do you feel like they've kind of pulled back on inventory positions going into the holidays, or is it too early to tell?

I think everybody is managing the holidays very closely. They're on top of their inventory and watching it real carefully, and I've talked with several of our biggest customers just in the last one to two weeks. I think everybody has a cautious outlook for the holidays, and everybody's trying to manage their inventory and an ability to chase as tightly as they can going into the holiday season.

Okay. Great. Thank you very much.

You bet.

Our next question is from the line of Carla Cassella with JPMorgan. Please go ahead.

Hi. My question was, relates to the inventory levels. You mentioned that half of the increase was planning for growth. Is that all US or international?

Carla, hi. Appreciate the question. Was wondering when it would come. But a couple of factors as you think about our inventory. First, as I mentioned, we're recovering this year from a low base of last year. The second, in specific response to your question, inventory buildup is concentrated on what I describe is healthy inventory, largely driven by programs with key customers in the Americas, which is where you're seeing our strongest revenue performance. If we look at our excess and absolute inventory, it's actually down versus a year ago, which is good news. And overall, as I earlier mentioned, we recommitted, and maybe a little more, to our perspective on full year margins, which we said would be higher than 50%. So that kind of explains how we're thinking about inventory for the balance of the year. As Chip mentioned, given the trends we're seeing in retail, we are keeping a careful eye on inventory levels and focus on managing inventory the way we have over the last couple of quarters.

Okay. Great. Go you ahead. Sorry, did I cut you off?

No, I was going to ask you, I hope it addresses your question.

Yes. I had one follow-up, though, on China. How much of the inventory do you have excess over there, and could we see a similar write-down to like what you did in India?

We're looking, and have been looking, at China for the last couple of quarters. And we have been managing inventory levels down, both in our stores, as well as -- because we have a large franchise base in China, also working with our franchise partners. The sense is, unless there's a major slowdown in the industry, we feel reasonable about our inventory levels.

Okay. Great. And then on the womens', the Revel launch, you mentioned this quarter that women's was down. Will the Revel launch be enough, just from the sell-in of it, to turn the women's positive, or is that not enough to move the needle?

It's still pretty small. I mean, for the third quarter it was probably a rounding error, and even as we roll into the fourth quarter, it's still in less than 1,000 stores. So it's not going to have a major impact on its own. However, having said that, it is based on the Curve ID platform, and we're trying to give Curve ID another shot of life as we launch Revel and play this up as also a Curve ID play. So we're very bullish on Revel and its potential long term. It is a real innovation that is a consumer wow, and as I said, it's off to a good start. And I think over time it can be a meaningful innovation that will drive our women's business in total by giving us real credibility on fit and finish with women at more premium price points, which is where this innovation deserves to live.

Okay. Great. And then you had mentioned that you've gotten some expanded programs at some of your retailers. We've seen some of that, I think as Macy's, Kohl's. Are there others that are doing it? Then, of course, I guess JC Penney still from the Dockers launch.

Right. So we work -- I mean, I think the best way to think about this is we're working with all of our top retailers on how can we take what we've learned from customers where we have upgraded the consumer experience and elevate the consumer experience every opportunity we've got. So we're working with all of the major retailers to do that. You've seen what we're doing at Macy's and Kohl's, and that's a good example. Each customer wants and deserves their own differentiated type of approach. We're working with them in a way that works inside their operation, that's consistent with their equity or their brand, but also does a great job of elevating our brand. And as we do that, almost universally when we do that it lifts the business.

Okay. And this is my last one, kind of in that same vein. You now anniversaried the JC Penney launch last August. Are you still seeing positive comps on top of the launch?

We are. We are.

Okay.

Which is a very good thing.

That's a great sign. Thank you.

You're welcome.

Our next question is from the line of Todd Harkrider with UBS. Please go ahead.

Appreciate it. You talked about talking to your biggest customers recently, and obviously one of those large department stores is having trouble turning around their business. And Levi's has always done a great job in the past redirecting lost sales when previous department stores closed. or reduced their store counts pretty aggressively. Can you share any thoughts on what -- if you're actually handling this one any differently than the past ones? And you talked about expanding the relationship with Macy's and Kohl's, but is there anything more comprehensive you're looking at, like maybe thinking of partnering with off-price today which you might not have done in the past, or any other color you could help out there? Thanks.

Yeah, Todd. Let me respond directly, I think, to what you're trying to get to, and then Chip can take the second half of the question. We're encouraged by the progress JC Penney's making shoring up their liquidity, and have not seen any change in their payment practices. They're a valued customer of ours, and our relationship is fairly strong with them. And overall, as Chip had earlier mentioned, our business with them remains strong. So I think that's where you're getting to, so I thought it address it directly. Chip, you want to --

The only other thing I would add would be that we truly value our relationship and the business that we have with all of our key wholesale customers. We work with them collaboratively to build our business and their business, and that's our focus. And we want to win with the winners, and continue to focus on building our business with our biggest customers.

Sounds good. That was the answer I was kind of looking for, appreciate it. And then your third quarter retail revenues, you said were up 5%, wholesale was up 3%. But when I look at your retail stores as a percentage of your overall mix, the first half it was 24%, and for the year-to-date through the third quarter it was 23%. Can you kind of provide a little bit more color on the mix shift in sales in the third quarter? And then I know you used to say that retail would probably max out around 20% of overall sales. Part of that is due to a little bit of sluggishness on the wholesale side, but obviously you're above that point today. Can you give any updated figures on where you think you can get retail today, and if the Internet has changed that mix, and where you see it? Because obviously you're doing great on the retail side, obviously.

Todd, let me respond to that in terms of retail mix. First, we don't sit back and -- we don't have a target retail mix as a percentage to the business. Traditionally over the years, if you step back many years, we were primarily a wholesaler. Over the years, renewed focus on retail, and with the perspective of getting closer to the customer, we're really focused on growing retail, and over the last couple of years making it more of an omnichannel focus. So our growth in e-commerce is reflected as part of retail, has also been fairly decent, been a decent clip. So as we continue to think of what the business longer term, keeping the focus on growing the omnichannel business is an important strategic driver for us, as Chip highlighted in his prepared remarks. I think the change in trend, or the numbers, is largely a reflection of softness in the quarter, but not necessarily a reflection of how we're thinking about the retail business.

Appreciate it. Thanks for taking my questions. Congratulations on another good quarter, and good luck with the fourth.

Thanks.

And our last question is from the line of Hal Holden with Barclays. Please go ahead.

This is Jon Kahnowitz in for Hal. Most of my questions have been answered. The one I wanted to quickly ask, do you see a little bit of a shift, or if you think you may see a shift towards some of the lower priced product. Is there a meaningful or any margin difference between the higher and the low end, or the higher price point product?

Nothing that is of material that we need to call out. Sorry, I didn't get your name. I know you're standing up for Hal.

This is Jon Kahnowitz. I work with Hal.

Jon, yeah. So Jon, nothing material that we can call out at this point.

Okay, great. That was it. Thank you very much.

At this time, I'd like to turn the floor back over to the Company for any closing remarks.

I'll keep this short and sweet since it's Friday afternoon for most of you, at least those of you on the East Coast. Thank you for joining us this quarter, and look forward to talking with you again. I guess it will be in February after we close the fiscal year. Thank you very much.

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