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No Celebration Just Yet: Levi’s Net Leaps 376% But Firm Still Cautious

Levi Strauss still isn't about to celebrate a turnaround despite a triple-digit increase in earnings in the second quarter, as a pivotal second half looms.

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NEW YORK — Levi Strauss & Co. still isn’t about to celebrate a turnaround despite a triple-digit increase in earnings in the second quarter.

Instead, the profits spurt simply sets the stage for what Levi’s executives believe could shape up to be a pivotal second half of the year.

The 152-year-old, San Francisco-based company reaped the benefits of sizable reductions in cost of sales and restructuring charges, leading to a 375.9 percent earnings gain in the second quarter ended May 29 to $26.8 million from $5.6 million in the year-ago period.

Levi’s continued to face depressed retail environments in the U.S. and Europe, however, causing sales for the quarter to slip 1.6 percent to $943.7 million from $958.8 million.

For the six months to date, earnings exploded 2,175.4 percent to $74.1 million from $3.3 million. Sales increased 1.5 percent to $1.95 billion from $1.92 billion.

“In a mixed second quarter retail environment, we delivered a solid quarter,” said Phil Marineau, chief executive officer, during the company’s conference call Tuesday. “We really are right where we expected to be at the midpoint of the year.”

Marineau mapped out the company’s top five priorities, stressing that number one on the list remains improving profitability and hitting financial targets. The company’s second priority is igniting global growth of the Levi’s business.

“We’ve made progress this quarter, but frankly, we’re not there yet,” Marineau said.

Continued growth of the Levi Strauss Signature brand in the mass channel ranked third. Bringing life back to a demoralized Dockers business ranked fourth, while improving cost and efficiency was fifth.

“Our gross profit improved for the sixth consecutive quarter,” Marineau said.

Cost of sales in the second quarter fell 340 basis points to 53.6 percent of sales, or $506.2 million, compared with 57 percent of sales, or $546.1 million, reported last year. Unburdening the balance sheet of charges had the greatest impact on the bottom line. Restructuring charges plunged 80 percent to $5.2 million from $25.7 million. Earlier this year, the company doubled the performance measurement period for its employee long-term incentive program to three years, a move that resulted in incentive compensation expenses falling 73.8 percent to $3.7 million.

Total debt increased to $2.11 billion during the quarter from $2.02 billion, caused by debt refinancing earlier this year, taxes and restructuring costs. The privately owned company releases its financial results because of its publicly traded bonds.

The core Levi’s brand brought in sales of $663 million, or 70.2 percent of sales. Domestic Levi’s sales fell 5 percent to $243.6 million. Robert Hanson, president of the U.S. Levi’s brand, said the women’s business buoyed results, with a 12 percent increase for the year-to-date and a 17 percent gain in sales of long bottoms for the second quarter.

Marineau said growth in the women’s domestic market has been a trend over the past two years.

“Women are rediscovering that we have great jeans,” he said in a phone interview, adding that now the company is positioning itself to lure men back to the brand with new fits and washes. “Men’s historically follows the women’s market and lags it, which certainly plays to our advantage since 75 percent of our sales are in men’s.”

Management sees no signs of a turnaround in the European retail market during the second half. European Levi’s sales slid 7 percent to $210.4 million from $226.1 million. Declines were most marked in the U.K., France, Germany and Spain, said Paul Mason, president of Levi Strauss Europe, during the call.

“Despite the declines, we are holding market share, illustrating that our strategies are working,” said Mason.

It’s been a different story for Levi’s in the Asian-Pacific region, where sales rose 19.7 percent to $183.3 million for the quarter.

“We’re now entering our sixth year of consistent profit growth,” said John Anderson, president of Levi’s Asia division, who added that the Levi’s brand represents 90 percent of total sales for the region.

John Goodman participated in his first conference call as U.S. president of a wallowing Dockers brand, which posted an 11.1 percent sales decline to $152.7 million. Global sales of Dockers, including the U.S., came in at $194.1 million, or 20.6 percent of sales. Management acknowledged that there is no quick fix for the brand, which spent six months on the auction block in 2004.

“Clearly, this is an area of the business that needs much work,” said Goodman about the Dockers women’s business.

“As you might expect, following the sales process of the Dockers brand last year, we expect it will take quite a while for this revitalization to occur,” said Marineau during the call.

The majority of that effort will be focused on upping the fashion quotient of the women’s line. Marineau said in a phone interview that the entire women’s Dockers assortment is being overhauled.

“You won’t see the full reflection of that until spring 2006,” he said.

Levi Strauss Signature, the company’s mass channel offering, has proved a bright spot after initial controversy arose over fears that it would cannibalize sales of the Levi’s core brand. Domestic Signature sales rose 2.8 percent to $75.9 million during the quarter. Global sales were $86.6 million, or 9.2 percent of sales. Back-to-school has the potential to be a breakout season for Signature, as it expands to 1,000 Kmart stores from 200. A stand-alone Signature store opened in Japan during the quarter, with tests under way for one in India later this year.

Advertising will feature prominently in the company’s campaign to expand the Levi’s brand. The firm’s advertising investment grew 20.8 percent to $143 million for the first six months, representing about 7 percent of sales. The ad budget will continue to grow in the second half and will shift somewhat from print to TV.

On the conference call, Marineau dismissed any concerns regarding reports of an impending denim glut for the back-to-school season.

“I think there was some concern earlier in the year, particularly in the U.S., given low retail sales in march and April,” concerns that were diminished by stronger sales results in the following months, said Marineau. “That said, this is not a problem we face. If anything, we have concerns that we have too little inventory in the U.S. given our customers’ desire to have less inventory.”

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