Levi Strauss raises its profit forecast on tariff refunds as its direct sales stall

Levi Strauss & Co. raised its full-year profit forecast on Wednesday after refunds of U.S. tariffs fattened its third-quarter margins. The part of the business the denim maker has been building for years, selling directly to shoppers through its own stores and website, barely grew.

Revenue for the quarter ended Aug. 30 rose 4% to $1.61 billion, or 5% on the organic basis the company uses to strip out currency swings, just shy of the $1.62 billion analysts had expected. Adjusted earnings came to 48 cents a share, well above the 36-cent consensus and up from 34 cents a year earlier. Under standard accounting, earnings from continuing operations were 43 cents a share, compared with 31 cents.

How much the tariff refunds did

Much of the profit jump came from refunds of tariffs Levi had paid under the International Emergency Economic Powers Act. The company booked $79 million of refunds against its cost of goods and another $5 million as interest income. Gross margin widened to 66.2% from 61.7%, and the adjusted operating margin to 15.5% from 11.8%.

Levi chose to spend part of the windfall. It put about $25 million back into the business during the quarter, mostly on extra promotions and marketing, and plans to redeploy about $60 million for the full year, including roughly $35 million in the fourth quarter. By the company's own math, the refunds added 16 cents to adjusted earnings per share and the reinvestment took back about 5 cents, a net lift of 11 cents. Take that out and adjusted earnings would have been about 37 cents, roughly in line with expectations rather than far ahead of them.

Where sales slowed

The weak spot was direct-to-consumer, which made up 45% of quarterly revenue. Sales through Levi's own stores and websites rose 2%, and comparable sales, which exclude the effect of opening and closing stores, grew just 0.4%. A year earlier they had grown at a high-single-digit pace. Direct sales in the U.S. fell 1%, while e-commerce rose 10%.

That is a sharp slowdown from the second quarter, when direct-to-consumer revenue grew 11% and comparable sales rose 6%. Chief Executive Michelle Gass acknowledged the miss. "While our direct-to-consumer business fell short of our internal expectations, we moved quickly to address the shortfall," she said, adding that recent trends have put the business "on track to deliver mid-single-digit growth in the fourth quarter."

Wholesale, the sales to department stores and other retailers, carried the quarter with a 6% gain, led by Europe and Asia. Asia grew 10% on an organic basis and Europe 5%, while the Americas managed 2% and U.S. revenue slipped 1%. Beyond Yoga, the company's activewear brand, grew 9% but still posted a $5 million operating loss.

What the new forecast assumes

For the fiscal year ending Nov. 29, Levi now expects adjusted earnings of $1.54 to $1.56 a share, up from $1.46 to $1.52. Analysts' consensus for the year was $1.54, so the new range starts at that mark. The updated outlook counts the tariff refunds, which the company said in July were not in its forecast, and assumes current tariff rates stay in place for the rest of the year.

Levi now sees gross margin up 1.3 percentage points from last year, instead of 0.1 point, and an adjusted operating margin of about 12.1%, compared with 12% before. The sales outlook barely moved: organic revenue growth of about 6%, the top of the previous 5.5% to 6% range, and reported growth of about 7%, the bottom of the old 7% to 7.5% range because of currency effects.

Buybacks, dividends and a new finance chief

Levi plans a new $100 million accelerated share repurchase, after retiring 9.4 million shares under a $200 million program that settled in the quarter, and had $240 million left under its buyback authorization at the end of August. It declared a quarterly dividend of 16 cents a share, 14% more than a year earlier, payable Nov. 4. Adjusted free cash flow for the first nine months was $427 million, up from $92.5 million a year earlier.

Chief Financial and Growth Officer Harmit Singh, who is retiring, hands the finance job on Nov. 1 to John Vandemore, who has been chief financial officer of Skechers for the past nine years. Singh stays on as a special adviser through Nov. 30.

How the stock has traded

Levi shares closed down 5% at $19.51 on Wednesday ahead of the report and were little changed in after-hours trading at 4:23 p.m. Eastern time, shortly after the release. As of early Wednesday afternoon the stock was down about 20% over three months and trading near the low end of its 52-week range of $17.72 to $25.70. Investors have often sold the shares after good news: they fell after three of Levi's previous four quarterly reports despite earnings that beat estimates each time.