Lower net earnings against the prior-year quarter tore at the fabric of denim-maker Levi Strauss's (NYSE:LEVI) recent success following its March 2019 initial public offering (IPO). The manufacturer's second-quarter 2019 earnings, released on Tuesday after the markets closed for trading, appeared to catch investors by surprise due to the wide difference in year-over-year quarterly results.

Shares opened down as much as 12% in the morning session on Wednesday following the release. Below, we'll dig into the details of the last three months, including specific factors behind the drop in net income, and look ahead to the second half of 2019. Note that all comparative numbers are presented against the prior-year quarter.

Levi Strauss: The raw numbers

Metric Q2 2019 Q2 2018 Growth (YOY)
Revenue $1.31 billion $1.25 billion 4.8%
Net income $28.2 million $74.9 million (62.3%)
Diluted earnings per share $0.07 $0.19 (63.2%)

Data source: Levi Strauss. YOY = year over year.

What happened at Levi Strauss this quarter?

Close-up of a pocket on a pair of blue jeans.

Image source: Getty Images.

  • The company's revenue growth of 5% translates into 9% expansion in constant-currency terms. This breaks a streak of six consecutive quarters of double-digit constant-currency revenue improvement, although a single percentage point of additional growth would have carried the streak forward.
  • Levi Strauss' direct-to-consumer, or DTC, revenue improved by 9% as a result of e-commerce growth and retail expansion. The company reported that it had 78 more company-operated stores at the end of the second quarter versus the prior-year period. For context, at quarter-end, Levi Strauss operated 854 stores globally and 500 company-operated "shop-in-shops" out of a total of 3,000 brand-dedicated stores and shop-in-shops.
  • Operating profits declined due to investments in the DTC channel, as well as higher advertising and promotion expenses that had been deferred from the first quarter to coincide with the company's annual marketing campaign. Operating margin decreased by 140 basis points, to 4.8%.
  • Levi Strauss' plunge in net earnings can also be traced to a single significant item of $29 million in expenses related to its March IPO. This figure includes nearly $25 million in commissions paid to underwriters on behalf of selling stockholders. The dual effect of lower margins and material ongoing IPO-related expenses appear to have catalyzed Wednesday's sell-off in LEVI shares.
  • Revenue in the Americas segment rose 3%, to $693 million, and increased 4% in constant-currency terms. European segment revenue increased by 9%, to $398 million, and advanced by 18% on a constant-currency basis. Similarly, the company's Asia business reported top-line expansion of 6%, to $209 million, while improving by 12% in constant currency.
  • The IPO expenses, the ramp-up in advertising and promotion expenses, and higher inventory investment resulted in weaker cash generation in the first six months of 2019. Operating cash flow of $162 million decreased by $66 million from the first half of 2018.

What management had to say

In Levi Strauss' earnings press release, CEO Chip Bergh focused on positive brand momentum, noting that the company gained market share across geographies and denim categories:

Our second quarter and first half results reflect the continued strength of our diversified business model as we delivered broad-based growth across all brands, regions and key product categories despite a challenging retail and macroeconomic environment. For both periods, the Levi's brand grew in all three regions across men's, women's, tops and bottoms and maintained its position at the center of culture through iconic products and consumer experiences.

Looking forward

Though likely of small solace to shareholders, Levi Strauss firmed up its yearlong outlook on Tuesday, presenting slightly higher financial targets from those issued last quarter. The organization expects year-over-year revenue growth at the high end of the mid-single-digit range in constant-currency terms versus a simpler earlier expectation of mid-single-digit revenue growth.

The company now expects adjusted EBIT (earnings before interest and taxes) margin growth of 10 basis points in constant currency versus last quarter's projection of full-year EBIT margin growth of "flat-to-slightly up." In the first two quarters of 2019, Levi Strauss has notched an EBIT margin of 10.5% against 10.3% in the comparable period, so at least on this measure, the company appears to be on track to meet its revised expectations. 

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