Levi Strauss & Co. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended May 28, 2017, compared with the periods ended May 29, 2016. The filing covers 2017, despite the request metadata identifying 2016 Q2. Levi Strauss is privately held; its common stock is not publicly traded.
Business context and results
The company designs, markets and sells apparel under the Levi’s, Dockers, Signature and Denizen brands through wholesale, franchised, company-operated retail and e-commerce channels. It reports three regions: Americas, Europe and Asia. Company-operated stores and e-commerce generated about 32% of first-half revenue, up from 29% a year earlier.
- Second quarter: Revenue was $1.068 billion, up 5.6% reported and 6.7% at constant currency. Gross profit was $558.4 million; gross margin rose to 52.3% from 51.1%. Operating income increased 7.9% to $62.7 million, and operating margin was 5.9% versus 5.7%.
- Second-quarter earnings: Net income attributable to Levi Strauss was $17.5 million, down 43.0% from $30.7 million. The quarter included a $22.8 million loss on early debt extinguishment and $18.1 million of other expense, largely reflecting foreign-exchange derivative losses. A $13.8 million income-tax benefit partly offset these items.
- First half: Revenue was $2.170 billion, up 4.9% reported and 6.0% constant currency. Gross margin was 51.8%, down from 52.1%; operating income fell 2.1% to $171.0 million and operating margin declined to 7.9% from 8.4%. Net income attributable to Levi Strauss was $77.7 million, down 19.6%.
- Regional revenue, second quarter: Americas revenue rose 2.2% reported; Europe rose 16.5%; Asia rose 2.1%. Europe was the largest growth contributor. Retail and e-commerce expansion supported growth, while U.S. Dockers wholesale sales were lower and Asia wholesale and franchised-store performance weakened.
Cash flow, balance sheet and debt
- First-half operating cash flow was $217.1 million, versus $103.3 million in 2016; management attributed the increase mainly to higher customer receipts and less cash used for inventory purchases. Investing activities used $48.8 million, including $52.9 million of capital expenditures. Financing activities used $112.5 million, including a $35 million dividend and debt-refinancing costs. Cash increased by $62.0 million to $437.5 million.
- At May 28, cash was $437.5 million and total debt was $1.039 billion, including $31.6 million of short-term debt. Long-term debt was $1.007 billion. Debt was about 98.6% fixed-rate, according to management.
- The company had no borrowings under its revolving credit facility and reported $714.3 million of unused availability. Cash plus unused availability totaled approximately $1.2 billion. Management said liquidity should be adequate for the next 12 months.
- Current assets were $1.642 billion and current liabilities were $733.6 million. Inventory was $780.6 million, up from $716.2 million at fiscal year-end. Pension liability was $337.3 million; postretirement medical benefits were $95.3 million.
Material changes and unusual items
- In February 2017, the company issued €475 million of 3.375% senior notes due 2027 and used the proceeds, together with cash, to tender for and redeem its 6.875% notes due 2022. It recorded $22.8 million of early-extinguishment losses, including $21.9 million in tender and call premiums. Total debt was slightly lower than at November 27, 2016.
- The revolving credit facility was extended through May 2022, with borrowing spreads and the fee on unused availability reduced.
- First-half effective tax rate was 16.0%, compared with 31.1% a year earlier. The decrease primarily reflected discrete benefits from releasing a foreign-subsidiary deferred-tax valuation allowance and excess tax benefits on equity compensation. These benefits affect comparability.
- Effective in 2017, certain global expenses were allocated to regional segments; comparative segment figures were revised. The company also early adopted stock-compensation accounting guidance, recording a $5.6 million income-tax benefit.
Outlook, commentary and risks
The filing provides no specific revenue or earnings guidance. Management described a challenging retail environment, including mixed consumer discretionary spending, declining traffic, promotional pressure, competition from e-commerce and fast fashion, and pressure on traditional wholesale retailers. It also cited currency volatility, sourcing and input-cost pressures, and uncertainty around future trade and tax rules. Retail expansion is supporting revenue but increasing selling and other operating costs. The company said it did not expect significant additional costs from its completed 2016 productivity initiative.
Management stated that it was in compliance with debt covenants and that pending ordinary-course litigation was not expected to materially affect financial condition, results or cash flows. Principal disclosed risks include changes in consumer demand and fashion preferences, wholesale-customer distress, competition, execution of retail expansion and productivity efforts, foreign-exchange and interest-rate movements, supply-chain costs, data security, pension funding, and possible trade or tax-law changes. No material changes to previously disclosed risk factors or market-risk exposures were reported.
Important facts for investors to verify
- How much of reported earnings and the lower first-half margin reflects recurring operations versus the debt-extinguishment charge, foreign-exchange losses and discrete tax benefits.
- Whether retail and e-commerce growth can offset higher store-related SG&A and pressure in wholesale, franchised and regional channels.
- Inventory levels and operating cash flow conversion in subsequent periods, given the first-half inventory increase and the company’s reliance on seasonal working capital.
- Debt-service capacity, refinancing terms, covenant restrictions and exposure to currency movements, including the effects of foreign-exchange contracts.
- Funding assumptions and obligations for pension and postretirement plans, as well as the company’s discretionary dividend decisions.