Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: February 27, 2011 (First Quarter of Fiscal Year 2011)
Business Overview: A privately held global apparel company designing and marketing jeans, casual wear, and accessories under the Levi's, Dockers, Signature, and Denizen brands. Operations are managed across three geographic segments: Americas, Europe, and Asia Pacific.
Key Financial Metrics
| Metric (in millions) | Q1 2011 | Q1 2010 |
|---|---|---|
| Net Revenues | $1,120.7 | $1,035.2 |
| Gross Profit | $558.0 | $532.9 |
| Gross Margin | 49.8% | 51.5% |
| Operating Income | $98.9 | $107.3 |
| Operating Margin | 8.8% | 10.4% |
| Net Income (Attributable to LSC) | $40.7 | $56.4 |
| Cash from Operating Activities | $46.0 | $75.5 |
| Cash and Cash Equivalents (Ending) | $249.1 | $315.4 |
| Total Debt (Long-term + Short-term) | $1,875.7 | $1,863.1 |
| Weighted-Average Interest Rate | 6.84% | 7.25% |
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 8.3% year-over-year on both reported and constant-currency bases. Growth was driven by the Americas (8.6%), Europe (1.8%), and Asia Pacific (18.0%).
- Margin Compression: Gross margin declined 170 basis points to 49.8%, primarily due to increased sales allowances, discounts, and markdowns of excess inventory. Operating margin fell to 8.8% from 10.4%.
- Profitability Decline: Net income attributable to the company decreased 27.8% to $40.7 million. This was driven by lower operating income and a significant swing in "Other income (expense), net" from a $12.5 million gain in 2010 to a $6.0 million loss in 2011 due to foreign exchange management losses.
- Cash Flow: Operating cash flow decreased 39% to $46.0 million, attributed to higher inventory builds and a $40 million pension plan contribution.
- Corporate Expenses: Corporate expenses rose 28.8% to $84.8 million, largely due to the reclassification of global marketing, IT, and HR costs from regional segments to corporate management.
Guidance, Outlook, and Risks
- Outlook: Management expects ongoing pricing pressure due to rising raw material costs (specifically cotton) and tightened supply. They anticipate potential product price increases or enhanced supply chain support.
- Japan Impact: The recent earthquake and tsunami in Japan occurred after the quarter-end; while no immediate material impact was noted, a slowdown in the Japanese economy is expected to adversely affect future results.
- Pension Funding: The company revised its 2011 pension contribution estimate to a range of $60 million to $80 million, up from prior estimates. A $40 million contribution was made in Q1.
- Dividends: A cash dividend of $20 million was paid in Q1. The company has no annual dividend policy and declares dividends at the Board's discretion based on financial condition and debt covenants.
- Risks: Key risks include consumer spending levels, raw material costs, foreign currency fluctuations, and the ability to successfully expand the dedicated store network.
Investor Verification Checklist
- Inventory Levels: Verify the sustainability of the inventory build (Total inventories increased to $624.3 million) and the extent of markdowns required to clear excess stock.
- Foreign Exchange Exposure: Assess the impact of currency fluctuations on future earnings, given the $6.0 million FX loss in Q1 and the company's significant international revenue mix.
- Pension Obligations: Monitor the remaining $20 million to $40 million in expected pension contributions for the fiscal year and their impact on liquidity.
- Debt Covenants: Confirm compliance with the fixed charge coverage ratio covenant (1.0:1.0) given the current liquidity position of $547.3 million (cash + unused credit facility availability).
- Store Expansion ROI: Evaluate the profitability of the 56 new company-operated stores added in the quarter, which drove higher selling expenses but contributed to revenue growth.