LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 29, 2010 (Third Quarter of Fiscal Year 2010)
Business Overview: A privately held global apparel company marketing jeans, casual pants, 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

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 6.6% in the quarter and 7.7% for the nine-month period compared to the prior year. Growth was driven by acquisitions, expansion of the dedicated store network, and strong Levi's brand performance in the Americas.
• Profitability Pressure: While gross margins improved (driven by higher-margin retail sales), operating income declined 12.3% in the quarter due to increased selling, general, and administrative (SG&A) expenses. SG&A rose 15.5% in the quarter, primarily due to store expansion and advertising investments.
• Debt Refinancing: In Q2 2010, the company refinanced significant debt, issuing new Euro and Senior notes. This resulted in a $16.6 million loss on early extinguishment of debt recorded in the nine-month period, though it lowered the weighted-average interest rate to 7.27% (from 7.49% in 2009).
• Tax Rate Spike: The effective income tax rate for the nine months ended August 29, 2010, was 59.3%, compared to 31.8% in the prior year. This increase was driven by two discrete charges totaling $28.2 million.
• Segment Performance: Americas and Europe operating income increased, while Asia Pacific operating income declined 19.0% in the quarter due to sales declines in Japan.

Guidance, Outlook, Risks, and Unusual Items

• Unusual Items (Tax Charges):
  • Japan Valuation Allowance: A $14.2 million charge was recorded due to negative financial performance in Japan, leading to a valuation allowance against deferred tax assets.
  • Health Care Act: A $14.0 million charge was recorded due to the Patient Protection and Affordable Care Act, which eliminates tax deductibility for Medicare Part D subsidies starting in 2014.
• Outlook & Strategy: Management remains focused on expanding the dedicated store network (which generated 15% of net revenues in the nine-month period) and driving productivity. Economic conditions remain difficult, particularly in Europe and Japan.
• Liquidity: Total liquidity (cash plus unused credit facility availability) stood at $544.6 million. The company has a $750 million senior secured revolving credit facility with $283.4 million currently available.
• Risks: Key risks include global economic conditions affecting consumer spending, foreign currency fluctuations, the ability to successfully expand the retail network, and the impact of the new healthcare legislation on future tax liabilities.

Investor Verification Checklist

• Japan Affiliate Performance: Verify the sustainability of the valuation allowance charge and the outlook for the Japanese market, which significantly impacted the effective tax rate.
• Debt Structure: Review the terms of the new 2018 Euro Notes and 2020 Senior Notes issued in May 2010 to understand future interest obligations and covenants.
• SG&A Efficiency: Monitor the return on investment for the aggressive expansion of company-operated stores and increased advertising spend, which compressed operating margins.
• Inventory Levels: Note that inventories increased significantly (from $451.3M to $565.5M year-over-year), requiring verification of sell-through rates to ensure no future write-downs.
• Dividend Policy: Confirm the company's ability to maintain dividend payments given the accumulated deficit position and debt covenants.