Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-K (Annual Report)
Period Ended: November 29, 2009
Ownership Structure: Privately held; nearly all common equity is owned by descendants of the founder, Levi Strauss, and their relatives via a voting trust. There is no public trading market for the stock.
The Company designs and markets jeans, casual and dress pants, tops, jackets, footwear, and accessories under the Levi's, Dockers, and Signature by Levi Strauss & Co. brands. Operations are managed through three geographic segments: Americas, Europe, and Asia Pacific. The Company operates approximately 414 company-operated retail stores globally.
Key Financial Metrics (Fiscal Year 2009)
| Metric | 2009 (in millions) | 2008 (in millions) |
|---|---|---|
| Net Revenues | $4,105.8 | $4,400.9 |
| Gross Profit | $1,973.4 | $2,139.8 |
| Gross Margin | 48.1% | 48.6% |
| Operating Income | $378.1 | $525.1 |
| Operating Margin | 9.2% | 11.9% |
| Net Income | $151.9 | $229.3 |
| Operating Cash Flow | $388.8 | $224.8 |
| Total Debt | $1,852.9 | $1,853.2 |
| Cash and Cash Equivalents | $270.8 | $210.8 |
| Working Capital | $778.9 | $713.6 |
Material Changes vs. Prior Period
- Revenue Decline: Net revenues decreased 6.7% (3% on a constant-currency basis) due to wholesale channel declines in Europe and the Americas, and declines in the Dockers brand in the Americas. These were partially offset by growth in the Levi's brand and revenues from new company-operated stores.
- Profitability Compression: Operating income fell 28.0% to $378.1 million. The operating margin declined to 9.2% from 11.9%, driven by unfavorable currency impacts (approx. $66 million), wholesale declines, and investments in retail expansion.
- Improved Cash Flow: Operating cash flow increased significantly to $388.8 million (up from $224.8 million) due to effective inventory management and lower operating expenses, which offset the revenue decline.
- Segment Performance:
- Americas: Operating income remained relatively flat ($346.3M vs $346.9M) despite revenue declines, aided by improved margins.
- Europe: Operating income dropped 40.0% to $154.8M due to currency headwinds and wholesale channel weakness.
- Asia Pacific: Operating income decreased 8.6% to $91.0M, primarily due to currency impacts and lower sales in Japan.
- Acquisitions: The Company acquired 73 U.S. outlet stores from Anchor Blue Retail Group and expanded its presence in Russia and other European markets, contributing to goodwill increases.
Guidance, Outlook, and Risks
Management Outlook:
- Management anticipates continued challenging economic conditions affecting consumer discretionary spending.
- Investments in 2010 are expected to increase advertising and selling expenses, potentially lowering operating margins temporarily.
- Projected capital expenditures for 2010 are $166 million, up from $83 million in 2009, driven by IT systems and headquarters improvements.
- Projected pension funding requirements may increase to as much as $140 million in 2011 due to market conditions affecting plan assets.
Key Risks and Contingencies:
- Debt Levels: Total debt remains high at approximately $1.9 billion. Debt covenants restrict dividend payments, share repurchases, and acquisitions. The next major debt maturity is in 2012.
- Customer Concentration: The top 10 wholesale customers accounted for 36% of net revenues in 2009. The loss of a major customer (e.g., Kohl's, which was nearly 10% of revenue) could have a material adverse effect.
- Foreign Currency: Approximately 43% of net revenues are generated outside the U.S. Fluctuations in exchange rates significantly impact reported earnings and cash flows.
- Pension Obligations: The Company has substantial unfunded pension liabilities. A decline in plan asset values or discount rates increases expenses and future funding requirements.
- Supply Chain: Reliance on independent contract manufacturers (approx. 95% of products) exposes the Company to risks regarding quality, labor practices, and raw material costs (primarily cotton).
Investor Verification Checklist
- Debt Covenants: Verify compliance with the fixed charge coverage ratio and other covenants in the senior secured revolving credit facility, especially given the high debt load.
- Customer Concentration: Monitor the financial health of top wholesale customers (specifically Kohl's and J.C. Penney) and their inventory levels.
- Pension Funding: Track the funded status of pension plans and the impact of discount rate changes on future cash requirements.
- Inventory Levels: Assess the effectiveness of inventory management initiatives in light of the global economic downturn and potential for obsolescence.
- Foreign Exchange Exposure: Evaluate the Company's hedging strategies and the sensitivity of earnings to currency fluctuations, particularly the Euro and Yen.
- Retail Expansion ROI: Monitor the profitability of the expanding company-operated retail store network, which has higher fixed costs than the wholesale model.