Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 29, 2005 (Second Quarter of Fiscal Year 2005)
Business Overview: A leading global branded apparel company marketing jeans, casual/dress pants, tops, and accessories under the Levi's®, Dockers®, and Levi Strauss Signature™ brands. Operations are organized into North America, Europe, and Asia Pacific regions.
Key Financial Metrics
| Metric | Three Months Ended May 29, 2005 | Six Months Ended May 29, 2005 |
|---|---|---|
| Net Sales | $943.7 million | $1,949.5 million |
| Gross Profit | $437.5 million (46.4% margin) | $924.1 million (47.4% margin) |
| Operating Income | $144.8 million (15.3% margin) | $328.6 million (16.9% margin) |
| Net Income | $26.8 million | $74.1 million |
| Cash and Cash Equivalents | $248.6 million | $248.6 million (Balance Sheet) |
| Total Debt (Long-term + Current) | $2,357.6 million | $2,357.6 million |
| Operating Cash Flow | N/A | ($67.6 million) used |
Material Changes vs. Prior Period
- Revenue: Net sales decreased 1.6% in the quarter but increased 1.5% year-to-date compared to the prior year. On a constant currency basis, sales decreased 4.4% (quarter) and 1.0% (six months), driven by declines in U.S. Levi's and Dockers brands and Europe, partially offset by growth in Asia Pacific and the Levi Strauss Signature brand.
- Profitability: Operating income surged 84.2% in the quarter and 136.0% year-to-date. This improvement was driven by higher gross margins (up 3.4 and 4.7 percentage points respectively), significantly lower restructuring charges, and reduced long-term incentive compensation expenses.
- Restructuring: Restructuring charges dropped dramatically to $5.2 million (quarter) and $8.4 million (six months) compared to $25.7 million and $80.0 million in the prior year periods. The prior year included significant charges for ERP suspension and organizational changes.
- Debt Refinancing: The company recorded a $43.0 million loss on early extinguishment of debt in the quarter ($66.0 million year-to-date) due to the repurchase of 2006 notes and redemption of 2008 notes. This was funded by the issuance of new 2015, 2012, and 2013 notes.
- Cash Flow: Operating cash flow turned negative ($67.6 million used) year-to-date, primarily due to a $99.4 million increase in inventory for the fall season and a $70.3 million decrease in accrued employee wages/benefits due to incentive plan payments.
Guidance, Outlook, and Risks
- Outlook: Management expects full-year gross margins to be in the mid-40% range. The company remains focused on profitability, cost structure, and growing the Levi's and Levi Strauss Signature brands while revitalizing Dockers.
- Liquidity: As of July 3, 2005, the company had approximately $457.2 million in net liquidity (unused credit facility availability plus liquid short-term investments). Management believes liquidity is adequate for 2005 operations.
- Debt Covenants: The company is in compliance with its senior secured term loan leverage ratio (3.5 to 1.0). A critical condition remains regarding the refinancing of remaining 2006 notes by May 1, 2006, to prevent the senior secured term loan from maturing in August 2006.
- Tax Contingencies: The company estimates an additional potential income tax exposure of approximately $28.9 million related to prior years, which has not been accrued as it does not currently meet liability recognition criteria. An agreement with the IRS regarding 1986-1989 returns reduced contingent liabilities by $4.2 million.
- Legal Proceedings: A favorable appellate court decision in the Comexma litigation (Mexico) vacated a $45 million award against the company. The plaintiff has appealed to the federal court level. Other litigation includes wrongful termination and class action securities suits with no material recent developments.
Investor Verification Checklist
- 2006 Refinancing Condition: Verify the company's ability to refinance or repay the remaining ~$78 million of 2006 notes by May 1, 2006, to avoid acceleration of the senior secured term loan.
- Inventory Levels: Monitor inventory build-up ($651 million) against sales velocity to ensure no significant markdowns are required for the fall season.
- U.S. Brand Performance: Assess the impact of product rationalization and licensing on U.S. Levi's and Dockers sales, which declined on a constant currency basis.
- Tax Exposure: Track the status of unresolved IRS examinations for tax years 1990-2004 and the potential $28.9 million exposure.
- Comexma Litigation: Monitor the federal court appeal regarding the Mexican anti-counterfeiting raid litigation.