LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 25, 2002 (Third Quarter of Fiscal Year 2002)
Business Overview: The Company is a global designer, marketer, and distributor of branded apparel, primarily denim jeans. The reporting period reflects ongoing execution of turnaround strategies, including product innovation and retailer relationship revitalization, amidst a challenging global retail and economic climate.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Net sales increased 3.5% in the quarter but decreased 4.9% for the nine-month period compared to the prior year. The nine-month decline was driven by weak retail conditions and the early stages of new product rollouts, though currency fluctuations masked a slightly larger decline on a constant currency basis.
• Profitability: Operating income for the nine months dropped significantly from $337.9 million to $120.6 million. This was primarily due to a net restructuring charge of $124.5 million and related expenses of $33.9 million associated with plant closures in the U.S. and Scotland.
• Restructuring: The Company recorded significant charges in the second quarter for closing two plants in Scotland and six in the U.S. In the third quarter, a reversal of $16.6 million was recorded due to updated estimates and the earlier-than-anticipated sale of the Scottish plants.
• Cash Flow: Operating cash flow improved dramatically to a positive $16.8 million for the nine months, compared to a use of $93.3 million in the prior year, largely due to a decrease in trade receivables and changes in working capital management.
• Tax Rate: The effective income tax rate for the fiscal year is projected at 50%, up from 37% in 2001, due to non-deductible expenses and lower projected earnings.

Guidance, Outlook, and Risks

• Outlook: Management expects weak economic and retail conditions to continue. They anticipate stabilizing net sales for the full year 2002 with a decline in the low single digits on a constant currency basis, with sales growth expected in 2003.
• Future Costs: The Company expects to incur an additional $20 million in restructuring-related expenses over the next 12-18 months, including pension enhancements and maintenance costs for closed plants.
• Debt Maturities: Significant debt obligations mature in 2003, including the credit facility (August 2003) and unsecured notes (November 2003). The Company is exploring refinancing alternatives.
• Credit Rating: Moody's downgraded the Company's senior secured credit facility to "B1" and senior unsecured notes to "Caa1" in August 2002, citing concerns over cash generation and debt reduction capabilities.
• Key Risks: Risks include dependence on key suppliers (e.g., Cone Mills for denim), foreign exchange volatility, changing consumer preferences, and the successful execution of plant closures and workforce reductions.

Investor Verification Checklist

• Restructuring Execution: Verify the timeline and cost savings realization from the closure of six U.S. and two Scottish plants.
• Debt Refinancing: Monitor progress on refinancing the $1.96 billion debt load maturing in 2003, especially given the recent credit rating downgrade.
• Inventory Levels: Review inventory turnover and markdown risks, as inventories increased by $86.9 million during the nine-month period in preparation for the holiday season.
• Tax Settlement: Confirm the final impact of the tentative IRS settlement regarding tax years 1990-1994, which resulted in a $148.5 million reclassification to accrued taxes.
• Supplier Concentration: Assess the impact of the amended supply agreement with Cone Mills Corporation, which ends exclusivity for 501(R) denim after March 2003.