Business context and reporting period
This filing is Levi Strauss & Co.’s Form 10-Q for the 13-week second quarter and six months ended May 27, 2018, compared with periods ended May 28, 2017. The request metadata says 2017 Q2, but the filing itself reports 2018 Q2. Levi Strauss sells apparel globally through the Americas, Europe and Asia; company-operated stores and e-commerce generated about 32% of first-half revenue. The company is privately held, with no public trading in its common stock.
Financial performance
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,245.7 | $1,067.9 | $2,589.4 | $2,169.8 |
| Gross profit | $670.9 | $558.4 | $1,409.0 | $1,122.9 |
| Gross margin | 53.9% | 52.3% | 54.4% | 51.8% |
| Operating income | $76.5 | $62.7 | $250.6 | $171.0 |
| Operating margin | 6.1% | 5.9% | 9.7% | 7.9% |
| Net income | $77.0 | $17.7 | $58.4 | $77.8 |
| Net income attributable to Levi Strauss & Co. | $74.9 | $17.5 | $55.9 | $77.7 |
Q2 revenue rose 16.6% reported and 12.9% in constant currency; first-half revenue rose 19.3% and 14.6%, respectively. Q2 operating income increased 22%. First-half attributable net income fell 28%, principally reflecting the provisional U.S. tax reform charge.
Cash flow, debt and liquidity
- First-half operating cash flow was $227.6 million, versus $217.1 million. Investing cash outflow was $79.3 million, including $61.2 million of property and equipment purchases; financing cash outflow was $79.8 million.
- Cash and equivalents were $698.7 million at May 27, 2018, up from $633.6 million at fiscal year-end. Management said liquidity should be adequate for the next 12 months. Cash plus unused revolving-credit availability was about $1.4 billion; unused availability was $698.1 million.
- Total debt was $1.057 billion, down from $1.077 billion at November 26, 2017. Long-term debt was $1.034 billion and short-term debt $23.1 million. About 98.6% of debt was fixed-rate; the company reported compliance with debt covenants.
- Unsecured long-term debt principal payments of approximately $1.05 billion are due after 2022. The company expects 2018 pension contributions of $124 million, raised from its prior estimate of $94.7 million.
Material changes and management commentary
- Revenue grew across all regions. Europe was the fastest-growing region, with first-half constant-currency growth of 24.7%; Americas and Asia grew 11.7% and 6.6%, respectively.
- Gross margin improvement reflected company-operated retail growth and favorable transactional currency effects. SG&A rose 19.9% in Q2 and 21.7% in the first half, driven in part by store expansion, higher advertising, distribution costs and incentive compensation. The company had 53 more company-operated stores at quarter-end than a year earlier.
- Interest expense declined, attributed primarily to lower borrowing rates following 2017 refinancing. Q2 net income also benefited from foreign-exchange gains and the absence of the $22.8 million debt-extinguishment loss recorded in Q2 2017.
- The first-half effective tax rate was 74.0%, including a provisional $137 million Tax Act charge: $99 million from remeasuring deferred taxes and $38 million transition tax. The company said estimates remain provisional and it had not estimated the impact of GILTI provisions.
- The board declared a $90 million 2018 dividend in two installments. The first $45 million was paid in Q1; the second $45 million was expected in Q4. The company has no established dividend policy.
Outlook, risks and contingencies
No specific revenue or earnings guidance is provided in the filing. Management cites volatile consumer spending, promotional pressure, competition, wholesale-channel challenges, supply-chain costs, foreign-exchange volatility and uncertainty over trade policy. The company noted that approximately 15%–20% of products sold in the U.S. are manufactured in China and Mexico; tariffs or changes to NAFTA could raise costs and adversely affect demand and results. Customs-duty assessments and appeals are ongoing, with outcomes subject to risk and uncertainty; management does not believe pending litigation will materially affect the company. Management also expects lease accounting changes to materially affect the balance sheet. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether the $137 million provisional tax charge changes as the company finalizes its Tax Act accounting, and the eventual GILTI impact.
- Whether revenue and margin growth continue to offset higher SG&A and the costs of expanding company-operated retail.
- Potential exposure to tariffs, NAFTA changes and other trade restrictions, particularly for U.S. products sourced from China and Mexico.
- Cash needs for the increased pension contributions, inventory, capital spending and the remaining dividend installment; confirm revolving-credit availability and debt covenant compliance.
- Developments in customs-duty proceedings and the balance-sheet impact of adopting the new lease standard.