Levi Strauss & Co. — Form 10-Q Summary
Period clarification: Although the request metadata says 2018 Q3, this filing covers the quarter ended August 25, 2019, and the nine months then ended. Comparisons below are to the corresponding 2018 periods. Amounts are U.S. dollars.
Business context
Levi Strauss designs, markets and sells apparel under the Levi’s, Dockers, Signature by Levi Strauss & Co. and Denizen brands. It reports three regions: Americas, Europe and Asia. Sales are made through wholesale and direct-to-consumer (DTC) channels. For the first nine months of 2019, DTC generated 37% of revenue, versus 36% a year earlier.
Financial performance
| Metric | Three months ended Aug. 25, 2019 | Three months ended Aug. 26, 2018 | Nine months ended Aug. 25, 2019 | Nine months ended Aug. 26, 2018 |
|---|---|---|---|---|
| Revenue | $1,447.1 million | $1,394.2 million | $4,194.5 million | $3,983.6 million |
| Gross profit / margin | $766.7 million / 53.0% | $741.6 million / 53.2% | $2,250.0 million / 53.6% | $2,150.6 million / 54.0% |
| Operating income / margin | $171.2 million / 11.8% | $159.4 million / 11.4% | $435.0 million / 10.4% | $411.6 million / 10.3% |
| Net income | $124.2 million | $129.6 million | $299.2 million | $188.0 million |
| Diluted EPS | $0.30 | $0.33 | $0.73 | $0.48 |
- Third-quarter revenue rose 3.8% reported and 5.2% at constant currency. Europe and Asia grew; Americas revenue declined 2.8%, mainly reflecting softer U.S. wholesale sales.
- Nine-month revenue increased 5.3% reported and 8.3% at constant currency, with growth across all regions and both channels. Currency translation reduced revenue by approximately $110 million for the nine-month period.
- Quarterly gross margin fell 0.2 percentage points, and nine-month gross margin fell 0.4 points, mainly due to unfavorable transactional currency effects; growth in company-operated retail partly offset the pressure.
- Quarterly net income fell 4.2%. The prior-year quarter benefited from a $7.1 million tax benefit and the current quarter had higher tax expense. Nine-month net income rose 59.1%, largely because 2018 included a $129.6 million one-time Tax Act charge.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $205.5 million, approximately flat year over year. Investing cash outflow was $198.4 million, including $128.0 million of capital expenditures. Financing provided $146.8 million, primarily reflecting IPO proceeds.
- Cash and cash equivalents were $863.8 million and short-term investments were $80.2 million at quarter-end. Total debt was $1.035 billion; reported net debt, a non-GAAP measure, was $90.6 million.
- Unused availability under the revolving credit facility was $734.7 million. The company reported total liquidity of approximately $1.7 billion, including cash, investments and unused facility availability.
- Long-term debt was $1.007 billion, principally senior notes due 2025 and 2027. The company said it was in material compliance with debt covenants. Weighted-average borrowing rates were 5.30% for the quarter and 5.28% year to date.
- The company reported nine-month adjusted free cash flow of $28.1 million, a non-GAAP measure; the comparable 2018 amount was negative $13.7 million.
Material developments and unusual items
- The company completed its IPO in March 2019, issuing shares at $17 each and receiving $234.6 million net proceeds. It also paid $24.9 million of underwriting commissions on behalf of selling stockholders, recorded as a non-operating expense in the second quarter, and incurred $3.5 million of other IPO costs in SG&A.
- The IPO ended the contractual put right on certain equity awards; $351.2 million previously classified as temporary equity was reclassified to additional paid-in capital. The company also replaced most outstanding unvested cash-settled awards with equity-settled awards.
- After quarter-end, the board increased the second 2019 dividend to $0.15 per share, approximately $59 million, payable in the fourth quarter. The company stated it has no established dividend policy.
- In September 2019, the company agreed to acquire operating assets for its Levi’s and Dockers businesses in Chile, Peru and Bolivia for approximately $35 million plus transaction costs; closing was expected by the first quarter of 2020.
- The company adopted revenue-recognition guidance in fiscal 2019 with no retained-earnings impact. It expects lease accounting changes effective in the first quarter of 2020 to materially increase balance-sheet assets and liabilities.
Outlook, management commentary and risks
- Management said liquidity should be adequate for the next 12 months. Capital priorities are organic investment, dividends (targeting at least approximately $114 million annually, subject to board discretion and debt restrictions), potential repurchases to offset equity-award dilution, and strategic acquisitions.
- No specific full-year revenue or earnings guidance is provided in the filing text. Management cautioned that interim results may not indicate full-year results.
- Management described a challenging retail environment, with volatile discretionary spending, promotional activity, pressure on wholesale channels and financially troubled retailers. Store expansion and DTC investment support growth but increase selling costs.
- Key exposures include foreign exchange, tariffs and trade-policy changes, consumer demand and competition, wholesale customer concentration, sourcing and raw-material costs, and execution of store, e-commerce and technology initiatives. Top ten wholesale customers accounted for 25% of quarterly revenue; no single customer accounted for 10% or more.
- Pending ordinary-course litigation was not expected by management to materially affect financial condition, results or cash flows. Customs-duty audit assessments remain subject to uncertainty; the company is contesting them and says it does not believe the claims have merit.
Important facts for investors to verify
- Confirm the reporting period: this is a 2019 Q3 filing, not a 2018 Q3 filing.
- Assess whether Europe and Asia growth can offset continuing weakness in Americas wholesale sales, and monitor constant-currency growth against reported growth.
- Track gross-margin pressure from currency and the costs and returns of expanding company-operated stores and DTC.
- Review cash conversion, inventory growth, capital expenditure requirements, debt maturities, revolving-facility availability and dividend commitments.
- Evaluate the Chile, Peru and Bolivia acquisition’s closing, integration, cost and expected contribution, as well as the balance-sheet impact of lease-accounting adoption.
- Distinguish GAAP results from management’s non-GAAP adjusted measures and review the reconciliations and excluded items, particularly IPO costs, stock-based compensation and tax effects.