LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co. (Privately held)

Filing Type: Form 10-Q (Quarterly Report)

Period Ended: May 25, 2008 (Second Quarter of Fiscal 2008)

Overview: The Company designs and markets apparel under the Levi's, Dockers, and Signature brands across three regions: Americas, Europe, and Asia Pacific. The second quarter results were significantly impacted by the implementation and stabilization of a new Enterprise Resource Planning (ERP) system in the United States, which caused order fulfillment issues and increased operating expenses. Additionally, the Company faced a challenging economic environment and weak retail conditions in the U.S.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated net revenues decreased 7.9% in the quarter and 1.7% for the six-month period compared to the prior year. On a constant currency basis, the decline was 12.8% for the quarter. The Americas region saw a 19.3% reported decline, driven by the ERP implementation and weak consumer demand.
• Profitability Compression: Operating income dropped 56.2% in the quarter and 22.5% for the six-month period. Net income fell 98.5% in the quarter (from $45.7M to $0.7M) and 26.1% for the six-month period.
• Expense Increases: Selling, General, and Administrative (SG&A) expenses rose 11.8% in the quarter and 15.9% for the six-month period. This was primarily due to costs associated with the U.S. ERP implementation, retail expansion, and currency fluctuations.
• Debt Reduction: The Company reduced total debt by approximately $18.7 million during the six-month period, primarily through the redemption of remaining 12.25% senior notes due 2012 and regular term loan payments.
• Dividend Payment: A one-time cash dividend of $50 million was declared and paid in April 2008.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the revenue and operating income declines to the U.S. ERP implementation, which caused order fulfillment disruptions, and a weak retail environment. While gross margins improved due to favorable sales mix and lower sourcing costs, these were offset by revenue declines and higher SG&A. The Company expects ERP stabilization issues to continue through the remainder of the fiscal year.

Key Risks and Contingencies:

• ERP Implementation: Ongoing stabilization of the U.S. ERP system poses risks to order fulfillment and internal controls.
• Economic Conditions: Inflation, weak consumer spending in the U.S., and tightening credit environments for wholesale customers.
• Brand Performance: Challenges in revitalizing the U.S. Dockers brand and declining results in mature Asia Pacific markets (e.g., Japan).
• Legal Proceedings: A wrongful termination litigation trial has been rescheduled to January 2009. A class-action securities litigation settlement was filed for preliminary approval in June 2008.
• Tax Uncertainties: The Company has $183.3 million in unrecognized tax benefits, with a potential decrease of up to $98.8 million in the next 12 months due to a California refund claim resolution.

Investor Verification Checklist

• ERP Stabilization Progress: Verify if order fulfillment issues have resolved and if the associated incremental costs are stabilizing.
• Americas Region Recovery: Monitor net sales trends in the Americas, specifically the impact of the ERP system on wholesale shipments and the performance of the Dockers brand.
• Debt Covenants: Confirm continued compliance with debt covenants given the significant drop in operating income and net income.
• Restructuring Costs: Track the execution of announced facility closures (Philippines manufacturing, Italy distribution) and associated future charges estimated at $5.3 million.
• Tax Liability Resolution: Monitor the outcome of the California state tax refund claim, which could materially impact future income tax expense.