Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-K (Annual Report)
Period Ended: November 28, 2010
Overview: Levi Strauss & Co. is a privately held global apparel company, primarily owned by the descendants of its founder. The company designs and markets jeans, casual and dress pants, tops, skirts, jackets, footwear, and accessories under the Levi's, Dockers, Signature by Levi Strauss & Co., and Denizen brands. Products are sold in more than 110 countries through wholesale channels, approximately 2,300 brand-dedicated retail stores (including 470 company-operated), and online platforms.
Key Financial Metrics
| Metric | Fiscal 2010 | Fiscal 2009 |
|---|---|---|
| Net Revenues | $4,410.6 million | $4,105.8 million |
| Gross Profit | $2,222.9 million | $1,973.4 million |
| Gross Margin | 50.4% | 48.1% |
| Operating Income | $381.4 million | $378.1 million |
| Operating Margin | 8.6% | 9.2% |
| Net Income | $149.4 million | $150.7 million |
| Net Income Attributable to LSC | $156.5 million | $151.9 million |
| Operating Cash Flow | $146.3 million | $388.8 million |
| Total Debt | $1.86 billion | $1.85 billion |
| Cash and Cash Equivalents | $269.7 million | $270.8 million |
| Working Capital | $891.6 million | $778.9 million |
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 7.4% (6.0% on a constant-currency basis) driven by growth in all three geographic regions (Americas, Europe, Asia Pacific). Growth was fueled by the Levi's brand, acquisitions in 2009, and the expansion of the dedicated store network, partially offset by declines in the wholesale channel in certain markets.
- Margin Compression: While gross margin improved to 50.4% (from 48.1%), operating margin declined to 8.6% (from 9.2%). This was due to increased strategic investments, including the expansion of company-operated stores and higher advertising and promotion expenses.
- Cash Flow Decline: Operating cash flow decreased significantly to $146.3 million from $388.8 million in 2009. This decline reflected planned expenditures for strategic initiatives, inventory builds to support growth, and higher payments to vendors.
- Debt Refinancing: The company recorded a $16.6 million loss on the early extinguishment of debt following refinancing activities in the second quarter of 2010, which included the issuance of new Euro and Senior notes and the repurchase of older debt.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management expects to maintain a gross margin in the high-40s to low-50s. The company anticipates continued investment in advertising, selling expenses, and capital expenditures in fiscal 2011 to support long-term growth strategies, which may result in a lower operating margin. Key strategic objectives include strengthening brands globally, expanding the dedicated store network, and capitalizing on developing markets.
Key Risks & Contingencies:
- Economic Conditions: The global economic downturn continues to impact consumer confidence and spending, particularly in Europe. Wholesale customers may reduce inventories or cancel orders.
- Raw Material Costs: Substantial increases in cotton prices during the second half of 2010 have pressured the supply chain. The company has begun raising product prices to mitigate these costs, but further fluctuations could impact profitability.
- Debt Obligations: The company carries approximately $1.9 billion in debt. High debt levels restrict operating flexibility and increase vulnerability to adverse economic conditions. A significant portion of debt is due in 2012 and 2014.
- Pension Funding: Estimated pension contributions for 2011 are projected to increase to approximately $135 million due to the reduction in the fair value of plan assets relative to obligations.
- Customer Concentration: The top ten wholesale customers accounted for 33% of net revenues in 2010. The loss of a major customer could have a material adverse effect.
Investor Verification Checklist
- Debt Maturity Profile: Verify the ability to service debt obligations, specifically the $108.3 million due in 2012 and $323.7 million due in 2014, given the current liquidity position.
- Pension Funding Requirements: Confirm the actual 2011 pension contribution amount, as the $135 million estimate is subject to recalculation based on market conditions and discount rates.
- Cotton Price Impact: Monitor the effectiveness of price increases in offsetting rising raw material costs and the potential impact on sales volume.
- Store Expansion ROI: Assess the profitability of the expanding company-operated retail network, which is driving higher SG&A expenses and capital expenditures.
- Japan Subsidiary Performance: Review the financial performance of the Japanese subsidiary, which recently required a valuation allowance against deferred tax assets due to negative financial results.