LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co. (Privately held)

Filing Type: Form 10-Q (Unaudited)

Reporting Period: Three and six months ended May 27, 2007 (Fiscal Year 2007)

Overview: The Company designs and markets jeans and related apparel under the Levi's, Dockers, and Levi Strauss Signature brands across North America, Europe, and Asia Pacific. The Company operates through three geographic segments and utilizes a 52-week fiscal year ending in late November.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net revenues increased 5.8% for the quarter and 6.5% for the six-month period compared to the prior year. Growth was driven by North America (U.S. Levi's and Dockers brands) and emerging markets in Asia Pacific (India, China), alongside favorable foreign currency translation in Europe.
• Profitability: Net income increased 13.7% for the quarter and 40.8% for the six-month period. This was primarily due to lower interest expense, a reduced loss on early extinguishment of debt, and higher operating income.
• Margin Pressure: Gross margin decreased slightly (0.8 percentage points for the quarter, 0.4 for six months) due to higher sales allowances, discounts, and inventory markdowns in Japan and Korea.
• Debt Reduction: Total debt decreased by approximately $57.4 million compared to the prior year period. In April 2007, the Company redeemed $380 million of floating rate senior notes using a new $325 million term loan and cash on hand.
• Cash Flow: Operating cash flow decreased to $126.4 million (from $200.6 million) primarily due to timing differences in trade receivables collections and higher payments for incentive compensation.

Guidance, Outlook, and Risks

Outlook: Management expects to achieve modest growth in full-year net revenues and net income compared to 2006, alongside continued cash flow generation and debt reduction.

Key Risks and Challenges:

• Regional Performance: Declining results in Japan and Korea (Asia Pacific's largest markets) are offsetting growth in newer markets. High retail inventory levels persist in these regions.
• U.S. Market: Consumer spending pressures related to the housing market, interest rates, and energy prices. Continued challenges with the Levi Strauss Signature brand performance.
• Operational: Risks associated with the implementation of the SAP enterprise resource planning system and the ability to sustain improvements in the European business.
• Accounting Changes: The Company is assessing the impact of adopting SFAS 158 (pension accounting) and FIN 48 (income tax uncertainty), which may affect future balance sheet and income statement presentations.

Investor Verification Checklist

• Debt Refinancing Impact: Verify the long-term interest rate exposure following the redemption of floating rate notes and the issuance of the new 2014 term loan.
• Asia Pacific Inventory: Monitor inventory levels and sales trends in Japan and Korea, as these markets are currently underperforming and impacting regional margins.
• Restructuring Costs: Track the execution of the Heusenstamm, Germany distribution center closure and Eastern European reorganization, including associated lease liabilities and severance costs.
• Working Capital Management: Review the trend in trade receivables, which contributed significantly to the decline in operating cash flow in the first half of 2007.
• Brand Mix: Assess the trajectory of the Levi Strauss Signature brand in the U.S. mass channel, which continues to face sales declines.