LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 28, 2006 (Second Quarter of Fiscal 2006)
Ownership Status: Privately held; nearly all common equity owned by descendants of the founder.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Consolidated net revenues decreased 0.9% for the quarter and 3.4% for the six-month period compared to 2005. On a constant currency basis, revenues were flat for the quarter and down 1.5% for the six months.
• Profitability: Operating income declined 20.7% (quarter) and 13.1% (six months) year-over-year, driven by lower gross profit and higher selling/compensation costs. However, Net Income increased 50.2% (quarter) and 26.9% (six months) primarily due to a discrete tax benefit and reduced debt extinguishment losses.
• Regional Performance:
  • Europe: Significant decline in net revenues (down 17.1% reported, 12.7% constant currency) and operating income (down 23.4%) due to lower demand and strategic retailer exits.
  • Asia Pacific: Net revenues increased 3.9% (reported) and 6.2% (constant currency), driven by Levi's brand growth and licensing expansion.
  • North America: Net revenues increased 4.6% (quarter) and 0.7% (six months). U.S. Dockers brand saw strong growth (11.2% quarter), while U.S. Levi Strauss Signature declined.
• Debt Refinancing: The company prepaid its $488.8 million term loan in March 2006 using proceeds from new note issuances ($350 million 2016 notes and €100 million 2013 Euro notes). This resulted in a $33.0 million loss on early extinguishment of debt for the period, compared to $43.0 million in the prior year quarter.

Guidance, Outlook, and Risks

• Management Commentary: Management remains cautious regarding the sales outlook for the remainder of 2006 due to lower demand in Europe, retailer consolidations in the U.S., and Wal-Mart's increased focus on private label products. The company is focused on sustaining profitability and generating strong cash flows.
• Tax Benefit: A discrete, non-cash tax benefit of approximately $31.5 million was recognized in Q2 2006 due to a modification in the ownership structure of foreign subsidiaries, reducing the residual tax on unremitted foreign earnings.
• Restructuring: Ongoing restructuring activities include the closure of the Little Rock, Arkansas distribution center (eliminating ~315 jobs) and consolidation of Nordic operations. Total restructuring charges were $7.3 million for the quarter and $10.4 million for the six months.
• Liquidity: The company maintains a revolving credit facility with $550 million maximum availability. As of May 28, 2006, net availability was approximately $131.7 million after reserves and letters of credit. Total liquidity (including liquid short-term investments) was $455.7 million.
• Risks: Key risks include changing retail environments, consumer spending levels, energy prices, foreign currency fluctuations, and the ability to revitalize the European business. Significant management turnover is also noted as a risk factor.

Investor Verification Checklist

• CEO Succession: Verify the timeline and terms of CEO Philip A. Marineau's retirement (end of fiscal 2006) and the appointment of R. John Anderson as COO.
• Europe Turnaround: Monitor the execution of strategies to improve sales trends in Europe, where revenues and operating income declined significantly.
• Debt Covenants: Confirm compliance with the amended revolving credit facility, specifically the requirement to maintain a $75 million reserve and the suspension of covenants.
• Tax Liability Exposure: Review the $12.7 million potential exposure to additional income tax liabilities related to prior years that has not been accrued.
• Restructuring Costs: Track the utilization of the $24.8 million restructuring liability balance and any additional charges related to the Little Rock closure.