Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 25, 2003 (Second Quarter of Fiscal Year 2003)
Context: The company reported results amidst a weak global economic and retail climate, characterized by reduced consumer confidence and pricing pressures. The period included significant debt refinancing activities, including the issuance of $575 million in senior notes and the repurchase of a substantial portion of its 6.80% notes due in 2003. The company also continued restructuring initiatives in Europe and the U.S. to streamline operations.
Key Financial Metrics
| Metric | Three Months Ended May 25, 2003 |
Six Months Ended May 25, 2003 |
Six Months Ended May 26, 2002 |
|---|---|---|---|
| Net Sales | $930.0 million | $1,805.1 million | $1,858.8 million |
| Gross Profit | $384.6 million | $744.0 million | $768.1 million |
| Gross Margin | 41.3% | 41.2% | 41.3% |
| Operating Income | $56.4 million | $103.9 million | $23.9 million |
| Operating Margin | 6.1% | 5.8% | 1.3% |
| Net Income (Loss) | $(13.4) million | $(37.9) million | $(33.2) million |
| Diluted EPS | $(0.36) | $(1.02) | $(0.89) |
| Cash from Operations | N/A | $(344.3) million (Used) | $113.6 million (Provided) |
| Total Debt (Principal) | Approx. $2.31 billion (as of May 25, 2003) | ||
| Cash & Equivalents | $121.0 million (plus $23.4 million restricted cash) |
Material Changes vs. Prior Period
- Revenue: Net sales increased 0.7% in the quarter but decreased 2.9% for the six-month period compared to the prior year. On a constant currency basis, sales declined 4.7% (quarter) and 8.0% (six months) due to weak retail conditions.
- Profitability: Operating income improved significantly compared to the prior year, primarily because the prior year included $141.1 million in restructuring charges. Excluding restructuring items, operating income decreased due to lower sales and higher marketing expenses.
- Restructuring: The company recorded net reversals of $5.5 million (quarter) and $9.7 million (six months) related to prior restructuring initiatives, contrasting with the large charges taken in 2002.
- Interest Expense: Interest expense increased 49.0% in the quarter and 35.9% for the six months, driven by higher average debt balances and the issuance of 12.25% senior notes in early 2003.
- Cash Flow: Operating cash flow turned negative, using $344.3 million for the six months, compared to a positive $113.6 million in the prior year. This was driven by a $110 million tax settlement payment, restructuring payments, and increased inventory levels.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Sales: Management anticipates full-year 2003 net sales on a constant currency basis will be approximately flat compared to 2002, with second-half growth expected to offset first-half declines. Growth is expected to be driven by the introduction of the "Levi Strauss Signature" brand in mass channels (e.g., Wal-Mart).
- Margins: Full-year 2003 gross margin is expected to be in the range of 40% to 42%. Operating margin is expected to be 8% to 10%.
- Expenses: Full-year advertising expense is expected to be 7% to 8% of sales. Marketing, general, and administrative expenses are expected to be 32% to 34% of sales.
- Debt: The company expects debt less cash on hand to peak in the third quarter of 2003, approximately $600 million higher than the 2002 year-end level, due to seasonal working capital needs and mass channel expansion.
Risks and Contingencies
- Liquidity and Covenants: On June 25, 2003, the company amended its senior secured credit facility to increase the maximum permitted leverage ratio and delay the tightening of coverage ratios. This amendment increased interest rates by 25 basis points. The company remains in compliance but faces tight liquidity constraints.
- Tax Litigation: The company settled most issues related to tax years 1990-1995 with a $110 million payment. Returns for 1996-1999 remain under examination. An adverse outcome could materially affect liquidity.
- Legal Proceedings: Two former tax department employees filed a wrongful termination lawsuit alleging fraudulent tax transactions and manipulation of financial statements. The company denies the allegations and has initiated an internal review.
- Market Conditions: Continued weak economic conditions, consumer spending declines, and pricing pressures in key markets (Americas and Europe) pose ongoing risks to sales volume and margins.
Investor Verification Checklist
- Debt Maturity Wall: Verify the company's ability to refinance or repay the remaining $22.6 million of 6.80% notes due November 1, 2003, and the $368 million Tranche B term loan due 2006, given the recent credit facility amendment.
- Mass Channel Execution: Monitor the performance of the "Levi Strauss Signature" brand launch in Wal-Mart and other mass channels to validate the second-half sales growth guidance.
- Tax Exposure: Track the outcome of the ongoing IRS examination for tax years 1996-1999 and the internal review regarding the wrongful termination lawsuit allegations.
- Inventory Levels: Assess the risk of markdowns on the increased inventory levels ($834 million) accumulated for mass channel entry and seasonal needs.
- Covenant Compliance: Monitor quarterly compliance with the amended leverage and coverage ratios in the senior secured credit facility, particularly as the ratios tighten in late 2003.