Business Context and Reporting Period
Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 24, 2003
Context: This filing is a restatement of previously reported financial results. The Company announced on October 9, 2003, that it would restate financial statements for fiscal years 2001 and 2002, as well as the first two quarters of 2003, due to accounting errors related to tax returns and the improper treatment of deferred tax liabilities. The filing also reflects a significant increase in the valuation allowance against deferred tax assets based on a revised long-term forecast assuming flat business performance.
Key Financial Metrics (Restated)
All figures in thousands, except per share data.
| Metric | Three Months Ended Aug 24, 2003 |
Nine Months Ended Aug 24, 2003 |
Three Months Ended Aug 25, 2002 (Restated) |
Nine Months Ended Aug 25, 2002 (Restated) |
|---|---|---|---|---|
| Net Sales | $1,083,748 | $2,892,803 | $1,019,744 | $2,882,547 |
| Gross Profit | $397,261 | $1,150,609 | $419,078 | $1,184,824 |
| Gross Margin % | 36.7% | 39.8% | 41.1% | 41.1% |
| Operating Income | $190,586 | $319,228 | $98,368 | $118,074 |
| Operating Margin % | 17.6% | 11.0% | 9.6% | 4.1% |
| Net Income (Loss) | $(4,313) | $(104,194) | $6,377 | $(13,672) |
| Cash and Cash Equivalents | $50,677 | (Balance Sheet Item) | ||
| Total Debt (Long-term + Current) | $2,367,000 | (Principal Payments Schedule) |
Liquidity: As of August 24, 2003, cash and cash equivalents were $50.7 million. Restricted cash of $23.4 million was segregated to repay maturing notes. As of February 29, 2004, total U.S. liquidity (availability plus liquid investments) was approximately $366 million.
Material Changes vs. Prior Period
- Restatement Impact: Compared to the draft Form 8-K filed in October 2003, the restated Q3 2003 results show a shift from net income of $21.8 million to a net loss of $4.3 million. Operating income increased from $97.9 million to $190.6 million due to a $129.1 million reversal of long-term incentive compensation expense, which was offset by a $135.5 million increase in income tax expense.
- Valuation Allowance: The Company recorded a $282.4 million increase in the valuation allowance against deferred tax assets for the full year 2003, driven by a revised forecast assuming no revenue growth. This resulted in a significant non-cash tax expense.
- Revenue Trends: Net sales increased 6.3% in Q3 2003 compared to Q3 2002, driven by the launch of the Levi Strauss Signature brand at Wal-Mart and strength in Asia Pacific. However, constant currency sales for the nine-month period decreased 4.2% due to weak retail conditions and deflationary pressures.
- Margin Compression: Gross margin declined to 36.7% in Q3 2003 from 41.1% in the prior year, attributed to wholesale price reductions, increased sales allowances, and a shift to lower-priced products.
Guidance, Outlook, and Risks
- Management Commentary: The Company retained Alvarez & Marsal, Inc. in December 2003 to assist with financial turnaround strategies. An interim CFO, James P. Fogarty, was appointed. The Company suspended the installation of an enterprise resource planning system indefinitely to reduce costs, expecting a $35-$45 million asset write-down in Q1 2004.
- Outlook: Management revised its 2004 plan to reflect adverse business developments. The long-term forecast used for tax valuation assumes flat performance with no revenue growth or cost reductions, as the impact of turnaround actions is not yet determinable.
- Restructuring: The Company finalized plans to close remaining North American manufacturing plants. It expects net cash payments of approximately $140 million in 2004 related to plant closures, organizational changes, and restructuring.
- Legal Proceedings: The Company faces wrongful termination litigation from former tax employees alleging fraudulent tax-motivated transactions. Additionally, two putative bondholder class actions were filed in late 2003 and early 2004 alleging material misstatements in financial reports.
- Credit Ratings: Credit ratings were downgraded significantly by major agencies (S&P, Moody's, Fitch) throughout late 2003, with S&P lowering the corporate credit rating to "CCC" and Moody's to "Ca" or "Caa2".
Investor Verification Checklist
- Restatement Accuracy: Verify the specific adjustments made to 2001, 2002, and Q1/Q2 2003 financials regarding tax errors and deferred tax liabilities.
- Tax Valuation Allowance: Assess the sustainability of the $282.4 million valuation allowance and the assumptions regarding future taxable income used to justify it.
- Liquidity and Covenants: Monitor compliance with the fixed charge coverage ratio covenants in the new $500 million term loan and $650 million revolving credit facility entered into in September 2003.
- Restructuring Costs: Track the actual cash outflows for plant closures and the ERP system suspension against the projected $140 million for 2004.
- Legal Exposure: Monitor the progress of the wrongful termination suit and bondholder class actions for potential financial impact.
- Turnaround Progress: Evaluate the effectiveness of the Alvarez & Marsal engagement and the new management team in stabilizing sales and margins.