LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Nine months ended August 26, 2001 (Fiscal Year 2001)
Industry: Apparel Manufacturing and Retail

Levi Strauss & Co. reported results for the third quarter of fiscal 2001, a period marked by weak economic conditions in the U.S. and Japan, retail market softness, and the impact of the September 11, 2001 terrorist attacks on consumer confidence and economic outlooks.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 12.8% in the quarter and 10.0% for the nine-month period compared to the prior year. The decline was driven by volume decreases in the Americas (down 14.0% QoQ) and Asia Pacific (down 20.3% QoQ), attributed to weak economies and retail consolidation in Japan.
• Profitability Compression: Net income fell 60.3% in the quarter and 40.5% for the nine months. Operating income declined 19.9% in the quarter.
• Cash Flow Reversal: Operating activities shifted from providing $199.3 million in cash in the prior year to using $93.3 million in the current period. This was primarily due to increased inventory levels, payments for annual incentives, and an IRS tax settlement.
• Inventory Build-up: Total inventories increased to $796.2 million from $652.2 million at the end of the prior fiscal year, reflecting lower sales velocity in the U.S. market.
• Debt Restructuring: The company issued $497.5 million in senior notes in January 2001 and completed a $110 million domestic receivables securitization in July 2001 to refinance debt and lower borrowing costs.

Guidance, Outlook, and Risks

• Outlook: Management anticipates net sales will decline in fiscal year 2002 due to continued difficult retail and economic conditions. The company is planning production and operating expenses accordingly.
• Impact of September 11: The terrorist attacks created significant uncertainty regarding the global economy and consumer behavior, adding risk to the remainder of the fiscal year.
• Margin Targets: Full-year gross margin is expected to remain within the target range of 40% to 42%. Advertising expense is expected to remain within the 8% to 9% of sales target.
• Restructuring: Ongoing initiatives to close excess capacity and reduce costs continue. The restructuring reserve balance stood at $53.4 million as of August 26, 2001.
• Rating Downgrade: On August 31, 2001, Moody's downgraded the company's senior secured credit facility to "Ba3" and senior unsecured notes to "B2" with a negative outlook, citing declining sales and excess inventory.
• Accounting Changes: The company adopted SFAS 133 (Derivatives) and SFAS 140 (Transfers of Financial Assets), resulting in minor transition adjustments and changes in how securitizations are accounted for.

Investor Verification Checklist

• Inventory Levels: Verify the company's ability to work through the $144 million increase in inventory without significant markdowns, as management expects to carry excess inventory into year-end.
• Liquidity Position: Monitor the $63.8 million cash balance against the $2.16 billion total debt load and the negative operating cash flow trend.
• Debt Covenants: Confirm continued compliance with the financial covenants of the $1.05 billion senior secured credit facility, particularly given the recent credit rating downgrade.
• Japan Market Exposure: Assess the impact of retail bankruptcies and consolidation in Japan, which accounts for 55% of the Asia Pacific region's business.
• Product Recall Costs: Track the financial impact of the European product recall ("glossy finish" jeans) which contributed to a $3.0 million gross margin hit in the quarter.