Business context and reporting period
Levi Strauss & Co. designs, markets and sells apparel under the Levi’s, Dockers, Signature and Denizen brands. It reports three geographic segments: Americas, Europe and Asia Pacific, and sells in more than 110 countries. The company is privately held; its common stock is not publicly traded.
Period clarification: Although the request metadata refers to “2010 Q4,” this filing is the Form 10-K for the fiscal year ended November 27, 2011. It includes comparative fiscal 2010 results and unaudited fourth-quarter data.
Financial performance and position
| Metric | FY2011 | FY2010 | Change |
|---|---|---|---|
| Net revenues | $4.762 billion | $4.411 billion | +8.0% reported; +6.2% constant currency |
| Gross profit / margin | $2.292 billion / 48.1% | $2.223 billion / 50.4% | Margin down 2.3 percentage points |
| Operating income / margin | $336.4 million / 7.1% | $381.4 million / 8.6% | Income down 11.8% |
| Net income attributable to Levi Strauss & Co. | $138.0 million | $156.5 million | Down 11.9% |
| Operating cash flow | $1.8 million | $146.3 million | Down substantially |
| Capital expenditures | $130.6 million | $154.6 million | Down |
Revenue rose in all regions: Americas +6.5%, Europe +6.2%, and Asia Pacific +15.2% on a reported basis. The Levi’s brand represented approximately 83% of net sales. Company-operated retail and online stores generated about 18% of net revenues, versus 15% in 2010.
Profitability weakened despite sales growth. Cost of goods sold rose 12.9%, faster than revenue, chiefly reflecting higher cotton costs and a greater share of sales through lower-margin channels used to manage inventory. Price increases did not fully offset cotton inflation. SG&A increased 6.2% to $1.956 billion, including higher store costs and investment in global IT systems.
At November 27, 2011, cash and cash equivalents were $204.5 million, working capital was $871.0 million, and total debt was $1.972 billion, excluding capital leases. Stockholders’ deficit attributable to the company was $165.6 million. The new asset-based revolving credit facility had $494.7 million of unused availability at year-end; together with cash, disclosed net liquidity was $699.2 million. The company reported compliance with debt covenants.
FY2011 fourth-quarter net revenues were $1.344 billion versus $1.290 billion in FY2010; operating income was $91.6 million versus $118.6 million, and net income attributable to the company was $44.1 million versus $86.4 million.
Material changes versus the prior comparable period
- Net revenues grew, with Asia Pacific the fastest-growing region. Retail expansion and currency gains contributed; Europe also faced wholesale order-fulfillment issues during ERP system implementation and stabilization.
- Gross margin fell from 50.4% to 48.1%, and operating margin fell from 8.6% to 7.1%, reflecting cotton inflation, channel mix and increased operating costs.
- Operating cash flow dropped to $1.8 million from $146.3 million, driven by inventory and vendor cash needs, including higher cotton costs and increased SG&A.
- Debt increased by approximately $109 million year over year. The September 2011 refinancing replaced the prior revolving facility; $100 million of revolver borrowings was repaid in the first quarter of 2012.
- Management and leadership changed: Charles Bergh became CEO in September 2011, succeeding John Anderson; other executive departures and related separation costs affected expenses.
Outlook, commentary, risks and unusual items
Management expected challenging economic and retail conditions, intense competition and cost pressure to continue. It anticipated operating-margin pressure in 2012, especially in the first half, and forecast 2012 gross margin in the “high-40s.” Planned priorities included growing global brands and dedicated retail, strengthening wholesale relationships, investing in IT and improving productivity. The filing does not provide a specific 2012 revenue or earnings forecast.
- Key operating risks: Cotton and other input-cost volatility, consumer spending weakness, pricing sensitivity, competition and retailer consolidation, customer and supplier concentration, overseas sourcing and logistics, foreign-exchange movements, and execution of the ERP implementation. The top ten wholesale customers accounted for 30% of FY2011 net revenues; no single customer represented 10% or more.
- Debt and benefit obligations: Debt service and covenants constrain flexibility; $0.5 billion of debt was variable-rate. Management estimated approximately $65 million of pension contributions in 2012. Pension and postretirement obligations are sensitive to actuarial assumptions and market conditions.
- Tax matters: Unrecognized tax benefits were $143.4 million at year-end; timing of any payment was unclear. The company said it did not anticipate a material liquidity effect from future payments of these liabilities.
- Legal and other commitments: The company reported ordinary-course litigation and did not expect pending proceedings to materially affect financial condition, results or cash flows. It disclosed $690 million of future operating lease payments and $526 million of purchase obligations.
- Unusual accounting item: A Q2 2011 correction for previously unaccounted-for embedded foreign-currency derivatives increased pretax income by $6.5 million and net income by $4.7 million; the company said the prior-period effect was not material and cash flow and operating income were unaffected.
- Ownership and liquidity: Shares are privately held and subject to transfer restrictions; no public trading market or established annual dividend policy exists. Debt agreements limit dividends and other restricted payments.
Important facts for investors to verify
- Whether cotton costs, pricing actions and channel mix allow gross margin to recover toward management’s 2012 “high-40s” outlook.
- Whether operating cash flow improves after the 2011 inventory build, and whether working-capital needs continue to drive revolver borrowing.
- Debt maturity, refinancing and covenant terms, including the potential acceleration of the revolving facility maturity in December 2013 if specified conditions are not met.
- ERP stabilization and its effects on customer order fulfillment, particularly in Europe.
- Actual pension funding needs, resolution of tax examinations and uncertain tax positions, and costs or outcomes of executive separations.
- Because the common stock is not publicly traded, the basis for any valuation and the practical limits on shareholder liquidity.