LEVI

Business Context and Reporting Period

Company: Levi Strauss & Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 30, 2010 (Second Quarter of Fiscal Year 2010)
Business Overview: A privately held global apparel company marketing jeans, casual pants, and accessories under the Levi's, Dockers, and Signature brands. Operations are divided into three geographic segments: Americas, Europe, and Asia Pacific.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 8.0% for the quarter and 8.4% for the six-month period compared to the prior year. On a constant-currency basis, growth was 4.6% (quarter) and 4.5% (six months).
• Profitability: Operating income increased 23.4% for the quarter and 8.8% for the six-month period. Gross margins improved significantly (51.1% vs. 45.9% in the prior year quarter) due to a higher mix of company-operated retail sales and favorable currency impacts.
• Net Income Volatility: While the six-month period showed a net income of $37.5 million, the second quarter resulted in a net loss of $18.4 million. This was primarily driven by a $16.6 million loss on the early extinguishment of debt and a significant increase in the effective tax rate.
• Segment Performance:
  • Americas: Revenues and operating income increased, driven by Levi's brand strength and outlet store acquisitions.
  • Europe: Revenues and operating income grew, aided by currency and retail expansion, offset by wholesale declines.
  • Asia Pacific: Reported revenue increased due to currency, but constant-currency revenue declined, primarily due to lower sales in Japan.

Guidance, Outlook, and Material Events

Debt Refinancing

In May 2010, the Company completed a major debt refinancing:

• Issued €300 million of 7.75% Senior Notes due 2018 and $525 million of 7.625% Senior Notes due 2020.
• Used proceeds to tender and redeem 9.75% Senior Notes due 2015 and 8.625% Senior Notes due 2013.
• Repurchased ¥10.9 billion of Yen-denominated Eurobonds due 2016.
• Impact: Recorded a $16.6 million loss on early extinguishment of debt, comprising tender premiums and write-offs of unamortized costs, partially offset by a gain on the Yen bond repurchase.

Tax Rate Increase

The effective income tax rate for the six months ended May 30, 2010, was 66.1%, compared to 37.2% in the prior year. This increase was driven by two discrete charges:

• Japan Affiliate: A $14.2 million charge to establish a valuation allowance against deferred tax assets due to recent negative financial performance in Japan.
• Health Care Act: A $14.0 million charge resulting from the enactment of the Patient Protection and Affordable Care Act, which eliminates the tax deductibility of Medicare Part D subsidies starting in 2014.

Liquidity and Outlook

The Company maintains a total liquidity position of $533.2 million (cash plus unused credit facility availability). Management expects adequate liquidity for the next twelve months. Strategic focus remains on expanding the dedicated store network, driving productivity, and managing inventory levels in a challenging global economic environment.

Investor Verification Checklist

• Debt Structure: Verify the maturity profile and interest rate implications of the new 2018 and 2020 notes versus the retired debt.
• Japan Operations: Assess the sustainability of the valuation allowance charge and the outlook for the Japanese affiliate's recovery.
• Tax Implications: Monitor the long-term impact of the Affordable Care Act on postretirement benefit costs and tax liabilities.
• Store Economics: Evaluate the return on investment for the 130 new company-operated stores added since May 2009, which drove margin expansion but increased SG&A expenses.
• Currency Exposure: Review the sensitivity of future earnings to foreign exchange fluctuations, particularly the Euro and Yen, given the significant currency impact on recent results.