LEVI STRAUSS & CO quarterly report, Q1 FY2019

Business context and reporting period

Levi Strauss & Co. designs, markets and sells apparel and accessories under the Levi’s, Dockers, Signature by Levi Strauss & Co. and Denizen brands. This Form 10-Q covers the 13 weeks ended February 24, 2019, the company’s fiscal first quarter of 2019, compared with the 13 weeks ended February 25, 2018. The filing describes the company’s March 2019 IPO as a subsequent event.

Financial results and key metrics

• Revenue grew 6.8% as reported and 10.7% at constant currency. Americas revenue rose 9.1% reported, Europe 2.7%, and Asia 8.0%.
• Wholesale revenue was $869.3 million and direct-to-consumer (DTC) revenue was $565.1 million. DTC represented 39% of revenue, versus 38% a year earlier.
• Gross margin fell 0.3 percentage point, primarily from unfavorable transactional currency effects; retail growth partly offset the decline. Operating margin improved 1.0 point as revenue growth and lower administration and advertising costs more than offset higher selling expenses.
• Adjusted EBIT, a non-GAAP measure, was $206.3 million, up 14.4%; adjusted EBIT margin was 14.4%, versus 13.4%. Adjusted net income was $150.9 million, versus $83.4 million.
• Operating cash flow declined to $55.8 million, reflecting higher inventory and SG&A payments and employee incentive compensation, partly offset by increased customer receipts and lower pension contributions. Investing used $80.2 million, including $99.9 million of short-term investment purchases, partly offset by foreign-exchange contract proceeds. Financing used $67.7 million, including a $55 million dividend.
• At quarter-end, cash and equivalents were $621.9 million and short-term investments were $100.0 million. Total debt was $1.041 billion and non-GAAP net debt was $319.2 million. Unused revolving-credit availability was $805.9 million; management reported total liquidity of approximately $1.5 billion, including cash, investments and availability.
• Long-term debt was $1.018 billion, principally senior notes due 2025 and 2027. The weighted-average rate on average borrowings was 5.22%, versus 4.77%. The company reported compliance with debt covenants.

Material changes versus the prior comparable period

• Net income swung to profit from a prior-year loss. The comparison is heavily affected by a prior-year Tax Act charge: $99.1 million for remeasurement of deferred tax assets and liabilities and approximately $37 million of transition tax on undistributed foreign earnings. The effective tax rate was 19.4%, versus 112.5%.
• Foreign-exchange effects reduced reported growth: currency translation unfavorably affected revenue by approximately $47.8 million and operating income by approximately $10 million. Constant-currency revenue growth was 10.7%.
• Company-operated store expansion supported DTC growth and increased selling costs. The company had 70 more company-operated stores than at the end of the prior-year quarter.
• Cash and equivalents decreased from $713.1 million at November 25, 2018, while the company added $100.0 million of short-term marketable securities. Total debt declined from $1.052 billion.
• ASC 606 was adopted using the modified retrospective method with no retained-earnings impact; it changed the presentation of certain sales allowances and related balances. The filing also reports adoption of updated cash-flow and pension-cost presentation standards.

Outlook, management commentary, risks and unusual items

• Management stated it expects adequate liquidity over the next 12 months. It described capital priorities as organic investment, dividends targeted at no less than the most recent annual amount of $110 million, potential share repurchases to offset equity-plan dilution, and strategic acquisitions. No specific revenue or earnings guidance for the year is provided in the filing text.
• The board had declared two $55 million dividends: the first was paid in Q1; the second was scheduled for Q4 2019. The company has no established dividend policy, and future dividends remain subject to board discretion and debt-agreement limits.
• In March 2019, the company completed its IPO, issuing 14,960,557 Class A shares at $17 per share and receiving $215.8 million net before approximately $7 million of other offering expenses. It also paid $24.9 million of underwriting costs attributable to selling stockholders, to be recorded as non-operating expense in Q2 2019. The IPO ended the contractual put right on certain equity awards; approximately $350 million of temporary equity was expected to be reclassified to paid-in capital.
• Key risks include volatile consumer demand and promotional activity, wholesale-customer concentration and retail consolidation, foreign exchange and interest rates, sourcing and raw-material costs, potential tariffs and trade-policy changes, store and e-commerce execution, cybersecurity, and pension obligations. The top ten wholesale customers accounted for 20% of revenue; no single customer accounted for 10% or more.
• The company reported customs-duty audits and related appeals in multiple jurisdictions; it is contesting the claims, but resolution remains subject to uncertainty. It did not expect ordinary-course pending litigation to materially affect financial condition, results or cash flows.

Important facts for investors to verify

• Whether constant-currency growth and margin improvement persist, particularly given unfavorable currency effects and the decline in gross margin.
• Whether operating cash flow strengthens and inventory and employee-related cash needs remain manageable.
• How the IPO proceeds, Q2 underwriting expense, equity-award changes and temporary-equity reclassification affect subsequent financial statements and share dilution.
• Whether the targeted annual dividend level remains affordable under operating results, liquidity needs and debt covenants.
• Developments in customs-duty assessments, trade and tariff policy, and foreign-exchange exposures and settlements.