SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
or
FOR THE FISCAL YEAR ENDEDNOVEMBER 28, 2004
Commission file number: 002-90139
LEVI STRAUSS & CO.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
1155 BATTERY STREET, SAN FRANCISCO, CALIFORNIA 94111
(Address of Principal Executive Offices)
(415) 501-6000
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x
The Company is privately held. Nearly all of its common equity is owned by members of the families of several descendants of the Company’s founder, Levi Strauss. There is no trading in the common equity and therefore an aggregate market value based on sales or bid and asked prices is not determinable.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock $.01 par value — 37,278,238 shares outstanding on February 16, 2005
Documents incorporated by reference: None
TABLE OF CONTENTS TO FORM 10-K
FOR FISCAL YEAR ENDING NOVEMBER 28, 2004
Item 1.
Business
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Submission of Matters to a Vote of Security Holders
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 10.
Directors and Executive Officers of the Registrant
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions
Item 14.
Principal Accountant Fees and Services
Item 15.
Exhibits and Financial Statement Schedules
SIGNATURES
Supplemental Information
PART I
Item 1. BUSINESS
Overview
We are one of the world’s leading branded apparel companies, with sales in more than 110 countries. We design and market jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s®, Dockers® and Levi Strauss Signature™ brands. We also license our trademarks in various countries throughout the world for accessories, pants, tops, footwear, home and other products. Pants, including jeans, casual and dress pants, represented approximately 85%, 85% and 86%, respectively, of our total units sold in 2004, 2003 and 2002.
We distribute our Levi’s® and Dockers® products primarily through chain retailers and department stores in the United States and primarily through department stores and specialty retailers abroad. We also distribute Levi’s® and Dockers® products through independently-owned franchised stores outside the United States and through a small number of company-owned stores located in the United States, Europe and Asia. We distribute our Levi Strauss Signature™ products through mass channel retailers worldwide, including Wal-Mart, Target and Kmart stores in the United States and Carrefour and ASDA-Wal-Mart abroad.
We were founded in San Francisco in 1853. We are a Delaware corporation. Our headquarters is located in San Francisco. Our stock is privately held primarily by descendants of the family of Levi Strauss and is not publicly traded. We conduct our operations in the United States primarily through Levi Strauss & Co. and outside the United States through foreign subsidiaries owned directly or indirectly by Levi Strauss & Co., including our 84% owned subsidiary in Japan and our 51% owned joint venture in Turkey.
Our business is organized into three geographic regions. The following table provides employee headcount as of the end of fiscal year 2004 and 2004 net sales and operating income for those regions and for our corporate functions:
Region and Geographies(1)
North America
(United States, Canada and Mexico)
Europe
Asia Pacific
(Asia Pacific, Middle East, Africa and South America)
Corporate expense
Total
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Our Business Strategy
Our vision is to market the most appealing and widely-worn casual clothing in the world. We focus on the following key business strategies:
Innovate and Lead From the Core
We believe that an integrated presentation of new and innovative products and marketing programs targeted to specific consumer and retail segments is crucial to generating consumer demand, strengthening the core health of our brands and enabling growth from that core. We focus on:
Achieve Operational Excellence
We continue to focus relentlessly on improving our cost structure and our operational efficiency. We focus on:
Foster Strong Retailer Relationships and Improve our Presence at Retail
We distribute our products in a wide variety of retail formats around the world including chain and department stores, mass channel retailers, franchise stores dedicated to our brands and specialty retailers. We must ensure that the economics for our retail customers are attractive, that the right products are available and in stock at retail, and that our products are presented in ways that enhance brand appeal and attract consumers. We focus on:
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Sell Where They Shop
We want to sell products to consumers where they shop. To do this, we are making relevant products accessible through multiple channels of distribution at prices that meet consumer expectations. We focus on:
We believe that our business strategies are directly aligned with industry dynamics and that we are building the right core capabilities and operating processes to execute these strategies in a manner consistent with our values.
Our Brands and Products
We market a broad range of branded apparel for diverse demographic groups in markets around the world. Through a number of sub-brands and product lines under the Levi’s®, Dockers® and Levi Strauss Signature™ brands, we target specific consumer segments and provide product differentiation for a wide range of retail channels. We focus on creating new, innovative products relevant to our target consumers, as well as ensuring that our core traditional products are updated with new fits, fabrics, finishes and features. We strive to leverage our global brand recognition, product design and marketing capabilities by taking products and design concepts developed in one region and introducing them in other geographic markets. We also license our Levi’s®, Dockers® and Levi Strauss Signature™ trademarks for a variety of products.
Levi’s® Brand
Since 1873, when our founder Levi Strauss and tailor Jacob Davis received the U.S. patent to make riveted denim clothing, creating the first blue jean, Levi’s® jeans have become one of the most widely recognized brands in the history of the apparel industry. The original jean has evolved to include a wide range of men’s, women’s and kids’ products designed to appeal to a variety of consumer segments who shop in a number of different retail channels. We sell Levi’s® brand products in more than 110 countries around the world.
Our Levi’s® brand features a wide selection of product offerings, including:
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Sales of men’s, women’s and kids’ products as a percentage of Levi’s® brand sales for the periods indicated were approximately as follows:
Men
Women
Kids
Dockers® Brand
We market casual clothing, primarily pants and tops, under the Dockers® brand in more than 50 countries, with the United States generating approximately 79% of total Dockers® brand sales in 2004 and approximately 83% in 2003.
Our Dockers® brand offerings are primarily targeted to men and women ages 25 to 39 and include:
Sales of men’s, women’s and kids’ products as a percentage of Dockers® brand sales for the periods indicated were approximately as follows:
Levi Strauss Signature™ Brand
Our Levi Strauss Signature™ brand offers men’s, women’s and kids’ apparel for value-conscious consumers who shop in mass channel retail stores. We introduced the brand in North America and Asia in 2003 and in Europe in early 2004. Our products include a range of denim and non-denim pants and shirts as well as denim jackets for men and women with product styling, finish and design that is distinct from our Levi’s® brand. Our men’s offering includes five-pocket regular and relaxed fit jeans. For the young men’s consumer, we offer five pocket jeans in a loose straight, low loose boot and low straight fits, combined with non-five pocket styling such as the carpenter and cargo pants in denim and non-denim fabrics. Our boys products feature five-pocket relaxed and loose fits, and other non-five pocket fits with trend core styling and finishes. Our women’s and girls’ five
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pocket offering feature the misses relaxed fit, misses and juniors low-rise bootcut jean, and the girls’ low-rise flare jean. We also offer alternative jeanswear products for the women’s and girl’s, segments with non-five pocket jeans, capris, skirts or skorts for girls.
Sales of men’s, women’s and kids’ products as a percentage of Levi Strauss Signature™ brand sales for the periods indicated were approximately as follows:
Licensing
We license the Levi’s®, Dockers® and Levi Strauss Signature™ trademarks for a variety of product categories complementary to our core bottoms products and also for accessory products. Our licensed products by brand include:
In addition, we enter into agreements with third parties to produce, market and distribute our core products in several countries with smaller markets, including various Latin American and Middle Eastern countries.
We enter into comprehensive licensing agreements with our licensees covering royalty payments, product design and manufacturing standards, marketing and sale of licensed products and protection of our trademarks. We require our licensees to comply with our code of conduct for contract manufacturing, engage independent monitors to perform regular on-site inspections and assessments of production facilities and submit the results to us for our review.
The following table shows our royalty income from trademark licensing in 2004 and 2003 by brand in the United States, and in total for our North America, Europe and Asia Pacific regions:
(Dollars in thousands)
U. S. Levi’s® brand
U. S. Dockers® brand
U. S. Levi Strauss Signature™ brand
Canada and Mexico (all brands)
North America (all brands)
Europe (all brands)
Asia Pacific (all brands)
Total royalty income
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Our Go-to-Market Process
We refer to the process from initial product concept to placement of the product on the retailer’s shelf as the “go-to-market process.” It is designed to:
Each brand modifies its go-to-market process based on market requirements, including product category, distribution channel and consumer segment differences, within the framework of our principal strategies, activities and tasks. We are continuously looking for ways to refine our go-to-market process to improve market performance and position our brands to be as responsive, competitive and profitable as possible. Our focus areas in 2005 include improving the linkage between demand and supply planning and refining our go-to-market processes to better reflect different consumer segments and demands.
Sourcing, Manufacturing and Logistics
Organization. Our worldwide supply chain organization is responsible for taking a product from the design concept stage through production to delivery at retail. Our objective is to leverage our global scale to achieve product development and sourcing efficiencies across brands and regions while maintaining our focus on local market service levels and inventory management.
Product Procurement. We obtain our products from a combination of independent manufacturers and company-owned or leased facilities. Since 1997, we have shifted substantially toward outsourcing our production by closing 45 company-owned production and finishing facilities in North America, Europe and Australia, including the closures of our plants in Australia and Spain in 2004. We believe that outsourcing allows us to maintain greater production flexibility, in terms of both location and nature of production, while helping us refine our cost structure and avoid the substantial capital expenditures and costs related to operating a large internal production capability. We continue to lease or own and operate five manufacturing plants located in Europe (2), Asia (2) and South Africa (1) as of the end of 2004, as compared to eight manufacturing plants at the end of 2003. We also lease a manufacturing facility in Dongguan, China where a third party operates production activities for us.
We source our products from contract manufacturers in two ways:
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The following table shows, for the periods indicated, the approximate percentage of our pants, tops and other products sourced through our owned plants, under cut-make-trim arrangements with contractors and under package arrangements with contractors:
Sourcing arrangement
Self-Manufacture
Sourced from Contractors:
Cut-Make-Trim
Package
Subtotal — Sourced from Contractors
We are increasing our use of package production in all three regions where we operate. For example, we source most of our U.S. Dockers® and Levi Strauss Signature™ products on a package basis. We now source most of our non-denim Levi’s®, Dockers® and Levi Strauss Signature™ products for the European market on a package basis. For our U.S. Levi’s® products, and for denim products in Europe and Asia Pacific, we expect to shift most cut-make-trim arrangements to package production during 2005.
We use numerous independent manufacturers located throughout the world for the production and finishing of our garments. We typically conduct business with our garment manufacturing and finishing contractors on an order-by-order basis. We inspect fabrics and finished goods as part of our quality control program to ensure that consumers receive products that meet our high standards.
The following table shows, for 2004 and 2003, the approximate percentage of our sourcing from contractors by geographic region:
Sourcing region
United States and Canada
South and Central America (including Mexico and the Caribbean basin)
Africa
Asia
Australia
In 2004, we sourced products from contractors located in approximately 45 countries around the world, with no single country representing more than 20% of our production. Contractors in Mexico produced approximately 19% of our products in 2004. We do not expect the recent elimination of quotas under the WTO Agreement on Textiles and Clothing to result in material changes in our source base in 2005. We expect our Asia sourcing to continue to grow.
Contractor Standards. We require all third-party contractors who manufacture or finish products for us to abide by a stringent code of conduct that sets guidelines for employment practices such as wages and benefits, working hours, health and safety, working age and disciplinary practices, and for environmental, ethical and legal matters. We regularly assess manufacturing and finishing facilities to see if they are complying with our code of conduct. Our program includes periodic on-site facility inspections and continuous improvement activities. We also hire independent monitors to supplement our efforts.
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Logistics. We own and operate dedicated distribution centers in a number of countries and we also outsource distribution activities to third party logistics providers, including third party arrangements in the United States, Europe and Asia. Distribution center activities include receiving finished goods from our plants and contractors, inspecting those products and shipping them to our customers. We continually explore opportunities in all of our regions to improve efficiencies and reduce costs in both our in-bound and out-bound logistics activities.
Sales, Distribution and Customers
We distribute our products in a wide variety of retail formats around the world, including chain and department stores, franchise stores dedicated to our brands, specialty retailers and mass channel retailers. Our distribution strategy focuses on ensuring that the economics for our retail customers are attractive, that the right products are available and in stock at retail and that our products are priced and presented in ways that enhance brand appeal and attract consumers.
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The following table shows our principal distribution channels in North America, Europe and Asia Pacific and the approximate percentage of our total net sales in 2004 generated through these channels:
Channel
Brand
Approximate % of
consolidated net sales
regional net sales
Department Stores
(e.g. Dillards, Federated, May Co.)
Levi’s®
Dockers®
National chains
(e.g. J.C. Penney, Kohl’s, Sears)
Other
(includes specialty, warehouse, Canada, Mexico and others)
Mass merchants
(e.g. Kmart, Target, Wal-Mart)
Levi Strauss Signature™
Dedicated retail and outlet stores
(owned, franchised and licensed)
Independent retailers, department stores, and mail order
(e.g. El Corte Ingles, Karstadt)
(e.g. Carrefour, ASDA-Wal-Mart)
Specialty stores, department stores and others
(e.g. Eiko Shoji, Lotte, Right-On Stores)
Mass merchants and general merchandise stores
(e.g. Jusco, Saty)
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Sales to our top five and top 10 customers accounted for approximately 31% and 39%, respectively, of our consolidated net sales in 2004 as compared to approximately 34% and 43%, respectively, in 2003. Our top 10 customers for 2004 were (in alphabetical order): El Corte Ingles in Europe, Goody’s Family Clothing, Inc., J.C. Penney Company, Inc., Kohl’s, The May Department Stores Company, Mervyn’s, Sears, Roebuck & Co., Target Corporation, and Wal-Mart Stores, Inc. in the United States and Right-On Stores in Japan. J.C. Penney represented approximately 9% and 11% of our consolidated net sales in 2004 and 2003, respectively.
In North America, we distribute our products through national and regional chains, department stores, specialty stores, and the mass channel. We have approximately 3,300 retail customers operating more than 28,000 locations in the United States, Canada and Latin America. We also target premium products like Levi’s® Vintage Clothing to independent, image-conscious specialty stores in major metropolitan areas who cater to more fashion-forward, trend-initiating consumers.
Our European Levi’s® and Dockers® brand customers include large department stores, such as El Corte Ingles in Spain, Galeries Lafayette in France and Kaufhof and Karstadt in Germany; single-brand Levi’s® Store and Dockers® Store retail shops; mail-order accounts; and a substantial number of independent retailers operating either a single or small group of jeans-focused stores or general clothing stores. In early 2004, we launched our Levi Strauss Signature™ brand products in Carrefour stores in France, in ASDA-Wal-Mart stores in the United Kingdom, at Migros in Switzerland, and in Wal-Mart and Handelshof stores in Germany.
The more varied and fragmented nature of European retailing means that we are less dependent on major customers than we are in the United States. Our top 10 customers in Europe accounted for approximately 12% and 11% of our total Europe region net sales for 2004 and 2003, respectively.
In Asia Pacific, we distribute our products through specialty stores, including multi-brand as well as independently owned Levi’s® Store retail shops, department stores and, for the Levi Strauss Signature™ brand, mass channel and general merchandise retailers such as Target and Kmart stores operated by Coles Myer Ltd., Lowes and Big W in Australia and Jusco stores in Japan. As in Europe, the varied and fragmented nature of Asian retailing means we are less dependent on individual customers in the region. Our Asia Pacific business is heavily weighted toward Japan, which represented approximately 45% and 52% of our net sales in the region in 2004 and 2003, respectively.
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Dedicated Stores
The following table shows the number of dedicated retail and outlet stores we and our franchisees and licensees operated as of November 28, 2004:
Operated by LS&CO.
Levi’s® retail and outlet stores
Dockers® retail and outlet stores
Levi’s®/Dockers® retail and outlet stores
Franchised or Licensed
As of November 28, 2004, we operated 40 retail and outlet stores dedicated to the Levi’s® brand, including Levi’s® Stores in the United States located in New York, Chicago, Costa Mesa, Santa Monica, San Francisco, San Diego, Miami, Boston, Portland and Seattle and in Europe in London, Paris and Berlin. Our outlet stores are located in the United States, France, Germany, Japan and the United Kingdom. In addition, we operate 41 “shop-in-shop” retail stores in Korea. Sales from company-operated stores represented approximately 2% of our total net sales for 2004.
We have a network of approximately 1,100 franchised or other licensed stores selling Levi’s® brand or Dockers® brand products under the “Original Levi’s® Store,” “Levi’s® Store,” “Selvedge®” and “Dockers® Store” names in Europe, Asia, Canada, Mexico and South America. These dedicated-format stores are strategically important as vehicles for demonstrating the breadth of our product line, enhancing brand image and generating sales. These stores also are an important distribution channel in newer and smaller markets in Eastern Europe, Asia and South America. These stores are owned and operated by independent third parties. We also license third parties to operate outlet stores in the United States and abroad.
Sales from dedicated retail and outlet stores, including owned, franchised and licensed stores, represented approximately 11% of our total net sales for 2004. Our owned and operated, franchised and licensed stores are an increasingly important part of our strategy for expanding controlled distribution of our products in the United States and abroad, and we expect this expansion to continue.
Internet
We operate websites devoted to the Levi’s®, Dockers® and Levi Strauss Signature™ brands as marketing vehicles to enhance consumer understanding of our brands. We do not sell products directly to consumers through these internet websites. Our sites enable visitors to link to authorized online retailers through our sites. In the United States, our products are currently sold online through specifically authorized third-party internet sites that meet our standards relating to customer service, return policy, site content, trademark use and other matters. In Canada and Europe, authorized dealers and mail order accounts who meet our standards may sell our products to consumers through their own internet sites.
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Advertising and Promotion
We engage in advertising, retail and promotion activities to drive consumer demand for our brands. We incurred expenses of approximately $302.6 million, or 7.4% of total net sales, in 2004 on these activities, compared with expenses of approximately $283.0 million, or 6.9% of net sales, in 2003. We advertise through a broad mix of media, including television, national publications, billboards and other outdoor vehicles. We execute region-specific marketing programs that are based on globally consistent brand values. This approach allows us to achieve consistent brand positioning while giving us flexibility to optimize program execution in local markets. We try to make sure our advertising spending is efficient and will generate the maximum impact for the amount spent. We also use other marketing vehicles, including event and music sponsorships, product placement in television shows, music videos and films and alternative marketing techniques, including street-level and nightclub events and similar targeted, small-scale activities.
Levi’s® Brand. We seek through our marketing programs to drive consumer awareness and demand for our core jeanswear product assortments.
Dockers® Brand. Our Dockers® brand marketing strategy emphasizes the innovative technological features and style of our products.
Levi Strauss Signature™ Brand. During 2004, we worked to increase the visibility of our Levi Strauss Signature™ brand through print advertising and increased sponsorship activity.
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Competition
The worldwide apparel industry is highly competitive and fragmented. In all three of our regions we compete with numerous branded manufacturers, retailer private labels, designers and vertically integrated specialty store retailers.
Principal competitive factors include:
We believe our competitive strengths include:
We face intense competition across all of our brands from vertically integrated specialty stores, retailer private labels, designer labels and other branded labels. We sell core and seasonal products under the Levi’s®, Dockers® and Levi Strauss Signature™ brands to retailers in diverse channels across a wide range of retail price points. As a result, we face a wide range of competitors, including:
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Brands such as VF Corporation’s Lee and Wrangler brands, Diesel and Pepe Jeans London have a pan-European presence. Strong local brands and retailers exist in certain markets, including G-Star in the Netherlands and Miss Sixty in Italy. Other competitors include vertically integrated specialty retailers, such as Zara, Hennes & Mauritz AB, Next and Celio. Companies based in the United States, such as Gap, Inc., Polo Ralph Lauren and Tommy Hilfiger, also compete with us in Europe. The khaki and casual pant segment in Europe is fragmented and there is currently no significant pan-European branded competitor of our Dockers® brand in Europe. Competitors in local markets include store private labels and, in Germany, Hugo Boss.
Japan continues to be our largest market in Asia Pacific, representing approximately 45% of regional net sales in 2004. Asia Pacific is a fragmented market, with athletic wear companies such as adidas-Salomon and Nike, Inc. emerging as pan-regional competitors. Competitors in jeanswear consist of regional brands, such as Edwin, Something and Bobson in Japan and U.S. companies such as Gap, Inc., VF Corporation and Earl Jeans. We also face competition from vertically integrated specialty stores, such as UNIQLO and Giordano.
Trademarks
Substantially all of our global trademarks are owned by Levi Strauss & Co., our parent and U.S. operating company. We regard our trademarks as our most valuable assets and believe they have substantial value in the marketing of our products. The Levi’s®, Dockers®, Levi Strauss Signature™, Silvertab®and 501® trademarks, the Wings and Anchor Design, the Arcuate Stitching Design, the Tab Device and the Two Horse® design are among our core trademarks. We protect these trademarks by registering them with the U.S. Patent and Trademark Office and with governmental agencies in other countries, particularly where our products are manufactured and/or sold. We work vigorously to enforce and protect our trademark rights by engaging in regular market reviews, helping local law enforcement authorities detect and prosecute counterfeiters, issuing cease-and-desist letters against third parties infringing or denigrating our trademarks and initiating litigation as necessary. We also work with trade groups and industry participants seeking to strengthen laws relating to the protection of intellectual property rights in markets around the world. We grant licenses to other parties to manufacture and sell products with our trademarks in product categories and in geographic areas in which we do not operate.
Seasonality and Backlog
In 2004, our net sales in the first, second and third and fourth quarters represented 24%, 24%, 24% and 28%, respectively, of our total net sales for the year.
Orders are generally subject to cancellation and we sell and ship substantial volume on an at-once replenishment basis. As a result of these factors, our order backlog may not be indicative of future shipments.
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Government Regulation
We are subject to federal, state, local and foreign laws and regulations affecting our business, including those related to labor, employment, worker health and safety, environmental protection, products liability, product labeling, consumer protection, and anti-corruption. In the United States, these laws include the Occupational Safety and Health Act, the Consumer Product Safety Act, the Flammable Fabrics Act, the Textile Fiber Product Identification Act, the Foreign Corrupt Practices Act and the rules and regulations of the Consumer Products Safety Commission and the Federal Trade Commission. We are also subject to import and export laws, including U.S. economic sanction and embargo regulations and other related laws such as the U.S. anti-boycott law and the U.S. export controls regulations. We are also subject to comparable laws of the European Union, Japan and other foreign jurisdictions where we have a presence. We believe that we are in substantial compliance with the applicable federal, state, local, and foreign rules and regulations governing our business.
In addition, all of our import operations are subject to tariffs and quotas set by the governments through mutual agreements or bilateral actions. Countries in which our products are manufactured or imported may from time to time impose additional new quotas, duties, tariffs or other restrictions on our imports or adversely modify existing restrictions. Adverse changes in these import costs and restrictions, or our suppliers’ failure to comply with customs regulations or similar laws, can result in substantial costs and harm our business.
Our operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, the Caribbean Basin Initiative and the European Economic Area Agreement, and the activities and regulations of the World Trade Organization. Generally, these trade agreements have positive effects on trade liberalization and benefit our business by reducing or eliminating the duties and/or quotas assessed on products manufactured in a particular country. However, trade agreements can also impose requirements that adversely affect our business, such as limiting the countries from which we can purchase raw materials and setting quotas on products that may be imported from a particular country into our key markets such as the United States or the European Union. Some trade agreements can provide our competitors with an advantage over us, or increase our costs, either of which could have an adverse effect on our business and financial condition. The elimination of quotas on textile and apparel imports by World Trade Organization member countries at the end of 2004 could result in increased sourcing from developing countries which historically have lower labor costs, including China. For more information, see “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors That May Affect Future Results — Our business is subject to risks associated with sourcing and manufacturing overseas”.
Social Responsibility
Since our founding, we have emphasized conducting our business in a socially responsible manner and giving back to the communities in which we operate throughout the world. We continue that tradition today through corporate philanthropy, employee volunteerism and responsible business practices. Our strong commitment to workers’ rights is reflected in our history of public advocacy for responsible trade policies and our business practices with manufacturing and finishing contractors.
Employees
As of November 28, 2004, we employed approximately 8,850 people, approximately 2,800 of whom were located in the United States. Of our 8,850 employees, approximately 3,500 were associated with manufacturing of our products and approximately 5,350 were non-production employees. Of the non-production employees, approximately 1,265 worked in distribution. Most of our distribution employees in the United States are covered by various collective bargaining agreements. Outside the United States, most of our production and distribution employees are covered by either industry-sponsored and/or state-sponsored collective bargaining mechanisms. We consider our relations with our employees to be good and have not recently experienced any material job actions or labor shortages.
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The following table shows our approximate number of employees by region, including changes in the number from 2003 to 2004:
Region
Corporate
Item 2. PROPERTIES
We conduct manufacturing, distribution and administrative activities in owned and leased facilities. We operate five manufacturing-related facilities abroad and 14 distribution-only centers around the world. We have renewal rights for most of our property leases. We anticipate that we will be able to extend these leases on terms satisfactory to us or, if necessary, locate substitute facilities on acceptable terms. We believe our facilities and equipment are in good condition and are suitable for our needs. Information about our key operating properties in use as of November 28, 2004 is summarized in the following table:
Location
Primary Use
Little Rock, AR
Distribution
Hebron, KY
Canton, MS
Henderson, NV
Westlake, TX
Data Center
Etobicoke, Canada
Naucalpan, Mexico
Heustenstamm, Germany
Kiskunhalas, Hungary
Manufacturing, Finishing and Distribution
Milan, Italy
Plock, Poland
Manufacturing and Finishing
Warsaw, Poland
Northhampton, U.K
Sabedell, Spain
Helsingborg, Sweden
Adelaide, Australia
Cape Town, South Africa
Corlu, Turkey
Hiratsuka Kanagawa, Japan
Karawang, Indonesia
Finishing
Makati, Philippines
Manufacturing
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We also lease a manufacturing facility in Dongguan, China where a third party operates production activities for us.
Our global headquarters and the headquarters of our North America business are both located in leased premises in San Francisco, California. Our Europe and Asia Pacific headquarters are located in leased premises in Brussels, Belgium and Singapore. As of November 28, 2004, we also leased or owned 104 administrative and sales offices in 39 countries, as well as leased a small number of warehouses in four countries.
In addition, as of November 28, 2004, we had 51 company-operated retail and outlet stores in leased premises in eight countries. We had 23 stores in the North America region, 20 stores in the Europe region and eight stores in the Asia Pacific region. In addition we operate 41 shop-in-shop stores in Korea. In 2004, we opened nine company-operated stores and closed nine stores. We also own or lease several facilities we formerly operated and have subleased or are working to sell or sublease many of those facilities. For example, on February 16, 2005, we entered into an agreement to sell our former Valencia Street facility in San Francisco. Completion of the sale is subject to customary contingencies and conditions.
Item 3. LEGAL PROCEEDINGS
Wrongful Termination Litigation. On April 14, 2003, two former employees of our tax department filed a complaint in the Superior Court of the State of California for San Francisco County in which they allege that they were wrongfully terminated in December 2002. Plaintiffs allege, among other things, that Levi Strauss & Co. engaged in a variety of fraudulent tax-motivated transactions over several years, that we manipulated tax reserves to inflate reported income and that we fraudulently failed to set appropriate valuation allowances against deferred tax assets. They also allege that, as a result of these and other tax-related transactions, our financial statements for several years violated generally accepted accounting principles and Securities and Exchange Commission (the “SEC”) regulations and are fraudulent and misleading, that reported net income for these years was overstated and that these various activities resulted in our paying excessive and improper bonuses to management for fiscal year 2002. Plaintiffs in this action further allege that they were instructed by us to withhold information concerning these matters from our independent registered public accounting firm and the Internal Revenue Service, that they refused to do so and, because of this refusal, they were wrongfully terminated. Plaintiffs seek a number of remedies, including compensatory and punitive damages, attorneys’ fees, restitution, injunctive relief and any other relief the court may find proper.
On March 12, 2004, plaintiffs filed a complaint in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. In this complaint, in addition to restating the allegations contained in the state complaint, plaintiffs assert that we violated Sections 1541A et seq. of the Sarbanes-Oxley Act by taking adverse employment actions against plaintiffs in retaliation for plaintiffs’ lawful acts of compliance with the administrative reporting provisions of the Sarbanes-Oxley Act. Plaintiffs seek a number of remedies, including compensatory damages, interest lost on all earnings and benefits, reinstatement, litigation costs, attorneys’ fees and any other relief that the court may find proper. The district court has now related this case to the securities class action (described below) styled In re: Levi Strauss & Co. Securities Litigation.
On December 7, 2004, plaintiffs requested and we agreed to, a stay of their state court action in order to first proceed with their action in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. On February 7, 2005, the parties submitted the joint agreement to the court for approval.
We are vigorously defending these cases and are pursuing our related cross-complaint against the plaintiffs in the state case. We do not expect this litigation to have a material impact on our financial condition or results of operations.
On September 15, 2003, we announced that our Audit Committee had completed its investigation of the tax and related accounting issues raised in the wrongful termination suit. The Audit Committee concluded that our
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tax and related accounting positions were reasonable and legally defensible and noted that in the course of its investigation it did not discover evidence of tax or other fraud. The Audit Committee also did not find evidence that information was improperly withheld from the Internal Revenue Service with respect to these issues in connection with Internal Revenue Service audits. The Audit Committee investigation was initiated following the filing of the wrongful termination litigation.
The scope of the Audit Committee investigation was to review issues raised in the complaint. The Audit Committee retained independent counsel, Simpson Thacher & Bartlett LLP, to assist it in the investigation. An independent accounting firm was retained by Simpson Thacher & Bartlett LLP to consult on specified accounting issues. The investigation took place over a period of approximately four and one-half months, and involved extensive discussions with employees of the company, various legal and tax advisors, and our independent registered public accounting firm, as well as an extensive review of documents.
In addition to the conclusions noted above, the Audit Committee observed that, during the period from 1994 through 2001, we established, maintained and released varying amounts of unspecified tax reserves. These tax reserves were not supported by sufficient contemporaneous documentation that related the reserves to specified tax exposures. In reviewing the matter, the Committee noted that these tax reserves were communicated to and discussed with our independent registered public accounting firm at the time they were created and maintained. We and our Audit Committee are of the view that the handling of the unspecified tax reserves during these periods was not intended to, and did not, materially affect our SEC-filed financial statements. There was also no evidence of tax or other fraud in connection with the establishment or the release of these reserves.
In the course of the Audit Committee investigation, we communicated with the SEC on an informal basis, and we expect to continue these communications with respect to the results of the investigation and further developments relating to the litigation as appropriate.
Class Actions Securities Litigation. On March 29, 2004, the United States District Court for the Northern District of California, San Jose Division, issued an order consolidating two recently filed putative bondholder class-actions (styled Orens v. Levi Strauss & Co., et al. and General Retirement System of the City of Detroit, et al. v. Levi Strauss & Co., et al.) against us, our chief executive officer, a former chief financial officer, our corporate controller, our directors and financial institutions alleged to have acted as our underwriters in connection with our April 6, 2001 and June 16, 2003 registered bond offerings. Additionally, the court appointed a lead plaintiff and approved the selection of lead counsel. The consolidated action is styled In re Levi Strauss & Co., Securities Litigation, Case No. C-03-05605 RMW (class action).
The action purports to be brought on behalf of purchasers of our bonds who made purchases pursuant or traceable to our prospectuses dated March 8, 2001 or April 28, 2003, or who purchased our bonds in the open market from January 10, 2001 to October 9, 2003. The action makes claims under the federal securities laws, including Sections 11 and 15 of the Securities Act of 1933, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, relating to our SEC filings and other public statements. Specifically, the action alleges that certain of our financial statements and other public statements during this period materially overstated our net income and other financial results and were otherwise false and misleading, and that our public disclosures omitted to state that we made reserve adjustments that plaintiffs allege were improper. Plaintiffs contend that these statements and omissions caused the trading price of our bonds to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief. We are in the initial stages of this litigation and expect to defend the action vigorously. We cannot currently predict the impact, if any, that this action may have on our financial condition or results of operations.
On May 26, 2004, the court related this action to the federal wrongful termination action discussed above, such that each action is pending before the same judge.
On July 15, 2004, we filed a motion to dismiss this action. The matter came before the court on October 15, 2004, and, after oral argument had concluded, the court took the matter under submission. The court has not yet
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issued a ruling. We cannot currently predict the impact, if any, that this action may have on our financial condition or results of operations.
Other Litigation. In the ordinary course of business, we have various other pending cases involving contractual matters, employee-related matters, distribution questions, product liability claims, trademark infringement and other matters. We do not believe there are any pending legal proceedings that will have a material impact on our financial condition or results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during our 2004 fiscal fourth quarter.
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PART II
Our shares of common stock are held by members of the families of several descendants of our founder, Levi Strauss, and by several former members of our management. There is no established public trading market for our shares and none of our shares are convertible into shares of any other class of stock or other securities.
All shares of our common stock are deposited in a voting trust, a legal arrangement that transfers the voting power of the shares to a trustee or group of trustees. As of November 28, 2004, the four voting trustees are Peter E. Haas, Sr., Peter E. Haas, Jr., Robert D. Haas and F. Warren Hellman. The voting trustees have the exclusive ability to elect and remove directors, amend our by-laws and take certain other actions which would normally be within the power of stockholders of a Delaware corporation. Our equity holders, who, as a result of the voting trust, legally hold “voting trust certificates,” not stock, retain the right to direct the trustees on specified mergers and business combinations, liquidations, sales of substantially all of our assets and specified amendments to our certificate of incorporation.
The voting trust will last until April 2011, unless the trustees unanimously decide, or holders of at least two-thirds of the outstanding voting trust certificates decide, to terminate it earlier. If Robert D. Haas ceases to be a trustee for any reason, then the question of whether to continue the voting trust will be decided by the holders. If Peter E. Haas, Sr. ceases to be a trustee, his successor will be his spouse, Miriam L. Haas. The existing trustees will select the successors to the other trustees. The agreement among the stockholders and the trustees creating the voting trust contemplates that, in selecting successor trustees, the trustees will attempt to select individuals who share a common vision with the sponsors of the 1996 transaction that gave rise to the voting trust, represent and reflect the financial and other interests of the equity holders and bring a balance of perspectives to the trustee group as a whole. A trustee may be removed if the other three trustees unanimously vote for removal or if holders of at least two-thirds of the outstanding voting trust certificates vote for removal.
Our common stock, as noted, and the voting trust certificates, are not publicly held or traded. All shares and the voting trust certificates are subject to a stockholders’ agreement. The agreement, which expires in April 2016, limits the transfer of shares and certificates to other holders, family members, specified charities and foundations and to us. The agreement does not provide for registration rights or other contractual devices for forcing a public sale of shares or certificates, or other access to liquidity. The scheduled expiration date of the stockholders’ agreement is five years later than that of the voting trust agreement in order to permit an orderly transition from effective control by the voting trust trustees to direct control by the stockholders.
We may hold “annual stockholders’ meetings” to which all voting trust certificate holders are invited to attend. These meetings are not a “meeting of stockholders” in the traditional corporate law sense. Under the voting trust agreement, the trustees, not the voting trust certificate holders, elect the directors and vote the shares on most other corporate matters. In addition, the meetings are not official formal meetings, under the voting trust agreement, of the voting trust certificate holders. Instead, these annual gatherings are opportunities for the voting trust certificate holders to interact with the board of directors and management and to learn more about our business.
As of November 28, 2004, there were 168 record holders of voting trust certificates.
We did not declare or pay any dividends in our two most recent fiscal years, and we do not expect to pay any dividends in 2005. Our senior secured term loan and senior secured revolving credit facility prohibit our declaring or paying any dividends without first obtaining consents from our lenders. In addition, the indentures relating to our 11.625% senior notes due 2008, our 12.25% senior notes due 2012 and our 9.75% senior notes due 2015 limit our ability to pay dividends. For more detailed information about our credit agreements and senior notes, see “Item 5 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition” and Note 7 to our Consolidated Financial Statements.
We did not repurchase any of our common stock during the fourth quarter of 2004.
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Item 6. SELECTED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial data. The summary statements of operations data and cash flow data for fiscal years 2004, 2003, 2002 and 2001 and the consolidated balance sheet data at the end of such periods are derived from our consolidated financial statements that have been audited by KPMG LLP, an independent registered public accounting firm. The following statements of operations data and cash flow data for fiscal 2000 and the consolidated balance sheet data at the end of such period are derived from our financial statements that were previously audited by Arthur Andersen LLP, independent public accountants, and restated by company management as a result of the 2001 reaudit by KPMG LLP, but were not reaudited by KPMG LLP.
The financial data set forth below should be read in conjunction with, and are qualified by reference to, “Item 5—Management’s Discussion and Analysis of Financial Condition and Results of Operations”, our consolidated financial statements and the related notes to those financial statements, included elsewhere in this report. Certain prior year amounts have been reclassified to conform to the 2004 presentation.
Statements of Operations Data:
Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Long-term incentive compensation expense (reversal)(1)
Gain on disposal of assets(2)
Other operating income
Restructuring charges, net of reversals(3)
Operating income
Interest expense
Other (income) expense, net
Income (loss) before taxes
Income tax expense(4)
Net income (loss)
Statements of Cash Flow Data:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Balance Sheet Data:
Cash and cash equivalents
Working capital
Total assets
Total debt, excluding capital leases
Stockholders’ deficit(5)
Other Financial Data:
Depreciation and amortization
Capital expenditures
Ratio of earnings to fixed charges(6)
Deficit of earnings to fixed charges(7)
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Introduction
Overview. We are one of the world’s leading branded apparel companies, with sales in more than 110 countries. We design and market jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s®, Dockers® and Levi Strauss Signature™ brands. We also license our trademarks in various countries throughout the world for accessories, pants, tops, footwear, home and other products.
Our net sales for 2004 were $4.1 billion. Net sales for the year by region and by brand were as follows:
We distribute our Levi’s® and Dockers® products primarily through chain retailers and department stores in the U.S. and primarily through department stores and specialty retailers abroad. We also distribute Levi’s® and Dockers® products through independently-owned franchised stores outside the United States and through a small number of company-owned stores located in the United States, Europe and Asia. We distribute our Levi Strauss Signature™ products through mass channel retailers worldwide including Wal-Mart, Kmart and Target Stores in the United States and Carrefour and ASDA-Wal-Mart abroad.
Our business is organized into three geographic regions. The following tables provide employee headcount as of the end of fiscal year 2004 and 2004 net sales and operating income for those regions and for our corporate functions:
2004Net Sales
(millions)
2004OperatingIncome
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Our Results. We focused in 2004 on execution against our key priorities for 2004: stabilizing sales and improving profitability; reducing costs and increasing cash flow; and executing changes in our U.S. and European organizations, our global supply chain organization and our go-to-market process to reduce the time it takes to get new products to market. Results of operations for 2004 are summarized as follows:
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Our Business and Organization. Since the beginning of fiscal 2004, we have taken a number of actions relating to our organization, management and cost structure. These actions included:
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In addition, on February 1, 2005, we announced that we had appointed Hans Ploos van Amstel as our senior vice president and chief financial officer, and on February 3, 2005, our Board of Directors elected Leon J. Level to join the board. For more information about Mr. Ploos van Amstel and Mr. Level, please see “Item 10 — Directors and Executive Officers”.
Our Priorities for 2005. We continue to focus on our core strategies in 2005. In executing those strategies, our priorities in 2005 are to:
Our Financing Arrangements. In 2004 and in early 2005, we made several significant changes in our financing arrangements:
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Our Debt and Liquidity. As of February 13, 2005, our total availability under our amended senior secured revolving credit facility was approximately $400.3 million. We had no outstanding borrowings under this facility, but had utilization of other credit-related instruments such as documentary and standby letters of credit. Our unused availability was approximately $281.3 million. In addition, we had liquid short-term investments in the United States totaling approximately $129.6 million, resulting in a net liquidity position (availability and liquid short-term investments) of $410.9 million in the United States.
Results of Operations
Year Ended November 28, 2004 as Compared to Year Ended November 30, 2003
The following table summarizes, for the years indicated, items in our consolidated statements of operations, the changes in these items from 2003 to 2004 and these items expressed as a percentage of net sales (amounts may not total due to rounding).
Long-term incentive compensation expense (reversal)
Gain on disposal of assets
Restructuring charges, net of reversals
Other expense, net
Income tax expense
Consolidated net sales were essentially flat and, on a constant currency basis, decreased 4.0%.
The following table shows our net sales for our North America, Europe and Asia Pacific businesses and the changes in these results from 2003 to 2004.
Year Ended
November 28,2004
November 30,2003
$ Increase(Decrease)
Total net sales
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North America net sales decreased 6.3% and, on a constant currency basis, decreased 6.5%.
The following table presents our net sales in our North America region broken out for our U.S. brands and for Canada and Mexico, including changes in these results from 2003 to 2004.
U.S. Levi’s® brand
U.S. Dockers® brand
U.S. Levi Strauss Signature ™ brand
Canada and Mexico
Total North America net sales
The following discussion summarizes net sales performance in 2004 of our U.S. brands. In these sections, the tables showing net sales for the Levi’s® and Dockers® brands break out net sales between “Licensed Categories” and “Continuing Categories.”
We believe this presentation is useful to the reader because it shows the impact of product category licensing on our net sales. As we move to licensing more of our non-core product lines, we expect our revenues from “licensed categories” to decrease and our revenues from royalty payments to increase. We present this data for our U.S. Levi’s® and Dockers® brands only because there has been no significant licensing of product categories that we have marketed and sold ourselves in our U.S. Levi Strauss Signature™brand or in our Europe and Asia Pacific businesses.
In addition, in the sections discussing the U.S. Levi’s® and Dockers® brands, we use the term “dilution”. By “dilution”, we mean the impact on sales of recording allowances for estimated returns, discounts and retailer promotions and incentives.
Levi’s® Brand. The following table shows net sales of our U.S. Levi’s® brand, including the changes in these results from 2003 to 2004.
U.S. Levi’s® brand — Continuing categories
U.S. Levi’s® brand — Licensed categories
Total U.S. Levi’s® brand net sales
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Net sales in our U.S. Levi’s® brand in 2004 decreased 9.2% from 2003. The decrease was primarily due to the following factors:
Partially offsetting these factors were an increase in sales in our main channels of distribution, the elimination of our volume incentive fund program, and lower product returns and allowances.
Key product, marketing and operational initiatives in 2005 include:
Dockers® Brand. The following table shows net sales of our U.S. Dockers® brand, including changes in these results from 2003 to 2004.
U.S. Dockers® brand — Continuing categories
U.S. Dockers® brand — Licensed categories
U.S. Dockers® brand — Discontinued Slates® pants
Total U.S. Dockers® brand net sales
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Net sales in our U.S. Dockers® brand in 2004 decreased 20.9% from 2003. The decrease was primarily due to the following factors:
Partially offsetting these factors were the improved performance of our men’s Dockers® proStyle™ pants and tops and women’s Metro and capri pants categories. Lower overall dilution resulting from the full-year effect of changes made to our volume incentive program and lower price differentials achieved through better inventory management also helped offset the net sales decline.
Levi Strauss Signature™ Brand. Net sales in our U.S. Levi Strauss Signature™ brand in 2004 increased 55.1% or $119.3 million as compared to the prior year. This increase primarily reflects expansion of our customer base during 2004. Key factors in driving our net sales results were as follows:
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Europe net sales increased 5.0% and, on a constant currency basis, decreased 5.7%.
The following table presents our net sales in our Europe region broken out for our brands including changes in these results from 2003 to 2004.
Europe Levi’s® brand
Europe Dockers® brand
Europe Levi Strauss Signature™ brand
Total Europe net sales
Levi’s® Brand. Weak market and retail conditions, poor order fulfillment performance and product rationalization actions drove the 7.2% net sales decrease in the Levi’s® brand in Europe on a constant currency basis in 2004. The sales decline was primarily in our men’s category, with the largest decreases occurring in Spain, France, Germany and the Benelux. Our businesses in Italy and the United Kingdom reported sales increases for the year on a constant currency basis.
While our net sales for the year were down, the rate of decline improved during the second and third quarters, and net sales increased in the fourth quarter as compared to the same period in the prior year. We took a number of actions to improve our sales performance including:
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We believe these actions led to the improving sales trend during the year, including a 2% increase in sales on a constant currency basis for the fourth quarter of 2004 as compared to the same period in the prior year.
Dockers® Brand. A weak retail replenishment business due to soft consumer demand resulted in an 18.0% net sales decrease in the Dockers® brand on a constant currency basis in 2004. Poor customer service performance, including low order fulfillment rates, also adversely affected the business.
During the fourth quarter we announced that we are reorganizing the Dockers® business in Europe. We are currently in the process of developing a new business model and marketing program for the brand. We are moving management of the business from Amsterdam to Brussels, our European headquarters. We expect that the changes will improve the brand’s financial performance in Europe and decrease complexity through a more streamlined organization. We believe the move will allow the brand to reduce its facility costs as well as leverage the resources of the larger Levi Strauss Europe organization. We are also in the process of rationalizing the Dockers® product line by focusing on core products. We expect these changes in the product range will be reflected at retail stores in the fall of 2005. During the third quarter of 2005, we expect to incur restructuring charges of approximately $7.7 million in connection with these changes. For more information, see Note 3 to our Consolidated Financial Statements.
Levi Strauss Signature™ Brand. We launched the Levi Strauss Signature™ brand in France, Germany, the United Kingdom and Switzerland in 2004. Our focus in 2005 is on building our business in these launch markets, where our customers include Carrefour in France, Wal-Mart in Germany, ASDA-Wal-Mart in the United Kingdom and Migros in Switzerland, and on targeted expansion to other countries.
Asia Pacific net sales increased 18.8% and, on a constant currency basis, increased 12.0%.
The following table presents our net sales in our Asia Pacific region broken out for our brands, including changes in these results from 2003 to 2004.
Asia Pacific Levi’s® brand
Asia Pacific Dockers® brand
Asia Pacific Levi Strauss Signature™ brand
Total Asia Pacific net sales
Our Asia Pacific region realized a 12.0% increase in net sales on a constant currency basis in 2004 compared with 2003. While our net sales for the year were up, the rate of growth slowed during the second half of the year. The net sales increase for the year was driven by an 11.3% increase in net sales on a constant
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currency basis of our Levi’s® brand products and our continuing expansion of our Levi Strauss Signature™ brand in Japan, Australia and Taiwan. Net sales increased in most countries in the region, with the exception of Australia and Singapore, which were affected by soft retail conditions in those countries. South Korea, our fastest growing business in the region, continued to achieve strong growth, with an increase in net sales of approximately 43.0% from 2003 on a constant currency basis. Japan, which represents our largest business in Asia Pacific with approximately 45% of regional net sales for 2004, had a 6.0% increase in net sales from 2003 on a constant currency basis.
The increases in the Asia Pacific region were attributable to a number of factors, including:
Our focus areas in 2005 include driving innovation and newness in our core products, including the 501® jean and our Levi’s® LadyStyle™ collection; continuing to enhance retail presentation and dedicated franchise store distribution around the region; integrating new markets that were moved to the Asia Pacific organization in 2004 (Turkey, South Africa and Latin America); and expanding distribution of our Levi Strauss Signature™ business.
Gross profit increased 13.3%. Gross margin was 43.8%, reflecting an increase of 5.3 percentage points.
Factors that increased our gross profit included:
Our gross margin increased primarily due to a favorable mix of more profitable core products, our product rationalization efforts, including decisions to exit underperforming categories, lower returns and sales allowances, lower sourcing costs, reflecting the closure of our remaining North America manufacturing plants and the shift of production to lower cost sources, and a lower proportion of sales of marked-down obsolete and excess products, particularly in the United States. The increase was partially offset by the lower gross margin on Levi Strauss Signature™ products.
Our cost of goods sold is primarily comprised of cost of materials, labor and manufacturing overhead and also includes the cost of inbound freight, internal transfers, and receiving and inspection at manufacturing facilities as these costs vary with product volume. We include substantially all the costs related to receiving and inspection at distribution centers, warehousing and other activities associated with our distribution network in selling, general and administrative expenses. Our gross margins may not be comparable to those of other companies in our industry, since some companies may include costs related to their distribution network in cost of goods sold.
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Selling, general and administrative expenses decreased 4.0% and decreased as a percentage of net sales by 1.2 percentage points.
Various factors contributed to the decrease in our selling, general and administrative expenses:
These decreases were partially offset by the following:
Selling, general and administrative expenses also include distribution costs, such as costs related to receiving and inspection at distribution centers, warehousing, shipping, handling and certain other activities associated with our distribution network. These expenses totaled $215.1 million (5.3% of consolidated net sales) in 2004 as compared to $211.6 million (5.2% of consolidated net sales) in 2003. The increase is due to the impact of foreign currency translation. U.S. distribution expenses totaled $127.2 million (5.7% of net sales in the United States) and $135.3 million (5.6% of net sales in the United States) for 2004 and 2003, respectively. The decrease in these expenses primarily reflect lower benefit expense related to our benefit plan amendment and restructuring initiatives, lower shipping volume, cost reductions at our U.S. third-party distribution centers and non-recurrence of start-up costs incurred in 2003 associated with our initial shipments of Levi Strauss Signature™ products in the United States.
Long-term incentive compensation expense was $45.2 million as compared to net reversals of $138.8 million in 2003.
Our 2003 results reflect a substantial reversal of long-term incentive compensation plan accruals as a result of lower than expected payouts in 2003 due to changes in our financial performance. The $45.2 million expense for 2004 reflects our new long-term incentive compensation program and the related payouts in July 2004 and estimated remaining payouts due in February and July 2005.
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Other operating income increased 30.3%.
Other operating income is comprised of royalty income we generate through licensing our trademarks in connection with the manufacturing, advertising, distribution and sale of products by third-party licensees. In 2004, royalty income increased $12.1 million as compared to 2003. The increase was attributable primarily to our decision to license additional Levi’s® and Dockers® brand product categories, an increase in the number of licensees and increased sales by licensees of accessories, sportswear, and home products, partially offset by decreased sales by licensees of footwear.
Restructuring charges, net of reversals, were $133.6 million as compared to $89.0 million in 2003.
Our restructuring charges for 2004 reflected the following activities:
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Operating income increased 15.2%. Operating margin was 8.9%, reflecting an increase of 1.2 percentage points.
The following table shows our operating income by brand in the United States and in total for our North America, Europe and Asia Pacific regions, the changes in results from 2003 to 2004 and results presented as percentage of net sales:
$ Increase
(Decrease)
2003
% of Net
Sales
U.S. Levi Strauss Signature™ brand
Regional operating income
Corporate:
Long-term incentive compensation (expense) reversal
Depreciation and amortization expense
Other corporate expense
Total corporate expense
Total operating income
In 2004, higher regional operating income and lower corporate expenses were partially offset by increased long-term incentive compensation expense and higher restructuring charges.
Regional Summaries. The following summarizes the changes in operating income by region:
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Long-term incentive compensation expense (reversal). The increase is attributable to the current year expense for our 2004 incentive compensation program and our recording in 2003 of reversals of previously recorded incentive compensation plan accruals due to lower expected payouts under our prior long-term incentive compensation plans.
Restructuring charges, net of reversals. Our restructuring charges increased primarily as a result of our 2004 reorganization initiatives, including the closing of our plants in Australia and Spain, our organizational changes in Europe and North America and our suspension of a worldwide enterprise resource planning system.
Other corporate expense. We reflect annual incentive compensation plan costs for corporate employees, post-retirement medical benefit plan curtailment gains and corporate staff costs in other corporate expense. The decrease in total other corporate expense of $66.2 million in 2004 was primarily attributable to a higher curtailment gain related to our post-retirement medical plan and lower salaries and lower expenses resulting from our comprehensive cost reduction initiatives. Partially offsetting these factors were higher expenses associated with our annual incentive compensation plan.
The following table summarizes significant components of other corporate expense:
Annual incentive compensation plan — corporate employees
Post-retirement medical benefit plan curtailment gain
Corporate staff costs and other expense
Total other corporate expense
Interest expense increased 2.3%.
The higher interest expense was primarily due to higher effective interest rates in 2004. The weighted average interest rate on average borrowings outstanding for 2004 and 2003, including the amortization of debt issuance costs and interest rate swap cancellations, was 10.60% and 10.05%, respectively. The increase in our weighted average interest rate resulted primarily from a higher interest rate on our senior secured term loan obtained during the fourth quarter of 2003, as compared to our 2003 senior secured credit facility it replaced. The weighted average interest rate on average borrowings outstanding excludes interest payable to participants under our deferred compensation plans and other miscellaneous items.
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Other expense, net decreased 94.0%.
The following table summarizes significant components of other expense, net:
Foreign exchange management contracts losses
Foreign currency transaction gains
Interest income
Loss on early extinguishment of debt
Minority interest — Levi Strauss Japan K.K.
Minority interest — Levi Strauss Istanbul Konfeksiyon
The $84.9 million decrease in other expense, net, was primarily driven by a decrease in losses on foreign exchange management contracts and the recognition in 2003 of a $39.4 million loss on early extinguishment of debt. The loss on early extinguishment of debt in 2003 related to our purchase of $327.3 million in principal amount of our 6.80% notes, the write-off of unamortized bank fees associated with the refinancing in January 2003 of our 2001 bank credit facility and the refinancing in September 2003 of both our January 2003 credit facility and our July 2001 U.S. receivables securitization transaction. The decrease was partially offset by lower foreign currency transaction gains in 2004.
We use foreign exchange management contracts such as forward, swap and option contracts, to manage foreign currency exposures. Outstanding derivative instruments are recorded at fair value and the changes in fair value are recorded in “other expense, net”. At contract maturity, the realized gain or loss related to derivative instruments is also recorded in “other expense, net”. The decrease in foreign exchange management contract losses, from $84.8 million in 2003 to $26.8 million in 2004, was due to a reduction in outstanding foreign currency exposures and lower depreciation of the U.S. dollar against major foreign currencies in 2004 as compared to 2003.
Foreign currency transactions are transactions denominated in a currency other than the recording entity’s functional currency. At the date the foreign currency transaction is recognized, each asset, liability, revenue, expense, gain or loss arising from the transaction is measured and recorded in the functional currency of the recording entity using the exchange rate in effect at that date. Balances denominated in a foreign currency are adjusted, or remeasured, to reflect the current exchange rate at each balance sheet date. The changes in the recorded balances caused by remeasurement at the exchange rate are recorded in “other expense, net”. For 2004 and 2003, the net gains of $15.0 million and $21.0 million, respectively, were caused by remeasurement of foreign currency denominated balances at the exchange rates existing at the balance sheet dates. For more information, see “Item 7A — Quantitative and Qualitative Disclosures About Market Risk”.
Income tax expense decreased by $252.9 million.
Income tax expense was $65.1 million for 2004 compared to $318.0 million for 2003. The $252.9 million decrease is primarily related to our recording in 2003 of a $282.4 million increase in valuation allowance against deferred tax assets, including our foreign tax credits, state and foreign net operating loss carryforwards and alternative minimum tax credits. For more information, see “Tax Matters”.
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Net income was $30.4 million, compared to a net loss of $349.3 million in 2003.
The increase in net income for 2004 was due primarily to higher gross profit, lower selling general and administrative expense, increased royalty income, lower foreign exchange management contracts losses, lower income tax expense and the recognition in 2003 of a loss on early extinguishment of debt, partially offset by the impact of the prior year reversal of long-term incentive compensation and increased restructuring charges in the current year.
Year Ended November 30, 2003 as Compared to Year Ended November 24, 2002
Our 2003 and 2002 financial results discussed below give effect to our transfer, effective at the beginning of fiscal 2004, from the Europe and the North America regions to the Asia Pacific region, of management responsibility for our Middle East, Africa and South America businesses.
The following table summarizes, for the periods indicated, selected items in our consolidated statements of income, the changes in such items from 2002 to 2003 and such items expressed as a percentage of net sales (amounts may not total due to rounding).
Consolidated net sales decreased 1.3% and, on a constant currency basis, decreased 5.7%.
The following table shows our net sales for our North America, Europe and Asia Pacific businesses, the changes in these results from 2002 to 2003 and these results presented as a percentage of net sales (amounts may not total due to rounding).
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The primary factors underlying the decrease in our net sales were a weak retail climate and deflationary pressures in most apparel markets in which we operate, and wholesale price reductions we took in the United States in mid-2003. As a result of these factors, sales of our Levi’s® and Dockers® products in the United States and Europe were lower. This decrease was offset in part by sales from the launch of our Levi Strauss Signature™ brand in the United States in July 2003 and in Canada, Australia and Japan in the fourth quarter of 2003. The decrease in net sales was also offset in part by the continuing strength of our Asia Pacific business.
North America net sales decreased 3.1% and, on a constant currency basis, decreased 3.2%.
The following table presents our net sales in our North America region broken out for our U.S. brands and for Canada and Mexico, including changes in these results for 2003 compared to 2002.
We believe the overall decline in North America net sales for 2003 compared to 2002 was due to a number of factors, including the following:
The decrease in North America net sales for 2003 compared to 2002 was offset in part by sales from the launch in July 2003 of our Levi Strauss Signature™ brand into Wal-Mart stores in the United States and during the fourth quarter into Canada. We shipped a range of men’s, women’s and kids’ products into nearly 3,000 Wal-Mart stores across the United States in one of the largest brand launches in apparel history.
We introduced a number of new products during 2003 including Levi’s® brand corduroys with new styles, an improved fabric feel and performance and a wide range of new colors. We extended our popular Dockers® Go Khaki® pant with Stain Defender®finish to our women’s khaki lines. We also introduced our Dockers® Individual Fit® waistband technology, featuring an expandable waistband, into a number of our men’s and women’s products.
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Europe net sales decreased 5.4% and, on a constant currency basis, decreased 19.6%.
The following table presents our net sales in our Europe region broken out for our brands including changes in these results for 2003 compared 2002:
Net sales in Europe were affected by more severe market conditions than those prevailing in the United States. These market conditions included weak economies, low consumer confidence, price deflation in apparel and a stagnant retail environment. Our core replenishment business in the region suffered, particularly replenishment of 501® jeans products, in part due to retailers adopting more conservative purchasing patterns to reduce high inventory levels. A less favorable product mix also contributed to our constant currency sales decrease in 2003, reflecting in part lower sales of 501® jeans and increased sales of lower priced Levi’s®580™ jeans and tops. Finally, we believe actions we took in Europe to move closeout and slow moving inventory, and unauthorized sales of our products, also adversely affected our sales in 2003.
Asia Pacific net sales increased 20.4% and, on a constant currency basis, increased 11.0%.
The following table presents our net sales in our Asia Pacific region broken out for our brands including changes in these results for 2003 compared to 2002.
Sales growth in Asia reflected the impact of our new products, including the super premium Red Loop™ product introduced in August and improved retail presentation. In Japan, which accounted for approximately 52% of our net sales in the Asia Pacific region for 2003, net sales increased approximately 14% on a constant currency basis compared to 2002. The positive results in Japan also reflected the opening of additional independently owned retail stores dedicated to the Levi’s® brand. Our Levi’s® Type 1™ product line and our Red Tab™ products, including a revitalized 501® jean, performed well in the region. In addition, we introduced our Levi Strauss Signature™ brand into mass channel retailers in Australia and Japan during the fourth quarter of 2003.
Gross profit decreased 6.8%. Gross margin was 38.5%, reflecting a decrease of 2.3 percentage points.
Factors that reduced our gross profit in 2003 included the following:
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Cost savings from our 2002 plant closures partially offset the impact of these factors.
Gross profit in 2003 was also adversely affected by restructuring related expenses in 2003 of $27.6 million primarily associated with the 2003 plant closures in the United States. These expenses primarily related to workers’ compensation, post-retirement health and pension plan charges. Gross profit in 2002 was adversely affected by restructuring related expenses of $49.5 million associated with plant closures in the United States and Scotland. Most of those expenses were for workers’ compensation and pension enhancements in the United States.
Unlike in prior periods, gross profit in 2003 does not include post-retirement medical benefits related to retired manufacturing employees, as we have closed our manufacturing plants in the United States. These costs, totaling approximately $37.0 million for 2003, are now reflected in selling, general and administrative expenses. For 2003, gross profit benefited from the translation impact of stronger foreign currencies of approximately $97 million.
Selling, general and administrative expenses increased 5.2% and increased as a percentage of net sales by 2.1 percentage points.
The primary factors that contributed to the increase in our selling, general and administrative expenses in 2003 were as follows:
These increases were partially offset by the following:
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Long-term incentive compensation net reversals were $138.8 million as compared to expense of $70.3 million for 2002.
For 2003, we had a net reversal of $138.8 million in long-term incentive compensation, reflecting our performance in 2003, our expectations for 2004 and the impact of income tax expense and other items under our long-term incentive compensation plan. Our long-term incentive compensation expenses in 2002 were $70.3 million.
Other operating income increased 15.9%.
Other operating income includes royalty income we generate through licensing our trademarks to accessory, country and other licensees. The increase is primarily attributable to an increase in 2003 in new licensees, and increased sales in 2003 by licensees of sportswear, loungewear and accessories.
Restructuring charges, net of reversals, were $89.0 million in 2003, as compared to $115.5 million in 2002.
In 2003, we recorded charges of $104.4 million associated with plant closures in the United States and Canada, and organizational changes in Europe and the United States. These charges were offset by reversals of $15.4 million in 2003, based primarily on lower costs than we had estimated for our 2002 U.S. plant closures. In 2002, we recorded charges of $142.0 million associated with plant closures in the United States and Scotland and a reorganizational initiative in Europe. These charges were offset by reversals of $26.5 million in 2002 relating primarily to lower employee benefit and other costs than we had estimated for our 1997 – 1999 plant closures and November 2001 reorganizational actions in our U.S. business.
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Operating income increased 23.3%. Operating margin was 7.7%, reflecting an increase of 1.6 percentage points.
The following table shows our operating income broken out by region, the changes in these items from 2002 to 2003 and these items presented as percentage of net sales:
Long-term incentive compensation reversal (expense)
In 2003, lower corporate expense, partially offset by lower regional operating income, resulted in an increase in total operating income. The lower corporate expense was primarily driven by reversals of previously recorded incentive compensation plan accruals due to lower expected payouts under our prior long-term incentive compensation plans and lower restructuring charges, net of reversals, partially offset by an increase in other corporate expenses.
Other corporate expense. Our total other corporate expenses were lower than 2002 due primarily to decreases in annual incentive compensation expense totaling $0.8 million in 2003, compared to an expense of $33.2 million in 2002 and higher curtailment gains of $21.0 million in 2003 as compared to $12.6 million in 2002, reflecting the changes we made to our post-retirement medical plans during the year.
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Annual incentive plan — corporate employees
Interest expense increased 36.3%.
The higher interest expense was primarily due to higher average debt balances and higher effective interest rates in 2003. The higher average debt balances of $433.6 million were due primarily to tax settlement and incentive compensation payments in early 2003 and higher inventories. The weighted average cost of borrowings for 2003 and 2002 was 10.05% and 9.14%, respectively. The increase in the weighted average interest rate reflects the issuance during the first quarter of 2003 of $575.0 million of senior notes due 2012 at a stated interest rate of 12.25%. The weighted average interest rate on average borrowings outstanding excludes interest payable to participants under unfunded deferred compensation plans and other items.
Other expense, net increased 120.1%
Interest rate management contracts gains
Foreign currency transaction (gains) losses
The $49.3 million increase in other expense, net, was primarily driven by our recognition of loss on early extinguishment of debt in 2003, increased foreign exchange management contract losses and lower interest income, partially offset by increased foreign currency transaction gains. Our recognition in 2003 of a $39.4 million loss on early extinguishment of debt related to our purchase of $327.3 million in principal amount of our 6.80% notes and the write-off of unamortized bank fees associated with the refinancing in January 2003 of our 2001 bank credit facility and the refinancing in September 2003 of both our January 2003 credit facility and our July 2001 U.S. receivables securitization transaction.
The increase in foreign exchange management contract losses, from $57.4 million in 2002 to $84.8 million in 2003, was due to changes in outstanding exposures under management and changes in foreign currency exchange rates.
The increase in foreign currency transaction gains, from $4.0 million in losses in 2002 to $21.0 million in gains in 2003 was due to the remeasurement of foreign currency denominated balances at the exchange rates existing at the balance sheet dates.
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The decrease in interest income in 2003 was primarily related to the receipt in the third quarter of 2002 of interest income on a refund arising from a legal settlement associated with custom duties in Mexico. The net gain on disposal of assets in 2003 relates to the sale of fixed assets associated with our 2002 U.S. plant closures.
Income tax expense increased by $298.8 million.
Income tax expense was $318.0 million for 2003, compared to $19.2 million for 2002, primarily related to the $282.4 million increase in valuation allowance against our deferred tax assets, including our foreign tax credits, state and foreign net operating loss carryforwards and alternative minimum tax credits.
Net loss was $349.3 million in 2003, compared to $7.3 million net income in 2002.
The impact of the valuation allowance on our income tax expense, together with increased interest expense resulting from higher average debt balances and effective interest rates in 2003, far offset the increase in our operating income, and drove the net loss for 2003.
Tax Matters
Overview. Income tax expense was $65.1 million for 2004 compared to $318.0 million for 2003. The difference between 2004 and 2003 is primarily related to the 2003 tax expense relating to an increase in the valuation allowance against our deferred tax assets, including our foreign tax credits, state and foreign net operating loss carryforwards, and alternative minimum tax credits. We believe the main drivers in our effective tax rate for the foreseeable future will be the impact on our tax provision of changes to our valuation allowance against our deferred tax assets, our ability to successfully resolve open tax issues with the tax authorities on terms more or less favorable than our current estimates and our ability to credit rather than deduct foreign taxes on our U.S. federal income tax return.
Valuation Allowance. Realization of our deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. Accordingly, we evaluate all significant available positive and negative evidence, including the existence of losses in recent years and our forecast of future taxable income, in assessing the need for a valuation allowance. The underlying assumptions we used in forecasting future taxable income require significant judgment and take into account our recent performance. As a result of these calculations, the valuation allowance increased by $37.1 million and $282.4 million for 2004 and 2003, respectively.
The following table shows the components of the changes in our valuation allowance during 2004. While we believe the valuation allowance was appropriately stated at November 28, 2004, changes in our expectations regarding the utilization of our deferred tax assets could result in an increase or decrease in our provision for income taxes in future periods, and such impact could be material. Improvement or deterioration in our projected earnings, changes in tax laws regarding carryforward periods and movement into or out of recent and cumulative loss positions for certain of our foreign affiliates, could lead to changes in our expectation regarding utilization of our deferred tax assets.
Foreign tax credits on unremitted non-U.S. earnings
Alternative minimum tax credits carryforward
Foreign net operating loss carryforwards and other foreign deferred tax assets
U.S. state net operating loss carryforward
Foreign tax credit carryforwards
Net valuation allowance change
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We cannot provide assurance that our future business performance will enable us to conclude that we will be able to fully utilize the net deferred tax assets remaining after application of the valuation allowance. Moreover, if our business or expectations decline further, we may be required to record additional valuation allowances in future periods. On the other hand, improvements in our business performance may in the future require us to record a reversal of all or a portion of the valuation allowance because we may change our assessment of our ability to use our foreign tax credits and net operating loss carryforwards.
Examination of Tax Returns. We have unresolved tax issues in our consolidated U.S. federal corporate income tax returns for the prior 19 years. Many of these years are currently under examination by the Internal Revenue Service.
During 2004, we reached a partial agreement with the Internal Revenue Service for the years 1990 to 1994 and paid $42 million in tax and interest in November 2004. We also received a Revenue Agent’s Report during the year for additional issues related to the 1990 to 1994 tax years. The most significant unresolved issue relating to these tax years was the subject of an unfavorable Technical Advice Memorandum from the National Office of the Internal Revenue Service with regard to certain positions we took on prior returns. We filed a protest with the Appeals Division of the Internal Revenue Service relating to the remaining unresolved items for these years.
Although we believe that our accrued tax liabilities are adequate to cover the net exposure arising from our U.S. federal, state and foreign tax loss contingencies as of November 28, 2004, we cannot provide assurance that we will be able to reach settlement with the tax authorities on terms that are acceptable to us. Due to the numerous years under review and the magnitude and nature of the issues remaining to be resolved, it is also possible that our final settlement may increase or decrease the amount of U.S. federal net operating loss, foreign tax credit, and alternative minimum tax credit carryforwards that are currently recorded on our balance sheet. As some, but not all, of these assets have related valuation allowances, to the extent the final settlement with the tax authorities changes our estimate of our tax loss and credit carryforwards, income tax expense may be increased or decreased. It is possible that an adverse outcome resulting from any settlement or future examination may require us to increase our recorded income tax expense and may adversely affect our liquidity, and such impact could be material.
Ability to Credit Foreign Taxes. We believe it is more likely than not that our foreign tax credit carryforward of approximately $50.5 million will expire unused. Accordingly, we have fully offset the related gross deferred tax asset with a valuation allowance. As we are not permanently reinvesting the earnings of our foreign affiliates, we must also account for the residual income tax that will be assessed upon the repatriation of our unremitted earnings. For these purposes, we have also projected that it is more likely than not that we will be unable to fully utilize the foreign tax credits that may accompany the repatriated earnings. Accordingly, we expect to deduct, rather than credit, foreign taxes in future years and have partially offset these foreign tax credits with a valuation allowance to bring our gross deferred tax asset to its net realizable value.
In reaching our determination regarding the recoverability of available foreign tax credits, we considered the impact of the American Jobs Creation Act of 2004 which extended the carryforward life of foreign tax credits from five to ten years. While this was a positive development that will assist us as we try to utilize our foreign tax credits in future periods, it has not ultimately changed our view regarding the recoverability of this deferred tax asset. Our provision for income tax could be reduced in 2005 or future years if we change our view as to our ability to utilize our foreign tax credits. Additionally, we have reviewed other provisions of the new law, including the beneficial dividend-received deduction available for certain distributions from foreign subsidiaries during 2005. Due to the high base-period calculation associated with this deduction and other factors, we do not expect this provision of the law to materially affect our provision for income taxes.
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Liquidity and Capital Resources
Liquidity Outlook
We believe we will have adequate liquidity in 2005 to operate our business and to meet our cash requirements. We believe that we will be in compliance with the financial covenants contained in our senior secured term loan and our senior secured revolving credit facility.
Cash Sources
Our key sources of cash include earnings from operations and borrowing availability under our senior secured revolving credit facility. As of November 28, 2004, we had total cash and cash equivalents of approximately $299.6 million, a $156.2 million increase from the $143.4 million cash balance as of November 30, 2003. The increase was primarily due to lower levels of inventory, higher gross profits and lower cash operating expenses, partially offset by higher interest payments and payments for our restructuring initiatives.
As of November 28, 2004, our total availability under our amended senior secured revolving credit facility was approximately $488.1 million. We had no outstanding borrowings under this facility, but had utilization of other credit-related instruments such as documentary and standby letters of credit. Our unused availability was approximately $360.0 million. In addition, we had liquid short-term investments in the United States totaling approximately $262.0 million, resulting in a net liquidity position (availability and liquid short-term investments) of $622.0 million in the United States.
As of February 13, 2005, our total availability under our amended senior secured revolving credit facility was approximately $400.3 million. We had no outstanding borrowings under this facility, but had utilization of other credit-related instruments such as documentary and standby letters of credit. Our unused availability was approximately $281.3 million. In addition, we had liquid short-term investments in the United States totaling approximately $129.6 million, resulting in a net liquidity position (availability and liquid short-term investments) of $410.9 million in the United States.
Cash Uses
Our principal cash requirements include working capital, capital expenditures, cash restructuring costs, payments of interest on our debt, payments of taxes and payments for U.S. pension and postretirement health benefit plans. The following table presents selected cash uses in 2004 and the related projected cash requirements for such items in 2005:
Selected items
(Dollars in millions)
Restructuring activities(1)
Interest
Federal, foreign and state income tax liabilities (net of refunds)(2)
Prior years’ income tax liabilities, net(3)
Capital expenditures(4)
Post-retirement health benefit plans
Pension plans
Total selected cash requirements
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The following table provides information about our significant cash contractual obligations and commitments as of November 28, 2004:
Contractual and Long-term Liabilities:
Long-term debt obligations(1)
Capital lease obligations(2)
Operating leases(3)
Purchase obligations(4)
Post-retirement obligations(5)
Pension obligations(6)
Long-term employee related benefits(7)
Other long-term liabilities(8)
Amounts reflect estimated commitments of $232.0 million for inventory purchases, $10.7 million for capital expenditures and $146.7 million for information technology and other professional services. We do not have any material long-term raw materials supply agreements. We typically conduct business with our
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raw material suppliers, garment manufacturing and finishing contractors on an order-by-order basis. Most arrangements are cancelable without a significant penalty and with short notice (usually 30 to 90 days). Our projected cash requirements for capital expenditures reflects estimates related to spending on the enterprise resource planning system project in Asia Pacific and other spending over the next twelve months.
Information in the two preceding tables reflects our estimates of future cash payments. These estimates and projections are based upon assumptions that are inherently subject to significant economic, competitive, legislative and other uncertainties and contingencies, many of which are beyond our control. Accordingly, our actual expenditures and liabilities may be materially higher or lower than the estimates and projections reflected in these tables. The inclusion of these projections and estimates should not be regarded as a representation by us that the estimates will prove to be correct.
Off-Balance Sheet Arrangements, Guarantees and Other Contingent Obligations
Off-Balance Sheet Arrangements. We have no material special-purpose entities or off-balance sheet debt obligations.
Indemnification Agreements. In the ordinary course of our business, we enter into agreements containing indemnification provisions under which we agree to indemnify the other party for specified claims and losses. For example, our trademark license agreements, real estate leases, consulting agreements, logistics outsourcing agreements, securities purchase agreements and credit agreements typically contain these provisions. This type of indemnification provision obligates us to pay certain amounts associated with claims brought against the other party as the result of trademark infringement, negligence or willful misconduct of our employees, breach of contract by us including inaccuracy of representations and warranties, specified lawsuits in which we and the other party are co-defendants, product claims and other matters. These amounts are generally not readily quantifiable: the maximum possible liability or amount of potential payments that could arise out of an indemnification claim depends entirely on the specific facts and circumstances associated with the claim. We have insurance coverage that minimizes the potential exposure to certain of these claims. We also believe that the likelihood of substantial payment obligations under these agreements to third parties is low and that any such amounts would be immaterial.
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Cash Flows
The following table summarizes, for the periods indicated, selected items in our consolidated statements of cash flows:
Cash provided by (used for) operating activities
Cash used for investing activities
Cash (used for) provided by financing activities
2004 as compared to 2003
Cash provided by operating activities was $199.9 million in 2004, compared to cash used for operating activities of $190.7 million in 2003.
The increase of $390.6 million in cash provided by operating activities was primarily due to the following factors:
Partially offsetting these factors are increased interest payments of $233.5 million and restructuring payments of $143.6 million during 2004, compared to $191.9 million and $49.7 million, respectively, for 2003.
Cash used for investing activities was $12.9 million in 2004, compared to $84.5 million in 2003.
The decrease for 2004 resulted primarily from reduced investments in information technology systems, due in part to our decision to indefinitely suspend the installation of a worldwide enterprise resource planning system and reduced capital expenditures as a result of cost control measures, and lower realized losses on net investment hedges, partially offset by lower proceeds from sales of property, plant and equipment.
Cash used for investing activities in 2003 primarily represented purchases of information systems enhancements and realized losses on net investment hedges. These items were partially offset by proceeds primarily from the sale of assets associated with the U.S. plant closures.
Cash used for financing activities was $32.1 million for 2004, compared to cash provided by financing activities of $349.1 million for 2003.
Cash used for financing activities in 2004 primarily reflected required payments on our customer service center equipment financing and term loan in addition to repayments on short-term borrowings.
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Cash provided by financing activities for 2003 was $349.1 million, which primarily reflected our issuance of our 12.25% senior unsecured notes due 2012 and our entry into the September 2003 senior secured term loan. These items were partially offset by the maturity and repayment of $350.0 million in principal amount of our 6.80% notes due November 1, 2003, debt issuance costs associated with our first and fourth quarter 2003 debt financing transactions, the retirement of our domestic and European receivables securitization financing arrangements and the retirement of an industrial development revenue refunding bond.
2003 as compared to 2002
Cash used for operating activities was $190.7 million in 2003, compared to cash provided by operating activities of $200.7 million in 2002.
The increase in cash used for operating activities for 2003 was primarily due to lower sales in Europe and North America during the fourth quarter and the introduction of our Levi Strauss Signature™ brand, which resulted in higher inventory balances. In addition, we made payments in the first quarter of 2003 of approximately $95.0 million, net of employee deferrals, under our employee incentive compensation plan and approximately $110.0 million in settlement of examinations by the Internal Revenue Service of our income tax returns for the years 1990 through 1995.
Cash used for operating activities for 2002 reflects higher net sales in the fourth quarter of 2002 compared to the same period in 2001. In addition, inventories were lower due to improved inventory management and the impact of sales incentive programs.
Cash used for investing activities was $84.5 million in 2003, compared to $59.4 million in 2002.
The increase in cash used for investing activities for 2003 resulted primarily from purchases of information systems enhancements and realized losses on net investment hedges. These items were partially offset by proceeds primarily from the sale of assets associated with the U.S. plant closures.
Cash used for investing activities in 2002 primarily represented purchases of property, plant and equipment and realized losses on net investment hedges, partially offset by proceeds received on sales of property, plant and equipment. The purchases primarily related to sales office capital improvements and systems upgrades. The proceeds received on the sale of property, plant and equipment arose mainly from the sale during the first quarter of 2002 of an idle distribution center located in Nevada.
Cash provided by financing activities was $349.1 million in 2003, compared to cash used for financing activities of $143.6 million in 2002.
Cash provided by financing activities for 2003 primarily reflected the issuance of the 2012 notes and entry into the September 2003 senior secured term loan. These items were partially offset by the maturity and repayment of $350.0 million in principal amount of our 2003 notes, debt issuance costs associated with our first and fourth quarter 2003 debt financing transactions, the retirement of our domestic and European receivables securitization financing arrangements and the retirement of an industrial development revenue refunding bond.
We used cash in 2002 primarily for the repayment of existing debt.
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Indebtedness
Overview. The following table sets forth the components of our debt and cash and cash equivalents as of November 28, 2004, and after giving effect to our issuance in December 2004 of $450.0 million of notes due 2015 and our repurchase in January 2005 through a tender offer of approximately $372.1 million aggregate principal amount of our notes due 2006, our debt, net of cash on hand, was $2.1 billion, compared with $2.2 billion as of November 30, 2003:
Dollars in thousands
Long-Term Debt:
Secured:
Term Loan
Revolving credit facility
Customer service center equipment financing(1)
Notes payable, at various rates
Subtotal
Unsecured:
Notes:
7.00%, due 2006
11.625% Dollar denominated, due 2008
11.625% Euro denominated, due 2008
12.25% Senior Notes, due 2012
9.75% Senior Notes, due 2015
Yen-denominated Eurobond 4.25%, due 2016
Current maturities
Total long-term debt
Short-Term Debt:
Short-term borrowings
Current maturities of long-term debt
Total short-term debt
Total long-term and short-term debt
Restricted cash
As of November 28, 2004, we had fixed rate debt of approximately $2.0 billion (86% of total debt) and variable rate debt of approximately $0.3 billion (14% of total debt). The borrower of substantially all of our debt is Levi Strauss & Co., our parent and U.S. operating company.
Principal Payments. The table below sets forth, as of November 28, 2004, the required aggregate short-term and long-term debt principal payments for the next five fiscal years and thereafter, giving effect to our issuance
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in December 2004 of $450.0 million of notes due 2015, our repurchase in January 2005 through a tender offer of approximately $372.1 aggregate principal amount of our notes due 2006, and the refinancing condition scenarios under our senior secured term loan. The maturity date of our senior secured term loan will be August 1, 2006 if we have not refinanced, repaid or otherwise irrevocably set aside funds to repay the 2006 notes by May 1, 2006, or will be October 15, 2007 if we have met the 2006 refinancing condition by May 1, 2006, but have not refinanced, repaid or otherwise irrevocably set aside funds to repay the 2008 notes by July 15, 2007. See “— Senior Secured Term Loan and Senior Secured Revolving Credit Facility — Early Maturity or Default if Notes Not Refinanced” for a more detailed discussion of these refinancing conditions.
2005(1)
2006(2)
2007
2008
2009
Thereafter
Description of Principal Indebtedness.
We summarize below material terms of our senior secured term loan, senior secured revolving credit facility and other financing arrangements.
Senior Secured Term Loan and Senior Secured Revolving Credit Facility
Principal Amount; Use of Proceeds. On September 29, 2003, we entered into a $500.0 million senior secured term loan agreement and a $650.0 million senior secured revolving credit facility. We used the borrowings under these agreements to refinance our January 2003 senior secured credit facility and our 2001 domestic receivables securitization agreement, and also use the borrowings for working capital and general corporate purposes. On August 13, 2004, we entered into a fourth amendment to our senior secured revolving credit facility. On August 30, 2004, we entered into an amendment to our senior secured term loan. The amendments primarily provided for the lenders’ consent to our proposed sale of our Dockers® business. The amendment to the term loan also made changes in the prepayment provisions and the financial, operational and certain other covenants in our revolving credit facility and term loan, including replacing a consolidated fixed charge ratio covenant with a consolidated senior secured leverage ratio covenant. On November 24, 2004, we entered into a fifth amendment to our senior secured revolving credit facility permitting us to convert any cash collateralized letter of credit into a non-cash collateralized letter of credit. The material terms of these amendments are reflected in the discussion below.
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Term Loan. Our term loan consists of a single borrowing of $500.0 million, divided into two tranches, a $200.0 million tranche subject to a fixed rate of interest and a $300.0 million tranche subject to floating rates of interest. The loan matures on September 29, 2009. Principal payments on the term loan in an amount equal to 0.25% of the initial principal amount must be made quarterly commencing with the last day of the first fiscal quarter of 2004, and the remaining principal amount of the term loan must be repaid at maturity.
We are permitted to prepay the term loan at any time, subject to the payment of certain make-whole premiums to the lenders if we desire to prepay the loans outside of certain prepayment periods. The periods during which these make-whole premiums are applicable to voluntary prepayments depend on whether or not we have, as of March 31, 2006, refinanced, repaid or otherwise irrevocably set aside funds for the repayment of all of our senior unsecured notes due 2006 as required by the term loan agreement. The make-whole premium is calculated by taking the present value of (i) all interest payments due through to the end of the relevant make-whole period plus (ii) any additional prepayment premium (as described below) if such prepayment were made on the day after the relevant make-whole period. If we choose to prepay the term loan outside of the make-whole periods, we are not required to pay any make-whole premium, but we will be required to pay an additional prepayment premium based on a percentage (which declines over time) of the principal amount of the term loan prepaid. Our term loan also requires mandatory prepayments in specified circumstances, such as if we engage in a sale of certain intellectual property assets.
Revolving Credit Facility. The revolving credit facility is an asset-based facility, in which the borrowing availability varies according to the levels of our accounts receivable, inventory and cash and investment securities deposited in secured accounts with the administrative agent or other lenders. Subject to the level of this borrowing base, we may make and repay borrowings from time to time until the maturity of the facility. The maturity date of the facility is September 29, 2007, at which time all borrowings under the facility must be repaid. We may make voluntary prepayments of borrowings at any time and must make mandatory prepayments if certain events occur, such as asset sales. We must pay an early termination fee if the facility is terminated prior to September 29, 2005.
Early Maturity or Default if Notes Not Refinanced. The term loan agreement requires us to refinance, repay or otherwise set aside funds for all of our senior unsecured notes due 2006 and 2008 not later than six months prior to their respective maturity dates, failing which the maturity of the term loan is accelerated to a date three months prior to the scheduled maturity date of the 2006 or the 2008 notes, respectively. As a result, unless we have refinanced, repaid or otherwise irrevocably set aside funds for the payment of all of the 2006 notes by May 1, 2006, the term loan will become due on August 1, 2006, and unless we have repaid all of the 2008 notes by July 15, 2007, the term loan will become due on October 15, 2007.
We may satisfy this note refinancing requirement under the term loan in one of two ways. First, we may refinance the 2006 and 2008 notes by issuing new debt on terms similar to those of our 12.25% notes due 2012 and using the proceeds to repurchase, repay or otherwise set aside the funds for the notes. Second, we may repurchase or otherwise set aside funds to repay the 2006 and 2008 notes if we meet specified conditions. Those conditions include our maintaining (after giving effect of the repayment on a pro forma basis) a leverage ratio that does not exceed 4.75 to 1.0 (for the 2006 notes) and 4.5 to 1.0 (for the 2008 notes) and an interest coverage ratio that exceeds 1.85 to 1.0 (for the 2006 notes) and 2.0 to 1.0 (for the 2008 notes). These ratios apply only to the note refinancing requirements; they are not ongoing financial covenants.
The revolving credit facility contains a similar note refinancing requirement with respect to the 2006 notes, except that the consequence of a failure to repay the notes is a breach of covenant, not early maturity. We may also satisfy this requirement under the revolving credit facility if we reserve cash or have borrowing availability sufficient to repay the 2006 notes and thereafter have $150.0 million of borrowing availability under the revolving credit facility. In February 2005, we obtained a limited waiver under our revolving credit facility permitting us to repay, repurchase, redeem or otherwise refinance our 2008 notes prior to refinancing fully the 2006 notes. See “Item 9B—Other Information” for more information.
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Although we used the proceeds from our recent issuance of senior notes due 2015 to repurchase a substantial portion of the 2006 notes, as of February 13, 2005, approximately $78.0 million of the 2006 notes remain outstanding. As a result, we have not yet met the 2006 refinancing condition.
Interest Rates. The interest rate for the floating rate tranche of our term loan is 6.875% over the eurodollar rate or 5.875% over the base rate. The interest rate for the fixed rate tranche of our term loan is 10.0% per annum. The interest rate for our revolving credit facility is, for LIBOR rate loans, 2.75% over the LIBOR rate (as defined in the credit agreement) or, for base rate loans, 0.50% over the Bank of America prime rate.
Guarantees and Security. Our obligations under each of the term loan and revolving credit facility are guaranteed by our domestic subsidiaries. The revolving credit facility is secured by a first-priority lien on domestic inventory and accounts receivable, certain domestic equipment, patents and other related intellectual property, 100% of the stock in all domestic subsidiaries, 65% of the stock of certain foreign subsidiaries and other assets. Excluded from the assets securing the revolving credit facility are all of our most valuable real property interests and all of the capital stock of our affiliates in Germany and the United Kingdom and any other affiliates that become restricted subsidiaries under the indenture governing our notes due 2006 and the Yen-denominated Eurobond due 2016 (such restricted subsidiaries also are not permitted to be guarantors). The term loan is secured by a lien on trademarks, copyrights and other related intellectual property and by a second-priority lien on the assets securing the revolving credit facility.
Term Loan Leverage Ratio Covenant. The term loan contains a consolidated senior secured leverage ratio, which is measured as of the end of each fiscal quarter. The ratio is generally defined as the ratio of consolidated secured debt to “Pro Forma Consolidated EBITDA” (as defined in the term loan agreement) for the previous four fiscal quarters. The computation of Pro Forma Consolidated EBITDA allows us to add back all restructuring and restructuring related charges less the aggregate amount of cash payments made during such period by us in respect of restructuring charges (other than (i) cash payments on restructuring charges incurred prior to May 31, 2004 and (ii) an aggregate of up to $100 million of restructuring charges incurred on or after May 31, 2004 to the extent paid in cash and which we have notified the lenders that we will exclude for purposes of calculating the leverage ratio covenant in any fiscal quarter).
We must ensure that the ratio is not more than:
As of November 28, 2004, we were in compliance with the consolidated senior secured leverage ratio.
Revolving Credit Facility Fixed Charge Coverage Ratio. The revolving credit facility contains a fixed charge coverage ratio. The ratio is measured only if certain availability thresholds are not met. In that case, the ratio is measured as of the end of each month. This ratio is generally defined as the ratio of (i) EBITDA less the sum of (a) capital expenditures and (b) the provision for federal, state and local income taxes for the current period to (ii) the sum of (x) interest charges paid in cash for the relevant period and (y) repayments of scheduled debt during the period. We are required to maintain a ratio of least 1.0 to 1.0 when the covenant is required to be tested. As of November 28, 2004, we were not required to perform this calculation.
Under our credit agreements, EBITDA is generally defined as consolidated net income plus (i) consolidated interest charges, (ii) the provision for federal, state, local and foreign income taxes, (iii) depreciation and amortization expense, (iv) other (income) expense and (v) restructuring and restructuring related charges, less cash payments made in respect of the restructuring charges.
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Factors that could cause us to breach these leverage and fixed charge coverage ratio covenants include lower operating income, higher current tax expenses for which we have not adequately reserved, higher cash restructuring costs, higher interest expense due to higher debt or floating interest rates and higher capital spending. There are no other financial covenants in either agreement we are required to meet on an ongoing basis.
Certain Mergers and Asset Sales Permitted under Term Loan. The term loan permits us to merge or sell all or substantially all of our assets, subject to certain conditions (including financial ratios) similar to those contained in the merger covenant in the indentures relating to our senior unsecured notes due 2008, 2012 and 2015.
Events of Default. The term loan and the revolving credit facility each contain customary events of default, including payment failures; failure to comply with covenants; failure to satisfy other obligations under the credit agreements or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; material judgments; pension plan terminations or specified underfunding; substantial voting trust certificate or stock ownership changes; specified changes in the composition of our board of directors; and invalidity of the guaranty or security agreements. The cross-default provisions in each of the term loan and the revolving credit facility apply if a default occurs on other indebtedness in excess of $25.0 million and the applicable grace period in respect of the indebtedness has expired, such that the lenders of or trustee for the defaulted indebtedness have the right to accelerate. If an event of default occurs under either the term loan or the revolving credit facility, our lenders may terminate their commitments, declare immediately payable the term loan and all borrowings under each of the credit facilities and foreclose on the collateral, including (in the case of the term loan) our trademarks.
Senior Unsecured Notes Due 2015
Principal, Interest and Maturity. On December 22, 2004, we issued $450.0 million in notes to qualified institutional buyers. These notes are unsecured obligations that rank equally with all of our other existing and future unsecured and unsubordinated debt. They are 10-year notes maturing on January 15, 2015 and bear interest at 9.75% per annum, payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2005. We may redeem some or all of the notes prior to January 15, 2010 at a price equal to 100% of the principal amount plus accrued and unpaid interest and a “make-whole” premium. Thereafter, we may redeem all or any portion of the notes, at once or over time, at redemption prices specified in the indenture governing the notes, after giving the required notice under the indenture. In addition, at any time prior to January 15, 2008, we may redeem up to a maximum of 33 1/3% of the original aggregate principal amount of the notes with the proceeds of one or more public equity offerings at a redemption price of 109.75% of the principal amount plus accrued and unpaid interest, if any, to the date of redemption. Costs representing underwriting fees and other expenses of approximately $10.0 million will be amortized over the term of the notes to interest expense.
Use of Proceeds. We used $372.1 million of the $450.0 million of gross proceeds from the notes offering to purchase $372.1 million in aggregate principal amount of our 2006 notes through a tender offer. We began the tender offer at the time we launched the bond offering and completed it on January 12, 2005. We intend to use the remaining proceeds to repay outstanding debt (which may include any remaining 2006 notes), or for the payment of fees and expenses relating to the offering and tender offer. We may also elect to use these remaining proceeds for other corporate purposes consistent with the requirements of our credit agreements, indentures and other agreements.
Covenants. The indenture governing these notes contains covenants that limit our and our subsidiaries’ ability to incur additional debt; pay dividends or make other restricted payments; consummate specified asset sales; enter into transactions with affiliates; incur liens; impose restrictions on the ability of a subsidiary to pay dividends or make payments to us and our subsidiaries; merge or consolidate with any other person; and sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets or our subsidiaries’
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assets. These covenants are comparable to those contained in the indenture governing our 11.625% notes due 2008 and our 12.25% notes due 2012.
Asset Sales. The indenture governing these notes provides that our asset sales must be at fair market value and the consideration must consist of at least 75% cash or cash equivalents or the assumption of liabilities. We must use the net proceeds from the asset sale within 360 days after receipt either to repay bank debt, with an equivalent permanent reduction in the available commitment in the case of a repayment under our revolving credit facility, or to invest in additional assets in a business related to our business. To the extent proceeds not so used within the time period exceed $10.0 million, we are required to make an offer to purchase outstanding notes at par plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under our senior secured term loan and senior secured revolving credit facility.
Change in Control. If we experience a change in control as defined in the indenture governing the notes, then we will be required under the indenture to make an offer to repurchase the notes at a price equal to 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under our senior secured term loan and senior secured revolving credit facility.
Events of Default. The indenture governing these notes contains customary events of default, including failure to pay principal, failure to pay interest after a 30-day grace period, failure to comply with the merger, consolidation and sale of property covenant, failure to comply with other covenants in the indenture for a period of 30 days after notice given to us, failure to satisfy certain judgments in excess of $25.0 million after a 30-day grace period, and certain events involving bankruptcy, insolvency or reorganization. The indenture also contains a cross-acceleration event of default that applies if debt of Levi Strauss & Co. or any restricted subsidiary in excess of $25.0 million is accelerated or is not paid when due at final maturity.
Covenant Suspension. If these notes receive and maintain an investment grade rating by both Standard and Poor’s and Moody’s and we and our subsidiaries are and remain in compliance with the indenture, then we and our subsidiaries will not be required to comply with specified covenants contained in the indenture. These provisions are comparable to those contained in the indenture governing our 11.625% notes due 2008 and our 12.25% notes due 2012.
Other Financing Arrangements
Our other principal financing arrangements are summarized below:
Senior Unsecured Notes Due 2006. In 1996, we issued $450.0 million in senior unsecured notes maturing in November 2006. The notes bear interest at a rate of 7.00%. On December 16, 2004 we began a tender offer to purchase all of these notes using the proceeds from our December 2004 issuance of our 9.75% notes due 2015, at a purchase price of $1,052.23 per $1,000.00 principal amount. As a result of the tender offer, on January 12, 2005, we purchased $372.1 million in aggregate principal amount of the 7.00% notes due 2006. The premium paid as a result of the tender offer was approximately $19.4 million, and will be recorded as a loss on early extinguishment of debt in the first quarter of 2005. The remaining $77.7 million in outstanding notes are unsecured and rank equally with all of our other existing and future unsecured and unsubordinated debt. The indenture governing these notes contains customary investment-grade security events of default and restricts our ability and the ability of our subsidiaries and future subsidiaries, to incur liens, engage in sale and leaseback transactions and engage in mergers and sales of assets. The indenture also contains a cross-acceleration event of default that applies if debt in excess of $25.0 million is not paid at its stated maturity or upon acceleration and such payment default has not been cured within 30 days after we have been given a notice of default by the trustee or by holders of at least 25% in principal amount of the outstanding notes. In addition, our term loan agreement requires us to refinance, repay or otherwise irrevocably set aside funds for all of our senior unsecured notes due 2006 not later than six months prior to their
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maturity date, failing which the maturity of the term loan is accelerated to a date three months prior to the scheduled maturity date of the 2006 notes. For more information, see “Senior Secured Term Loan and Senior Secured Revolving Credit Facility” above.
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Other Sources of Financing
We are a privately held corporation. Historically, we have primarily relied on cash flow from operations, borrowings under our credit facilities, issuances of notes and other forms of debt financing. We regularly explore our financing and debt reduction alternatives, including new credit agreements, equipment and real estate financing, equity financing, securitizations and unsecured and secured note issuances.
Credit Ratings
On December 22, 2004, we issued $450.0 million in 9.75% senior notes due 2015. Moody’s Investor Services assigned its Ca rating to the notes, affirmed its existing ratings and revised its outlook for us from negative to stable. Standard and Poor’s Ratings Service assigned its CCC unsecured debt rating to the notes, affirmed its existing ratings and changed its outlook from developing to negative. Fitch Ratings assigned its CCC+ rating to the notes, maintained its existing ratings and maintained its outlook as negative. For more information about our credit ratings, see “Factors that May Affect Future Results — Risks relating to our substantial debt — Our ability to obtain new financing and trade credit and the costs associated with new financing and trade credit may be adversely affected by changes in our credit ratings.”
Effects of Inflation
We believe that inflation in the regions where most of our sales occur has not had a significant effect on our net sales or profitability.
Foreign Currency Translation
The functional currency for most of our foreign operations is the applicable local currency. For those operations, assets and liabilities are translated into U.S. dollars using period-end exchange rates and income and expense accounts are translated at average monthly exchange rates. The U.S. dollar is the functional currency for foreign operations in countries with highly inflationary economies and certain other subsidiaries. The translation adjustments for these entities are included in “Other expense, net.”
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the related notes. We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Changes in such estimates, based on more accurate future information, or different assumptions or conditions, may affect amounts reported in future periods.
We summarize our critical accounting policies below.
Revenue recognition. We recognize revenue on sale of product when the goods are shipped and title passes to the customer provided that: there are no uncertainties regarding customer acceptance; persuasive evidence of an arrangement exists; the sales price is fixed or determinable; and collectibility is probable. Revenue is recognized when the sale is recorded net of an allowance for estimated returns, discounts and retailer promotions and incentives.
We recognize allowances for estimated returns, discounts and retailer promotions and incentives in the period when the sale is recorded. Allowances principally relate to U.S. operations and primarily reflect price discounts, non-volume-based incentives and other returns and discounts. We estimate non-volume-based
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allowances by considering customer and product-specific circumstances and commitments, as well as historical customer claim rates. Actual allowances may differ from estimates due to changes in sales volume based on retailer or consumer demand and changes in customer and product-specific circumstances.
Inventory valuation. We value inventories at the lower of cost or market value. Inventory costs are based on standard costs on a first-in first-out basis, which are updated periodically and supported by actual cost data. We include materials, labor and manufacturing overhead in the cost of inventories. In determining inventory market values, substantial consideration is given to the expected product selling price. We consider various factors, including estimated quantities of slow-moving and obsolete inventory, by reviewing on-hand quantities, outstanding purchase obligations and forecasted sales. We then estimate expected selling prices based on our historical recovery rates for sale of slow-moving and obsolete inventory and other factors, such as market conditions and current consumer preferences. Estimates may differ from actual results due to the quantity, quality and mix of products in inventory, consumer and retailer preferences and economic conditions.
Restructuring reserves. Upon approval of a restructuring plan by management with the appropriate level of authority, we record restructuring reserves for certain costs associated with plant closures and business reorganization activities as they are incurred or when they become probable and estimable. Restructuring costs associated with initiatives commenced prior to January 1, 2003 were recorded in compliance with Emerging Issues Task Force No. 94-3 and primarily include employee severance, certain employee termination benefits, such as outplacement services and career counseling, and resolution of contractual obligations.
For initiatives commenced after December 31, 2002, we recorded restructuring reserves in compliance with Statement of Financial Accounting Standards No. (“SFAS”) 112, “Employers’ Accounting for Postemployment Benefits,” and SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” resulting in the recognition of employee severance and related termination benefits for recurring arrangements when they become probable and estimable and on the accrual basis for one-time benefit arrangements. We record other costs associated with exit activities as they are incurred. Employee severance and termination benefit costs reflect estimates based on agreements with the relevant union representatives or plans adopted by us that are applicable to employees not affiliated with unions. These costs are not associated with nor do they benefit continuing activities. Changing business conditions may affect the assumptions related to the timing and extent of facility closure activities. We review the status of restructuring activities on a quarterly basis and, if appropriate, record changes based on updated estimates.
Income tax assets and liabilities. We provide for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We maintain valuation allowances where it is more likely than not all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in our tax provision in the period of change. In determining whether a valuation allowance is warranted, we take into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. We are also subject to examination of our income tax returns for multiple years by the Internal Revenue Service and other tax authorities. We periodically assess the likelihood of adverse outcomes resulting from these examinations to determine the impact on our deferred taxes and income tax liabilities and the adequacy of our provision for income taxes.
Derivative and foreign exchange management activities. We recognize all derivatives as assets and liabilities at their fair values. The fair values are determined using widely accepted valuation models that incorporate quoted market prices and dealer quotes and reflect assumptions about currency fluctuations based on current market conditions. The aggregate fair values of derivative instruments used to manage currency exposures are sensitive to changes in market conditions and to changes in the timing and amounts of forecasted exposures.
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Not all exposure management activities and foreign currency derivative instruments will qualify for hedge accounting treatment. Changes in the fair values of those derivative instruments that do not qualify for hedge accounting are recorded in “Other expense, net” in the Statements of Operations. As a result, net income may be subject to volatility. The derivative instruments that qualify for hedge accounting currently hedge our net investment position in certain of our subsidiaries. For these instruments, we document the hedge designation by identifying the hedging instrument, the nature of the risk being hedged and the approach for measuring hedge effectiveness. Changes in fair values of derivative instruments that qualify for hedge accounting are recorded as cumulative translation adjustments in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit.
Employee benefits
Pension and Post-retirement Benefits. We have several non-contributory defined benefit retirement plans covering substantially all employees. We also provide certain health care benefits for employees who meet age, participation and length of service requirements at retirement. In addition, we sponsor other retirement plans for our foreign employees in accordance with local government programs and requirements. We retain the right to amend, curtail or discontinue any aspect of the plans at any time. Any of these actions (including changes in actuarial assumptions and estimates), either individually or in combination, could have a material impact on our consolidated financial statements and on our future financial performance.
We account for our U.S. and certain foreign defined benefit pension plans and our post-retirement benefit plans using actuarial models in accordance with SFAS 87, “Employers’ Accounting for Pension Plans,” and SFAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” These models use an attribution approach that generally spreads individual events over the estimated service lives of the employees in the plan. The attribution approach assumes that employees render service over their service lives on a relatively smooth basis and as such, presumes that the income statement effects of pension or post-retirement benefit plans should follow the same pattern. Our policy is to fund our retirement plans based upon actuarial recommendations and in accordance with applicable laws and income tax regulations, as well as in accordance with our credit agreements.
Net pension income or expense is determined using assumptions as of the beginning of each fiscal year. These assumptions are established at the end of the prior fiscal year and include expected long-term rates of return on plan assets, discount rates, compensation rate increases and medical trend rates. We use a mix of actual historical rates, expected rates and external data to determine the assumptions used in the actuarial models.
Employee Incentive Compensation. We maintain short-term and long-term employee incentive compensation plans. These plans are intended to reward eligible employees for their contributions to our short-term and long-term success. Provisions for employee incentive compensation are recorded in accrued salaries, wages and employee benefits and long-term employee related benefits. Changes in the liabilities for these incentive plans generally correlate with our financial results and projected future financial performance and could have a material impact on our consolidated financial statements and on future financial performance.
Estimates and Assumptions
Preparation of our financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in our financial statements. Key estimates and assumptions for us include those relating to:
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In 2004, changes in estimates and assumptions based on current year data had a substantial impact on our results. For example:
Changes in our estimates, based on more accurate future information, or different assumptions or conditions, may affect amounts we report in future periods.
FORWARD-LOOKING STATEMENTS
Except for the historical information contained in this report, certain matters discussed in this report, including (without limitation) statements under “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Although we believe that, in making any such statements, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected.
These forward-looking statements include statements relating to our anticipated financial performance and business prospects and/or statements preceded by, followed by or that include the words “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project,” “could,” “plans,” “seeks” and similar expressions. These forward-looking statements speak only as of the date stated and we do not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these expectations may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control, that could cause actual results to differ materially from those suggested by the forward-looking statements, including, without limitation:
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For more information on these and other factors, see “Factors That May Affect Future Results.” We caution you to not place undue reliance on these forward-looking statements. All subsequent written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements and factors that may affect future results contained throughout this report.
New Accounting Standards
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 132R (“FAS 132R”), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. This Statement provides disclosure requirements for defined benefit pension plans and other post-retirement benefit plans. The statement was effective for annual financial statements with fiscal years ended after December 15, 2003, and for interim periods that began after December 15, 2003. We have adopted FAS 132R during 2004. The adoption of FAS 132R did not have any impact on our operating results or financial position.
In December 2003, the FASB published a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46R”), to clarify some of the provisions of the original interpretation, and to exempt certain entities from its requirements. Under the revised guidance, there are new effective dates for companies that have interests in structures that are commonly referred to as special-purpose entities. The rules are effective in financial statements for periods ending after March 15, 2004. FIN 46R did not have any impact on our operating results or financial position because we do not have any variable interest entities.
In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides a three-step impairment model for determining whether an investment is other-than-
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temporarily impaired and requires us to recognize such impairments as an impairment loss equal to the difference between the investment’s cost and fair value at the reporting date. The guidance is effective for us during the first quarter of fiscal 2005. We do not believe that the adoption of EITF 03-1 will have a significant effect on our financial statements.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FAS 106-2), providing final guidance on accounting for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”). We adopted the provisions of FAS 106-2 during the year ended November 28, 2004. We recorded the effects of the federal subsidy provided by the Act in measuring our net periodic post-retirement benefit cost for the year ended November 28, 2004, which resulted in a reduction in our accumulated post-retirement benefit obligation (“APBO”) for the subsidy related to benefits attributed to past service of $21.4 million. The subsidy resulted in a reduction in our current period net periodic post-retirement benefit costs for the year ended November 28, 2004 of $1.7 million. We expect to receive subsidy payments beginning in fiscal year ending November 30, 2006 (see Note 12 to our Consolidated Financial Statements).
In November 2004, the FASB issued SFAS No. 151 “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“FAS 151”). FAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, FAS 151 requires that allocation of fixed and production facilities overheads to conversion costs should be based on normal capacity of the production facilities. The provisions in Statement 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not believe that the adoption of FAS 151 will have a significant effect on our financial statements.
In November 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29” (“FAS 153”). The provisions of this statement is effective for non monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This statement eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance — that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. We do not believe that the adoption of FAS 153 will have a significant effect on our financial statements.
In November 2004, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). The guidance should be applied to a component of an enterprise that is either disposed of or classified as held for sale in fiscal periods that began after December 15, 2004. We do not believe that the adoption of EITF 03-13 will have a significant effect on our financial statements.
In December 2004, the FASB issued Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, (“FAS 109-2”). The American Jobs Creation Act of 2004 introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. FAS 109-2 provides accounting and disclosure guidance for the repatriation provision, and was effective immediately upon issuance. We do not believe that the adoption of FAS 109-2 will have a significant effect on our financial statements.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
Risks Relating to our Substantial Debt
We have substantial debt and interest payment requirements that may restrict our future operations and impair our ability to meet our obligations under the notes.
As of November 28, 2004, giving effect to the issuance of our 2015 notes as of such date and our repurchase as of such date of $372.1 million of our 2006 notes, our pro forma total debt was approximately $2.1 billion and we had approximately $471.3 million of additional borrowing capacity under our revolving credit facility. Our substantial debt could have important adverse consequences. For example, it could:
The majority of borrowings under our senior secured term loan and senior secured revolving credit facility are, and will continue to be, at variable rates of interest. As a result, increases in market interest rates may require a greater portion of our cash flow to be used to pay interest.
Our ability to satisfy our obligations and to reduce our total debt depends on our future operating performance and on economic, financial, competitive and other factors, many of which are beyond our control. We cannot assure that our business will generate sufficient cash flow or that future financings will be available to provide sufficient proceeds to meet these obligations or to successfully execute our business strategy.
Restrictions in our notes indentures and our 2003 senior secured term loan and senior secured revolving credit facility may limit our activities.
The indentures relating to our senior unsecured notes, our Yen-denominated Eurobond, and our senior secured term loan and senior secured revolving credit facility contain restrictions, including covenants limiting our ability to incur additional debt, grant liens, make investments, prepay specified debt, consolidate, merge or acquire other businesses, sell assets, pay dividends and other distributions, make capital expenditures, and enter into transactions with affiliates. We also are required to meet a leverage ratio under the terms of our senior secured term loan and, in certain circumstances, a fixed charge coverage ratio under our senior secured revolving credit facility. These restrictions may make it difficult for us to successfully execute our business strategy or to compete with companies not similarly restricted. In particular, these restrictions, in combination with our leveraged condition, could limit our ability to restructure our business or take other actions that require additional funds or that cause us to incur charges or costs that adversely affect our compliance with our leverage and fixed charge coverage ratio covenants.
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If we are unable to service our indebtedness or repay or refinance our indebtedness as it becomes due, we may be forced to sell assets or we may go into default, which could cause other indebtedness to become due, and adversely affect the trading value of our debt securities.
If we are unable to pay interest on our indebtedness when due, or to repay or refinance the principal amount of our indebtedness when due, we will go into default under the terms of the documents governing such indebtedness. If that happens, the holders of our indebtedness could elect to declare the indebtedness due and payable and, in the case of the revolving credit facility, terminate their commitments. Prior to or after these defaults, the holders of our indebtedness could exert pressure on us to sell assets or take other actions, including the initiation of bankruptcy proceedings or the commencement of an out-of-court debt restructuring, which may not be in the best interests of the company or holders of our debt securities. If we attempt an asset sale, whether on our own initiative or as a result of pressure from holders of our indebtedness, we may not be able to complete a sale on terms acceptable to us. For example, in May 2004 we began to explore the sale of our Dockers® casual clothing business. We took this action because we believed a sale would help us substantially reduce our debt, improve our capital structure and focus our resources on our other brands. On October 18, 2004, after evaluating the offers we received, we announced that we had decided to keep the brand. Any default under our indebtedness, or the perception that we may go into default, would also adversely affect the trading value of our debt securities.
If our foreign subsidiaries are unable to distribute cash to us when needed, we may be unable to satisfy our obligations under our debt securities.
We conduct our foreign operations through foreign subsidiaries, which accounted for approximately 45% and 41% of our net sales during the years ended November 28, 2004 and November 30, 2003, respectively. As a result, we depend upon funds from our foreign subsidiaries for a portion of the funds necessary to meet our debt service obligations, including payments on our debt securities. We only receive the cash that remains after our foreign subsidiaries satisfy their obligations. If those subsidiaries are unable to pass on the amount of cash that we need, we will be unable to make payments to holders of our debt securities. Any agreements our foreign subsidiaries enter into with other parties, as well as applicable laws and regulations limiting the right and ability of non-U.S. subsidiaries and affiliates to pay dividends and remit earnings to affiliated companies, may restrict the ability of our foreign subsidiaries to pay dividends or make other distributions to us.
Our ability to obtain new financing and trade credit and the costs associated with new financing and trade credit may be adversely affected by downgrades or other changes in our credit ratings.
The credit ratings assigned to our indebtedness may affect both our ability to obtain new financing and trade credit and the costs of our financing and credit. Although ratings downgrades do not trigger any material obligations or provisions under our financing or other contractual relationships, it is possible that rating agencies may downgrade our credit ratings or change their outlook about us (as they did in late 2003 and, in the case of Standard & Poor’s Ratings Service and Moody’s Investor Service with respect to their outlook, in December 2004), which could have an adverse impact on us. For example, if our credit ratings are downgraded, it could increase our cost of capital, make our efforts to raise capital or trade credit more difficult and have an adverse impact on our reputation.
Risks Relating to the Industry in Which We Compete
Our sales are heavily influenced by general economic cycles.
Apparel is a cyclical industry that is heavily dependent upon the overall level of consumer spending. Purchases of apparel and related goods tend to be correlated with the level of consumer spending on discretionary goods. Our customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and canceling orders. As a result, any substantial deterioration in general economic conditions or increases in interest rates, or acts of war, terrorist or political events that diminish consumer spending and confidence in any of the regions in which we compete, could reduce our sales and adversely affect our business and financial condition.
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Intense competition in the worldwide apparel industry could reduce our sales and prices.
We face a variety of competitive challenges from other domestic and foreign jeanswear and casual apparel marketers, fashion-oriented apparel marketers, athletic and sportswear marketers, specialty retailers and retailers of private label jeanswear and casual apparel products, some of which have greater financial and marketing resources than we do. We compete with these companies primarily on the basis of:
Increased competition in the worldwide apparel industry, including from international expansion of vertically-integrated specialty stores, from department stores, chain stores and mass channel retailers developing exclusive labels or expanding the brands they carry and from internet-based competitors, could reduce our sales and prices and adversely affect our business and financial condition.
The worldwide apparel industry has experienced price deflation, which has affected, and may continue to affect, our results of operations.
The worldwide apparel industry has experienced price deflation in recent years. The deflation is attributable to increased competition, increased product sourcing in lower cost countries, growth of the mass merchant channel of distribution, commoditization of the khaki market in the United States, changes in trade agreements and regulations and reduced relative spending on apparel and increased value-consciousness on the part of consumers reflecting, in part, general economic conditions. Downward pressure on prices has, and may continue to:
Because of our high debt level, we may be less able to respond effectively to these developments than our competitors who have less financial leverage.
The success of our business depends upon our ability to offer innovative and upgraded products at attractive price points.
The worldwide apparel industry is characterized by constant product innovation due to changing consumer preferences and by the rapid replication of new products by competitors. As a result, our success depends in large part on our ability to continuously develop, market and deliver innovative and stylish products at a pace,
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intensity, and price competitive with other brands in our segments. In addition, we must create products that appeal to multiple consumer segments at a range of price points. Any failure on our part to regularly and rapidly develop innovative products and update core products could:
The importance of product innovation and market responsiveness in apparel requires us to continue to shorten the time it takes us to bring new products to market, strengthen our product development and commercialization capabilities, rely more on successful commercial relationships with third parties such as design, fiber, fabric and finishing providers and compete and negotiate effectively for new technologies and product components. The exposure of our business to changes in consumer preferences is heightened by our reliance on offshore manufacturers, as offshore outsourcing may increase lead times between production decisions and customer delivery.
In addition, our focus on inventory management may result, from time to time, in our not having an adequate supply of products to meet consumer demand and cause us to lose sales. For example, during 2004, we were unable to fulfill some customer orders in our U.S. business as a result of a convergence of tight inventory management, increased demand, supply constraints and our own operational challenges. Moreover, if we misjudge consumer preferences, our brand image may be impaired, and we may be required to dispose of a substantial amount of closeout or slow-moving products, which would have an adverse effect on our gross profit and earnings.
Increases in the price of raw materials or their reduced availability could increase our cost of sales and decrease our profitability.
The principal fabrics used in our business are cotton, synthetics, wools and blends. The prices we pay for these fabrics are dependent on the market price for raw materials used to produce them, primarily cotton. The price and availability of cotton may fluctuate significantly, depending on a variety of factors, including crop yields, weather, supply conditions, government regulation, economic climate and other unpredictable factors. Any raw material price increases could increase our cost of sales and decrease our profitability unless we are able to pass higher prices on to our customers. Moreover, any decrease in the availability of cotton could impair our ability to meet our production requirements in a timely manner.
Our business is subject to risks associated with sourcing and manufacturing overseas.
We import raw materials and finished garments into all of our operating regions. Substantially all of our import operations are subject to tariffs and quotas set by governments through mutual agreements or bilateral actions. In addition, the countries in which our products are manufactured or imported may from time to time impose additional new quotas, duties, tariffs or other restrictions on our imports or adversely modify existing restrictions. Adverse changes in these import costs and restrictions, or our suppliers’ failure to comply with customs regulations or similar laws, could harm our business.
Our operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, the Caribbean Basin Initiative and the European Economic Area Agreement, and the activities and regulations of the World Trade Organization. Generally, these trade agreements have positive effects on trade liberalization by reducing or eliminating the duties and/or quotas assessed on products manufactured in a particular country. However, trade agreements can also impose
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requirements that adversely affect our business, such as limiting the countries from which we can purchase raw materials and setting quotas on products that may be imported from a particular country into our key markets such as the United States or the European Union. In fact, some trade agreements can provide our competitors with an advantage over us, or increase our costs or contribute to price deflation, which could have an adverse effect on our business and financial condition.
In addition, the elimination of quotas on textile and approved imports by World Trade Organization member countries at the end of 2004 could result in increased sourcing from developing countries which historically have lower labor costs, including China. There may be competitors who can quickly create cost and sourcing advantages from these changes in trade arrangements, which could have an adverse effect on our business and financial condition.
Our ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as labor disputes or increased U.S. or other country homeland security requirements. These issues could delay importation of products or require us to locate alternative ports or warehousing providers to avoid disruption to our customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on our business and financial condition.
Risks Relating to Our Business
Our net sales have declined in recent years, we remain highly leveraged and actions we have taken and may take to turn around our business may not be successful in the long term.
Our net sales have declined over the last seven fiscal years, from $6.0 billion in 1998 to $4.1 billion in 2004, a decrease of 31.7%. We cannot provide assurance that the strategic, operations and management changes we have taken in recent years, or additional cost reduction and other performance improvement actions we may take, will be successful, or that we can increase our sales, improve our profitability and cash flow or reduce our debt. Our financial condition remains highly leveraged, reducing our operating flexibility and impairing our ability to respond to developments in the worldwide apparel industry as effectively as competitors that do not have comparable financial leverage.
We may be unable to maintain or increase our sales through our primary distribution channels.
In the United States, chain stores and department stores are the primary distribution channels for our Levi’s® and Dockers® products. We may be unable to increase sales of our products through these distribution channels, in part because these customers maintain substantial private label offerings and seek to differentiate their brands and products from those of their competitors. Our financial results in the United States are also dependent in part on the effectiveness of our promotional programs with our key chain and department store customers. In addition, other channels, including vertically integrated specialty stores and mass channel retailers, account for a large portion of sales in jeanswear and casual wear sales and have placed substantial competitive pressure generally on the chain and department store channels. Our lack of a substantial presence in the vertically integrated specialty store market, where companies such as Gap Inc. compete, weakens our ability to market to younger consumers.
In Europe, department stores and independent jeanswear retailers are our primary distribution channels. These customers have experienced challenges competing against vertically integrated specialty stores. Further success by vertically integrated specialty stores may adversely affect the sales of our products in Europe.
We also do not have a large portfolio of company-owned stores and internet distribution channels, unlike some of our competitors. Although we own a small number of stores located in selected major urban areas and we intend to increase our company-owned retail presence, we do not expect them to produce substantial unit
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volume or sales. As a result, we have only a small presence in the vertically-integrated specialty store arena, and we have less control than some of our competitors over the distribution and presentation at retail of our products, which could make it more difficult for us to implement our strategy.
Our mass channel initiative could erode our margins and our sales of our Levi’s® products.
In July 2003 we began selling a new casual clothing brand, the Levi Strauss Signature™ brand, in Wal-Mart Stores, Inc.’s Wal-Mart stores in the United States. The Levi Strauss Signature™ brand is also now available in Target Corporation’s Target stores in the United States, Kmart and other U.S. mass channel retailers and in mass channel retail stores in Europe and Asia. We anticipate that the products will be available in additional mass channel retail customers in the future. Although our research to date indicates that we have not experienced any substantial cannibalization of our Levi’s® brand, it is possible that sales of Levi Strauss Signature™ products through the mass channel may result in reduced sales of our other brands. In addition, although our research has not shown that this has occurred in the markets where we have introduced the brand, by offering a less expensive brand in the mass channel, it is possible that we may adversely affect the perception and appeal of our Levi’s® brand by both consumers who purchase our products and by our current customers who sell our products, which could result in an overall decrease in sales and margins. Finally, we may face demands from mass channel retailers for wholesale prices for our products that we believe we cannot offer on a sustained and profitable basis.
We depend on a group of key U.S. customers for a significant portion of our sales. A significant adverse change in a customer relationship or in a customer’s performance or financial position could harm our business and financial condition.
Net sales to our ten largest customers totaled approximately 39% and 43% of total net sales in 2004 and 2003, respectively. One customer, J.C. Penney Company, Inc., accounted for approximately 9% and 11% of net sales in 2004 and 2003, respectively. Moreover, we believe that consolidation in the retail industry has centralized purchasing decisions and given customers greater leverage over suppliers like us, and we expect this trend to continue. For example, Sears Roebuck and Co. (a Levi’s® brand and Dockers® brand customer) and Kmart Corporation (a Levi Strauss Signature™ brand customer) have announced plans to merge. More recently, media reports have indicated that Federated Department Stores Inc. and May Department Stores Co., both Levi’s® brand and Dockers®brand customers and two of our top ten customers, engaged in preliminary merger discussions. If consolidation in the industry continues, our net sales and results of operations may be increasingly sensitive to a deterioration in the financial condition of, or other adverse developments with, one or more of our customers.
While we have long-standing customer relationships, we do not have long-term contracts with any of our customers, including J.C. Penney or Wal-Mart Stores, Inc. As a result, purchases generally occur on an order-by-order basis, and the relationship, as well as particular orders, can generally be terminated by either party at any time. A decision by a major customer, whether motivated by competitive considerations, financial difficulties, economic conditions or otherwise, to decrease its purchases from us, to reduce our floor space or fixtures for our products or to change its manner of doing business with us, could adversely affect our business and financial condition. In addition, during recent years, various retailers, including some of our customers, have experienced significant changes and difficulties, including consolidation of ownership, increased centralization of purchasing decisions, restructurings, bankruptcies and liquidations.
These and other financial problems of some of our retailers increase the risk of extending credit to these retailers. A significant adverse change in a customer relationship or in a customer’s financial position could cause us to limit or discontinue business with that customer, require us to assume more credit risk relating to that customer’s receivables or limit our ability to collect amounts related to previous purchases by that customer, all of which could harm our business and financial condition.
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Our revenues are dependent on sales of branded jeans products. If our sales of these products significantly decline, our market share and our results of operations will be adversely affected.
Our revenues are derived mostly from sales of branded jeans products. Our Levi’s® brand, which consists primarily of denim bottoms, generated approximately 70% of our total net sales in 2004 and 2003. In 2004, net sales of Levi’s® brand products accounted for approximately 57% of net sales in North America, approximately 88% of net sales in Europe and approximately 94% of net sales in Asia Pacific. In 2003, net sales of Levi’s® brand products accounted for approximately 58% of net sales in North America, approximately 90% of net sales in Europe and approximately 96% of net sales in Asia Pacific. Our relative percentage of our total net sales represented by jeans products increased following our entry in 2003 in the mass channel with our Levi Strauss Signature™ brand. Because of our dependence on branded jeans products, any significant decrease in our sales of these products could harm our business and financial condition.
We rely on outsourced manufacturing of our products. Our inability to secure production sources meeting our quality, cost, working conditions and other requirements, or failures by our contractors to perform, could harm our sales, service levels and reputation.
We have in recent years substantially increased our use of independent contract manufacturers and supply relationships in which the contractors purchase directly fabric and other raw materials and may supply design and development services. As a result, we depend on independent contract manufacturers to maintain adequate financial resources, to secure a sufficient supply of raw materials and to maintain sufficient development and manufacturing capacity in an environment characterized by continuing cost pressure and increased demands for product innovation and speed-to-market.
This dependence could subject us to difficulty in obtaining timely delivery of products of acceptable quality. In addition, a contractor’s failure to ship products to us in a timely manner or to meet the required quality standards could cause us to miss the delivery date requirements of our customers. The failure to make timely deliveries may cause our customers to cancel orders, refuse to accept deliveries, impose non-compliance charges through invoice deductions or other charge-backs, demand reduced prices or reduce future orders, any of which could harm our sales, reputation and overall profitability.
We do not have material long-term contracts with any of our independent manufacturers and these manufacturers generally may unilaterally terminate their relationship with us at any time. In addition, the continuing shift in the apparel industry towards outsourcing has intensified competition for quality contractors, some of which have long-standing relationships with our competitors or who may have less volatility than us in their ordering patterns or less perceived risk in their ability to pay. Our financial condition or the financial condition of our suppliers may make it more difficult for our suppliers to obtain sufficient financing to support our requirements, particularly as we shift toward package production. To the extent we are not able to secure or maintain relationships with manufacturers that are able to fulfill our requirements, our business would be harmed.
We require contractors to meet our standards in terms of working conditions, environmental protection, security and other matters before we are willing to place business with them. As such, we may not be able to obtain the lowest-cost production. In addition, the labor and business practices of independent apparel manufacturers have received increased attention from the media, non-governmental organizations, consumers and governmental agencies in recent years. Any failure by our independent manufacturers to adhere to labor or other laws or appropriate labor or business practices, and the potential litigation, negative publicity and political pressure relating to any of these events, could harm our business and reputation.
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Our international operations expose us to political and economic risks.
We generated approximately 45% and 41% of our net sales outside the United States in 2004 and 2003, respectively, and a substantial amount of our products came from sources outside of the country of distribution. As a result, we are subject to the risks of doing business abroad, including:
The functional currency for most of our foreign operations is the applicable local currency. As a result, fluctuations in foreign currency exchange rates affect the results of our operations and the value of our foreign assets, which in turn may adversely affect reported earnings and the comparability of period-to-period results of operations. For 2004, net sales were approximately flat compared to 2003 but decreased 4.0% on a constant currency basis. In addition, although we engage in hedging activities to manage our foreign currency exposures, our earnings may be subject to volatility since we are required to record in income the changes in the market values of our exposure management instruments that do not qualify for hedge accounting treatment. Changes in currency exchange rates may also affect the relative prices at which we and foreign competitors sell products in the same market. In addition, changes in the value of the relevant currencies may affect the cost of certain items required in our operations.
The success of our business depends on our ability to attract and retain qualified employees.
We need talented and experienced personnel in a number of areas including our core business activities. An inability to retain and attract qualified personnel, especially our key executives, could harm our business. For example, we have recently had several changes in our senior management, including three chief financial officers in the past 18 months. Our ability to attract and retain qualified employees is adversely affected by the San Francisco location of our headquarters due to the high cost of living in the San Francisco area. Other factors that have affected, and may continue to affect, our ability to retain and attract employees include our recent financial performance; the disruption associated with our restructuring and cost reduction initiatives; our reliance on cash incentive compensation programs tied to our financial performance; concerns regarding financial reporting, litigation and other developments affecting our reputation; and concerns regarding our ability to achieve our business and financial objectives.
Our reorganization, cost reduction, management and related actions may disrupt our business, result in substantial restructuring charges and result in substantial management and employee reduction and turnover.
In 2004, we took a number of actions relating to our organization, management and cost structure, including:
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These changes and developments in our business processes, systems, organizations and management could result in business disruption and executional error as we transition to new processes and roles, increased employee turnover, adverse effects on employee morale and delays in modernizing our information systems and decision support capabilities. This in turn could harm our business and adversely affect our results of operations.
We have substantial liabilities and cash requirements associated with pension, post-retirement health benefit and deferred compensation plans, and with our restructuring activities.
Our employee benefit and compensation plans and restructuring activities have resulted in substantial liabilities on our balance sheet:
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In addition, we do not have stock option, stock purchase or similar equity employee compensation programs. As a result, our incentive compensation programs rely on cash payments to plan participants.
These plans and activities have and will generate substantial cash requirements for us. For example, in 2004, we made net cash payments of approximately $144 million relating to our restructuring activities, post-retirement health benefits plans and U.S. pension plans. For 2005, we expect to make net cash payments of approximately $57 million relating to restructuring activities, approximately $36 million under our post-retirement health benefits plan and approximately $19 million as contributions to our U.S. pension plans.
We cannot provide assurance that participants in our deferred compensation plan will not seek distributions in response to concerns about our financial condition or liquidity.
Future net periodic benefit costs for our pension and post-retirement health care plans may be volatile and are dependent upon the future marketplace performance of plan assets; changes in actuarial assumptions regarding such factors as selection of a discount rate, the expected rate of return on plan assets and escalation of retiree health care costs; plan amendments affecting benefit payout levels; and profile changes in the beneficiary populations being valued. In addition, in January 2005 the Bush Administration proposed legislation that would affect pension plan funding. The legislation addresses funding calculations and levels, including tying funding requirements to the financial health of the plan sponsor, putting limits on granting additional benefits for underfunded plans, and making increases in Pension Guaranty Corporation flat rate premiums. The actual impact of this legislation on our plans would depend on its requirements as enacted but, if adopted, this or similar legislation could result in the need for additional cash payments by us into our U.S. pension plans.
These liabilities may impair our liquidity, have an unfavorable impact on our ability to obtain financing and place us at a competitive disadvantage compared to some of our competitors who do not have such liabilities and cash requirements.
Beginning in 2005, we are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. Failure to timely comply with the requirements of Section 404 or any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on the trading price of our debt securities.
Beginning with our annual report for the year ending November 27, 2005, Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), will require us to include an internal control report with our annual report on Form 10-K. That report must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year. This report must also include disclosure of any material weaknesses in internal control over financial reporting that we have identified. Additionally, our independent registered public accounting firm will be required to issue reports on management’s assessment of our internal control over financial reporting and their evaluation of the operating effectiveness of our internal control over financial reporting. Public Company Accounting Oversight Board Auditing Standard No. 2 provides the professional standards and related performance guidance for our independent registered public accounting firm to attest to, and report on, our assessment of the effectiveness of our internal control over financial reporting under Section 404. Our assessment requires us to make subjective judgments. In addition, because Auditing Standard No. 2 is newly effective, some of the judgments will be in areas that may be open to interpretation and therefore the report may be uniquely difficult to prepare and our independent registered public accounting firm may not agree with our assessment.
Our independent registered public accounting firm has in the past identified material weaknesses and significant deficiencies in our internal controls. In October 2003, we announced that we were amending financial
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information previously included in our fiscal year 2001 financial statements and in press releases issued in September 2003 announcing our results for the third quarter of 2003. The announcement resulted from our recognition that we had made an accounting error in our financial reporting treatment of tax return errors made in 1998 and 1999 and our determination that, as a result, we needed to restate our fiscal year 2001 financial statements. We later determined that the adjustments to the 2001 statements would affect the financial statements for subsequent periods, and we decided it was appropriate to restate our 2002 and first and second quarter 2003 financial statements. In December 2003 and June 2004, we received letters from our independent registered public accounting firm relating to this matter which identified reportable conditions and material weaknesses in our internal control systems and made certain recommendations. These reportable conditions and material weaknesses included inadequate internal controls to prevent and detect misstatements of accounting information and inadequate involvement of our global controller’s group, the corporate controller and the chief financial officer in the review and disclosure of tax information. Although our independent registered public accounting firm in conjunction with their audit of our consolidated financial statements for 2004 did not advise our management or our Audit Committee of any material weaknesses related to our internal control or operations, our independent registered public accounting firm did identify three new significant deficiencies in our internal controls. See “Item 9A—Controls and Procedures” for a discussion of these new significant deficiencies.
Achieving compliance with Section 404 within the prescribed period, and remedying the significant deficiencies that have been recently identified, and any additional deficiencies, significant deficiencies or material weaknesses that we or our independent registered public accounting firm may identify, may require us to incur significant costs and expend significant time and management resources. We cannot assure you that any of the measures we implement to remedy these deficiencies will effectively mitigate or remediate such deficiencies. In addition, we cannot assure you that we will be able to complete the work necessary for our management to issue its management report in a timely manner, or that we will be able to complete any work required for our management to be able to conclude that our internal control over financial reporting is operating effectively. If we are not able to complete the assessment under Section 404 in a timely manner, we and our independent registered public accounting firm would be unable to conclude that our internal control over financial reporting is effective as of November 27, 2005. As a result, investors could lose confidence in our reported financial information, which could have an adverse effect on the trading price of our debt securities. In addition, we can give no assurance that our independent registered public accounting firm will agree with our management’s assessment or conclude that our internal control over financial reporting is operating effectively.
Adverse outcomes resulting from examination of our income tax returns may affect our liquidity.
We have unresolved issues in our consolidated U.S. federal income tax returns for the prior 19 years. Certain of these years are presently under examination by the Internal Revenue Service. We have not yet reached a full settlement with the Internal Revenue Service for these years and we cannot assure you that we will be able to reach a full settlement for these years on terms that are acceptable to us. In addition, our income tax returns for these or other years may be the subject of future examination by the Internal Revenue Service or other tax authorities. An adverse outcome resulting from any settlement or future examination may lead to an increase in our provision for income taxes on our income statement and adversely affect our liquidity. Our tax liabilities for prior years have generated substantial cash needs for us, including a payment of approximately $42.0 million in November 2004. In 2005, we project U.S. federal, state and foreign income tax payments of approximately $116.0 million for prior year tax liabilities. Our recorded tax liabilities for these issues reflect estimates based on significant assumptions, including an assumption that the Internal Revenue Service would not successfully assess any penalties in respect of taxes for prior years. Actual costs to resolve these open tax issues may be substantially different from our estimate.
Our success depends on the continued protection of our trademarks and other proprietary intellectual property rights.
Our trademarks and other intellectual property rights are important to our success and competitive position, and the loss of or inability to enforce trademark and other proprietary intellectual property rights could harm our
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business. We devote substantial resources to the establishment and protection of our trademark and other proprietary intellectual property rights on a worldwide basis. We cannot assure that our efforts to establish and protect our trademark and other proprietary intellectual property rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products. Moreover, we cannot assure that others will not assert rights in, or ownership of, our trademarks and other proprietary intellectual property or that we will be able to successfully resolve those claims. In addition, the laws and enforcement mechanisms of some foreign countries may not allow us to protect our proprietary rights to the same extent as we do in the United States and other countries.
We are the subject of putative class action litigation by holders of our debt securities.
As further described under “Part I — Item 3 — Legal Proceedings”, we are the subject of a putative class action lawsuit by holders of our debt securities in the Federal district court for the Northern District of California. This lawsuit alleges violations of the Federal securities laws based on allegedly false and misleading financial statements and other public statements issued by us. Although we intend to defend this lawsuit vigorously, we may be required to devote significant management and financial resources to the defense of these actions. An adverse outcome in this lawsuit could have a material adverse effect on our liquidity, financial condition and access to the capital markets.
Our approach to corporate governance may lead us to take actions that conflict with our creditors’ interests as holders of our debt securities.
All of our common stock is owned by a voting trust described under “Principal Stockholders.” Four voting trustees have the exclusive ability to elect and remove directors, amend our by-laws and take other actions which would normally be within the power of stockholders of a Delaware corporation. Although the voting trust agreement gives the holders of two-thirds of the outstanding voting trust certificates the power to remove trustees and terminate the voting trust, three of the trustees, as a group based on their ownership of voting trust certificates, have the ability to block all efforts by the two-thirds of the holders of the voting trust certificates to remove a trustee or terminate the voting trust. In addition, the concentration of voting trust certificate ownership in a small group of holders, including these three trustees, gives this group the voting power to block stockholder action on matters for which the holders of the voting trust certificates are entitled to vote and direct the trustees under the voting trust agreement.
Our principal stockholders created the voting trust in part to ensure that we would continue to operate in a socially responsible manner while seeking the greatest long-term benefit for our stockholders, employees and other stakeholders and constituencies. We measure our success not only by growth in economic value, but also by our reputation, the quality of our constituency relationships and our commitment to social responsibility. As a result, we cannot assure that the voting trustees will cause us to be operated and managed in a manner that benefits our creditors or that the interests of the voting trustees or our principal equity holders will not diverge from our creditors.
Our annual financial statements for 2000 have been restated and are unaudited.
Our selected financial information for 2000 included in Item 6 of this Annual Report on Form 10-K is derived from our financial statements that are unaudited. Our original financial statements for 2000 were audited by Arthur Andersen LLP, independent certified public accountants. These financial statements were subsequently restated by company management as a result of the 2001 reaudit by KPMG LLP, an independent registered public accounting firm, but were not reaudited by KPMG LLP. As a result, holders of our notes may have no effective remedy against any independent registered public accounting firm in connection with a material misstatement or omission in such financial information included in this Annual Report on Form 10-K.
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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVE FINANCIAL INSTRUMENTS
We are exposed to market risk primarily related to foreign currencies and interest rates. We actively manage foreign currency risks with the objective of maximizing our U.S. dollar value. We hold derivative positions only in currencies to which we have exposure. We currently do not hold any interest rate derivatives.
We are exposed to credit loss in the event of nonperformance by the counterparties to the foreign exchange contracts. However, we believe these counterparties are creditworthy financial institutions and do not anticipate nonperformance. We monitor the creditworthiness of our counterparties in accordance with our foreign exchange and investment policies. In addition, we have International Swaps and Derivatives Association, Inc. (ISDA) master agreements in place with our counterparties to mitigate the credit risk related to the outstanding derivatives. These agreements provide the legal basis for over-the-counter transactions in many of the world’s commodity and financial markets.
FOREIGN EXCHANGE RISK
The global scope of our business operations exposes us to the risk of fluctuations in foreign currency markets. This exposure is the result of certain product sourcing activities, some inter-company sales, foreign subsidiaries’ royalty payments, net investment in foreign operations and funding activities. Our foreign currency management objective is to mitigate the potential impact of currency fluctuations on the value of our cash flows. We typically take a long-term view of managing exposures, using forecasts to develop exposure positions and engaging in their active management.
We operate a centralized currency management operation to take advantage of potential opportunities to naturally offset exposures against each other. For any residual exposures, we enter into spot exchange, forward exchange, cross-currency swaps and option contracts to hedge certain anticipated transactions as well as certain firm commitments, including third party and inter-company transactions. We manage the currency risk as of the inception of the exposure. We do not currently manage the timing mismatch between our forecasted exposures and the related financial instruments used to mitigate the currency risk.
Our foreign exchange risk management activities are governed by a foreign exchange risk management policy approved by our board of directors. Our foreign exchange committee, comprised of a group of our senior financial executives, reviews our foreign exchange activities to ensure compliance with our policies. The operating policies and guidelines outlined in the foreign exchange risk management policy provide a framework that allows for an active approach to the management of currency exposures while ensuring the activities are conducted within established parameters. Our policy includes guidelines for the organizational structure of our risk management function and for internal controls over foreign exchange risk management activities, including various measurements for monitoring compliance. We monitor foreign exchange risk, interest rate risk and related derivatives using different techniques including a review of market value, sensitivity analysis and a Value-at-Risk model.
At November 28, 2004, we had U.S. dollar spot and forward currency contracts to buy $793.8 million and to sell $504.1 million against various foreign currencies. Additionally we had Australian Dollar forward currency contracts to buy 1.3 million Australian Dollars ($1.0 million equivalent) against the Polish Zloty and the New Zealand Dollar. These contracts are at various exchange rates and expire at various dates through March 2005.
We have entered into option contracts to manage our exposure to numerous foreign currencies. At November 28, 2004, we had bought U.S. dollar option contracts resulting in a net long position against various foreign currencies of $12.0 million should the options be exercised. Additionally we bought Euro options resulting in a net long position against Japanese Yen of 10.0 million Euros ($13.3 million equivalent) should the options be exercised. To finance the premium related to bought options, we sold U.S. dollar options resulting in a
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net long position against various currencies of $36.6 million should the options be exercised. The option contracts are at various strike prices and expire at various dates through February 2005.
At the respective maturity dates of the outstanding spot, forward and option currency contracts, we expect to enter into various derivative transactions in accordance with our currency risk management policy.
The following table presents the currency, average forward exchange rate, notional amount and fair values for our outstanding forward and swap contracts as of November 28, 2004. The average forward rate is the forward rate weighted by the total of the transacted amounts. The notional amount represents the total net position outstanding as of the stated date. A positive amount represents a long position in U.S. dollar versus the exposure currency, while a negative amount represents a short position in U.S. dollar versus the exposure currency. The net position is the sum of all buy transactions minus the sum of all sell transactions. All amounts are stated in U.S. dollar equivalents. We use widely accepted valuation models that incorporate quoted market prices or dealer quotes to determine the estimated fair value of our foreign exchange derivative contracts. All transactions will mature before the end of March 2005.
Outstanding Forward and Swap Transactions
(Dollars in Thousands except Average Forward Exchange Rates)
Currency
Australian Dollar
Canadian Dollar
Swiss Franc
Danish Krona
Euro
British Pound
Hungarian Forint
Japanese Yen
Korean Won
Mexican Peso
Norwegian Krona
New Zealand Dollar
Polish Zloty
Swedish Krona
Singapore Dollar
Taiwan Dollar
South African Rand
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The following table presents the currency, average strike rate, notional amount and fair value of our outstanding foreign currency options. All amounts are stated in U.S. dollar equivalents. The notional amount represents the total net position outstanding as of the stated date should the option be exercised. A positive amount represents a long position in U.S. dollars, while a negative amount represents a short position in U.S. dollars, versus the relevant currency. We use a weighting factor based on the notional amounts of the outstanding transactions to determine the average strike rate. We use widely accepted valuation models that incorporate quoted market prices or dealer quotes to determine the estimated fair value of our foreign exchange derivative contracts. All transactions expire before the end of February 2005.
Outstanding Options Transactions
(Dollars in Thousands except Average Strike Rates)
Interest Rate Risk
We maintain a mix of medium and long-term fixed and variable rate debt. We currently do not actively manage the related interest rate risk and hold no interest rate derivatives.
The following table provides information about our financial instruments that are sensitive to changes in interest rates. The table gives effect to our issuance of $450.0 million of 9.75% notes due 2015 and subsequent repurchase of $372.1 million of our 7.0% notes due 2006, as if such actions took place as of November 28, 2004. The table presents principal (face amount) outstanding balances of our debt instruments and the related weighted average interest rates for the years indicated. The applicable floating rate index is included for variable rate instruments. All amounts are stated in U.S. dollar equivalents.
Interest Rate Table as of November 28, 2004
(Dollars in Thousands Unless Otherwise Stated)
FairValue2004
Debt Instruments
Fixed Rate (US$)
Average Interest Rate
Fixed Rate (Yen 20 billion)
Fixed Rate (Euro 125 million)
Variable Rate (US$)
Average Interest Rate*
Total principal (face amount) of our debt instruments
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Stockholders and Board of Directors
Levi Strauss & Co.:
We have audited the accompanying consolidated balance sheets of Levi Strauss & Co. and subsidiaries as of November 28, 2004 and November 30, 2003, and the related consolidated statements of operations, stockholders’ deficit and comprehensive income and cash flows for each of the years in the three-year period ended November 28, 2004. In connection with our audits of the consolidated financial statements, we have also audited the related financial statement Schedule II. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audit.
We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Levi Strauss & Co. and subsidiaries as of November 28, 2004 and November 30, 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended November 28, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement Schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
San Francisco, CA
February 14, 2005
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LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
November 28,
2004
November 30,
Current Assets:
Trade receivables, net of allowance for doubtful accounts of $29,002 and $26,956
Inventories:
Raw materials
Work-in-process
Finished goods
Total inventories
Deferred tax assets, net of valuation allowance of $26,364 and $25,281
Other current assets
Total current assets
Property, plant and equipment, net of accumulated depreciation of $486,439 and $491,121
Goodwill
Other intangible assets
Non-current deferred tax assets, net of valuation allowance of $360,319 and $324,269
Other assets
Current Liabilities:
Current maturities of long-term debt and short-term borrowings
Current maturities of capital lease
Accounts payable
Restructuring reserves
Accrued liabilities
Accrued salaries, wages and employee benefits
Accrued income taxes
Total current liabilities
Long-term debt, less current maturities
Long-term capital lease, less current maturities
Post-retirement medical benefits
Pension liability
Long-term employee related benefits
Long-term income tax liabilities
Other long-term liabilities
Minority interest
Total liabilities
Commitments and contingencies (Note 9)
Stockholders’ deficit:
Common stock — $.01 par value; 270,000,000 shares authorized; 37,278,238 shares issued and outstanding
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive loss
Stockholders’ deficit
Total liabilities and stockholders’ deficit
The accompanying notes are an integral part of these financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
November 24,
2002
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
Common
Stock
Additional
Paid-In
Capital
Accumulated
Deficit
Comprehensive
Income (Loss)
Stockholders’
Balance at November 25, 2001
Net income
Other comprehensive loss, (net of tax)
Total comprehensive loss
Balance at November 24, 2002
Net loss
Other comprehensive loss (net of tax)
Balance at November 30, 2003
Total comprehensive income
Balance at November 28, 2004
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Non-cash asset write-offs associated with reorganization initiatives
Unrealized foreign exchange gains (losses)
(Increase) decrease in trade receivables
Decrease (increase) in inventories
Decrease (increase) in other current assets
Decrease in other non-current assets
Increase (decrease) in accounts payable and accrued liabilities
Decrease in net deferred taxes
Increase (decrease) in restructuring reserves
Addition to deferred tax valuation allowance
Increase (decrease) in accrued salaries, wages and employee benefits
Increase (decrease) in accrued income taxes
(Decrease) increase in long-term employee related benefits
(Decrease) increase in other long-term liabilities
Other, net
Net cash provided by (used for) operating activities
Cash Flows from Investing Activities:
Purchases of property, plant and equipment
Proceeds from sale of property, plant and equipment
Cash outflow from net investment hedges
Net cash used for investing activities
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt
Repayments of long-term debt
Net decrease in short-term borrowings
Debt issuance costs
Increase in restricted cash
Net cash (used for) provided by financing activities
Effect of exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes
Restructuring initiatives
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED NOVEMBER 28, 2004, NOVEMBER 30, 2003 AND NOVEMBER 24, 2002
NOTE 1: SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The consolidated financial statements of Levi Strauss & Co. and its wholly-owned and majority-owned foreign and domestic subsidiaries (“LS&CO.” or the “Company”) are prepared in conformity with generally accepted accounting principles in the United States. All significant intercompany balances and transactions have been eliminated. LS&CO. is privately held primarily by descendants and relatives of its founder, Levi Strauss.
The Company’s fiscal year consists of 52 or 53 weeks, ending on the last Sunday of November in each year. The 2004 fiscal year consisted of 52 weeks ended November 28, 2004, the 2003 fiscal year consisted of 53 weeks ended November 30, 2003 and the 2002 fiscal year consisted of 52 weeks ended November 24, 2002. All amounts herein, unless otherwise indicated, are in thousands. The fiscal year end for certain foreign subsidiaries is fixed at November 30 due to certain local statutory requirements and does not include 53 weeks in 2003. All references to years relate to fiscal years rather than calendar years. Certain reclassifications have been made to prior year amounts to reflect the current year presentation.
Nature of Operations
The Company is one of the world’s leading branded apparel companies, with sales in more than 110 countries. The Company designs and markets jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories, for men, women and children under the Levi’s®, Dockers® and Levi Strauss Signature™ brands. The Company markets its Levi’s®, Dockers® and Levi Strauss Signature™ brand products in three geographic regions: North America, Europe and Asia Pacific. As of November 28, 2004, the Company employed approximately 8,850 employees.
The stockholders’ deficit initially resulted from a 1996 transaction in which the Company’s stockholders created new long-term governance arrangements, including a voting trust and stockholders’ agreement. As a result, shares of stock of a former parent company, Levi Strauss Associates Inc., including shares held under several employee benefit and compensation plans, were converted into the right to receive cash. The funding for the cash payments in this transaction was provided in part by cash on hand and in part from proceeds of approximately $3.3 billion of borrowings under bank credit facilities. The Company’s ability to satisfy its obligations and to reduce its debt depends on the Company’s future operating performance and on economic, financial, competitive and other factors.
In 2004, 2003 and 2002, the Company had one customer, J.C. Penney Company, Inc., that represented approximately 9%, 11% and 12%, respectively of net sales. Net sales to the Company’s ten largest customers totaled approximately 39%, 43% and 45% of net sales during 2004, 2003 and 2002, respectively.
Restricted Cash
Restricted cash as of November 28, 2004 was comprised of approximately $1.9 million related to required cash deposits for customs and rental guarantees in Europe. Restricted cash as of November 30, 2003 was immaterial.
Reclassification of Outstanding Checks
The Company included approximately $60.5 million of outstanding checks in “accounts payable” in the consolidated balance sheet as of November 30, 2003. Outstanding checks represent checks that have been issued
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
by the Company but have not been processed against the Company’s bank accounts as of the balance sheet date. As of November 28, 2004, the Company has reported approximately $23.0 million of outstanding checks as a reduction in “cash and cash equivalents” in the consolidated balance sheet and statement of cash flows for the year then ended, and the prior year amount has been reclassified to reflect the current year presentation.
Correction of Intercompany Accounts
The Company’s results of operations for the year ended November 28, 2004 include a pre-tax benefit of approximately $5.0 million related to the correction of an error in accounting for certain intercompany transactions. The $5.0 million benefit was recorded in cost of goods sold, and represents the cumulative amount of intercompany charges related to a sourcing arrangement between one of the Company’s U.S. subsidiaries and its subsidiary in Mexico that were not properly eliminated in consolidation during the years 1990 through 2003. The amount of such charges in any of the years 1990 through 2003 were not material to the Company’s consolidated results of operations for those periods, nor was the inclusion of the benefit in the results of operations for 2004 considered material.
Income Tax Return to Provision Reconciliation
The Company’s results of operations for the year ended November 28, 2004 include a charge of approximately $6.2 million related to the recording of an adjustment resulting from the completion of the Company’s 2003 U.S. federal income tax return to provision reconciliation in August 2004. The $6.2 million expense was recorded in income tax expense and results from a correction to the projected taxable income that was utilized in connection with the preparation of the 2003 financial statements. The amount of such adjustment was not material to the Company’s consolidated results of operations for 2003, nor is the inclusion of the expense in the results of operations for 2004 considered material.
Asia Pacific Enterprise Resource Planning System
In December 2003, the Company decided to suspend indefinitely its worldwide enterprise resource planning (“ERP”) project. Accordingly, in the first quarter of 2004, the Company wrote off $33.4 million of the capitalized worldwide ERP project costs since, in light of the Company’s level of operating losses and emphasis on reducing operating costs, management at that time believed there was little likelihood of resuming the worldwide ERP project in the foreseeable future.
In August 2004, as a result of completing its business and organizational review, management of the Company decided to implement a more limited ERP system with respect to its Asia Pacific region to support the business growth in that region. Certain of the previously written off capitalized assets associated with the suspended worldwide ERP project, primarily comprised of software and licenses with an original cost of approximately $4-5 million, have been identified as useful in the implementation of this new ERP system for the Asia Pacific region. Under the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”, previously written down assets are not reversed, and accordingly, there will be no adjustment to write-up the assets identified for use in this initiative. However, upon quantification of the actual assets utilized, the Company going forward will disclose in the notes to the financial statements the original cost and pro forma depreciation expense related to such assets for the applicable periods to provide data regarding the benefit associated with their utilization. (See also Note 3 to the Consolidated Financial Statements.)
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The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the related notes. The following discussion addresses the Company’s critical accounting policies, which are those that are most important to the portrayal of its financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Changes in such estimates, based on more accurate future information, or different assumptions or conditions, may affect amounts reported in future periods.
The Company’s critical accounting policies are summarized below.
Revenue recognition. The Company recognizes revenue on sale of product when the goods are shipped and title passes to the customer provided that: there are no uncertainties regarding customer acceptance; persuasive evidence of an arrangement exists; the sales price is fixed or determinable; and collectibility is probable. Revenue is recognized when the sale is recorded net of an allowance for estimated returns, discounts and retailer promotions and incentives.
The Company recognizes allowances for estimated returns, discounts and retailer promotions and incentives in the period when the sale is recorded. Allowances principally relate to U.S. operations and primarily reflect price discounts, non-volume-based incentives and other returns and discounts. The Company estimates non-volume-based allowances by considering customer and product-specific circumstances and commitments, as well as historical customer claim rates. Actual allowances may differ from estimates due to changes in sales volume based on retailer or consumer demand and changes in customer and product-specific circumstances.
Inventory valuation. The Company values inventories at the lower of cost or market value. Inventory costs are based on standard costs on a first-in first-out basis, which are updated periodically and supported by actual cost data. The Company includes materials, labor and manufacturing overhead in the cost of inventories. In determining inventory market values, substantial consideration is given to the expected product selling price. The Company considers various factors, including estimated quantities of slow-moving and obsolete inventory, by reviewing on-hand quantities, outstanding purchase obligations and forecasted sales. The Company then estimates expected selling prices based on historical recovery rates for sale of slow-moving and obsolete inventory and other factors, such as market conditions and current consumer preferences. Estimates may differ from actual results due to the quantity, quality and mix of products in inventory, consumer and retailer preferences and economic conditions.
Restructuring reserves. Upon approval of a restructuring plan by management with the appropriate level of authority, the Company records restructuring reserves for certain costs associated with plant closures and business reorganization activities as they are incurred or when they become probable and estimable. Restructuring costs associated with initiatives commenced prior to January 1, 2003 were recorded in compliance with Emerging Issues Task Force No. 94-3 and primarily include employee severance, certain employee termination benefits, such as outplacement services and career counseling, and resolution of contractual obligations.
For initiatives commenced after December 31, 2002, the Company recorded restructuring reserves in compliance with Statement of Financial Accounting Standards No. (“SFAS”) 112, “Employers’ Accounting for Postemployment Benefits,” and SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,”
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resulting in the recognition of employee severance and related termination benefits for recurring arrangements when they become probable and estimable and on the accrual basis for one-time benefit arrangements. The Company records other costs associated with exit activities as they are incurred. Employee severance and termination benefit costs reflect estimates based on agreements with the relevant union representatives or plans adopted that are applicable to employees not affiliated with unions. These costs are not associated with nor do they benefit continuing activities. Changing business conditions may affect the assumptions related to the timing and extent of facility closure activities. The Company reviews the status of restructuring activities on a quarterly basis and, if appropriate, records changes based on revised estimates.
Income tax assets and liabilities. The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The Company maintains valuation allowances where it is more likely than not all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the Company’s tax provision in the period of change. In determining whether a valuation allowance is warranted, the Company takes into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The Company is also subject to examination of its income tax returns for multiple years by the Internal Revenue Service and other tax authorities. The Company periodically assesses the likelihood of adverse outcomes resulting from these examinations to determine the impact on its deferred taxes and income tax liabilities and the adequacy of its provision for income taxes.
Derivative and foreign exchange management activities. The Company recognizes all derivatives as assets and liabilities at their fair values. The fair values are determined using widely accepted valuation models that incorporate quoted market prices and dealer quotes and reflect assumptions about currency fluctuations based on current market conditions. The aggregate fair values of derivative instruments used to manage currency exposures are sensitive to changes in market conditions and to changes in the timing and amounts of forecasted exposures.
Not all exposure management activities and foreign currency derivative instruments will qualify for hedge accounting treatment. Changes in the fair values of those derivative instruments that do not qualify for hedge accounting are recorded in “Other expense, net” in the Statements of Operations. As a result, net income may be subject to volatility. The derivative instruments that qualify for hedge accounting currently hedge the Company’s net investment position in certain of its subsidiaries. For these instruments, the Company documents the hedge designation by identifying the hedging instrument, the nature of the risk being hedged and the approach for measuring hedge effectiveness. Changes in fair values of derivative instruments that qualify for hedge accounting are recorded as cumulative translation adjustments in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit.
Pension and Post-retirement Benefits. The Company has several non-contributory defined benefit retirement plans covering substantially all employees. The Company also provides certain health care benefits for employees who meet age, participation and length of service requirements at retirement. In addition, the Company sponsors other retirement plans for its foreign employees in accordance with local government programs and requirements. The Company retains the right to amend, curtail or discontinue any aspect of the
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plans at any time. Any of these actions (including changes in actuarial assumptions and estimates), either individually or in combination, could have a material impact on the Company’s consolidated financial statements and on its future financial performance.
The Company accounts for its U.S. and certain foreign defined benefit pension plans and its post-retirement benefit plans using actuarial models in accordance with SFAS 87, “Employers’ Accounting for Pension Plans,” and SFAS 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” These models use an attribution approach that generally spreads individual events over the estimated service lives of the employees in the plan. The attribution approach assumes that employees render service over their service lives on a relatively smooth basis and as such, presumes that the income statement effects of pension or post-retirement benefit plans should follow the same pattern. The Company’s policy is to fund its retirement plans based upon actuarial recommendations and in accordance with applicable laws, income tax regulations and its credit agreements.
Net pension income or expense is determined using assumptions as of the beginning of each fiscal year. These assumptions are established at the end of the prior fiscal year and include expected long-term rates of return on plan assets, discount rates, compensation rate increases and medical trend rates. The Company uses a mix of actual historical rates, expected rates and external data to determine the assumptions used in the actuarial models.
Employee Incentive Compensation. The Company maintains short-term and long-term employee incentive compensation plans. These plans are intended to reward eligible employees for their contributions to the Company’s short-term and long-term success. Provisions for employee incentive compensation are recorded in accrued salaries, wages and employee benefits and long-term employee related benefits. Changes in the liabilities for these incentive plans generally correlate with the Company’s financial results and projected future financial performance and could have a material impact on its consolidated financial statements and on future financial performance.
Other Significant Accounting Policies
Cost of Goods Sold
Cost of goods sold is primarily comprised of cost of materials, labor and manufacturing, product sourcing and development overhead. Cost of goods sold also includes the cost of inbound freight, internal transfers, and receiving and inspection at manufacturing facilities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are primarily comprised of costs relating to advertising, marketing, selling, distribution, information technology and other corporate functions. Distribution costs include costs related to receiving and inspection at distribution centers, warehousing, shipping, handling and certain other activities associated with the Company’s distribution network. These expenses totaled $215.1 million, $211.6 million and $184.7 million for 2004, 2003 and 2002, respectively. Shipping and handling charges billed to the Company’s customers were insignificant.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense is recorded in selling, general and administrative expenses. For 2004, 2003 and 2002, total advertising expense was $302.6 million, $282.9 million and $307.1 million, respectively.
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Other Operating Income
Other operating income represents royalties earned for the use of the Company’s trademarks in connection with the manufacturing, advertising, distribution and sale of products by third party licensees. The Company enters into licensing agreements with the majority of the agreements having a term of at least one year. Such amounts are earned and recognized as products are sold by licensees based on royalty rates as set forth in the licensing agreements. The earnings process is complete when the licensees sell the products. Royalty income for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 was $52.0 million, $39.9 million and $34.5 million, respectively.
Other Expense, Net
Significant components of other expense, net are summarized below:
Foreign exchange management contracts
Interest rate management contracts
The Company uses foreign exchange management contracts, such as forward, swap and option contracts, to manage foreign currency exposures. Outstanding derivative instruments are recorded at fair value and changes in fair value are recorded in “other expense, net”. At contract maturity, the realized gain or loss related to derivative instruments is also recorded in “other expense, net”.
Foreign currency transactions are transactions denominated in a currency other than the entity’s functional currency. At the date the foreign currency transaction is recognized, each asset, liability, revenue, expense, gain or loss arising from the transaction is measured and recorded in the functional currency of the recording entity using the exchange rate in effect at that date. At each balance sheet date for each entity, recorded balances denominated in a foreign currency are adjusted, or remeasured, to reflect the current exchange rate. The changes in the recorded balances caused by remeasurement at the current exchange rate are also recorded in “other expense, net”.
Gains and losses arising from the remeasurement of the Company’s Yen-denominated Eurobond placement, to the extent that the indebtedness is not subject to a hedging relationship, are also included in foreign currency transaction (gains) losses.
Included in loss on early extinguishment of debt in 2003 is the write-off of capitalized debt issuance costs associated with the refinancing and termination of the Company’s 2001 senior secured credit facility, its 2003 secured credit facility and its 2001 U.S. receivables securitization agreement.
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Minority Interest
Minority interest is included in “Other expense, net,” in the Consolidated Statements of Operations and in “Minority interest” in the Consolidated Balance Sheets, and includes a 16.4% minority interest of Levi Strauss Japan K.K., the Company’s Japanese affiliate, and a 49.0% minority interest of Levi Strauss Istanbul Konfeksiyon, the Company’s Turkish affiliate.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are stated at amortized cost, which approximates fair market value.
Property, Plant and Equipment
Property, plant and equipment are carried at cost, less accumulated depreciation. The cost is depreciated on a straight-line basis over the estimated useful lives of the related assets. Buildings are depreciated over 20 to 40 years, and leasehold improvements are depreciated over the lesser of the life of the improvement or the initial lease term. Machinery and equipment includes furniture and fixtures, automobiles and trucks, and networking communication equipment, and is depreciated over a range from three to 20 years. Capitalized internal-use software is carried at cost less accumulated amortization and is amortized over three years on a straight-line basis.
Goodwill and Other Intangible Assets
Goodwill resulted primarily from a 1985 acquisition of LS&CO. by Levi Strauss Associates Inc., a former parent company that was subsequently merged into the Company in 1996. Pursuant to the provisions of Statement of Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized and is subject to an annual impairment test which the Company performs in the fourth quarter of each fiscal year. Intangible assets are primarily comprised of owned trademarks with indefinite useful lives. Pursuant to the provisions of SFAS 142, intangible assets with indefinite lives are not amortized. The Company’s remaining intangible assets are amortized over their estimated useful lives ranging from 3 to 12 years.
The Company adopted the provision of SFAS 142 at the beginning of fiscal 2003. A reconciliation of previously reported net income (loss) to amounts adjusted for the exclusion of goodwill and trademark amortization, net of related income tax effect, is as follows:
Goodwill and trademark amortization, net of tax
Adjusted net income (loss)
Long-Lived Assets
In accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that
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the carrying amount of an asset may not be recoverable. If the carrying amount of an asset exceeds the expected future undiscounted cash flows, the Company measures and records an impairment loss for the excess of the carrying value of the asset over its fair value.
Translation Adjustment
The functional currency for most of the Company’s foreign operations is the applicable local currency. For those operations, assets and liabilities are translated into U.S. dollars using period-end exchange rates and income and expense accounts are translated at average monthly exchange rates. Net changes resulting from such translations are recorded as a separate component of “Accumulated other comprehensive loss” in the consolidated financial statements.
The U.S. dollar is the functional currency for foreign operations in countries with highly inflationary economies. The translation adjustments for these entities, as applicable, are included in “Other expense, net.”
Self-Insurance
The Company is partially self-insured for workers’ compensation and certain employee health benefits. Accruals for losses are made based on the Company’s claims experience and actuarial assumptions followed in the insurance industry, including provisions for incurred but not reported losses. Actual losses could differ from accrued amounts. (See Note 15 to the Consolidated Financial Statements)
Workers’ Compensation. The Company carries insurance deductibles of $200,000 per occurrence for workers’ compensation. Insurance has been purchased for significant claims in excess of $200,000 per occurrence up to statutory limits. Aggregate insurance in the amount of $5.0 million was purchased during the period December 1, 2003 through November 28, 2004 for losses in excess of $10.0 million in the aggregate.
Health Benefits. The Company provides medical coverage to substantially all eligible active and retired employees and their dependents under either a fully self-insured arrangement or an HMO insured plan. There is stop-loss coverage for active salaried employees (as well as those salaried retirees who retired after June 1, 2001) that has a $2.0 million lifetime limit on medical coverage and stop loss coverage for all active hourly employees. This stop-loss coverage provides payment on the excess of any individual claim incident over $500,000 for salaried employees and $300,000 for hourly employees in any given year.
In December 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 132R (“FAS 132R”), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. The statement provides disclosures requirements for defined benefit pension plans and other post-retirement benefit plans. The statement was effective for annual financial statements with fiscal years ending after December 15, 2003, and for interim periods beginning after December 15, 2003. The Company adopted FAS 132R during the year ended November 28, 2004. The adoption of FAS 132R did not have any impact on the Company’s operating results or financial position.
In December 2003, the FASB published a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46R”), to clarify some of the provisions of the original interpretation, and to exempt certain entities from its requirements. Under the revised guidance, there are new effective dates for companies that have interests in structures that are commonly referred to as special-purpose entities. The rules are effective
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in financial statements for periods ending after March 15, 2004. FIN 46R did not impact the Company’s operating results or financial position because the Company does not have any variable interest entities.
In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides a three-step impairment model for determining whether an investment is other-than-temporarily impaired and requires the Company to recognize such impairments as an impairment loss equal to the difference between the investment’s cost and fair value at the reporting date. The guidance is effective for the Company during the first quarter of fiscal 2005. The Company does not believe that the adoption of EITF 03-1 will have a significant effect on its financial statements.
In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FAS 106-2), providing final guidance on accounting for the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”). The Company adopted the provisions of FAS 106-2 during the year ended November 28, 2004 and recorded the effects of the federal subsidy provided by the Act in measuring its net periodic post-retirement benefit cost for the year. This resulted in a reduction in the Company’s accumulated post-retirement benefit obligation for the subsidy related to benefits attributed to past service of $21.4 million. The subsidy resulted in a reduction in the Company’s current period net periodic post-retirement benefit costs for the year ended November 28, 2004 of $1.7 million. The Company expects to receive subsidy payments beginning in fiscal year ending November 30, 2006 (see Note 12 to the Consolidated Financial Statements).
In November 2004, the FASB issued SFAS No. 151 “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“FAS 151”). FAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, FAS 151 requires that allocation of fixed and production facilities overhead to conversion costs should be based on normal capacity of the production facilities. The provisions in FAS 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of FAS 151 will have a significant effect on its financial statements.
In November 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29” (“FAS 153”). The provisions of this statement is effective for non monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This statement eliminates the exception to fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance — that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. The Company does not believe that the adoption of FAS 153 will have a significant effect on its financial statements.
In November 2004, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). The guidance should be applied to a component of an enterprise that is either disposed of or classified as held for sale in fiscal periods beginning after December 15, 2004. The Company does not believe that the adoption of EITF 03-13 will have a significant effect on its financial statements.
In December 2004, the FASB issued Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FAS 109-2”).
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The American Jobs Creation Act of 2004 introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. FAS 109-2 provides accounting and disclosure guidance for the repatriation provision, and was effective immediately upon issuance. The Company does not believe that the adoption of FAS 109-2 will have a significant effect on its financial statements.
NOTE 2: ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Transition
Adjustment
NetInvestmentHedges
TranslationAdjustments
Totals
Accumulated other comprehensive income (loss) at November 25, 2001
Gross changes
Tax
Reclassification of cash flow hedges to other income/expense (net of tax of $248)
Other comprehensive income (loss), net of tax
Accumulated other comprehensive income (loss) at November 24, 2002
Accumulated other comprehensive income (loss) at November 30, 2003
Accumulated other comprehensive loss at November 28, 2004
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NOTE 3: RESTRUCTURING RESERVES
SUMMARY
The following describes the activities associated with the Company’s reorganization initiatives. Severance and employee benefits relate to items such as severance packages, out-placement services and career counseling for employees affected by the plant closures and reorganization initiatives. Reductions consist of payments for severance and employee benefits, and other restructuring costs, and foreign exchange differences.
For the year ended November 28, 2004, the Company recognized restructuring charges, net of reversals, of $133.6 million. As of November 28, 2004, the Company’s total restructuring reserves balance was $50.8 million, with approximately $42.0 million recorded as a current liability, and the remaining $8.8 million included in other long-term liabilities on the consolidated balance sheet. The Company expects to utilize the majority of its restructuring reserve balance during fiscal year 2005.
The following table summarizes the 2004 activity and the reserve balances as of November 28, 2004 and November 30, 2003, associated with the Company’s plant closures and reorganization initiatives:
2004 Reorganization Initiatives
2004 Worldwide ERP** Installation Indefinite Suspension
2003 U.S. Organizational Changes***
2003 North America Plant Closures***
2003 Europe Organizational Changes
2002 Europe Reorganization Initiative
2002 U.S. Plant Closures
2001 Corporate Restructuring Initiatives
Restructuring Reserves
2004 Worldwide ERP** Asset Write-offs
2003 North America Plant Closures Asset Write-offs
2004 U.S. Organizational Changes Asset write-offs
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In December 2003, the Company retained the management consulting firm Alvarez & Marsal, Inc. to work with the Company’s leadership team in analyzing the Company’s business strategies, plans and operations. As a result of this review, the Company commenced the following reorganization initiatives in 2004.
2004 Spain Plant Closures
During the year ended November 28, 2004, the Company commenced the process of closing its two owned and operated manufacturing plants in Spain. During the year ended November 28, 2004, the Company recorded a charge of $27.3 million related to the displacement of approximately 450 employees associated with this initiative and for other restructuring costs. The amount of the charge was determined based upon the severance benefits for this action, as negotiated with local representatives for the employees. The plant ceased operations in the fourth quarter of 2004. As of November 28, 2004, approximately 430 employees had been displaced. Current appraised values indicate that there does not appear to be an impairment issue relating to the carrying amounts of the plants’ property, plant and equipment. The Company expects to incur no additional restructuring costs in connection with this action.
2004 Australia Plant Closure
On August 26, 2004, the Company announced that it was closing its owned and operated manufacturing plant in Adelaide, Australia. During the year ended November 28, 2004, the Company recorded severance costs of approximately $2.6 million related to the displacement of approximately 90 employees associated with this initiative. The amount of the charge was determined based upon severance benefits. As of November 28, 2004, approximately 75 employees had been displaced. Current appraised values indicate that there does not appear to be an impairment issue relating to the carrying amounts of the plant’s property, plant and equipment. The Company expects to incur no additional restructuring costs in connection with this action.
2004 U.S. Organizational Changes
During the year ended November 28, 2004, the Company reduced resources associated with the Company’s corporate support functions by eliminating staff, not filling certain open positions and outsourcing most of the transaction activities in the U.S. human resources function. This initiative resulted in the displacement of approximately 200 employees. During the year ended November 28, 2004, the Company recorded a charge for severance and lease termination costs of approximately $27.1 million, and other restructuring costs of approximately $0.5 million, related to this initiative. As of November 28, 2004, approximately 175 individuals had been displaced. The Company estimates that it will incur future additional restructuring charges related to this initiative, principally in the form of severance and employee benefits payments, of approximately $2.1 million, which will be recorded as they become estimable and probable.
2004 Europe Organizational Changes
During the year ended November 28, 2004, the Company commenced additional reorganization actions which will result in the displacement of approximately 125 employees in its European operations. As of November 28, 2004, approximately 110 employees have been displaced. During the year ended November 28, 2004, the Company recorded a charge for severance and lease termination costs of approximately $15.3 million related to these actions. The Company estimates that it will incur additional restructuring charges of approximately $14.5 million relating to these actions, principally in the form of severance and employee benefits payments, which will be recorded as they become probable and estimable.
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2004 Dockers® Europe Organizational Changes
During 2004, the Company commenced the process of changing its Dockers® business model in Europe. The Company plans to transfer and consolidate Dockers® Europe’s operations in Brussels, which is the European headquarters of Levi Strauss & Co. The Company anticipates that the move will take place in the third quarter of 2005, resulting in the closure of its Amsterdam office and the displacement of approximately 65 employees based there. In November 2004, the president of the Dockers® business in Europe, along with the leaders of the marketing and merchandising functions, left employment with the Company. As of November 28, 2004, the Company recorded a charge of approximately $1.5 million, primarily related to severance and related benefits resulting from the termination of the three executives. During the third quarter of 2005, the Company expects to incur additional restructuring costs of approximately $7.7 million relating to this initiative in the form of severance and employee benefits payments, contract termination costs and asset disposals, which will be recorded as they become estimable and probable, or in the case of contract termination costs, when the related contracts are terminated.
The table below displays the restructuring activity for the year ended November 28, 2004, and the balance of the restructuring reserves as of November 28, 2004, for the 2004 reorganization initiatives discussed above.
Severance and employee benefits
Other restructuring costs
Subtotal — Spanish Plant Closures
2004 Australia Plant Closures
Subtotal — Australia Plant Closures
Subtotal — U.S. Organizational Changes
Subtotal — Europe Organizational Changes
2004 U.S. Organizational Changes Asset Write-offs
Total — 2004 Reorganizational Changes
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2004 Indefinite Suspension of Enterprise Resource Planning System Installation
In December 2003, the Company indefinitely suspended the installation of a worldwide enterprise resource planning system in order to reduce costs and prioritize work and resource use, and as a result the Company recorded a charge of approximately $42.8 million during fiscal 2004 related to this initiative. The charge was comprised of approximately $2.7 million related to the displacement of approximately 40 employees, $6.7 million for other restructuring costs primarily related to non-cancelable project contractual commitments and $33.4 million to write-off capitalized costs related to the project. As of November 28, 2004, all the employees related to this initiative had been displaced. The Company expects to incur no additional restructuring costs in connection with this action.
As discussed in Note 1, in August 2004 the Company decided to implement a new enterprise resource planning system for its Asia Pacific region. This decision will likely result in the utilization of certain assets, primarily comprised of software and licenses with an original cost of approximately $4 to $5 million, that had been previously written off in the first quarter of 2004 due to the indefinite suspension of the worldwide initiative.
The table below displays the restructuring activity and liability balance of the reserve for the 2004 ERP installation indefinite suspension.
Asset write-offs
2003 U.S. Organizational Changes
On September 10, 2003, the Company announced a reorganization of its U.S. business to further reduce the time it takes from initial product concept to placement of the product on the retailer’s shelf and to reduce costs. During the fourth quarter of fiscal 2003, the Company recorded an initial charge of $22.4 million in connection with this initiative, reflecting the displacement of approximately 350 salaried employees in various U.S. locations. As a result of these initiatives, the Company recorded charges during the year ended November 28, 2004 of $7.3 million, net of reversals for additional severance and benefits related to the displacement of 189 employees, and $0.9 million, respectively, for other restructuring costs. As of November 28, 2004, all employees had been displaced.
During fiscal year 2005, the Company expects to incur an insignificant amount of additional employee-related restructuring costs related to this initiative for termination benefits and other restructuring costs, which will be recorded as they become estimable and probable.
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The table below displays the activity and liability balance of the reserve for the 2003 U.S. organizational changes.
2003 North America Plant Closures
The Company closed its sewing and finishing operations in San Antonio, Texas in January 2004. The Company’s three Canadian facilities, two sewing plants in Edmonton, Alberta and Stoney Creek, Ontario, and a finishing center in Brantford, Ontario, closed in March 2004, displacing approximately 2,050 employees. Production from the San Antonio and Canadian facilities has been shifted to third-party contractors located primarily outside the United States and Canada. During the third quarter of 2003, the Company recorded a charge of approximately $11.0 million for asset write-offs associated with the U.S. and Canadian plant closures. During the fourth quarter of 2003, the Company recorded a charge of $42.1 million consisting of $41.3 million for severance and employee benefits and $0.8 million for other restructuring costs. The Company recorded additional charges during the year ended November 28, 2004 of $12.9 million, net of reversals, for additional severance and employee benefits, facility closure costs and asset write-offs related to these initiatives. As of November 28, 2004, a total of approximately 2,000 employees had been displaced in connection with these plant closures.
During fiscal year 2005, the Company expects to incur additional restructuring costs of approximately $0.7 million for costs relating to contract termination and asset disposals, which will be recorded as they become estimable and probable, or in the case of contract termination costs, when the related contracts are terminated.
The table below displays the restructuring activity and liability balance of the reserve for the 2003 North American plant closures.
During the fourth quarter of 2003, the Company announced reorganization actions to consolidate and streamline operations in its European headquarters in Belgium and in various field offices. As a result, the Company recorded a charge of $28.9 million consisting of $28.1 million for severance and employee benefits and $0.8 million for other restructuring costs. The charge reflected the estimated displacement of approximately
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330 employees. During 2004, the Company recorded a net reversal of approximately $0.6 million as a result of lower than anticipated severance and employee benefits related to this initiative. In addition, the Company recorded a charge of approximately $0.8 million, net of reversals, primarily for legal fees associated with severance negotiations. As of November 28, 2004, all of the employees had been displaced. The Company expects to incur no additional restructuring costs in connection with this action.
The table below displays the activity and liability balance of the reserve for this initiative.
2002 Europe Reorganization Initiatives
In November 2002, the Company initiated the first of a series of reorganization initiatives affecting several countries to realign its resources with its European sales strategy to improve customer service, reduce operating costs and streamline product distribution activities. These actions included the closures of the leased distribution centers in Belgium, France and Holland during the first half of 2004. During the year ended November 28, 2004, the Company recorded a net reversal of approximately $0.4 million as a result of lower than anticipated severance and employee benefits related to this initiative. As of November 28, 2004, all of the employees had been displaced. The Company expects to incur no additional restructuring costs in connection with this initiative.
In 2002, the Company closed six manufacturing plants in the United States, resulting in the displacement of approximately 3,500 employees. For the year ended November 28, 2004, the Company reversed approximately $3.6 million of remaining restructuring reserves related to this initiative due to lower than estimated employee benefit costs. The Company expects to incur no additional restructuring costs in connection with this action.
The table below displays the current year activity for this reserve.
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NOTE 4: INCOME TAXES
The Company’s income tax expense was $65.1 million for the year ended November 28, 2004 compared to $318.0 million for the same period in 2003. The difference between 2004 and 2003 is primarily related to the prior year tax expense relating to a $282.4 million increase in valuation allowance for foreign tax credits, state and foreign net operating loss carryforwards, and alternative minimum tax credits.
The U.S. and foreign components of income (loss) before taxes are as follows:
Domestic
Foreign
Total income before taxes
Income tax expense consists of the following:
Federal — U.S.
Current
Deferred
State — U.S.
Consolidated
Total income tax expense
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For 2004, 2003 and 2002, the Company’s income tax expense differs from the amount computed by applying the U.S. federal statutory income tax rate of 35% to income (loss) before taxes as follows:
Income tax expense at U.S. federal statutory rate
State income taxes, net of U.S. federal impact
Change in valuation allowance
Impact of foreign operations
Goodwill and trademark amortization
Reassessment of reserves due to change in estimate
Other, including non-deductible expenses(1)
The “State income taxes, net of U.S. federal impact” item above reflects the state tax benefit generated by domestic tax losses in the United States, net of the related U.S. federal impact. As not all state losses meet the more likely than not standard for realization, the Company reverses a portion of this benefit from the annual effective tax rate through an increase in the valuation allowance, which is discussed in more detail below. In addition, for 2004 this line includes a non-recurring benefit of approximately $8.3 million arising from a change in the overall state apportionment ratio, changes in state corporate income tax rates, and other factors.
The “Change in valuation allowance” item above relates primarily to deferred tax assets for foreign tax credits, state and foreign net operating loss carryforwards, alternative minimum tax credit carryforwards, and other foreign deferred tax assets. The Company evaluates all significant available positive and negative evidence, including the existence of losses in recent years and its forecast of future taxable income, in assessing the need for a valuation allowance. The underlying assumptions the Company used in forecasting future taxable income require significant judgment and take into account the Company’s recent performance. The valuation allowance increased by $37.1 million, $282.4 million, and $0.6 million for 2004, 2003 and 2002, respectively.
The $37.1 million net increase in 2004 reflects additions of $75.2 million and reversals of $38.1 million as shown in the following table:
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The $18.9 million reversal with respect to foreign tax credits on unremitted foreign earnings arises primarily from a reduction in the gross foreign taxes that are available to accompany future repatriations from foreign affiliate. The $19.2 million reversal with respect to alternative minimum tax credits carryforwards is due primarily to improved business results in the current year and the unlimited carryforward period for the credits. The $39.4 million increase with respect to foreign net operating loss carryforwards and other foreign deferred tax assets is due primarily to a current year increase in the related gross deferred tax asset. Similarly, the $11.2 million increase with respect to deferred tax assets for state net operating loss carryforwards is due primarily to additional current year domestic losses. Additionally, the $24.6 million increase with respect to foreign tax credit carryforwards of the Company and its U.S. affiliates is due primarily to an increase in the related gross deferred tax asset during the current year.
The $282.4 million increase in 2003 relates primarily to deferred tax assets for foreign tax credits, alternative minimum tax credits, and certain state and foreign net operating loss carryforwards. The valuation allowances were established during 2003 as it became more likely than not the Company would not realize a benefit from those assets.
The “Impact of foreign operations” item above reflects differences between the income tax expense relating to the Company’s foreign operations and the U.S. federal statutory income tax rate of 35%. The most significant reconciling items include an additional expense of approximately $20.9 million relating to the Company’s decision to deduct, rather than credit, foreign tax payments, a benefit of approximately $11.2 million relating to the Company’s decision to remove foreign withholding taxes from its calculation of the residual tax due upon the expected future repatriation of foreign earnings, and a benefit of approximately $25.2 million relating primarily to profits and losses earned in foreign jurisdictions with valuation allowances against net operating loss carryforwards. For 2003, the significant reconciling items include the impact of deducting foreign tax payments and the impact of profits and losses in certain foreign jurisdictions. For 2002, the Company’s effective tax rate was not materially impacted by the Company’s foreign operations due to the Company’s ability to utilize foreign tax credits, benefit foreign losses, and other factors.
The “Reassessment of reserves due to change in estimate” item above relates primarily to changes in the Company’s estimate of its contingent tax liabilities. The total increase relates primarily to changes in estimates for existing items and additional new tax exposure items identified during the year. In 2004, the total increase includes additional contingent foreign tax liabilities of approximately $7.8 million, additional net U.S. contingent tax liabilities of approximately $3.4 million, and annual interest on prior year tax liabilities of approximately $4.8 million, net of the related tax benefit.
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The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of November 28, 2004 and November 30, 2003 are presented below.
Deferred tax assets:
Foreign tax credits on unremitted foreign earnings
Post-retirement benefits
Federal net operating loss carryforward
Employee compensation and benefit plans
Foreign net operating loss carryforward
Additional minimum pension liability
Restructuring and special charges
Prepaid royalty income
Inventory basis difference
Foreign tax credit carryforward
State net operating loss carryforward
Alternative minimum tax credit carryforward
Foreign exchange gains and losses
Less: Valuation allowance
Deferred tax liabilities:
Additional U.S. tax on unremitted foreign earnings
Total net deferred tax assets
At November 28, 2004, cumulative foreign operating losses of approximately $415.7 million generated by the Company were available to reduce future taxable income. Approximately $36.3 million of these operating losses expire between the years 2005 and 2014. The remaining $379.4 million carryforward indefinitely. The gross deferred tax asset for the cumulative foreign operating losses of approximately $133.6 million is partially offset by a valuation allowance of approximately $127.8 million.
At November 28, 2004, the Company had a U.S. federal net operating loss carryforward of approximately $428.1 million that will begin to expire in 2022 if not utilized. The utilization of such net operating loss and credit carryforwards may be subject to a substantial annual limitation due to any future “changes in ownership”, as defined by provisions of Section 382 of the Internal Revenue Code of 1986, as amended, and similar state and foreign provisions. Should the Company become subject to this annual limitation, it may result in the expiration of the net operating loss and credit carryforwards before utilization. The gross deferred asset relating to these loss carryforwards of approximately $149.8 million is not offset by a valuation allowance due primarily to taxable temporary differences relating to the Company’s unremitted foreign earnings.
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At November 28, 2004, the Company had foreign tax credit carryforwards of approximately $50.5 million that will begin to expire in 2010 if not utilized. These foreign tax credit carryforwards are completely offset by a valuation allowance due to the carryforward period and limitations in the tax law regarding usage.
At November 28, 2004, the Company had alternative minimum tax credit carryforwards of approximately $24.3 million which carryforward indefinitely.
In addition, at November 28, 2004, the Company had a deferred tax asset of approximately $36.3 million relating to state net operating loss carryforwards. These losses are scheduled to expire between 2005 and 2024 if not utilized. This deferred tax asset is completely offset by a valuation allowance as it is more likely than not the losses will expire unused.
Examination of Tax Returns. The Company has unresolved issues in its consolidated U.S. federal corporate income tax returns for the prior 19 years. A number of these tax returns and certain other state and foreign tax returns are under examination by various regulatory authorities. The Company continuously reviews issues raised in connection with these on-going examinations to evaluate the adequacy of its reserves.
During 2004, the Company reached a partial agreement with the Internal Revenue Service for the years 1990 to 1994 and paid $42.0 million in tax and interest in November 2004. The Company also received a Revenue Agent’s Report during the year for additional issues related to the 1990 to 1994 tax years. The most significant unresolved issue relating to these tax years was the subject of an unfavorable Technical Advice Memorandum from the National Office of the Internal Revenue Service with regard to certain positions taken by the Company on prior returns. The Company filed a protest with the Appeals Division of the Internal Revenue Service relating to the remaining unresolved items for these years.
The Company believes that its accrued tax liabilities are adequate to cover all probable U.S. federal, state, and foreign income tax loss contingencies at November 2004. However, it is reasonably possible the Company may also incur additional income tax liabilities relating to prior years. The Company estimates this additional potential exposure to be approximately $28.6 million. Should the Company’s view as to the likelihood of incurring these additional liabilities change, additional income tax expense may be accrued in future periods. This $28.6 million amount has not been accrued because it currently does not meet the recognition criteria for liabilities under generally accepted accounting principles in the United States.
Reclassifications. As of November 28, 2004 the Company reclassified its remaining balance of contingent tax liabilities from non-current to current to reflect its expected resolution of these open tax issues. Accordingly, the Company’s total long-term liabilities were $0 and $143.1 million at November 28, 2004 and November 30, 2003, respectively.
NOTE 5: PROPERTY, PLANT AND EQUIPMENT
The components of property, plant and equipment (“PP&E”) are as follows:
Land
Buildings and leasehold improvements
Machinery and equipment
Capitalized internal-use software
Construction in progress
Total PP&E
Accumulated depreciation
PP&E, net
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As of November 28, 2004, the Company had approximately $2.3 million of PP&E, net, available for sale, consisting primarily of assets related to closed manufacturing facilities in the United States.
Depreciation expense for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 was $62.4 million, $63.9 million and $59.4 million, respectively.
Construction in progress at November 28, 2004, primarily related to the installation of various analytical software systems in the United States. Construction in progress at November 30, 2003, primarily related to the installation of a worldwide enterprise resource planning system. In the first quarter of 2004, the Company decided to indefinitely suspend this project. (See Note 1 to the Consolidated Financial Statements).
NOTE 6: GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill was $199.9 million as of November 28, 2004 and November 30, 2003. Other intangible assets were as follows:
Amortized intangible assets:
Unamortized intangible assets:
Amortization expense for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 was approximately $0.2 million, $0.3 million and $10.9 million, respectively. Future amortization expense for the next five fiscal years with respect to the Company’s finite lived intangible assets as of November 28, 2004 is estimated at approximately $0.3 million per year.
Pursuant to the provisions of Statement of Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, the company is required to perform an annual impairment test on its goodwill and indefinite lived intangible assets. The Company performed such a test in the fourth quarter of 2004 and determined that no impairment to the carrying value existed for its goodwill or indefinite lived intangible assets.
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NOTE 7: LONG-TERM DEBT
Long-term debt is summarized below:
Term loan
Customer service center equipment financing (1)
7.00%, due 2006 (2)
Principal Amount; Use of Proceeds. On September 29, 2003, the Company entered into a $500.0 million senior secured term loan agreement and a $650.0 million senior secured revolving credit facility. The Company used the borrowings under these agreements to refinance the Company’s January 2003 senior secured credit facility and the Company’s 2001 domestic receivables securitization agreement, and also uses the borrowings for working capital and general corporate purposes. On August 13, 2004, the Company entered into a fourth amendment to the Company’s senior secured revolving credit facility. On August 30, 2004, the Company entered into an amendment to the Company’s senior secured term loan. The amendments primarily provided for the lenders’ consent to the Company’s proposed sale of the Company’s Dockers® business. The amendment to the
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term loan also made changes in the prepayment provisions and the financial, operational and certain other covenants in the Company’s revolving credit facility and term loan, including replacing a consolidated fixed charge ratio covenant with a consolidated senior secured leverage ratio covenant. On November 24, 2004, the Company entered into a fifth amendment to its senior secured revolving credit facility permitting it to convert any cash collateralized letter of credit into a non-cash collateralized letter of credit. The material terms of these amendments are reflected in the discussion below.
Term Loan. The Company’s term loan consists of a single borrowing of $500.0 million, divided into two tranches, a $200.0 million tranche subject to a fixed rate of interest and a $300.0 million tranche subject to floating rates of interest. The loan matures on September 29, 2009. Principal payments on the term loan in an amount equal to 0.25% of the initial principal amount must be made quarterly commencing with the last day of the first fiscal quarter of 2004, and the remaining principal amount of the term loan must be repaid at maturity.
The Company is permitted to prepay the term loan at any time, subject to the payment of certain make-whole premiums to the lenders if the Company desires to prepay the loans outside of certain prepayment periods. The periods during which these make-whole premiums are applicable to voluntary prepayments depend on whether or not the Company has, as of March 31, 2006, refinanced, repaid or otherwise set aside funds for the repayment of all of the Company’s senior unsecured notes due 2006 as required by the term loan agreement. The make-whole premium is calculated by taking the present value of (i) all interest payments due through to the end of the relevant make-whole period plus (ii) any additional prepayment premium (as described below) if such prepayment were made on the day after the relevant make-whole period. If the Company chooses to prepay the term loan outside of the make-whole periods, the Company is not required to pay any make-whole premium, but the Company will be required to pay an additional prepayment premium based on a percentage (which declines over time) of the principal amount of the term loan prepaid. The Company’s term loan also requires mandatory prepayments in specified circumstances, such as if the Company engages in a sale of certain intellectual property assets.
Revolving Credit Facility. The revolving credit facility is an asset-based facility, in which the borrowing availability varies according to the levels of the Company’s accounts receivable, inventory and cash and investment securities deposited in secured accounts with the administrative agent or other lenders. Subject to the level of this borrowing base, the Company may make and repay borrowings from time to time until the maturity of the facility. The maturity date of the facility is September 29, 2007, at which time all borrowings under the facility must be repaid. The Company may make voluntary prepayments of borrowings at any time and must make mandatory prepayments if certain events occur, such as asset sales. The Company must pay an early termination fee if the facility is terminated prior to September 29, 2005.
The Company additionally has the ability to deposit cash or certain investment securities with the administrative agent for the facility to secure the Company’s reimbursement and other obligations with respect to letters of credit. Such cash-collateralized letters of credit are subject to lower letter of credit fees.
Interest Rates. The interest rate for the floating rate tranche of the Company’s term loan is 6.875% over the eurodollar rate or 5.875% over the base rate. The interest rate for the fixed rate tranche of the Company’s term loan is 10.0% per annum. The interest rate for the Company’s revolving credit facility is, for LIBOR rate loans, 2.75% over the LIBOR rate (as defined in the credit agreement) or, for base rate loans, 0.50% over the Bank of America prime rate.
Early Maturity or Default if Notes Not Refinanced. The term loan agreement requires the Company to refinance, repay or otherwise irrevocably set aside funds for all of the Company’s senior unsecured notes due 2006 and 2008 not later than six months prior to their respective maturity dates, failing which the maturity of the term loan is accelerated to a date three months prior to the scheduled maturity date of the 2006 or the 2008 notes,
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respectively. As a result, unless the Company has refinanced, repaid or otherwise irrevocably set aside funds for the payment of all of the 2006 notes by May 1, 2006, the term loan will become due on August 1, 2006, and unless the Company has repaid all of the 2008 notes by July 15, 2007, the term loan will become due on October 15, 2007.
The Company may satisfy this note refinancing requirement under the term loan in one of two ways. First, the Company may refinance the 2006 and 2008 notes by issuing new debt on terms similar to those of the Company’s 12.25% notes due 2012 and using the proceeds to repurchase, repay or otherwise irrevocably set aside the funds for the notes. Second, the Company may repurchase or otherwise set aside funds to repay the 2006 and 2008 notes if the Company meets specified conditions. Those conditions include the Company maintaining (after giving effect of the repayment on a pro forma basis) a leverage ratio that does not exceed 4.75 to 1.0 (for the 2006 notes) and 4.5 to 1.0 (for the 2008 notes) and an interest coverage ratio that exceeds 1.85 to 1.0 (for the 2006 notes) and 2.0 to 1.0 (for the 2008 notes). These ratios apply only to the note refinancing requirements; they are not ongoing financial covenants.
The revolving credit facility contains a similar note refinancing requirement with respect to the 2006 notes, except that the consequence of a failure to repay the notes is a breach of covenant, not early maturity. The Company may also satisfy this requirement under the revolving credit facility if the Company reserves cash or has borrowing availability sufficient to repay the 2006 notes and thereafter has $150.0 million of borrowing availability under the revolving credit facility. See “Item 9B—Other Information” for more information.
Guarantees and Security. The Company’s obligations under each of the term loan and revolving credit facility are guaranteed by the Company’s domestic subsidiaries. The revolving credit facility is secured by a first-priority lien on domestic inventory and accounts receivable, certain domestic equipment, patents and other related intellectual property, 100% of the stock in all domestic subsidiaries, 65% of the stock of certain foreign subsidiaries and other assets. Excluded from the assets securing the revolving credit facility are all of the Company’s most valuable real property interests and all of the capital stock of the Company’s affiliates in Germany and the United Kingdom and any other affiliates that become restricted subsidiaries under the indenture governing the Company’s notes due 2006 and the Yen-denominated Eurobond due 2016 (such restricted subsidiaries also are not permitted to be guarantors). The term loan is secured by a lien on trademarks, copyrights and other related intellectual property and by a second-priority lien on the assets securing the revolving credit facility.
Term Loan Leverage Ratio Covenant. The term loan contains a consolidated senior secured leverage ratio, which is measured as of the end of each fiscal quarter. The ratio is generally defined as the ratio of consolidated secured debt to “Pro Forma Consolidated EBITDA” (as defined in the term loan agreement) for the previous four fiscal quarters. The computation of Pro Forma Consolidated EBITDA allows the Company to add back all restructuring and restructuring related charges less the aggregate amount of cash payments made during such period by the Company in respect of restructuring charges (other than (i) cash payments on restructuring charges incurred prior to May 31, 2004 and (ii) an aggregate of up to $100 million of restructuring charges incurred on or after May 31, 2004 to the extent paid in cash and which the Company has notified the lenders that the Company will exclude for purposes of calculating the leverage ratio covenant in any fiscal quarter).
The Company must ensure that the ratio is not more than:
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As of November 28, 2004, the Company was in compliance with the consolidated senior secured leverage ratio.
Revolving Credit Fixed Charge Coverage Ratio.The revolving credit facility contains a fixed charge coverage ratio. The ratio is measured only if certain availability thresholds are not met. In that case, the ratio is measured as of the end of each month. This ratio is generally defined as the ratio of (i) EBITDA less the sum of (a) capital expenditures and (b) the provision for federal, state and local income taxes for the current period to (ii) the sum of (x) interest charges paid in cash for the relevant period and (y) repayments of scheduled debt during the period. The Company is required to maintain a ratio of least 1.0 to 1.0 when the covenant is required to be tested. As of November 28, 2004, the Company was not required to perform this calculation.
Under the Company’s credit agreements, EBITDA is generally defined as consolidated net income plus (i) consolidated interest charges, (ii) the provision for federal, state, local and foreign income taxes, (iii) depreciation and amortization expense, (iv) other (income) expense and (v) restructuring and restructuring related charges, less cash payments made in respect of the restructuring charges.
Factors that could cause the Company to breach these leverage and fixed charge coverage ratio covenants include lower operating income, higher current tax expenses for which the Company has not adequately reserved, higher cash restructuring costs, higher interest expense due to higher debt or floating interest rates and higher capital spending. There are no other financial covenants in either agreement the Company is required to meet on an ongoing basis.
Covenants. The term loan and the revolving credit facility each contain customary covenants restricting the Company’s activities as well as those of the Company’s subsidiaries, including limitations on the Company’s, and the Company’s subsidiaries’, ability to sell assets; engage in mergers; enter into capital leases or certain leases not in the ordinary course of business; enter into transactions involving related parties or derivatives; incur or prepay indebtedness or grant liens or negative pledges on the Company’s assets; make loans or other investments; pay dividends or repurchase stock or other securities; guaranty third party obligations; make capital expenditures; and make changes in the Company’s corporate structure.
Certain Mergers and Asset Sales Permitted under Term Loan. The term loan permits the Company to merge or sell all or substantially all of the Company’s assets, subject to certain conditions (including financial ratios) similar to those contained in the merger covenant in the indentures relating to the Company’s senior unsecured notes due 2008, the Company’s senior unsecured notes due 2012 and the Company’s senior unsecured notes due 2015.
Events of Default. The term loan and the revolving credit facility each contain customary events of default, including payment failures; failure to comply with covenants; failure to satisfy other obligations under the credit agreements or related documents; defaults in respect of other indebtedness; bankruptcy, insolvency and inability to pay debts when due; material judgments; pension plan terminations or specified underfunding; substantial voting trust certificate or stock ownership changes; specified changes in the composition of the Company’s board of directors; and invalidity of the guaranty or security agreements. The cross-default provisions in each of the term loan and the revolving credit facility apply if a default occurs on other indebtedness in excess of $25.0 million and the applicable grace period in respect of the indebtedness has expired, such that the lenders of or trustee for the defaulted indebtedness have the right to accelerate. If an event of default occurs under either the term loan or the revolving credit facility, the Company’s lenders may terminate their commitments, declare immediately payable the term loan and all borrowings under each of the credit facilities and foreclose on the collateral, including (in the case of the term loan) the Company’s trademarks.
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Customer Service Center Equipment Financing
In December 1999 the Company entered into a secured financing transaction consisting of a five-year credit facility secured by owned equipment at customer service centers (distribution centers) located in Nevada, Mississippi and Kentucky. The amount financed in December 1999 was $89.5 million, comprised of a $59.5 million tranche (“Tranche 1”) and a $30.0 million tranche (“Tranche 2”). Borrowings under Tranche 1 had a fixed interest rate equal to the yield of a four-year Treasury note plus an incremental borrowing spread. Borrowings under Tranche 2 had a floating quarterly interest rate equal to the 90 day LIBOR plus an incremental borrowing spread based on the Company’s leverage ratio at that time. Proceeds from the borrowings were used to reduce the commitment amounts of the then-existing credit facilities.
The equipment in the customer service centers securing this facility was and is not part of the collateral securing the Company’s September 2003 bank credit facility. As of November 28, 2004, there was approximately $55.9 million principal amount outstanding under this facility. This remaining balance was paid at maturity on December 7, 2004.
Senior Notes Due 2006
In 1996, the Company issued $450.0 million ten-year notes maturing in November 2006 to qualified institutional investors in reliance on Rule 144A under the Securities Act of 1933 (the “Securities Act”). The notes are unsecured obligations of the Company and are not subject to redemption before maturity. The ten-year notes bear interest at 7.00% per annum, payable semi-annually in May and November of each year. The discount of approximately $4.7 million on the original issue is being amortized over the term of the notes using an approximate effective-interest rate method. Net proceeds from the notes offering were used to repay a portion of the indebtedness outstanding under a 1996 credit facility agreement.
In May 2000, the Company engaged in a voluntary exchange offer to the note holders. As a result of the exchange offer, all $450.0 million aggregate principal amount of the senior unsecured notes due 2006 were exchanged for new notes on identical terms registered under the Securities Act.
In December 2004, the Company commenced a cash tender offer for the outstanding principal amount of its $450.0 million senior unsecured notes due 2006. The tender offer expired on January 12, 2005. The Company purchased $372.1 million in principal amount tendered of the senior unsecured notes due 2006 with the proceeds from the issuance of the senior unsecured notes due 2015. See further discussion under “Subsequent Event — Issuance of Senior Notes due 2015” below.
Senior Notes Due 2008
Principal, Interest and Maturity. On January 18, 2001, the Company issued two series of notes payable totaling the then-equivalent of $497.5 million to qualified institutional investors in reliance on Rule 144A under the Securities Act and outside the United States in accordance with Regulation S under the Securities Act. The notes are unsecured obligations of the Company and are callable beginning January 15, 2005. The issuance was divided into two series: U.S. $380.0 million dollar notes (“Dollar Notes”) and 125.0 million euro notes (“Euro Notes”), (collectively, the “Notes”). Both series of notes are seven-year notes maturing on January 15, 2008 and bear interest at 11.625% per annum, payable semi-annually in January and July of each year. These Notes were offered at a discount of $5.2 million to be amortized over the term of the Notes. Costs representing underwriting fees and other expenses of $14.4 million on the original issue are amortized over the term of the Notes to interest expense.
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Use of Proceeds. Net proceeds from the offering were used to repay a portion of the indebtedness outstanding under the Company’s then effective credit facility.
Covenants. The indentures governing the Notes contain covenants that limit the Company’s and its subsidiaries’ ability to incur additional debt; pay dividends or make other restricted payments; consummate specified asset sales; enter into transactions with affiliates; incur liens; impose restrictions on the ability of a subsidiary to pay dividends or make payments to the Company and its subsidiaries; merge or consolidate with any other person; and sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the Company’s assets or the assets of the Company’s subsidiaries.
Asset Sales. The indenture governing these notes provides that the Company’s asset sales must be at fair market value and the consideration must consist of at least 75% cash or cash equivalents or the assumption of liabilities. The Company must use the net proceeds from the asset sale within 360 days after receipt either to repay bank debt, with an equivalent permanent reduction in the available commitment in the case of a repayment under the Company’s revolving credit facility, or to invest in additional assets in a business related to the Company’s business. To the extent proceeds not so used within the time period exceed $10.0 million, the Company is required to make an offer to purchase outstanding notes at par plus accrued an unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under the Company’s senior secured term loan and senior secured revolving credit facility.
Change in Control. If the Company experiences a change in control as defined in the indentures governing the Notes, the Company will be required under the indentures to make an offer to repurchase the Notes at a price equal to 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under the Company’s senior secured term loan and senior secured revolving credit facility.
Events of Default. The indenture governing these notes contains customary events of default, including failure to pay principal, failure to pay interest after a 30-day grace period, failure to comply with the merger, consolidation and sale of property covenant, failure to comply with other covenants in the indenture for a period of 30 days after notice given to the Company, failure to satisfy certain judgments in excess of $25.0 million after a 30-day grace period, and certain events involving bankruptcy, insolvency or reorganization. The indenture also contains a cross-acceleration event of default that applies if debt of the Company or of any restricted subsidiary in excess of $25.0 million is accelerated or is not paid when due at final maturity.
Covenant Suspension. If these notes receive and maintain an investment grade rating by both Standard and Poor’s and Moody’s and the Company and its subsidiaries are and remain in compliance with the indenture, then the Company and its subsidiaries will not be required to comply with specified covenants contained in the indenture.
Exchange Offer. In March 2001, after a required exchange offer, all but $200 thousand of the $380.0 million aggregate principal amount Dollar Notes and all but 595 thousand euro of the 125.0 million aggregate principal amount Euro Notes were exchanged for new notes on identical terms registered under the Securities Act.
Senior Notes Due 2012
Principal, Interest and Maturity. On December 4, 2002, January 22, 2003 and January 23, 2003, the Company issued a total of $575.0 million in notes to qualified institutional buyers. These notes are unsecured obligations that rank equally with all of the Company’s other existing and future unsecured and unsubordinated
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debt. They are 10-year notes maturing on December 15, 2012 and bear interest at 12.25% per annum, payable semi-annually in arrears on December 15 and June 15, commencing on June 15, 2003. The notes are callable beginning December 15, 2007. In addition, at any time prior to December 15, 2005, the Company may redeem up to a maximum of 33 1/3% of the original aggregate principal amount of the notes with the proceeds of one or more public equity offerings at a redemption price of 112.25% of the principal amount plus accrued and unpaid interest, if any, to the date of redemption. These notes were offered at a net discount of $3.7 million, which is amortized over the term of the notes using an approximate effective-interest rate method. Costs representing underwriting fees and other expenses of approximately $18.4 million are amortized over the term of the notes to interest expense.
Use of Proceeds. The Company used approximately $125.0 million of the net proceeds from the notes offering to repay remaining indebtedness under the Company’s 2001 bank credit facility and approximately $327.3 million of the net proceeds to purchase the majority of the 6.80% notes due November 1, 2003.
Covenants. The indenture governing these notes contains covenants that limit the Company and its subsidiaries’ ability to incur additional debt; pay dividends or make other restricted payments; consummate specified asset sales; enter into transactions with affiliates; incur liens; impose restrictions on the ability of a subsidiary to pay dividends or make payments to the Company and its subsidiaries; merge or consolidate with any other person; and sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the Company’s assets or its subsidiaries’ assets.
Change in Control. If the Company experiences a change in control as defined in the indenture governing the notes, then the Company will be required under the indenture to make an offer to repurchase the notes at a price equal to 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under the Company’s senior secured term loan and senior secured revolving credit facility.
Events of Default. The indenture governing these notes contains customary events of default, including failure to pay principal, failure to pay interest after a 30-day grace period, failure to comply with the merger, consolidation and sale of property covenant, failure to comply with other covenants in the indenture for a period of 30 days after notice given to the Company, failure to satisfy certain judgments in excess of $25.0 million after a 30-day grace period, and certain events involving bankruptcy, insolvency or reorganization. The indenture also contains a cross-acceleration event of default that applies if debt of the Company or any restricted subsidiary in excess of $25.0 million is accelerated or is not paid when due at final maturity.
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Exchange Offer. In June 2003, after a required exchange offer, all but $9.1 million of the $575.0 million aggregate principal amount of the notes were exchanged for new notes on identical terms registered under the Securities Act
Yen-denominated Eurobond Placement
In 1996, the Company issued a ¥ 20 billion principal amount eurobond (equivalent to approximately $180.0 million at the time of issuance) due in November 2016, with interest payable at 4.25% per annum. The bond is redeemable at the option of the Company at a make-whole redemption price commencing in 2006. Net proceeds from the placement were used to repay a portion of the indebtedness outstanding under a 1996 credit facility agreement.
The agreement governing these bonds contains customary events of default and restricts the Company’s ability and the ability of its subsidiaries and future subsidiaries to incur liens; engage in sale and leaseback transactions and engage in mergers and sales of assets. The agreement contains a cross-acceleration event of default that applies if any of the Company’s debt in excess of $25.0 million is accelerated and the debt is not discharged or acceleration rescinded within 30 days after the Company’s receipt of a notice of default from the fiscal agent or from the holders of at least 25% of the principal amount of the bond.
Subsequent Event — Issuance of Senior Notes Due 2015
Principal, Interest and Maturity. On December 22, 2004, the Company issued $450.0 million in notes to qualified institutional buyers. These notes are unsecured obligations that rank equally with all of the Company’s other existing and future unsecured and unsubordinated debt. They are 10-year notes maturing on January 15, 2015 and bear interest at 9.75% per annum, payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2005. The Company may redeem some or all of the notes prior to January 15, 2010 at a price equal to 100% of the principal amount plus accrued and unpaid interest and a “make-whole” premium. Thereafter, the Company may redeem all or any portion of the notes, at once or over time, at redemption prices specified in the indenture governing the notes, after giving the required notice under the indenture. In addition, at any time prior to January 15, 2008, the Company may redeem up to a maximum of 33 1/3% of the original aggregate principal amount of the notes with the proceeds of one or more public equity offerings at a redemption price of 109.75% of the principal amount plus accrued and unpaid interest, if any, to the date of redemption. Costs representing underwriting fees and other expenses of approximately $10.0 million will be amortized over the term of the notes to interest expense.
Use of Proceeds. The Company used approximately $372.1 million of the $450.0 million of gross proceeds from the notes offering to purchase approximately $372.1 million in aggregate principal amount of its 2006 notes through a tender offer. The Company began the tender offer at the time it launched the bond offering and completed it on January 12, 2005. The Company intends to use the remaining proceeds to repay outstanding debt (which may include any remaining 2006 notes), or for the payment of premiums, fees and expenses relating to the offering and tender offer. The Company may also elect to use these remaining proceeds for other corporate purposes consistent with the requirements of the Company’s credit agreements, indentures and other agreements.
Covenants. The indenture governing these notes contains covenants that limit the Company and its subsidiaries’ ability to incur additional debt; pay dividends or make other restricted payments; consummate specified asset sales; enter into transactions with affiliates; incur liens; impose restrictions on the ability of a subsidiary to pay dividends or make payments to the Company and its subsidiaries; merge or consolidate with any other person; and sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the
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Company’s assets or its subsidiaries’ assets. These covenants are comparable to those contained in the indenture governing the Company’s 11.625% notes due 2008 and the Company’s 12.25% notes due 2012.
Asset Sales. The indenture governing these notes provides that the Company’s asset sales must be at fair market value and the consideration must consist of at least 75% cash or cash equivalents or the assumption of liabilities. The Company must use the net proceeds from the asset sale within 360 days after receipt either to repay bank debt, with an equivalent permanent reduction in the available commitment in the case of a repayment under its revolving credit facility, or to invest in additional assets in a business related to its business. To the extent proceeds not so used within the time period exceed $10.0 million, the Company is required to make an offer to purchase outstanding notes at par plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under the Company’s senior secured term loan and senior secured revolving credit facility.
Change in Control. If the Company experiences a change in control as defined in the indenture governing the notes, then it will be required under the indenture to make an offer to repurchase the notes at a price equal to 101% of the principal amount plus accrued and unpaid interest, if any, to the date of repurchase. Any purchase or prepayment of these notes requires consent of the lenders under the Company’s senior secured term loan and senior secured revolving credit facility.
Events of Default. The indenture governing these notes contains customary events of default, including failure to pay principal, failure to pay interest after a 30-day grace period, failure to comply with the merger, consolidation and sale of property covenant, failure to comply with other covenants in the indenture for a period of 30 days after notice given to the Company, failure to satisfy certain judgments in excess of $25.0 million after a 30-day grace period, and certain events involving bankruptcy, insolvency or reorganization. The indenture also contains a cross-acceleration event of default that applies if debt of Levi Strauss & Co. or any restricted subsidiary in excess of $25.0 million is accelerated or is not paid when due at final maturity.
Covenant Suspension. If these notes receive and maintain an investment grade rating by both Standard and Poor’s and Moody’s and the Company and its subsidiaries are and remain in compliance with the indenture, then the Company and its subsidiaries will not be required to comply with specified covenants contained in the indenture. These provisions are comparable to those contained in the indenture governing the Company’s 11.625% notes due 2008 and the Company’s 12.25% notes due 2012.
Other Debt Matters
Debt Issuance Costs. The Company capitalizes debt issuance costs, which are included in other assets in the accompanying consolidated balance sheet. These costs are being amortized on a straight-line basis over the life of the related debt instruments. Unamortized debt issuance costs at November 28, 2004 and November 30, 2003 were $54.8 million. Amortization of debt issuance costs, which is included in interest expense, was $11.0 million, $13.4 million and $15.8 million in 2004, 2003 and 2002, respectively.
Accrued Interest. At November 28, 2004 and November 30, 2003 accrued interest was $65.6 million and $65.5 million, respectively, and is included in accrued liabilities.
Principal Short-term and Long-term Debt Payments
The maturity date of the term loan will be August 1, 2006 if the Company has not refinanced, repaid or otherwise irrevocably set aside funds to repay the 2006 notes by May 1, 2006, or will be October 15, 2007 if the Company has met the 2006 refinancing condition by May 1, 2006, but has not refinanced, repaid or otherwise irrevocably set aside funds to repay the 2008 notes by July 15, 2007.
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The table below sets forth, as of November 28, 2004, the Company’s required aggregate short-term and long-term debt principal payments for the next five fiscal years and thereafter, after giving effect to the issuance of $450.0 million of 9.75% notes due 2015 in December 2004 and the subsequent purchase of approximately $372.1 million of 7.00% notes due 2006 through a tender offer completed in January 2005, and refinancing condition scenarios under the senior secured term loan:
Fiscal year
Short-Term Credit Lines and Stand-By Letters of Credit
The Company’s total unused lines of credit were $376.0 million at November 28, 2004.
At November 28, 2004, the Company had unsecured and uncommitted short-term credit lines available totaling $16.0 million at various rates. These credit arrangements may be canceled by the bank lenders upon notice and generally have no compensating balance requirements or commitment fees.
As of November 28, 2004, the Company’s calculated availability of $488.1 million under its senior secured revolving credit facility was reduced by $128.1 million of letters of credit and other credit usage allocated under the Company’s senior secured revolving credit facility, yielding a net availability of $360.0 million. Included in the $128.1 million of letters of credit and other credit usage at November 28, 2004 were $19.3 million of trade letters of credit, $2.8 million of other credit usage and $106.0 million of stand-by letters of credit with various international banks, of which $84.1 million serve as guarantees by the creditor banks to cover U.S. workers compensation claims and customs bonds. The Company pays fees on the standby letters of credit, and borrowings against the letters of credit are subject to interest at various rates.
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Interest Rates on Borrowings
The Company’s weighted average interest rate on average borrowings outstanding during 2004, 2003 and 2002, including the amortization of capitalized bank fees, interest rate swap cancellations and underwriting fees, was 10.60%, 10.05% and 9.14%, respectively. The weighted average interest rate on average borrowings outstanding excludes interest payable to participants under deferred compensation plans and other miscellaneous items.
Dividends and Restrictions
Under the terms of the Company’s September 2003 senior secured term loan and senior secured revolving credit facility, the Company is prohibited from paying dividends to its stockholders. In addition, the terms of certain of the indentures relating to the Company’s unsecured senior notes limit the Company’s ability to pay dividends. There are no restrictions under the Company’s term loan and revolving credit facility or its indentures on the transfer of the assets of the Company’s subsidiaries to the Company in the form of loans, advances or cash dividends without the consent of a third party.
Capital Leases
The Company has a logistics services agreement in Europe with a third party that includes an element related to machinery and equipment that is treated as a capital lease. The agreement includes an initial fixed term of approximately five years which runs through 2009, and provides for a renewal option. The cost of the machinery and equipment under this capital lease is included in the consolidated balance sheets as property, plant and equipment, and was approximately $6.7 million as of November 28, 2004. The capitalized lease assets are being amortized on a straight-line basis over the five year life of the agreement. Accumulated depreciation of the leased equipment was approximately $0.8 million at November 28, 2004.
The minimum future lease payments required under capital leases and the present values of the minimum lease payments as of November 28, 2004 are as follows:
2005
2006
Total minimum lease payments
Less: amount representing interest
Present value of minimum lease payments
Less: current maturities of capital lease
Long-term capital lease
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NOTE 8: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount and estimated fair value (in each case including accrued interest) of the Company’s financial instrument assets and liabilities at November 28, 2004 and November 30, 2003 are as follows:
DEBT INSTRUMENTS:
U.S. dollar notes offerings
Euro notes offering
Yen-denominated eurobond placement
Customer service center equipment financing
Short-term and other borrowings
(1) Includes accrued interest of $65.6 million.
(2) Includes accrued interest of $65.5 million.
FOREIGN CURRENCY CONTRACTS:
Foreign exchange forward contracts
Foreign exchange option contracts
The increase in the estimated fair value of the Company’s total debt at November 28, 2004 as compared to the estimated fair value at November 30, 2003 was due primarily to higher trading prices for the Company’s publicly traded U.S. dollar notes offerings at November 28, 2004.
The Company has determined the estimated fair value of certain financial instruments using available market information and valuation methodologies. However, this determination involves application of judgment in interpreting market data, as such, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The Company uses widely accepted valuation models that incorporate quoted market prices or dealer quotes to determine the estimated fair value of its foreign exchange and option contracts. Dealer quotes and other valuation methods, such as the discounted value of future cash flows, replacement cost and termination cost have been used to determine the estimated fair value for long-term debt and the remaining financial instruments. The carrying values of cash and cash equivalents, trade receivables and short-term borrowings approximate fair value. The fair value estimates presented herein are based on information available to the Company as of November 28, 2004 and November 30, 2003.
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NOTE 9: COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company is obligated under operating leases for facilities, office space and equipment. At November 28, 2004, obligations under long-term leases were as follows:
The amounts shown for total minimum lease payments on operating leases have not been reduced by estimated future income of $8.9 million from non-cancelable subleases. The amounts shown for total minimum lease payments on operating leases have not been increased by estimated future operating expense and property tax escalations.
In general, leases relating to real estate include renewal options of up to approximately 20 years, except for the San Francisco headquarters office lease, which contains multiple renewal options of up to 78 years. Some leases contain escalation clauses relating to increases in operating costs. Certain operating leases provide the Company with an option to purchase the property after the initial lease term at the then prevailing market value. Rental expense for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 was $83.0 million, $81.6 million and $78.8 million, respectively.
Foreign Exchange Contracts
At November 28, 2004, the Company had U.S. dollar spot and forward currency contracts to buy $793.8 million and to sell $504.1 million against various foreign currencies. Additionally, the Company had Australian Dollar forward currency contracts to buy 1.3 million Australian Dollars (U.S.$1.0 million equivalent) against the Polish Zloty and the New Zealand Dollar. These contracts are at various exchange rates and expire at various dates through March 2005.
The Company has entered into option contracts to manage its exposure to various foreign currencies. At November 28, 2004, the Company had bought U.S. dollar option contracts resulting in a net long position against various foreign currencies of $12.0 million should the options be exercised. Additionally, the Company bought Euro options resulting in a net long position against Japanese Yen of 10.0 million Euros (U.S. $13.3 million equivalent) should the options be exercised. To finance the premium related to bought options, the Company sold U.S. dollar options resulting in a net long position against various currencies of $36.6 million should the options be exercised. The option contracts are at various strike prices and expire at various dates through February 2005.
The Company is exposed to credit loss in the event of nonperformance by the counterparties to the foreign exchange contracts. However, the Company believes these counterparties are creditworthy financial institutions and does not anticipate nonperformance.
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Other Contingencies
Wrongful Termination Litigation. On April 14, 2003, two former employees of the Company’s tax department filed a complaint in the Superior Court of the State of California for San Francisco County in which they allege that they were wrongfully terminated in December 2002. Plaintiffs allege, among other things, that Levi Strauss & Co. engaged in a variety of fraudulent tax-motivated transactions over several years, that the Company manipulated tax reserves to inflate reported income and that the Company fraudulently failed to set appropriate valuation allowances against deferred tax assets. They also allege that, as a result of these and other tax-related transactions, the Company’s financial statements for several years violate generally accepted accounting principles and Securities and Exchange Commission regulations and are fraudulent and misleading, that reported net income for these years was overstated and that these various activities resulted in the Company paying excessive and improper bonuses to management for fiscal year 2002. Plaintiffs in this action further allege that they were instructed by the Company to withhold information concerning these matters from the Company’s independent registered public accounting firm and the Internal Revenue Service, that they refused to do so and, because of this refusal, they were wrongfully terminated. Plaintiffs seek a number of remedies, including compensatory and punitive damages, attorneys’ fees, restitution, injunctive relief and any other relief the court may find proper.
On March 12, 2004, plaintiffs filed a complaint in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. In this complaint, in addition to restating the allegations contained in the state complaint, plaintiffs assert that the Company violated Sections 1541A et seq. of the Sarbanes-Oxley Act by taking adverse employment actions against plaintiffs in retaliation for plaintiffs’ lawful acts of compliance with the administrative reporting provisions of the Sarbanes-Oxley Act. Plaintiffs seek a number of remedies, including compensatory damages, interest lost on all earnings and benefits, reinstatement, litigation costs, attorneys’ fees and any other relief that the court may find proper. The district court has now related this case to the securities class action (described below) styled In re: Levi Strauss & Co. Securities Litigation.
On December 7, 2004, plaintiffs requested and the Company agreed to, a stay of their state court action in order to first proceed with their action in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. On February 7, 2005, the parties submitted the joint agreement to the court for approval.
The Company is vigorously defending these cases and is pursuing its related cross-complaint against the plaintiffs in the state case. The Company does not expect this litigation to have a material impact on its financial condition or results of operations.
On September 15, 2003, the Company announced that its Audit Committee had completed its investigation of the tax and related accounting issues raised in the wrongful termination suit. The Audit Committee concluded that the Company’s tax and related accounting positions were reasonable and legally defensible and noted that in the course of its investigation it did not discover evidence of tax or other fraud. The Audit Committee also did not find evidence that information was improperly withheld from the Internal Revenue Service with respect to these issues in connection with Internal Revenue Service audits. The Audit Committee investigation was initiated following the filing of the wrongful termination litigation.
The scope of the Audit Committee investigation was to review issues raised in the complaint. The Audit Committee retained independent counsel, Simpson Thacher & Bartlett LLP, to assist it in the investigation. An
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independent accounting firm was retained by Simpson Thacher & Bartlett LLP to consult on specified accounting issues. The investigation took place over a period of approximately four and one-half months, and involved extensive discussions with employees of the Company, various legal and tax advisors, and its independent registered public accounting firm, as well as an extensive review of documents.
In addition to the conclusions noted above, the Audit Committee observed that, during the period from 1994 through 2001, the Company established, maintained and released varying amounts of unspecified tax reserves. These tax reserves were not supported by sufficient contemporaneous documentation that related the reserves to specified tax exposures. In reviewing the matter, the Committee noted that these tax reserves were communicated to and discussed with the Company’s independent registered public accounting firm at the time they were created and maintained. The Company and its Audit Committee are of the view that the handling of the unspecified tax reserves during these periods was not intended to, and did not, materially affect its financial statements filed with the Securities and Exchange Commission (the “SEC”). There was also no evidence of tax or other fraud in connection with the establishment of these reserves.
In the course of the Audit Committee investigation, the Company communicated with the SEC on an informal basis, and expects to continue these communications with respect to the results of the investigation and further developments relating to the litigation as appropriate.
Class Actions Securities Litigation. On March 29, 2004, the United States District Court for the Northern District of California, San Jose Division, issued an order consolidating two recently filed putative bondholder class-actions (styled Orens v. Levi Strauss & Co., et al. and General Retirement System of the City of Detroit, et al. v. Levi Strauss & Co., et al.) against the Company, its chief executive officer, a former chief financial officer, its corporate controller, its directors and financial institutions alleged to have acted as its underwriters in connection with its April 6, 2001 and June 16, 2003 registered bond offerings. Additionally, the court appointed a lead plaintiff and approved the selection of lead counsel. The consolidated action is styled In re Levi Strauss & Co., Securities Litigation, Case No. C-03-05605 RMW (class action).
The action purports to be brought on behalf of purchasers of the Company’s bonds who made purchases pursuant or traceable to its prospectuses dated March 8, 2001 or April 28, 2003, or who purchased the Company’s bonds in the open market from January 10, 2001 to October 9, 2003. The action makes claims under the federal securities laws, including Sections 11 and 15 of the Securities Act of 1933, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, relating to the Company’s SEC filings and other public statements. Specifically, the action alleges that certain of the Company’s financial statements and other public statements during this period materially overstated its net income and other financial results and were otherwise false and misleading, and that its public disclosures omitted to state that it made reserve adjustments that plaintiffs allege were improper. Plaintiffs contend that these statements and omissions caused the trading price of the Company’s bonds to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief. The Company is in the initial stages of this litigation and expects to defend the action vigorously. The Company cannot currently predict the impact, if any, that this action may have on its financial condition or results of operations.
On July 15, 2004, the Company filed a motion to dismiss this action. The matter came before the court on October 15, 2004, and, after oral argument had concluded, the court took the matter under submission. The court has not yet issued a ruling. The Company cannot currently predict the impact, if any, that this action may have on its financial condition or results of operations.
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Other Litigation. In the ordinary course of business, the Company has various other pending cases involving contractual matters, employee-related matters, distribution questions, product liability claims, trademark infringement and other matters. The Company does not believe there are any pending legal proceedings that will have a material impact on its financial condition or results of operations.
NOTE 10: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The global scope of the Company’s business operations exposes it to the risk of fluctuations in foreign currency markets. The Company’s exposure results from certain product sourcing activities, some inter-company sales, foreign subsidiaries’ royalty payments, net investment in foreign operations and funding activities. The Company’s foreign currency management objective is to mitigate the potential impact of currency fluctuations on the value of its U.S. dollar cash flows. The Company typically takes a long-term view of managing exposures, using forecasts to develop exposure positions and engaging in their active management.
The Company operates a centralized currency management operation to take advantage of potential opportunities to naturally offset exposures against each other. For any residual exposures, the Company enters into spot exchange, forward exchange, cross-currency swaps and option contracts to hedge certain anticipated transactions as well as certain firm commitments, including third party and inter-company transactions. The Company manages the currency risk as of the inception of the exposure. The Company does not currently manage the timing mismatch between its forecasted exposures and the related financial instruments used to mitigate the currency risk.
The Company does not apply hedge accounting to its foreign currency derivative transactions, except for certain net investment hedging activities.
The Company primarily uses foreign exchange currency swaps to hedge the net investment in its European operations. For the contracts that qualify for hedge accounting, the related gains and losses are consequently included as cumulative translation adjustments in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit. At November 28, 2004, the fair value of qualifying net investment hedges was a $6.7 million net liability with the corresponding unrealized loss recorded as a cumulative translation adjustment in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit. At November 28, 2004, a $4.4 million realized loss has been excluded from hedge effectiveness testing and therefore is included in “Other expense, net” in the Company’s statement of operations.
The Company designates a portion of its outstanding yen-denominated Eurobond as a net investment hedge. As of November 28, 2004, a $10.1 million unrealized loss related to the translation effects of the yen-denominated Eurobond was recorded as a cumulative translation adjustment in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit.
The table below provides data about the realized and unrealized gains and losses associated with foreign exchange management activities reported in “Other expense, net.”
November 28, 2004
November 30, 2003
November 24, 2002
Other (income)
expense, net
Foreign Exchange Management
Interest Rate Management
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The table below gives an overview of the realized and unrealized gains and losses associated with foreign exchange management activities that are reported as cumulative translation adjustments in the “Accumulated other comprehensive loss” (“Accumulated OCI”) section of Stockholders’ Deficit.
OCI gain (loss)
Net Investment Hedges
Derivative Instruments
Yen Bond
Cumulative income taxes
The table below gives an overview of the fair values of derivative instruments associated with the Company’s foreign exchange management activities that are reported as an asset or (liability).
At November 28,
At November 30,
NOTE 11: GUARANTEES
Indemnification Agreements. In the ordinary course of business, the Company enters into agreements containing indemnification provisions pursuant to which the Company agrees to indemnify the other party for specified claims and losses. For example, the Company’s trademark license agreements, real estate leases, consulting agreements, logistics outsourcing agreements, securities purchase agreements and credit agreements typically contain such provisions. This type of indemnification provision obligates the Company to pay certain amounts associated with claims brought against the other party as the result of trademark infringement, negligence or willful misconduct of Company employees, breach of contract by the Company including inaccuracy of representations and warranties, specified lawsuits in which the Company and the other party are co-defendants, product claims and other matters. These amounts generally are not readily quantifiable: the maximum possible liability or amount of potential payments that could arise out of an indemnification claim depends entirely on the specific facts and circumstances associated with the claim. The Company has insurance coverage that minimizes the potential exposure to certain of such claims. The Company also believes that the likelihood of substantial payment obligations under these agreements to third parties is low and that any such amounts would be immaterial.
Covenants. The Company’s long-term debt agreements contain customary covenants restricting its activities as well as those of its subsidiaries, including limitations on its, and its subsidiaries’, ability to sell assets; engage in mergers; enter into capital leases or certain leases not in the ordinary course of business; enter into transactions involving related parties or derivatives; incur or prepay indebtedness or grant liens or negative pledges on its assets; make loans or other investments; pay dividends or repurchase stock or other securities; guaranty third party obligations; make capital expenditures; and make changes in its corporate structure.
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NOTE 12: EMPLOYEE BENEFIT PLANS
Pension Plans. The Company has several non-contributory defined benefit retirement plans covering substantially all employees. It is the Company’s policy to fund its retirement plans based on actuarial recommendations, consistent with applicable laws, income tax regulations and credit agreement requirements. Plan assets, which may be denominated in foreign currencies and issued by foreign issuers, are invested in a diversified portfolio of securities including stocks, bonds, real estate investment funds and cash equivalents. Benefits payable under the plans are based on either years of service or final average compensation. The Company retains the right to amend, curtail or discontinue any aspect of the plans at any time.
During the years ended November 28, 2004, November 30, 2003 and November 24, 2002, the Company recognized expense of $27.5 million, $38.3 million, and $27.3 million, respectively, related to its defined benefit retirement plans, including a net curtailment gain of approximately $1.8 million for the year ended November 28, 2004.
The $1.8 million net curtailment gain for the year ended November 28, 2004 resulted from a current year amendment to the Company’s U.S. employee benefit Home Office Pension Plan (the “HOPP”). The terms of the amendment are summarized below:
The Company’s pension expense for the years ended November 30, 2003 and November 24, 2002 include the recognition of pension termination losses of $3.9 million and $9.6 million respectively. These losses resulted from the Company’s adoption of early retirement programs during such years for certain employees affected by the Company’s reorganization initiatives. There were no such losses recognized for the year ended November 28, 2004.
The long term portion of the liability balances for all pension plans as of November 28, 2004 and November 30, 2003 was $217.5 million and $250.8 million, respectively. The current portions of the liability balances for all pension plans as of November 28, 2004 and November 30, 2003 were $15.2 million and $4.5 million, respectively, and are included in accrued salaries, wages and employee benefits on the accompanying Consolidated Balance Sheet.
Post-retirement Plans. The Company maintains two plans that provide post-retirement benefits, principally health care, to substantially all U.S. retirees and their qualified dependents. These plans have been established with the intention that they will continue indefinitely. However, the Company retains the right to amend, curtail or discontinue any aspect of the plans at any time. The plans are contributory and contain certain cost-sharing features, such as deductibles and coinsurance. The Company’s policy is to fund post-retirement benefits as claims and premiums are paid.
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During the years ended November 28, 2004, November 30, 2003 and November 24, 2002, the Company recognized income of $31.4 million and expense of $52.4, and $42.6 million, respectively, related to its post-retirement benefits plans, including net curtailment gains of $27.4 million, $21.0 million and $12.6 million, respectively. For the year ended November 28, 2004, income of $31.2 million was reflected in selling, general and administrative expenses, and income of approximately $0.2 million was included in cost of goods sold. For the year ended November 30, 2003, expense of approximately $32.7 million was included in selling general and administrative expenses, and expense of approximately $19.7 million was included in cost of goods sold. For the year ended November 24, 2002, expense of approximately $12.2 million was included in selling, general and administrative expenses, and expense of approximately $30.4 million was included in cost of goods sold.
The Company’s recognition of the $27.4 million net curtailment gain for the year ended November 28, 2004 was due to the following:
The $21.0 million net curtailment gain recognized for the year ended November 30, 2003 resulted from a 2003 amendment to one of the Company’s post-retirement benefits plans that reduced benefit coverage for certain employees and retired participants, and the impact of the Company’s displacement of approximately 350 salaried employees in various locations in the United States. The $12.6 million net curtailment gain recognized for the year ended November 24, 2002 resulted from the Company’s 2002 plant closures.
The long-term portion of the liability balances for the Company’s post-retirement benefits plans as of November 28, 2004 and November 30, 2003 was $493.1 million and $555.0 million, respectively. The current portions of the liability balances for the Company’s post-retirement plans as of November 28, 2004 and November 30, 2003 were $37.7 million and $41.4 million, respectively, and are included in accrued salaries, wages and employee benefits on the accompanying consolidated balance sheet.
Adoption of Financial Accounting Standards Board Staff Position 106-2. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”) was signed into law. The Act introduced a prescription drug benefit under Medicare (Medicare Part D) and a federal subsidy to sponsors of retirement health care plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB issued Staff Position 106-2, providing final guidance on accounting for the Act. The Company recorded the effects of the federal subsidy in measuring net periodic post-retirement benefit cost for the year ended November 28, 2004. This resulted in a reduction in the accumulated post-retirement benefit obligation (“APBO”) for the subsidy related to benefits attributed to past service of $21.4 million. The subsidy resulted in a reduction in current period net periodic post-retirement benefit costs for the year ended November 28, 2004 of $1.7 million. The components of these savings were the reduction in interest costs on APBO of $0.7 million, amortization of net loss of $1.0 million and an immaterial reduction in current period service costs. The Company expects to receive subsidy payments beginning in fiscal year ending November 30, 2006.
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SFAS 132R Disclosures. The following tables summarize activity of the Company’s defined benefit pension plans and post-retirement benefit plans in accordance with the disclosure requirements of SFAS 132R, “Employer’s Disclosure about Pension and Other Postretirement Benefits”:
Change in benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Plan participants’ contribution
Plan amendments
Actuarial loss (gain)
Net curtailment (gain) loss
Impact of foreign currency changes
Special termination benefits
Benefits paid (2)
Benefit obligation at end of year
Change in plan assets:
Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contribution
Plan participants’ contributions
Plan settlements (3)
Fair value of plan assets at end of year
Funded status
Unrecognized net transition obligation
Unrecognized prior service cost
Unrecognized net actuarial loss (gain)
Net amount recognized on the balance sheet
The consolidated balance sheets consist of:
Accrued benefit liability — current portion
Accrued benefit liability — long-term portion
Prepaid benefit cost
Intangible asset
Accumulated other comprehensive income
Net amount recognized on balance sheet
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The Company’s pension and post-retirement liabilities reflected on the consolidated balance sheets as of November 28, 2004 and November 30, 2003 consist of the following:
Current portion of SFAS 87 plans
Current portion of other benefit plans
Total current benefit plans liability
Long-term portion of SFAS 87 plans
Long-term portion of other benefit plans
Total long-term benefit plans liability
Information for pension benefit plans with accumulated benefit obligations exceeding the fair value of plan assets is as follows:
Aggregate projected benefit obligation
Aggregate accumulated benefit obligation.
Aggregate fair value of plan assets
The components of the Company’s net periodic benefit cost (income) were as follows:
Expected return on plan assets
Amortization of prior service cost
Amortization of transition asset
Amortization of actuarial (gain) loss
Termination benefits
Net periodic benefit cost (income)
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Assumptions used in the accounting for the Company’s benefit plans were as follows:
Weighted-average assumptions used to determine net periodic benefit cost:
Discount rate
Rate of compensation increase
Weighted-average assumptions used to determine benefit obligations:
Assumed health care cost trend rates were as follows:
Health care trend rate assumed for next year
Rate trend to which the cost trend is assumed to decline
Year that rate reaches the ultimate trend rate
During 2004, the Company changed its method for determining the discount rates used in accounting for its pension plans. The Company now utilizes a bond pricing model that is tailored to the attributes of its pension plans to determine the appropriate discount rate to use for each of its plans. In prior years, the Company utilized information from a third party bond index to determine its discount rates.
Assumed health care cost trend rates have a significant effect on the amounts reported for the Company’s post-retirement benefits plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
Effect on the Company’s total service and interest cost components
Effect on the Company’s post-retirement benefit obligation
The allocation of the Company’s pension plan assets, by asset category was as follows:
Asset category
Equity securities
Debt securities
Real estate
The Company utilizes the services of a third party independent investment manager to oversee the management of its plans’ assets. The Company’s investment strategy is to invest the plans’ assets in a diversified portfolio of domestic and international equity, fixed income and real estate securities with the objective of generating long-term growth in plan assets at a reasonable level of risk.
The Company’s contributions to the pension and post-retirement plans in 2005 are estimated to be approximately $19.3 million and $36.1 million, respectively.
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The Company’s estimated future benefit payments for the fiscal years 2005 through 2009, and in the aggregate for the years 2010 through 2014, which reflect expected future service, as appropriate, are anticipated to be paid as follows:
Pension
Benefits
Post-retirement
2010-2014
NOTE 13: EMPLOYEE INVESTMENT PLANS
The Company maintained three employee investment plans as of November 28, 2004. The Employee Savings and Investment Plan of Levi Strauss & Co. (“ESIP”) and the Levi Strauss & Co. Employee Long-Term Investment and Savings Plan (“ELTIS”) are two qualified plans that cover eligible Home Office employees and U.S. field employees, respectively. The Capital Accumulation Plan of Levi Strauss & Co. (“CAP”) was a non-qualified, self-directed investment program for highly compensated employees (as defined by the Internal Revenue Code). The CAP was terminated, effective November 29, 2004. Effective January 1, 2005, highly compensated ESIP participants may make excess deferral contributions under the Deferred Compensation Plan for Executives and Outside Directors.
Total amounts charged to expense for these plans for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 were $9.7 million, $0.9 million, and $13.3 million, respectively. As of November 28, 2004, the Company had accrued $6.6 million. As of November 30, 2003 there was no accrual related to these plans.
ESIP/ELTIS. Under ESIP and ELTIS, eligible employees may contribute and direct up to 15% of their annual compensation to various investments among a series of mutual funds. The Company matches 100% of ESIP participant’s contributions to all funds maintained under the qualified plan up to the first 7.5% of eligible compensation. Under ELTIS, the Company may match 50% of participant’s contributions to all funds maintained under the qualified plan up to the first 10% of eligible compensation. Employees are always 100% vested in the Company match. The ESIP and the ELTIS allow employees a choice of either pre-tax or after-tax contributions. The ELTIS also includes a profit sharing provision with payments made at the sole discretion of the board of directors. The Company matched eligible employee contributions in ELTIS at 50% for the fiscal years ended November 28, 2004, November 30, 2003, and November 24, 2002.
CAP. The CAP allowed eligible employees to contribute on an after-tax basis up to 10% of their eligible compensation to an individual retail brokerage account. The Company’s matching contributions were paid in cash to each employee’s account. Employees were 100% vested in the Company match. All investment decisions, related commissions and charges, investment results and tax reporting requirements were the responsibility of the employee. Certain employees were eligible to participate in the CAP plan after reaching specific contribution thresholds in the ESIP plan and salary thresholds. Highly paid participants in the ESIP were permitted to make after-tax contributions into the CAP for amounts that could not be contributed to the ESIP due to plan limitations. The Company would then match a portion of the CAP contributions.
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The Company’s matching of eligible employee contributions for CAP was determined based on a graded scale from 0% to 115%. The level of the matching contribution was determined at year end based upon business performance. The Company matched eligible employee contributions at 115%, 0% and 115% for the fiscal years ended November 28, 2004, November 30, 2003, and November 24, 2002, respectively.
NOTE 14: EMPLOYEE COMPENSATION PLANS
Annual Incentive Plan
The Annual Incentive Plan (“AIP”) is intended to reward individual contributions to the Company’s performance during the year. The amount of the cash bonus earned depends on business unit and corporate financial results as measured against pre-established targets, and also depends upon the performance and job level of the individual. Total amounts charged to expense for the years ended November 28, 2004, November 30, 2003 and November 24, 2002, were approximately $70.4 million, $9.1 million and $44.4 million, respectively. As of November 28, 2004 and November 30, 2003, the Company had accrued $70.4 million and $10.5 million, respectively, for the AIP plan, which was recorded in accrued salaries, wages and benefits.
Long-Term Incentive Plan
2004 Interim Long-Term Incentive Plan. In February 2004, the Company established a new interim cash-based long-term incentive plan for its management level employees, including its executive officers, and its non-stockholder directors. The Company set a target amount for each participant based on job level. The interim plan, which covers a 19-month period (December 2003 through June 2005), includes both performance and retention elements as conditions for payment. Key plan features include:
The terms of the plan are governed by the plan document. The Company’s board has discretion to interpret, amend and terminate the plan.
The Company recorded long-term incentive compensation expense of $45.2 million, a net reversal of $138.8 million, and expense of $70.3 million, for the years ended November 28, 2004, November 30, 2003 and November 24, 2002, respectively. The net reversal recorded in 2003 was attributable to lower than expected payouts under the plan in place in 2003 due to changes in the Company’s forecasted financial performance. As of November 28, 2004, the Company had accrued $34.7 million for the long-term incentive plan., which was recorded in accrued salaries, wages and benefits. As of November 30, 2003, there were no such amounts accrued.
2005 Long-Term Incentive Plan. The Company established a new long-term incentive plan effective at the beginning of fiscal 2005. The plan is intended to reward management and certain executive level employees for
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their long-term impact on total Company earnings performance. Performance will be measured at the end of a three-year period based on the Company’s performance over the period measured against the following pre-established targets: (i) the Company’s target cumulative earnings before interest, taxes, depreciation and amortization for the three-year period; and (ii) the target compound annual growth rate in the Company’s earnings before interest, taxes, depreciation and amortization over the three-year period. Individual target amounts are set for each participant based on job level. Awards will be paid out the quarter following the end of the three-year period based on Company performance against objectives. Executive officers are not participants in this plan. They participate in the new Senior Executive Long-Term Incentive Plan described below.
Senior Executive Long-Term Incentive Plan. At its meeting on February 3, 2005, the Company’s board approved the design of a new executive compensation plan, the Senior Executive Long-Term Incentive Plan. The plan is intended to provide long-term incentive compensation for the Company’s senior management. The Company’s executive officers and non-employee members of the board will be eligible to participate in the plan.
Key elements of the plan include the following:
The board did not establish the strike price, target price or the number of units to be granted to individual participants in the initial grant. The authority to make those determinations was delegated by the board to the board’s Human Resources Committee, with the concurrence of the chair of the board’s Finance Committee.
Other Compensation Plans
Cash Performance Sharing Plans. The Company awards cash payments to production employees worldwide through its Cash Performance Sharing Plans based on a percentage of annual salary and the same performance measures prescribed in the Company’s AIP plan. The largest individual plan is the U.S. Field Profit Sharing Plan that covers approximately 1,000 U.S. employees. The total amounts charged to expense for the U.S. Field Profit Sharing Plan for the years ended November 28, 2004, November 30, 2003 and November 24, 2002 were $2.3 million, $0.0 million and $3.2 million, respectively. As of November 28, 2004 and November 30, 2003, the Company had accrued $2.3 million and $0 million, respectively for its Cash Performance Sharing Plans, which was recorded in accrued salaries, wages and benefits.
Performance Sharing Plan. The Performance Sharing Plan is a new annual bonus plan in 2004 for non-management level employees in North and South America who do not participate in any other annual bonus plan. The purpose of the Plan is to reward participants when at least 100% of the annual business objectives are
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achieved. The performance measure used to determine award amounts under this plan is the same measure as in the AIP plan. The total amounts charged to expense for the Performance Sharing Plan for the year ended November 28, 2004 was $4.5 million. As of November 28, 2004, the Company had accrued $4.5 million for this plan, which was recorded in accrued salaries, wages and benefits.
NOTE 15: LONG-TERM EMPLOYEE RELATED BENEFITS
The liability for long-term employee related benefits is comprised of the following:
Workers’ compensation
Deferred compensation
Workers’ compensation. Included in the liability for workers’ compensation are accrued expenses related to the Company’s program in the United States that provides for early identification and treatment of employee injuries. Workers’ compensation expense of $3.2 million, $30.8 million and $42.1 million was recorded for the years ended November 28, 2004, November 30, 2003 and November 24, 2002, respectively. For the year ended November 28, 2004, the Company reduced its self-insurance reserves for workers compensation claims by approximately $18.0 million, which resulted in a decrease in selling general and administrative expense of $16.0 million and a decrease in cost of goods sold of $2.0 million. The reduction was driven by changes in the Company’s estimated future claims payments and related expenses as a result of more favorable than projected actual claims and expense experience during the year and corresponding reductions to claims projected for future periods. For the years ended November 30, 2003 and November 24, 2002, the Company’s workers compensation expense included provisions of $7.6 million and $17.9 million, respectively, related to the plant closures that occurred during those years. As of November 28, 2004 and November 30, 2003, the current portions of workers’ compensation liabilities were approximately $12.6 million and $16.1 million, respectively, and were included in accrued salaries, wages and employee benefits.
Deferred compensation. The Company has a non-qualified deferred compensation plan for executives and outside directors. As of November 28, 2004, and November 30, 2003, plan liabilities totaled $24.8 million and $27.8 million, respectively, of which approximately $3.7 million and $4.0 million for 2004 and 2003, respectively are associated with funds held in an irrevocable grantor’s trust (“Rabbi Trust”) established on January 1, 2003. The deferred compensation plan obligations are payable in cash upon retirement, termination of employment and/or certain other times in a lump-sum distribution or in installments, as elected by the participant in accordance with the plan.
The obligations of the Company under the Rabbi Trust consist of the Company’s unsecured contractual commitment to deliver, at a future date, any of the following: (i) deferred compensation credited to an account under the Rabbi Trust, (ii) additional amounts, if any, that the Company may, from time to time, credit to the Rabbi Trust, and (iii) notional earnings on the foregoing amounts. In the event that the fair market value of the Rabbi Trust assets as of any valuation date before a change of control is less than 90% of the Rabbi Trust funding requirements on such date, the Company must make an additional contribution to the Rabbi Trust in an amount sufficient to bring the fair market value of the assets in the Rabbi Trust up to 90% of the trust funding requirement. The Rabbi Trust assets are subject to the claims of the Company’s creditors in the event of the Company’s insolvency. The assets of the Rabbi Trust and the Company’s liability to the Plan participants are
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reflected in “Other long-term assets” and “Long-term employee related benefits,” respectively, on the Company’s consolidated balance sheet. The securities that comprise the assets of the Rabbi Trust are designated as trading securities under SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” Changes in the fair value of the securities have initially been recorded in “Other expense, net.” Expenses accrued under the plan are included in “Selling, general and administrative expenses.”
The Company also maintains a prior non-qualified deferred compensation plan relating to compensation expense payable before January 1, 2003. The Rabbi Trust is not a feature of that plan. As of November 28, 2004 and November 30, 2003 plan liabilities totaled $96.7 million and $111.0 million, respectively, of which $26.1 million and $17.8 million, respectively, was classified as short-term.
NOTE 16: COMMON STOCK
The Company has a capital structure consisting of 270,000,000 authorized shares of common stock, par value $.01 per share, of which 37,278,238 shares are issued and outstanding.
NOTE 17: RELATED PARTIES
Agreement with Alvarez & Marsal, Inc.
On December 1, 2003, the Company appointed James P. Fogarty, a managing director with Alvarez & Marsal, Inc. (“A&M”), as its interim chief financial officer. The Company’s agreement with Alvarez & Marsal, Inc. also provided that Antonio Alvarez, co-founding managing director of A&M, would serve as Senior Advisor to the Company and act as an executive officer. Mr. Alvarez completed his work as senior advisor and left that position in April 2004. On May 18, 2004, the Company amended its December 2003 engagement agreement with A&M. Under the amended agreement, the Company agreed to pay A&M, in addition to regular compensation for its services, a cash bonus of $1.5 million as an incentive for them to complete successfully their work in assisting the Company in implementing cost reduction actions and in respect of James P. Fogarty’s role as the Company’s chief financial officer. The Company paid $500,000 of this minimum bonus in each of June 2004 and October 2004, and paid the remaining amount in February 2005. In addition, the Company agreed to pay A&M an additional incentive bonus of $1.0 million, which will be paid by the Company in late February 2005 upon the Company’s achievement of certain financial performance, financial reporting and control and planning activities. During the year ended November 28, 2004, the Company expensed approximately $12.3 million related to services provided under the A&M agreement. As of November 28, 2004, the Company had accrued approximately $1.4 million related to amounts due to A&M, including the remaining bonus amounts payable.
Other transactions
Robert E. Friedman, a director of the Company, is founder and chairman of the board of the Corporation for Enterprise Development, a not-for-profit organization focused on creating economic opportunity by helping residents of poor communities save and invest, succeed as entrepreneurs and participate as contributors to and beneficiaries of the economy. In 2003, the Company donated $50,000 to the Corporation for Enterprise Development. During 2002, the Levi Strauss Foundation donated $65,000.
James C. Gaither, a director of the Company, was prior to 2004 senior counsel to the law firm Cooley Godward LLP. The firm provided legal services to the Company and to the Human Resources Committee of the Company’s Board of Directors during the years ended November 28, 2004, November 30, 2003 and November 24, 2002, and received fees for such services approximating $150,000, $250,000 and $18,000, respectively.
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Peter A. Georgescu, a director of the Company, is Chairman Emeritus of Young & Rubicam, Inc., WPP Group plc, a global advertising agency. The agency provided advertising services to the Company in 2003, and 2002 and received in fees approximately $18,800 and $15,200 respectively. No services were provided in 2004. Mr. Georgescu is a director of Toys “R” Us, Inc. The Company made a $5,000 donation to the Toys “R” Us Children’s Fund in 2004.
NOTE 18: BUSINESS SEGMENT INFORMATION
During 2004, the Company changed the structure of its U.S. business operations as a result of its reorganization initiatives. The Company’s business operations in the United States are now organized and managed principally through Levi’s®, Dockers® and Levi Strauss Signature™ commercial business units. The Company’s operations in Canada and Mexico are included in its North America region along with its U.S. commercial business units. The structure of its international business operations have not changed. They are organized and managed through its Europe and Asia Pacific regions. The Company’s Europe region includes Eastern and Western Europe; Asia Pacific includes Asia Pacific, the Middle East, Africa and Central and South America. Each of the business segments is managed by a senior executive who reports directly to the Company’s chief executive officer. The Company manages its business operations, evaluates performance and allocates resources based on the operating income of its segments, excluding restructuring charges, net of reversals, and excluding depreciation and amortization. Corporate expense is comprised of long-term incentive compensation (expense) reversal, restructuring charges, net of reversals, depreciation and amortization, and other corporate expenses, including corporate staff costs.
As a result of the changes in the Company’s reportable segments for the current year, the information for prior years has been revised to conform with the current year presentation. No single country other than the United States had net sales exceeding 10% of consolidated net sales for any of the years presented. The Company does not report assets by segment because assets are not allocated to its segments for purposes of measurement by the Company’s chief operating decision maker.
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Business segment information for the Company is as follows:
Net sales:
Total North America
Consolidated net sales
Operating income:
Consolidated operating income
Less: Interest expense
Less: Other expenses, net
Geographic information:
United States
Foreign countries
Long-lived assets:
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NOTE 19: QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below are the consolidated statements of operations for the first, second, third and fourth quarters of fiscal 2004, 2003 and 2002.
Year Ended November 28, 2004
Long-term incentive compensation
(Gain) loss on sale of assets
Income tax expense (benefit)
Year Ended November 30, 2003
Long-term incentive compensation (reversal)
Gain on sale of assets
Operating income (loss)
Net (loss)
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Year Ended November 24, 2002
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None.
Item 9A. CONTROLS AND PROCEDURES
In conjunction with their audit of our financial statements for the years ended November 30, 2003, November 24, 2002 and November 25, 2001, our independent registered public accounting firm identified certain items that were determined to be a material weakness under standards established by the American Institute of Certified Public Accountants:
In response to the matters described in these communications from our independent registered public accounting firm, we took actions during 2004 to address these issues, including the following:
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We believe these actions have strengthened our internal control over financial reporting and addressed the material weakness identified by our independent registered public accounting firm in conjunction with their prior year audit. In conjunction with their audit of our consolidated financial statements for 2004, our independent registered public accounting firm did not advise our management or our Audit Committee of any material weaknesses related to our internal controls or operations.
In addition, in conjunction with their audit, our independent registered public accounting firm identified three significant deficiencies in our internal control. None of them relate to the subject matter of the prior material weakness, and they do not in the aggregate constitute a material weakness. These significant deficiencies are summarized as follows:
We believe we will satisfactorily address most of the control deficiencies relating to these matters by the end of the first half of 2005, although there can be no assurance that we will do so.
As of November 28, 2004, we updated our evaluation of the effectiveness of the design and operation of our disclosure controls and procedures for purposes of filing reports under the Securities Exchange Act of 1934 (the “Exchange Act”). This controls evaluation was done under the supervision and with the participation of management, including our chief executive officer and our chief financial officer, and took into account the actions we took in 2004 in response to the communication of the material weakness from our independent registered public accounting firm in conjunction with their prior year audit. Our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures (as defined in Rule13(a)-15(e) and 15(d)-15(e) under the Exchange Act) are effective to provide reasonable assurance that information relating to us and our subsidiaries that we are required to disclose in the reports that we file or submit to the SEC is recorded, processed, summarized and reported with the time periods specified in the SEC’s rules and forms.
We will not be subject to the internal control requirements of Section 404 of the Sarbanes-Oxley Act of 2002 until our annual report for fiscal year 2005. Although we currently believe we are on schedule to achieve
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compliance with Section 404 within the prescribed time period, there can be no assurance we will timely meet such requirements. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Our Future Results—Risks Relating to Our Business—Beginning in 2005, we are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. Failure to timely comply with the requirements of Section 404 or any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on the trading price of our debt securities.”
Item 9B. OTHER INFORMATION
Limited Waiver Under Senior Secured Revolving Credit Facility Regarding Prepayment of 11.625% Senior Unsecured Notes due 2008
On February 15, 2005, we obtained a limited waiver under our senior secured revolving credit agreement, dated as of September 29, 2003, as amended on September 30, 2003, October 14, 2003, March 18, 2004, August 13, 2004 and November 24, 2004.
Under the limited waiver, the lenders have waived our compliance with clause (i) of the proviso to subsection 7.27(i) of the senior secured revolving credit agreement to the extent necessary to permit us to prepay all or part of our outstanding 11.625% senior unsecured notes due January 2008, provided that such prepayment is funded solely from the (a) proceeds of one or more new issuances of permitted notes that are issued after February 15, 2005, and (b) up to $77.9 million of unused proceeds from our issuance in December 2004 of our 9.75% notes due 2015.
The limited waiver took effect as of February 15, 2005.
A copy of the limited waiver is included with this Annual Report on Form 10-K as Exhibit 10.26.
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PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS
Set forth below is information concerning our directors and executive officers as of November 28, 2004.
Name
Office and Position
Robert D. Haas
Philip A. Marineau
Angela Glover Blackwell(5)(7)
Robert E. Friedman(5)
James C. Gaither(4)(7)
Peter A. Georgescu(4)(6)
Miriam L. Haas(1)(5)
Peter E. Haas, Jr.(6)
Walter J. Haas(5)
F. Warren Hellman(4)(6)
Patricia A. House(6)(7)
Patricia Salas Pineda(4)(5)
T. Gary Rogers(6)(7)
G. Craig Sullivan(4)(7)
R. John Anderson(2)
David G. Bergen
James P. Fogarty(3)
Robert L. Hanson
Scott A. LaPorta
Paul Mason
Albert F. Moreno
Fred D. Paulenich
Lawrence W. Ruff
Roberta H. Silten
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All members of the Haas family are descendants of our founder, Levi Strauss. Peter E. Haas, Jr. is a cousin of of Robert D. Haas and Walter J. Haas, who are brothers. Miriam L. Haas is the stepmother of Peter E. Haas, Jr. Robert E. Friedman is a descendant of Daniel E. Koshland, who joined his brother-in-law, Walter A. Haas, Sr., in our management in 1922.
Robert D. Haas is the Chairman of our board. He was named Chairman in 1989 and served as Chief Executive Officer from 1984 until 1999. Mr. Haas joined us in 1973 and served in a variety of marketing, planning and operating positions before becoming Chief Executive Officer.
Philip A. Marineau, a director since 1999, is our President and Chief Executive Officer. Prior to joining us, Mr. Marineau was the President and Chief Executive Officer of Pepsi-Cola North America from 1997 to 1999. From 1996 to 1997, Mr. Marineau was President and Chief Operating Officer of Dean Foods Company. From 1972 to 1996, Mr. Marineau held a series of positions at Quaker Oats Company including President and Chief Operating Officer from 1993 to 1996. Mr. Marineau is currently a director of Meredith Corporation and Kaiser Permanente.
Angela Glover Blackwell, a director since 1994, is founder and chief executive officer of PolicyLink, a nonprofit research, advocacy and communications organization devoted to eliminating poverty and strengthening communities. From 1995 to 1998, Ms. Blackwell was Senior Vice President of the Rockefeller Foundation where she oversaw the foundation’s domestic and cultural divisions. Ms. Blackwell was the founder of Oakland, California’s Urban Strategies Council, a nonprofit organization focused on reducing persistent urban poverty.
Robert E. Friedman, a director since 1998, is founder and Chairman of CFED, a Washington, D.C.-based not-for-profit organization focused on creating economic opportunity by helping residents of poor communities save and invest, succeed as entrepreneurs and participate as contributors to and beneficiaries of the economy. He also serves as a director of Ecotrust, the Rosenberg Foundation and the National Fund for Enterprise Development.
James C. Gaither, a director since 1988, is Managing Director of Sutter Hill Ventures, a venture capital investment firm. Prior to 2000, he was a partner of, and prior to 2004, he was senior counsel to, the law firm of Cooley Godward LLP in San Francisco, California. Prior to joining Cooley Godward in 1969, he served as law clerk to the Honorable Earl Warren, Chief Justice of the United States, special assistant to the Assistant Attorney General in the U.S. Department of Justice and staff assistant to the President of the United States, Lyndon B. Johnson. Mr. Gaither is currently a director of Nvidia Corporation, Siebel Systems, Inc., Kineto, Inc. and Satmetrix, Inc.
Peter A. Georgescu, a director since February 2000, is Chairman Emeritus of Young & Rubicam Inc. (now WPP Group plc), a global advertising agency. Prior to his retirement in January 2000, Mr. Georgescu served as Chairman and Chief Executive Officer of Young & Rubicam since 1993 and, prior to that, as President of Y&R Inc. from 1990 to 1993, Y&R Advertising from 1986 to 1990 and President of its Young & Rubicam international division from 1982 to 1986. Mr. Georgescu is currently a director of IFF Corporation, Toys “R” Us, Inc. and EMI Group plc.
Miriam L. Haas, a director since July 2004, is president of the Miriam and Peter Haas Fund. Ms. Haas is a trustee and chair of the accessions committee of the San Francisco Museum of Modern Art and is vice chair of the board of trustees and chair of the audit committee of the New York Museum of Modern Art. She is a member of the Board of Visitors at the Terry Sanford Institute of Public Policy at Duke University, the Advisory Board of the Haas Center for Public Service at Stanford University and the Global Philanthropists Circle.
Peter E. Haas, Jr., a director since 1985, is a director or trustee of each of the Levi Strauss Foundation, Red Tab Foundation, San Francisco Foundation, Walter and Elise Haas Fund and the Novato Youth Center Honorary
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Board. Mr. Haas was one of our managers from 1972 to 1989. He was Director of Product Integrity of The Jeans Company, one of our former operating units, from 1984 to 1989. He served as Director of Materials Management for Levi Strauss USA in 1982 and Vice President and General Manager in the Menswear Division in 1980.
Walter J. Haas, a director since 1995, served as Chairman and Chief Executive Officer of the Oakland A’s Baseball Company from 1993 to 1995, President and Chief Executive Officer from 1991 to 1993 and in other management positions with the club from 1980 to 1991.
F. Warren Hellman, a director since 1985, has served as chairman and general partner of Hellman & Friedman LLC, a private investment firm, since its inception in 1984. Previously, he was a general partner of Hellman Ferri (now Matrix Partners) and managing director of Lehman Brothers Kuhn Loeb, Inc. Mr. Hellman is currently a director of DN&E Walter & Co., Sugar Bowl Corporation, Osterweis Capital Management, Inc. and Offit Hall Capital Management. Mr. Hellman also served as a director of NASDAQ Stock Market, Inc. through February 2004.
Patricia A. House, a director since July 2003, is Vice Chairman of Siebel Systems, Inc. She has been with Siebel Systems, Inc. since its inception in July 1993 and has served as its Vice Chairman, Co-Founder and Vice President, Strategic Planning since January 2001. From February 1996 to January 2001, she served as its Co-Founder and Executive Vice President and from July 1993 to February 1996 as Co-Founder and Senior Vice President, Marketing. Ms. House is currently a director of Siebel Systems, Inc.
Patricia Salas Pineda, a director since 1991, is currently group vice president of corporate communications and general counsel for Toyota Motor North America, Inc., a position she assumed in September 2004. Prior to joining Toyota Motor North America, Inc., Ms. Pineda was vice president of legal, human resources and government relations and corporate secretary of New United Motor Manufacturing, Inc. with which she was associated since 1984. She is currently a trustee of the RAND Corporation and Mills College and a director of the James Irvine Foundation and Anna’s Linens.
T. Gary Rogers, a director since 1998, is Chairman of the Board and Chief Executive Officer of Dreyer’s Grand Ice Cream, Inc., a manufacturer and marketer of premium and super-premium ice cream products. He has held this position since 1977. He serves as a director of Shorenstein Company, L.P., Stanislaus Food Products and the Federal Reserve Bank of San Francisco.
G. Craig Sullivan, a director since 1998, is the retired Chairman of the Board and Chief Executive Officer of The Clorox Company, a major consumer products firm. He served as Chief Executive Officer of The Clorox Company from 1992 until June 2003. He remained Chairman of the board of The Clorox Company until his retirement in December 2003. Prior to his election as Chairman and Chief Executive Officer of The Clorox Company, Mr. Sullivan was group vice president with overall responsibility for manufacturing and marketing, the company’s laundry and cleaning products in the United States, the international business, the manufacturing and marketing of products for the food service industry and the corporate purchasing and distribution functions. Mr. Sullivan currently serves on the board of directors of Mattel, Inc. and Kimberly-Clark Corp.
R. John Anderson, our Senior Vice President and President of our Asia Pacific Division since 1998 and President of our global supply chain organization since March 2004, joined us in 1979. Mr. Anderson served as General Manager of Levi Strauss Canada and as President of Levi Strauss Canada and Latin America from 1996 to 1998. He has held a series of merchandising positions with us in Europe and the United States, including Vice President, Merchandising and Product Development for the Levi’s® brand in 1995. Mr. Anderson also served as interim president of Levi Strauss Europe from September 2003 to February 2004.
David G. Bergen, our Senior Vice President and Chief Information Officer, joined us in 2000. He was most recently Senior Vice President and Chief Information Officer of CarStation.com. From 1998 to 2000, Mr. Bergen was Senior Vice President and Chief Information Officer of LVMH, Inc. Prior to joining LVMH, Inc., Mr. Bergen held a series of management positions at Gap Inc., including Vice President of Application Development.
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James P. Fogarty, our Senior Vice President and Chief Financial Officer since December 2003, is a managing director of Alvarez & Marsal, Inc. and has been associated with the firm since 1994. During that time he has held a variety of management and advisory roles in several industries including serving as senior vice president and chief financial officer of The Warnaco Group, Inc. As part of his work with Alvarez & Marsal, Inc., he had held management positions with Bridge Information Systems, DDS Partners LLC, AM Cosmetics, Inc. and Color Tile, Inc. In addition, Mr. Fogarty provided restructuring advisory services to Freuhauf Trailer and Homeland Stores, Inc.
Robert L. Hanson is President of the Levi’s® brand in the United States. Before taking his current role in 2001, Mr. Hanson was President of the Levi’s® brand in Europe. From 1998 to 2000, he was Vice President of the Levi’s® brand in Europe. He began his career with us in 1988, holding executive-level advertising, marketing and business development positions in both the Levi’s® and Dockers® brands in the United States before taking his first position in Europe.
Scott A. LaPorta is President of the Levi Strauss Signature™ brand in the United States. Mr. LaPorta joined us in 2002 as the Chief Financial and Strategic Planning Officer for Levi Strauss Americas. In July 2003, Mr. LaPorta became Senior Vice President of Sales, Strategy and Finance for Levi Strauss Americas, until taking his current position in October of the same year. Before joining us, Mr. LaPorta was Executive Vice President and Chief Financial Officer of Park Place Entertainment.
Paul Mason, our Senior Vice President and President, Levi Strauss Europe, joined us in February 2004. Mr. Mason was chief executive officer of Matalan PLC, a discount clothing business and leading U.K. jeans retailer from 2002 to 2003. Prior to that time, he held senior positions with ASDA Group Limited, a subsidiary of Wal-Mart Stores, Inc., including chief operating officer, retailer director and logistics and human resources director. Mr Mason is a non-executive director of Rentokil-Initial plc (U.K).
Albert F. Moreno, our Senior Vice President and General Counsel since 1996, joined us in 1978. He held the position of Chief Counsel for Levi Strauss North America from 1994 to 1996 and Deputy General Counsel from 1985 to 1994. He is a member of the board of directors of Xcel Energy, Inc.
Fred Paulenich, our Senior Vice President of Worldwide Human Resources, joined us in 2000. Prior to joining us, Mr. Paulenich was Vice President and Chief Personnel Officer of Pepsi-Cola North America from 1999 to 2000. At Pepsi-Cola, he held a series of management positions including Vice President of Headquarters Human Resources from 1996 to 1998 and Vice President of Personnel from 1995 to 1996.
Lawrence W. Ruff, our Senior Vice President, Strategy and Planning since September 2003, joined us in 1987. From 1987 to 1996, he held a variety of marketing positions in the United States and Europe. He served as Vice President, Marketing and Development for Levi Strauss Europe, Middle East and Africa from 1996 to 1999 when he became Vice President, Global Marketing. In late 1999, he became Senior Vice President of Worldwide Marketing Services.
Roberta H. Silten is the President of the Dockers® brand in the United States. Before taking on her current role in 1999, Ms. Silten held various senior marketing and merchandising positions with us, most recently as the director of the Slates® brand, a dress pant line now part of the Dockers® brand. She began her career with us in 1995. Ms. Silten is a member of the board of directors of the Red Tab Foundation.
New Director
On February 3, 2005, we elected Leon J. Level to our board of directors, effective as of April 1, 2005. Mr. Level is currently chief financial officer and a director of Computer Sciences Corporation. Computer Sciences Corporation is a leading global information technology services company, offering services including systems design and integration; information technology and business process outsourcing; applications software development; Web and application hosting; and management consulting. Mr. Level, 64, has held ascending and varied financial management and executive positions at Computer Sciences Corporation (chief financial officer
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since 1989), Unisys Corporation (corporate vice president, treasurer and chairman of Unisys Finance Corporation), Burroughs Corporation (vice president, treasurer), The Bendix Corporation (executive director and assistant corporate controller) and Deloitte, Haskins & Sells (now Deloitte & Touche). Mr. Level is also currently a director of UTi Worldwide Inc. We expect Mr. Level to serve on our audit and finance committees.
New Chief Financial Officer
On February 1, 2005, we announced that Hans Ploos van Amstel, 40, will replace Mr. Fogarty as our senior vice president and chief financial officer, effective as of March 7, 2005. Mr. Ploos van Amstel had served as Vice President of Finance and Operations for our European business since 2003. Mr. Ploos van Amstel joined us from Procter & Gamble. Procter & Gamble’s principal business is the manufacturing and marketing of consumer and household products. Mr. Ploos van Amstel joined Procter & Gamble in 1989, where he served in various capacities throughout Europe and the Middle East, leading to his appointment in 1999 as Finance Director of Global Corporate F&HC, and culminating in his appointment in 2001 as Finance Director of Procter & Gamble’s F&HC Europe division.
Our Board of Directors
Our board of directors currently has 14 members and will be increased to 15 when Mr. Level joins the board. Our board is divided into three classes with directors elected for overlapping three-year terms. The term for directors in class 1 (Mr. Friedman, Mr. Georgescu, Mr. Sullivan and Mr. R.D. Haas) ends in 2005. The term for directors in class 2 (Ms. House, Ms. Pineda, Mr. Rogers, Mr. Hellman and Mr. P.E. Haas, Jr.) ends in 2006. The term for directors in class 3 (Ms. Blackwell, Mr. W. J. Haas, Mr. Gaither, Mr. Marineau and Ms. Haas) ends in 2007. Mr. Level, our new director, will be a member of class 1. Directors are elected by the trustees of the voting trust as provided under the voting trust agreement. Directors in each class may be removed at any time, with or without cause, by the trustees of the voting trust.
Committees. Our board of directors currently has four committees.
— Members: Mr. Gaither, Mr. Georgescu, Mr. Hellman, Ms. Pineda and Mr. Sullivan.
— Members: Ms. House, Mr. Georgescu, Mr. P.E. Haas, Jr., Mr. Hellman and Mr. Rogers.
— Members: Ms. Blackwell, Ms. House, Mr. Gaither, Mr. Rogers and Mr. Sullivan.
— Members: Ms. Blackwell, Mr. Friedman, Ms. Haas, Mr. W. J. Haas and Ms. Pineda.
Mr. R.D. Haas and Mr. Marineau are ex-officio members of all standing committees of the board of directors, except the audit committee. Mr. Level will serve on the audit committee and the finance committee.
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Compensation. Directors who are not stockholders or employees (Ms. Blackwell, Mr. Gaither, Mr. Georgescu, Ms. House, Ms. Pineda, Mr. Rogers and Mr. Sullivan) receive annual compensation in a target amount of approximately $93,000. This amount included an annual retainer fee of $36,000, meeting fees and long-term variable pay. The actual amount for each of these compensation components varies depending on the years of service, the number of meetings attended and the actual value of the long-term grants upon vesting. Directors are covered under travel accident insurance while on company business and are eligible to participate in a deferred compensation plan. In 2004, Mr. Gaither participated in the deferred compensation plan. Directors who are also stockholders or employees did not, as a board policy matter, receive compensation in 2004 or prior years for their services as directors.
In February 2004, we established an interim long-term incentive and retention plan for our management team. Directors who are not employees or stockholders were also participants in the plan. These directors received under the plan a single payment at the end of 2004; the plan provides for payments to management participants in three parts over time as a retention measure. For more information about developments in late 2003 and early 2004 relating to our incentive plans, see “Executive Compensation — Long-Term Incentive Compensation Plans.”
This table provides compensation information for our directors in 2004 who were not stockholders or employees:
Angela Glover Blackwell
James C. Gaither
Peter Georgescu
Patricia A. House
Patricia Salas Pineda
T. Gary Rogers
G. Craig Sullivan
On December 9, 2004, our board of directors approved the following actions with respect to our director compensation in 2005:
Our board members also will participate in our new senior executive long-term incentive compensation program. For more information, see “Executive Compensation—Long-Term Incentive Compensation Plans.”
Under our bylaws and management structure, our chairman of the board and former chief executive officer, Robert D. Haas, is a corporate officer and an executive officer. In view of the financial challenges facing us at the
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beginning of 2004 and in recognition of the transition in his role from chairman and chief executive officer to chairman, Mr. Haas voluntarily offered to reduce his compensation package. His annual salary for fiscal 2004 was $461,538, a decrease from $778,846 in 2003. Mr. Haas also received in fiscal 2004 a long-term incentive payment of $195,000. As of the beginning of 2004, Mr. Haas no longer participates in our annual incentive plan. He participates in our long-term incentive plans.
Audit Committee. The charter of the Audit Committee requires that the Audit Committee be comprised of at least three but not more than five members, none of whom may be family member directors or employees and none of whom may have any relationship with us that interferes with the exercise of their independence from our management and from us. The charter requires that each member of the Audit Committee be financially literate and that at one least one member must have accounting or related financial management experience. Our Corporate Governance Guidelines require that each member must be independent as required under applicable law.
Our Audit Committee has sole and direct authority to engage, appoint, evaluate and replace the independent auditor. The Audit Committee meets with our management regularly to discuss our internal controls and financial reporting process and our financial reports to the public. The committee also meets with our independent registered public accounting firm and with our financial personnel and internal auditors regarding these matters. Both our independent registered public accounting firm and our internal auditors regularly meet privately with this committee and have unrestricted access to the committee. The Audit Committee examines the independence and performance of our internal auditors and our independent registered public accounting firm. In addition, among its other responsibilities, the Audit Committee reviews our critical accounting policies, our annual and quarterly reports on Forms 10-K and 10-Q, and our earnings releases before they are published. The Audit Committee held eleven meetings during fiscal 2004.
Compensation Committee Interlocks and Insider Participation
The Human Resources Committee serves as the compensation committee of our board of directors. Ms. Blackwell, Ms. House and Messrs. Gaither, Rogers and Sullivan are members of the Human Resources Committee. No member of the Human Resources Committee is a current or former officer or employee of ours. In addition, there are no compensation committee interlocks between us and other entities involving our executive officers and our Board members who serve as executive officers of those other entities.
Mr. Gaither was, prior to 2004, senior counsel to the law firm Cooley Godward LLP. Cooley Godward provided legal services to us and to the Human Resources Committee in 2004, 2003 and 2002, for which we paid fees of approximately $150,000, $250,000 and $18,000, respectively, in those years.
Worldwide Code of Business Conduct
We have a Worldwide Code of Business Conduct which applies to all of our directors and employees, including the chief executive officer, the chief financial officer, the controller and our other senior financial officers. The Worldwide Code of Business Conduct covers a number of topics including:
A copy of the Worldwide Code of Business Conduct is filed as an exhibit to this Annual Report on Form 10-K.
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Item 11. EXECUTIVE COMPENSATION
Our Human Resources Committee of the board provides assistance to our board in the board’s oversight of our compensation, benefits and human resources programs and of senior management performance, composition and compensation. The committee reviews our compensation objectives and performance against those objectives, reviews market conditions and practices and our strategy and processes for making compensation decisions, reviews the performance of our chairman and chief executive officer and approves the annual and long-term compensation for our chairman, chief executive officer and executive officers. The committee also reviews our succession planning, diversity, director compensation and benefit plans.
Our executive compensation philosophy is intended to support our key business and talent objectives. Our business objectives focus on earnings, debt reduction and shareholder value. Our talent objectives focus on attracting, retaining and motivating individuals as required to deliver our targeted annual and long-term business results. In order to support the achievement of these objectives, we review the market practices of a similarly sized, competitive set of branded consumer product companies and major apparel competitors when setting compensation levels for our executives. Our intent is to position our executives’ compensation competitively against this set of companies.
The primary components of our executive compensation are base salary, annual bonus and long-term incentives. Base salary is paid for ongoing performance throughout the year. Our annual bonuses are intended to motivate and reward achievement of annual business and individual objectives. Our long-term incentives align with and reward for increasing shareholder value.
This table provides compensation information for our chief executive officer and the other four executive officers who were our most highly compensated officers and who were serving as executive officers as of the last day of the fiscal year. We refer to these individuals in this Form 10-K as our named executive officers. Our chief financial officer in 2004, Mr. Fogarty, is not an employee of ours. For more information about our relationship with Mr. Fogarty, see “Item 13 — Certain Relationships and Related Transactions.”
Summary Compensation Table
Name/Principal Position
President and Chief Executive Officer
Senior Vice President and President, Levi Strauss Europe
R. John Anderson
Senior Vice President and President, Levi Strauss, Asia Pacific Division(5)
President and General Manager, Levi’s® Brand, United States
President and General Manager, Levi Strauss Signature™ Brand, United States
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Long-Term Incentive Compensation Plans
Interim Long-Term Incentive Compensation Plan. In February 2004, we established a new interim cash-based long-term incentive plan for our management level employees, including our executive officers, and our non-shareholder directors. We set a target amount for each participant based on job level. The interim plan, which covers a 19-month period (December 2003 through June 2005), includes both performance and retention elements as conditions for payment. Key plan features include:
The terms of the plan are governed by the plan document. Our board has discretion to interpret, amend and terminate the plan. All of our executive officers (other than Mr. Mason) and our non-stockholder directors (Messrs. Gaither, Georgescu, Rogers and Sullivan and Mss. Blackwell, House and Pineda) are participants in the plan.
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The following table shows awards granted under our interim long-term incentive plan.
Interim Long-Term Incentive Plan — Awards in Last Fiscal Year (2004)
Paul Mason(1)
Leadership Shares Plan. We did not make any payments under our Leadership Shares Plan in 2004 or 2005. We will not make any further payments in respect of any outstanding awards under the plan.
2005 Long-Term Incentive Plan. At its meeting on February 3, 2005, our board approved the design of a new executive compensation plan, the Senior Executive Long-Term Incentive Plan. The plan is intended to provide long-term incentive compensation for our senior management. Our executive officers and non-employee members of our board are eligible to participate in the plan.
Our board did not establish the strike price, expected price or the number of units to be granted to individual participants in the initial grant. The authority to make those determinations was delegated by the board to our Human Resources Committee, with the concurrence of the chair of the board’s Finance Committee.
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Pension Plan Benefits
Messrs. Marineau, Hanson and LaPorta. The following table shows the estimated annual benefits payable upon retirement under our U.S. Home Office Pension Plan to persons at various covered compensation levels and years-of-service classifications prior to mandatory offset of Social Security benefits. Covered compensation is defined as annual base salary plus annual bonus, within certain IRS limits. An average of the highest covered compensation amounts within a predefined period is used to calculate the final annual pension benefits. For 2004, covered compensation for these named executive officers is the same as the total of their salary and bonus amounts shown in the Summary Compensation Table, subject to certain IRS limits. The table assumes retirement at the age of 65, with payment to the employee in the form of a single-life annuity.
U.S. Pension Plan Table
Final Average
Covered
Compensation
The following table shows, for each of Messrs. Marineau, Hanson and LaPorta, as of the end of 2004, the credited years of service, the 2004 compensation covered by the U.S. Home Office Pension Plan and the annual pension benefit each would receive at age 65 under the plan if he had left employment with us at the end of 2004:
AnnualPension
Benefit
Philip A. Marineau(1)
Scott A. LaPorta(2)
We made amendments to our U.S. Home Office Pension Plan in 2004 that affected Mr. Hanson and Mr. LaPorta. For more information about these changes, see Note 12 to the Consolidated Financial Statements.
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Mr. Mason. Mr. Mason participates in the Levi Strauss United Kingdom pension plan. This plan provides him both a defined benefit and a defined contribution pension. The plan provides a defined benefit pension based on a percentage of pensionable earnings (base pay) and eligible pension service (service with us), subject to local tax limits. The plan has a minimum vesting period of two years. Because Mr. Mason joined us in 2004, he is currently ineligible for benefits under the plan. We also contribute an amount equal to 20% of Mr. Mason’s annual bonus each year into a defined contribution account under the United Kingdom pension plan. Upon retirement, those funds will be used to purchase additional pension benefits.
Mr. Anderson. Mr. Anderson participates in the Levi Strauss Australia pension plan. He also participates in a supplemental plan. The pension payment Mr. Anderson will receive upon retirement is based on years of service and his final average salary. Under the supplemental plan, we contribute 20% of his annual base salary and bonus to his pension each year. If Mr. Anderson’s employment with us had been terminated at the end of 2004, his benefit under these combined plans, to be paid in a lump sum at age 65, would have been 2.8 million Australian dollars, or approximately $2.2 million.
Employment Agreements
Mr. Marineau. We have an employment agreement with Mr. Marineau. The agreement provides for a minimum base salary of $1.0 million in accordance with our executive salary policy and a target annual cash bonus of 90% of base salary, with a maximum bonus of 180% of base salary. In addition, Mr. Marineau is eligible to participate in all other executive compensation and benefit programs, including the Leadership Shares Plan, and the interim long-term incentive and the annual incentive plans described above. Under the employment agreement, we made a one-time grant of 810,000 Leadership Shares to compensate him for the potential value of stock options he forfeited upon leaving his previous employer to join us. We also provide under the agreement a supplemental pension benefit to Mr. Marineau.
The agreement is in effect until terminated by either Mr. Marineau or us. We may terminate the agreement upon Mr. Marineau’s death or disability, for cause (as defined in the agreement), and without cause upon 30 days notice. Mr. Marineau may terminate the agreement for good reason (as defined in the agreement) or other than for good reason upon 30 days notice to us. The consequences of termination depend on the basis for the termination:
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Mr. Mason. We have an employment agreement with Mr. Mason. Under the agreement, we have agreed to pay him a minimum base salary of £600,000. Mr. Mason is also eligible to earn an annual bonus under our Annual Incentive Plan, with a target incentive equal to 65% of his base salary, and he will participate in our Senior Executive Long-Term Incentive Plan beginning in 2005. In addition, in lieu of granting him a long-term incentive award in 2004, Mr. Mason was eligible to earn a special one-time bonus under a separate incentive arrangement, with a target incentive equal to 85% of his base salary, and was guaranteed to receive a minimum payout of £150,000 in early 2005. The amount of this bonus was equal to $1,563,675.
Under his agreement, Mr. Mason is also entitled to specified fringe benefits, including a company car, housing when abroad, medical insurance for Mr. Mason and his family and reimbursement of any additional taxes he may have to bear as a consequence of these fringe benefits. We have also agreed to provide Mr. Mason with supplementary pension benefits.
Mr. Mason’s employment agreement is in effect until terminated by either Mr. Mason or us. We may terminate the agreement without cause upon 12 months notice. If we terminate the agreement without cause, we have agreed to pay his salary, annual incentive, pension contributions and other normal allowances and benefits in lieu of a notice period.
Senior Executive Severance Arrangements
Messrs. Marineau and Mason. Mr. Marineau and Mr. Mason are eligible for severance benefits as provided in their respective employment agreements. Please see “Employment Agreements” for more information.
Messrs. Anderson, Hanson and LaPorta. Messrs. Anderson, Hanson and LaPorta are eligible for payments and other benefits under our Senior Executive Severance Plan, which is a discretionary, unfunded plan available to a select group of management to recognize their past service to us in the event their employment is involuntarily terminated. We may terminate or amend this plan at any time at our sole discretion.
Under the plan, in exchange for the executive’s execution of a general release agreement with us following an involuntary termination without cause, we will pay the executive his or her base salary, plus a target bonus amount for the fiscal year in which the executive is notified of his or her employment termination. We will make this payment in installments or on the same payment schedule and in and an amount no greater than the executive’s base salary at the time his/her employment terminated for a period ranging from 26 weeks to 104 weeks, depending on the executive classification.
In addition to these severance payments, we will pay an affected executive the same percentage of the monthly cost of the medical coverage we provide under the Consolidated Omnibus Budget Reconciliation Act (COBRA) (to the extent the executive elects COBRA coverage) that he was entitled to during his active employment. The subsidized COBRA medical coverage will continue during the period that the executive is entitled to receive severance payments, subject to a maximum period ending on the earlier of the 18-month period following the termination date or the date the executive is entitled to other medical coverage. We will also pay the cost of premiums under our standard basic life insurance program of $10,000 during the same period that we subsidize the COBRA coverage. If the executive becomes eligible to receive retiree health benefits, we will subsidize retiree medical coverage during the same period that we subsidize the COBRA coverage. In addition, we will provide an affected executive with career counseling and transition services.
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Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
All shares of our common stock are deposited in a voting trust, a legal arrangement that transfers the voting power of the shares to a trustee or group of trustees. The four voting trustees are Peter E. Haas, Sr., Peter E. Haas, Jr., Robert D. Haas and F. Warren Hellman. The voting trustees have the exclusive ability to elect and remove directors, amend our by-laws and take certain other actions which would normally be within the power of stockholders of a Delaware corporation. Our equity holders who, as a result of the voting trust, legally hold “voting trust certificates,” not stock, retain the right to direct the trustees on specified mergers and business combinations, liquidations, sales of substantially all of our assets and specified amendments to our certificate of incorporation.
The table on the following page contains information about the beneficial ownership of our voting trust certificates as of November 28, 2004, by:
Under the rules of the SEC, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of the security, or “investment power,” which includes the power to dispose of or to direct the disposition of the security. Under these rules, more than one person may be deemed a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which that person has no economic interest. Except as described in the footnotes to the table below, the individuals named in the table have sole voting and investment power with respect to all voting trust certificates beneficially owned by them, subject to community property laws where applicable.
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As of November 28, 2004, there were 168 record holders of voting trust certificates. The percentage of beneficial ownership shown in the table is based on 37,278,238 shares of common stock and related voting trust certificates outstanding as of November 28, 2004. The business address of all persons listed, including the trustees under the voting trust, is 1155 Battery Street, San Francisco, California 94111.
Peter E. Haas, Sr.
Peter E. Haas, Jr.
Miriam L. Haas (4)
Margaret E. Haas
Josephine B. Haas
Robert E. Friedman
F. Warren Hellman
Walter J. Haas
Peter A. Georgescu
James P. Fogarty
Fred P. Paulenich
Directors and executive officers as a group (21 persons)
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Stockholders’ Agreement
Our common stock and the voting trust certificates are not publicly held or traded. All shares and the voting trust certificates are subject to a stockholders’ agreement. The agreement, which expires in April 2016, limits the transfer of shares and certificates to other holders, family members, specified charities and foundations and to us. The agreement does not provide for registration rights or other contractual devices for forcing a public sale of shares, certificates or other access to liquidity. The scheduled expiration date of the stockholders’ agreement is five years later than that of the voting trust agreement in order to permit an orderly transition from effective control by the voting trust trustees to direct control by the stockholders.
Estate Tax Repurchase Policy
We have a policy under which we will repurchase a portion of the shares offered by the estate of a deceased stockholder in order to generate funds for payment of estate taxes. The purchase price will be based on a valuation received from an investment banking or appraisal firm. Estate repurchase transactions are subject to applicable laws governing stock repurchases, board approval and restrictions under our credit agreements. Our senior secured term loan and senior secured revolving credit facility prohibit repurchases without the consent of the lenders, and the indentures relating to our 11.625% notes due 2008, our 12.25% notes due 2012 and our 9.75% notes due 2015 limit our ability to make repurchases. The policy does not create a contractual obligation on our part. We may amend or terminate this policy at any time. No shares were repurchased under this policy in 2004, 2003 or 2002.
Valuation Policy
We have a policy under which we obtain, and make available to our stockholders, an annual valuation of our voting trust certificates. We use this valuation for, among other things, making determinations under our senior executive long-term incentive plan. The policy provides that we will make reasonable efforts to defend valuations we obtain which are challenged in any tax or regulatory proceeding involving a stockholder (including
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an estate) that used the valuation and was challenged on that use. The policy provides that we will not indemnify any stockholder against any judgment or settlement amounts or expenses specific to any individual stockholder arising from the use of a valuation. We may amend or terminate this policy at any time.
Voting Trustee Compensation
The voting trust agreement provides that trustees who are also beneficial owners of 1% or more of our stock are not entitled to compensation for their services as trustees. Trustees who are not beneficial owners of more than 1% of our outstanding stock may receive such compensation upon approval of our board. All trustees are entitled to reimbursement for reasonable expenses and charges which they may incur in carrying out their duties as trustees. As of November 28, 2004, each trustee beneficially owned more than 1% of our outstanding stock.
Voting Trustee Indemnification
Under the voting trust agreement, the trustees are not liable to us or to the holders of voting trust certificates for any actions undertaken in their capacity as trustees, except in cases of willful misconduct. The voting trust will indemnify the trustees in respect of actions taken by them under the voting trust agreement in their capacity as trustees, except in cases of willful misconduct.
We have agreed to reimburse the voting trust for any amounts paid by the trust as a result of its indemnity obligation on behalf of the trustees.
Limitation of Liability and Indemnification Matters
As permitted by Delaware law, we have included in our certificate of incorporation a provision to eliminate generally the personal liability of directors for monetary damages for breach or alleged breach of their fiduciary duties as directors. In addition, our by-laws provide that we are required to indemnify our officers and directors under a number of circumstances, including circumstances in which indemnification would otherwise be discretionary, and we are required to advance expenses to our officers and directors as incurred in connection with proceedings against them for which they may be indemnified. In addition, our board of directors adopted resolutions making clear that officers and directors of our foreign subsidiaries are covered by these indemnification provisions. We are not aware of any pending or threatened litigation or proceeding involving a director, officer, employee or agent of ours in which indemnification would be required or permitted. We believe that these indemnification provisions are necessary to attract and retain qualified persons as directors and officers.
Insofar as indemnification for liabilities under the Securities Act may be granted to directors, officers or persons controlling us under the foregoing provisions, we have been informed that in the opinion of the SEC this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Agreement with Alvarez & Marsal, Inc. relating to James P. Fogarty. On December 1, 2003, and as provided by our agreement with Alvarez & Marsal, Inc., we appointed James P. Fogarty as our interim chief financial officer, replacing William B. Chiasson who resigned from that position on December 5, 2003. Mr. Fogarty is a managing director with Alvarez & Marsal, Inc. Our agreement with Alvarez & Marsal, Inc. also provided that Antonio Alvarez would serve as Senior Advisor to us and will be an executive officer. Mr. Alvarez is a co-founding Managing Director of Alvarez & Marsal, Inc. Mr. Alvarez completed his work as senior advisor and left that position in April 2004. On February 1, 2005, we announced that Hans Ploos van Amstel will replace Mr. Fogarty effective as of March 7, 2005. For more information about Mr. Ploos van Amstel, please see “Item 10 — Directors and Executive Officers.”
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The agreement also provides that:
On May 18, 2004, we amended the agreement. Under the amended agreement, we agreed to pay Alvarez & Marsal, Inc., in addition to regular compensation for its services, a cash bonus of $1.5 million as an incentive for them to complete successfully their work in assisting us in implementing cost reduction actions and in respect of Mr. Fogarty’s role as our chief financial officer. We paid $500,000 of this minimum bonus in June 2004, an additional $500,000 in October 2004 and paid the remaining $500,000 in February 2005. In addition, we agreed to pay Alvarez & Marsal, Inc. an additional incentive bonus of $1.0 million, which we will pay in late February 2005 upon our achievement of certain financial performance, financial reporting and control and planning activities.
Directors. James C. Gaither, one of our directors, was, prior to 2004, senior counsel to the law firm Cooley Godward LLP. Cooley Godward provided legal services to us and to the Human Resources Committee of our board of directors in 2004, 2003 and 2002, for which we paid fees of approximately $150,000, $250,000 and $18,000, respectively, in those years.
Robert E. Friedman, one of our directors, is founder and chairman of the board of the Corporation for Enterprise Development, a not-for-profit economic development research, technical assistance and demonstration organization which works with public and private policymakers in governments, international organizations, corporations, private foundations, labor unions and community groups to design and implement economic development strategies. In 2003, we donated $50,000 to the Corporation for Enterprise Development. During 2002 the Levi Strauss Foundation donated $65,000.
Peter A. Georgescu, one of our directors, is Chairman Emerutus of Young and Rubicam, Inc., WPP Group plc, a global advertising agency. The agency provided advertising services to us in 2003 and 2002. We paid fees of approximately $18,800 and $15,200, respectively. We did not obtain any such services in 2004. Mr. Georgescu is a director of Toys “R” Us, Inc. We made a $5,000 donation to the Toys “R” Us Children’s Fund in 2004.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Engagement of the Independent Registered Public Accounting Firm. The Audit Committee is responsible for approving every engagement of KPMG to perform audit or non-audit services for us before KPMG is engaged to provide those services. The Audit Committee’s pre-approval policy provides as follows:
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Auditor Fees
The following table shows fees billed to or incurred by us for professional services rendered by KPMG during fiscal 2004 and 2003:
Services provided:
Audit fees(a)
Audit — related fees(b)
Total audit and audit-related fees
Tax fees(c)
All other fees
Total fees
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PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
List the following documents filed as a part of the report:
The following consolidated financial statements of the Company are included in Item 8:
All other schedules have been omitted because they are inapplicable, not required or the information is included in the Consolidated Financial Statements or Notes thereto.
Exhibits
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166
167
168
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SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
Valuation Allowance Against Deferred Tax Assets
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
By:
/s/ JAMES P. FOGARTY
Senior Vice President and Chief Financial Officer
Date: February 15, 2005
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James P. Fogarty, Gary W. Grellman, Jay A. Mitchell and Hilary A. Fenner, and each of them, his or her attorney-in-fact with power of substitution for him or her in any and all capacities, to sign any amendments, supplements or other documents relating to this Annual Report on Form 10-K he deems necessary or appropriate, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that such attorney-in-fact or his substitute may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
/s/ ROBERT D. HAAS
Chairman of the Board
/s/ PHILIP A. MARINEAU
Director, President and Chief Executive Officer
/s/ ANGELA GLOVERBLACKWELL
Director
/s/ JAMES C. GAITHER
/s/ MIRIAM L. HAAS
Miriam L. Haas
/s/ PETER E. HAAS, JR.
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/s/ WALTER J. HAAS
/s/ F. WARRENHELLMAN
/s/ PAT HOUSE
Pat House
/s/ PATRICIA SALASPINEDA
/s/ G. CRAIGSULLIVAN
/s/ GARY W. GRELLMAN
Gary W. Grellman
Vice President and Controller (Principal Accounting Officer)
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SUPPLEMENTAL INFORMATION
We will furnish our 2004 annual report to our voting trust certificate holders after the filing of this Form 10-K and will furnish copies of such material to the SEC at such time.
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EXHIBITS INDEX
1
2