Levi Strauss & Co. - 10-Q quarterly report FY

 

 

 

 

 

 

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 o     No þ

 

Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2of the Act).  Yes o     No þ

 

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 — 37,280,034 shares outstanding on April 13, 2009

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

 

 

Levi Strauss & Co. (“LS&CO.” or the “Company”) is one of the world’s leading branded apparel companies. The Company designs and markets jeans, casual and dress pants, tops, jackets and related accessories, for men, women and children under the Levi’s^®, Dockers^®and Signature by Levi Strauss & Co.^tmbrands. The Company markets its products in three geographic regions: Americas, Europe and Asia Pacific.

 

 

The unaudited consolidated financial statements of LS&CO. and its wholly-owned and majority-owned foreign and domestic subsidiaries are prepared in conformity with generally accepted accounting principles in the United States (“U.S.”) for interim financial information. In the opinion of management, all adjustments necessary for a fair statement of the financial position and the results of operations for the periods presented have been included. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended November 30, 2008, included in the Annual Report onForm 10-Kfiled by the Company with the Securities and Exchange Commission (“SEC”) on February 10, 2009.

 

The unaudited consolidated financial statements include the accounts of LS&CO. and its subsidiaries. All significant intercompany transactions have been eliminated. Management believes the disclosures are adequate to make the information presented herein not misleading. The results of operations for the three months ended March 1, 2009, may not be indicative of the results to be expected for any other interim period or the year ending November 29, 2009.

 

The Company’s fiscal year ends on the last Sunday of November in each year, except for certain foreign subsidiaries which are fixed at November 30 due to local statutory requirements. Apart from these subsidiaries, each quarter of both fiscal years 2009 and 2008 consists of 13 weeks, with the exception of the fourth quarter of 2008, which consisted of 14 weeks. All references to years relate to fiscal years rather than calendar years.

 

 

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 to consolidated financial statements. Estimates are based upon historical factors, current circumstances and the experience and judgment of its management. Management evaluates its estimates and assumptions on an ongoing basis and may employ outside experts to assist in its evaluations. Changes in such estimates, based on more accurate future information, or different assumptions or conditions, may affect amounts reported in future periods.

 

 

In December 2008, the Company acquired a 51% ownership interest in a business venture which distributes and markets Levi’s^®products within the Russian Federation for purchase consideration of approximately $16 million. Cash paid for the acquisition, net of cash acquired, was $3.5 million. The Company preliminarily allocated the purchase price to the fair values of the assets acquired and liabilities assumed at the acquisition date, including a liability related to a put option held by the third-party minority interest holder, with the difference of approximately $27 million recorded as goodwill.

 

The terms of the purchase agreement provide the third-party with a put option to sell its 49% minority interest in the business venture to the Company during established exercise periods, which begin on the fifth anniversary of

 

 

 

 

the date of acquisition, or upon the occurrence of certain other events. The amount payable is based on the business venture’s financial performance (as defined in the agreement) during the years preceding the applicable exercise period. In the purchase price allocation, the Company recorded a liability representing the estimated amount payable to the minority interest holder upon exercise of the put option at the commencement of the first exercise period, discounted to its fair value as of the acquisition date. This liability is included in “Minority interest and related liability” on the Company’s consolidated balance sheets. The Company is accreting this minority interest liability to the estimated future amount payable. Periodic accretion, as well as any changes in estimate resulting from the business venture’s actual financial performance, will be recorded to “Other income, net” in the Company’s consolidated statements of income.

 

Also included in “Minority interest and related liability” on the Company’s consolidated balance sheets is the 16.4% minority interest of third parties in Levi Strauss Japan K.K., the Company’s Japanese affiliate.

 

 

There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s consolidated financial statements, from those disclosed in the Company’s 2008 Annual Report onForm 10-K,except for the following:

 

 

 

The changes in the carrying amount of goodwill by business segment for the three months ended March 1, 2009, were as follows:

 

 

The increase in goodwill in Europe during the first quarter of 2009 resulted from the Company’s acquisition of a 51% ownership interest in the business venture which distributes and markets Levi’s^®products within the Russian Federation. See Note 1 for additional information.

 

 

 

 

 

The following table presents the Company’s financial instruments that are carried at fair value:

 

 

The following table presents the carrying value — including accrued interest as applicable — and estimated fair value of the Company’s financial instruments that are carried at adjusted historical cost:

 

 

The decline in fair value of the Company’s long-term debt, as compared to its carrying value, as of March 1, 2009, and November 30, 2008, is primarily due to changes in overall capital market conditions as demonstrated by lower liquidity in the markets, increases in credit spread, and decreases in bank lending activities, which result in investors moving from high yield securities to lower yield investment grade or U.S. Treasury securities in efforts to preserve capital.

 

The overall increase in fair value of the Company’s long-term debt as of March 1, 2009, as compared to November 30, 2008, is primarily due to slight improvements in the capital markets.

 

 

 

 

 

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are foreign currency risk and interest rate risk. Forward exchange contracts on various currencies are entered into to manage foreign currency exposures associated with certain product sourcing activities, some intercompany sales, foreign subsidiaries’ royalty payments, interest payments, earnings repatriations, net investment in foreign operations and funding activities. The Company designates its outstanding 2013 Euro senior notes and a portion of its outstanding Yen-denominated Eurobonds as net investment hedges to manage foreign currency exposures in its foreign operations. Interest rate swaps are entered into to manage interest rate risk associated with the Company’s variable-rate borrowings. The Company has not applied hedge accounting to its derivative transactions, except for certain net investment hedging 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 and to reduce the variability of certain cash flows at the subsidiary level. The Company actively manages certain forecasted foreign currency exposures and uses a centralized currency management operation to take advantage of potential opportunities to naturally offset foreign currency exposures against each other. The Company manages the currency risk associated with certain forecasted cash flows periodically and only partially manages the timing mismatch between its forecasted exposures and the related financial instruments used to mitigate the currency risk. As of March 1, 2009, the Company had U.S. dollar spot and forward currency contracts to buy $544.9 million and to sell $195.2 million against various foreign currencies. These contracts are at various exchange rates and expire at various dates through March 2010.

 

Effective May 1, 2008, the Company entered into a $100 million interest rate swap derivative to pay interest at a fixed-rate of approximately 3.2% and receive3-monthLIBOR variable rate interest payments quarterly through May 1, 2010.

 

The Company adopted SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133,” at the beginning of the first quarter of 2009, and has included here the expanded disclosures required by that statement.

 

 

 

 

The table below provides data about the carrying values of derivative and non-derivative instruments:

 

 

 

 

 

 

 

The table below provides data about the amount of gains and losses related to derivative and non-derivative instruments designated as net investment hedges included in the “Accumulated other comprehensive income (loss)” section of “Stockholders’ deficit” on the Company’s consolidated balance sheets, and in “Other income, net” in the Company’s consolidated statements of income:

 

 

 

The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

As of March 1, 2009, the Company’s total availability of $329.4 million under its senior secured revolving credit facility was reduced by $84.8 million of letters of credit and other credit usage allocated under the facility, yielding a net availability of $244.6 million. Included in the $84.8 million of letters of credit on March 1, 2009, were $11.9 million of trade letters of credit and bankers’ acceptances, $11.5 million of other credit usage and $61.4 million of stand-by letters of credit with various international banks, of which $31.3 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.

 

 

The Company’s weighted-average interest rate on average borrowings outstanding during the three months ended March 1, 2009, and February 24, 2008, was 7.52% and 8.31%, respectively.

 

 

 

 

 

The following table summarizes the components of net periodic benefit cost (income) and the changes recognized in accumulated other comprehensive income (loss) for the Company’s defined benefit pension plans and postretirement benefit plans:

 

 

 

 

 

 

 

 

The following describes the reorganization initiatives, including facility closures and organizational changes, associated with the Company’s restructuring liabilities as of March 1, 2009. In the table below, “Severance and employee benefits” relates to items such as severance packages, out-placement services and career counseling for employees affected by the closures and other reorganization initiatives. “Other restructuring costs” primarily relates to lease loss liability and facility closure costs. “Charges” represents the initial charge related to the restructuring activity. “Utilization” consists of payments for severance, employee benefits and other restructuring costs, the effect of foreign exchange differences and asset impairments. “Adjustments” includes revisions of estimates related to severance, employee benefits and other restructuring costs.

 

For the three months ended March 1, 2009, and February 24, 2008, the Company recognized restructuring charges, net, of $2.4 million and $2.2 million, respectively, which were recorded in “Selling, general and administrative expenses” in the Company’s consolidated statements of income. The following table summarizes the restructuring activity for the three months ended March 1, 2009, and the related restructuring liabilities balance as of November 30, 2008, and March 1, 2009:

 

 

 

 

 

 

 

 

 

The Company uses derivative instruments to manage its exposure to foreign currencies. The Company is exposed to credit loss in the event of nonperformance by the counterparties to the foreign exchange contracts. However, the Company believes that its exposures are appropriately diversified across counterparties and that these counterparties are creditworthy financial institutions. Please see Note 4 for additional information.

 

 

Litigation.  There have been no material developments in the Company’s litigation matters since it filed its 2008 Annual Report onForm 10-K.

 

In the ordinary course of business, the Company has various 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 of these pending legal proceedings that will have a material impact on its financial condition or results of operations or cash flows.

 

 

The following is a summary of the components of total comprehensive income, net of related income taxes:

 

 

The following is a summary of the components of “Accumulated other comprehensive loss,” net of related income taxes:

 

 

 

 

 

 

The following table summarizes significant components of “Other income, net”:

 

 

 

Effective Income Tax Rate.  The Company’s effective income tax rate was 35.4% and 35.2% for the three months ended March 1, 2009, and February 24, 2008, respectively. The Company’s income tax expense was $26.3 million and $52.6 million for the three months ended March 1, 2009, and February 24, 2008, respectively. The decrease in income tax expense was primarily due to lower income before taxes.

 

As of March 1, 2009, the Company’s total gross amount of unrecognized tax benefits was $157.5 million, of which $106.1 million would impact the Company’s effective tax rate, if recognized. As of November 30, 2008, the Company’s total gross amount of unrecognized tax benefits was $167.2 million, of which $104.6 million would have impacted the Company’s effective tax rate, if recognized. The reduction in gross unrecognized tax benefits was primarily due to the resolution of transfer pricing agreements with certain foreign tax jurisdictions. These agreements were consistent with management’s expectations in prior periods and have not materially impacted the Company’s effective income tax rate or its income tax provision in the current period.

 

As of March 1, 2009, the Company believes that it is reasonably possible that within the next twelve months unrecognized tax benefits could decrease by as much as $100.2 million, due primarily to the potential resolution of a refund claim with the State of California. However, at this point it is not possible to estimate whether the Company will realized any significant income tax benefit upon the resolution of this claim.

 

 

Robert D. Haas, a director and Chairman Emeritus of the Company, is the President of the Levi Strauss Foundation, which is not a consolidated entity of the Company. During the three-month periods ended March 1, 2009, and February 24, 2008, the Company donated $0.2 million and $7.1 million, respectively, to the Levi Strauss Foundation.

 

 

The Company’s reporting segments are the following three regions: Americas, Europe and Asia Pacific. Each regional segment is managed by a senior executive who reports directly to the chief operating decision maker: the Company’s chief executive officer. The Company’s management, including the chief operating decision maker, manages business operations, evaluates performance and allocates resources based on the regional segments’ net revenues and operating income.

 

 

 

 

Business segment information for the Company is as follows:

 

 

 

We design and market jeans, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s^®, Dockers^®and Signature by Levi Strauss & Co.^tm(“Signature”) brands around the world. We also license our trademarks in many countries throughout the world for a wide array of products, including accessories, pants, tops, footwear, home and other products.

 

Our business is operated through three geographic regions: Americas, Europe and Asia Pacific. Our products are sold in approximately 60,000 retail locations in more than 110 countries. We support our brands through a global infrastructure, both sourcing and marketing our products around the world. We distribute our Levi’s^®and Dockers^®products primarily through chain retailers and department stores in the United States and primarily through department stores, specialty retailers and franchised stores outside the United States. We distribute products under the Signature brand primarily through mass channel retailers in the United States and mass and other value-oriented retailers and franchised stores outside the United States. We also distribute our Levi’s^®and Dockers^®products through our online stores and 292 company-operated stores located in 25 countries, including the United States. These stores generated approximately 10% of our net revenues in the first quarter of 2009.

 

We derived nearly half of our net revenues and more than half of our regional operating income from our Europe and Asia Pacific businesses in the first quarter of 2009. Sales of Levi’s^®brand products represented approximately 78% of our total net sales in the first three months of 2009.

 

 

Our significant revenue declines in the first quarter of 2009 reflect the difficult market conditions manifest in most markets around the world and our ability to perform in such conditions.

 

 

Key challenges and risks for us during the remainder of the year include:

 

 

 

Fiscal year.  Our fiscal year ends on the last Sunday of November in each year, except for certain foreign subsidiaries which are fixed at November 30 due to local statutory requirements. Apart from these subsidiaries, each quarter of both fiscal years 2009 and 2008 consists of 13 weeks, with the exception of the fourth quarter of 2008, which consisted of 14 weeks.

 

Classification.  Our classification of revenues and expenses reflects the following:

 

 

Constant currency.  Constant currency comparisons are based on translating local currency amounts in both periods at the same foreign exchange rates. We routinely evaluate our constant currency financial performance in order to facilitate period-to-period comparisons without regard to the impact of changing foreign currency exchange rates.

 

 

The following table summarizes, for the periods indicated, our consolidated statements of income, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

The following table presents net revenues by reporting segment for the periods indicated and the changes in net revenue by reporting segment on both reported and constant currency bases from period to period:

 

 

Consolidated net revenues decreased on a reported basis for the three-month period ended March 1, 2009. Reported amounts were affected unfavorably by changes in foreign currency exchange rates across all regions, particularly in Europe.

 

Americas.  Net revenues in our Americas region decreased for the three-month period on both reported and constant currency bases. Currency affected net revenues unfavorably by approximately $11 million.

 

Net revenue declines in the region reflected the continued weakening retail environment. Net sales in the region decreased due to the bankruptcy filings in mid-2008 of two significant U.S. customers as well as lower demand and higher sales allowances and discounts for our U.S. Dockers^®brand products. The net revenue decline also reflected shipments to certain wholesale customers in February 2008 in anticipation of our March 2008 conversion to an enterprise resource planning (“ERP”) system in the United States. Apart from the lost volume related to the bankrupt customers and the pre-shipments, sales of our Levi’s^®brand products increased. Sales of our Signature brand products also increased in the region. Net revenues from our retail stores in the region were flat compared to the prior period, as additional revenues from new stores were offset by declines in same store sales.

 

Europe.  Net revenues in Europe decreased on both reported and constant currency bases. Currency affected net revenues unfavorably by approximately $45 million.

 

Net revenues in the region decreased primarily due to lower sales in our wholesale channels in our mature markets, reflecting a declining retail environment. This was partially offset by increased sales from company-operated retail stores opened subsequent to the first quarter of 2008. The decline in sales in our wholesale channels in our mature markets was primarily due to lower sales of our Levi’s^®Red Tab^tmwomen’s products, as sales of our 501^®products in the region were stable as compared to prior year.

 

Asia Pacific.  Net revenues in Asia Pacific increased on both reported and constant currency bases. Currency affected net revenues unfavorably by approximately $9 million.

 

Net sales increased in the region due to continued expansion of our dedicated store network in our developing markets, particularly China, as well as increased sales driven by product promotions across the region. Our Asia Pacific business, which grew overall in the quarter despite declining consumer confidence, experienced weakening retail performance at the end of the quarter.

 

The following table shows consolidated gross profit and gross margin for the periods indicated and the changes in these items from period to period:

 

 

Gross profit for the three-month period ended March 1, 2009, declined as compared to the same prior-year period due to our decline in net revenues, a decline in our consolidated gross margin, and the impact of the depreciation against the U.S. dollar of foreign currencies, primarily the Euro. Gross margins decreased in each of our regions primarily due to an increase in sales allowances and discounts and higher inventory markdown activity, reflecting our continued focus on managing inventories in a rapidly evolving retail market.

 

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 and occupancy costs associated with company-operated stores in cost of goods sold.

 

 

The following table shows our selling, general and administrative expenses (“SG&A”) for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues: