UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the Quarterly Period Ended May 30, 2004
OR
Commission file number: 333-36234
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)
None
(Former Name, Former Address, and Former Fiscal Year, if Changed Since Last Report)
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 whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x
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 July 12, 2004
INDEX TO FORM 10-Q
MAY 30, 2004
PART I—FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II—OTHER INFORMATION
Item 6.
SIGNATURE
Item 1. Financial Statements
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
May 30,
2004
November 30,
2003
Current Assets:
Cash and cash equivalents
Trade receivables, net of allowances of $26,573 in 2004 and $26,956 in 2003
Inventories
Deferred tax assets, net of valuation allowance of $25,281 in both 2004 and 2003
Other current assets
Total current assets
Property, plant and equipment, net of accumulated depreciation of $471,225 in 2004 and $491,121 in 2003
Goodwill, net of accumulated amortization of $151,569 in 2004 and in 2003
Other intangible assets, net of accumulated amortization of $36,415 in 2004 and $36,349 in 2003
Non-current deferred tax assets, net of valuation allowance of $324,269 in both 2004 and 2003
Other assets
Total Assets
Current Liabilities:
Current maturities of long-term debt and short-term borrowings
Accounts payable
Restructuring reserves
Accrued liabilities
Accrued salaries, wages and employee benefits
Accrued taxes
Total current liabilities
Long-term debt, less current maturities
Postretirement medical benefits
Pension liability
Long-term employee related benefits
Long-term tax liabilities
Other long-term liabilities
Minority interest
Total liabilities
Stockholders’ Deficit:
Common stock—$.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
Total stockholders’ deficit
Total Liabilities and Stockholders’ Deficit
The accompanying notes are an integral part of these financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
May 30, 2004
Six Months Ended
May 25, 2003
Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Other operating income
Restructuring charges, net of reversals
Operating income
Interest expense
Other expense, net
Income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
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:
Depreciation and amortization
Non-cash asset write-offs associated with reorganization initiatives
Gain on dispositions of property, plant and equipment
Unrealized foreign exchange (gains) losses
Decrease in trade receivables
Decrease in income taxes receivables
Decrease (increase) in inventories
Decrease (increase) in other current assets
Decrease (increase) in other long-term assets
Decrease in accounts payable and accrued liabilities
Decrease in restructuring reserves
Increase (decrease) in accrued salaries, wages and employee benefits
Increase (decrease) in accrued taxes
Decrease 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 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:
Interest
Income taxes
Restructuring initiatives
NOTE 1: PREPARATION OF FINANCIAL STATEMENTS
Basis of Presentation and Principles of Consolidation
The unaudited 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 (“U.S.”) for interim financial information. In the opinion of management, all adjustments necessary for a fair presentation 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 LS&CO. for the year ended November 30, 2003 included in the annual report on Form 10-K filed by LS&CO. with the Securities and Exchange Commission on March 1, 2004.
The unaudited consolidated financial statements include the accounts of Levi Strauss & Co. and its subsidiaries. All intercompany transactions have been eliminated. Management believes that the disclosures are adequate to make the information presented herein not misleading. Certain prior year amounts have been reclassified to conform to the current presentation. The results of operations for the three months and six months ended May 30, 2004 may not be indicative of the results to be expected for any other interim period or the year ending November 28, 2004.
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 consists of 52 weeks ending November 28, 2004. Each quarter of fiscal year 2004 consists of 13 weeks. The 2003 fiscal year consisted of 53 weeks ended November 30, 2003. The first, second and third quarters of fiscal year 2003 consisted of 13 weeks and the fourth quarter of 2003 consisted of 14 weeks.
The unaudited consolidated financial statements for the three and six months ended May 25, 2003 have been restated. All information in the notes to the unaudited consolidated financial statements referring to the three and six months ended May 25, 2003 gives effect to this restatement. Information about the restatement is included in the annual report on Form 10-K filed by LS&CO. with the Securities and Exchange Commission on March 1, 2004.
Exploration of the Sale of the Company’s Dockers® Business
On May 11, 2004, the Company announced that it is exploring the sale of its worldwide Dockers® casual clothing business and has retained Citigroup Inc. to assist it with the potential sale. The Company is exploring the sale of the Dockers® business because it believes that a sale would help the Company reduce substantially its debt, improve its capital structure and focus its resources on growing its Levi’s® brand and Levi Strauss Signature™ brand businesses. As previously announced, the Company intends to seek amendments to its senior secured term loan and senior secured revolving credit facility to facilitate any proposed sale of the Dockers® business. The proposed amendments would, among other things, provide for the lenders’ consent to a sale of the Dockers® business (which generated approximately 24% of the Company’s revenues in 2003), provided that the application of sale proceeds results in a reduction in the Company’s net debt of at least 30%. If accepted as currently proposed, the amendments would also provide the Company greater flexibility than is currently permitted in applying the proceeds of a sale among the various debt instruments currently outstanding, as well as greater flexibility under several negative covenants in the Company’s senior secured term loan and senior secured revolving credit facility.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the related notes. The Company believes that the following discussion addresses the Company’s critical accounting policies, which are those that are most important to the portrayal of the Company’s 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 summarizes its critical accounting policies 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 the Company’s 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 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 its 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. Such costs are recorded as a current liability. Restructuring costs associated with initiatives commenced prior to January 1, 2003 were recorded in compliance with Emerging Issues Task Force No. 94-3 as a current liability 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,” 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 by the Company 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 updated estimates.
Income tax assets and liabilities. In establishing its deferred income tax assets and liabilities, the Company makes judgments and interpretations based on the enacted tax laws and published tax guidance applicable to its operations. The Company records deferred tax assets and liabilities and evaluates the need for valuation allowances to reduce the deferred tax assets to estimated realizable amounts. The Company utilizes forecasts of future taxable income in assessing the adequacy of its valuation allowances. The likelihood of a material change in the Company’s expected realization of these assets is dependent on estimated assessments of future taxable income and ability to use foreign tax credit carryforwards, carrybacks and net operating losses; U.S. and foreign tax settlements; the effectiveness of tax planning strategies in the various relevant jurisdictions; and other factors. The Company is also subject to examination of income tax returns for multiple years by the Internal Revenue Service and other tax authorities. The Company 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. Changes in the Company’s valuation of the deferred tax assets or changes in the necessary reserve balances could impact its annual effective income tax rate.
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 and reflect assumptions about currency fluctuations based on current market conditions. The 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. The Company actively manages foreign currency exposures on an economic basis, using forecasts to develop exposure positions to protect the U.S. dollar value of cash flows.
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 do qualify for hedge accounting currently hedge the Company’s net investment position in 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 do qualify for hedge accounting are recorded in the “Accumulated other comprehensive loss” section of Stockholders’ Deficit.
Employee benefits
Pension and Postretirement 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 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 consolidated financial statements and on the Company’s future financial performance.
The Company accounts for its U.S. and certain foreign defined benefit pension plans and its postretirement 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 postretirement 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 and income tax regulations, as well as in accordance with 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.
The long-term liability balance for the Company’s pension plans was $226.8 million and $250.8 million as of May 30, 2004 and November 30, 2003, respectively. The short-term pension liability was $14.4 million and $4.5 million as of May 30, 2004 and November 30, 2003, respectively, and is recorded in “Accrued salaries, wages and employee benefits.” The long-term liability balance for the Company’s postretirement benefit plans was $514.4 million and $555.0 million as of May 30, 2004 and November 30, 2003, respectively. The short-term liability balance for postretirement benefit plans was $41.4 million as of both May 30, 2004 and November 30, 2003, respectively, and is recorded in “Accrued salaries, wages and employee benefits.”
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 correlate with the Company’s financial results and projected future financial performance and could have a material impact on the consolidated financial statements and on future financial performance. (For more information, see Note 10 to the Consolidated Financial Statements.)
Long-lived Assets Held for Sale
At May 30, 2004 and November 30, 2003, the Company had approximately $5.6 million and $2.2 million, respectively, of long-lived assets held for sale. Such assets are recorded in “Property, plant and equipment.” Long-lived assets held for sale as of May 30, 2004 are primarily comprised of assets associated with a closed manufacturing plant in San Antonio, Texas. (See Note 3 to the Consolidated Financial Statements.)
New Accounting Standards
In December 2003, the FASB issued SFAS 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This Statement changes the disclosure requirements for pension plans and other post-retirement benefit plans. It does not change the measurement or recognition of those plans required by SFAS 87, Employers’ Accounting for Pensions, SFAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, or SFAS 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. This Statement requires additional disclosures to those required in the original SFAS 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other post-retirement benefit plans. SFAS 132 requires that information be provided separately for pension plans and for other post-retirement benefit plans. SFAS 132 is effective for annual financial statements with fiscal years ending after December 15, 2003, and for interim periods beginning after December 15, 2003. The Company has adopted SFAS 132 and provided the interim period disclosure requirements for the period ended May 30, 2004. The adoption of SFAS 132 did not have any impact on the Company’s operating results or financial position.
In December 2003, the Financial Accounting Standards Board published a revision to Financial Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities” (“FIN 46R”) to clarify some of the provisions of FIN 46, and to exempt certain entities from its requirements. Under the new 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 the Company’s operating results or financial position because the Company does not have any variable interest entities.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law in the U.S. 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 Staff Position 106-2 will be implemented by the Company in the fourth quarter of Fiscal 2004. The Company is currently evaluating the impact of this guidance on the Company’s financial position, results of operations and cash flows.
NOTE 2: INVENTORY
The following is a summary of the components of inventory as of May 30, 2004 and November 11, 2003:
Inventories:
Raw materials
Work-in-process
Finished goods
Total inventories
As of May 30, 2004, the Company had total raw materials and work-in-process inventory of approximately $73 million, as compared to total raw materials and work-in-process inventory of approximately $94 million as of November 30, 2003. The $21 million decrease in raw materials and work-in-process inventory results from the Company’s continuing transition from self-manufacturing to outsourced production. As of May 30, 2004, the Company had excess and/or obsolete finished goods inventory with an original cost of approximately $110. Based upon the estimated recoveries of such inventory, the Company had marked down such inventory by approximately $35 million to its estimated recoverable value of $75 million. As of February 29, 2004, the Company had excess and/or obsolete finished goods inventory with an original cost of approximately $140 million. Based upon the estimated recoveries of such inventory, the Company had marked down such inventory by approximately $50 million to its estimated recoverable value of $90 million. During the first quarter of 2004, the Company reduced its estimated allowance for obsolete and slow-moving inventory by approximately $5.3 million due to improvements in its estimation process. These improvements related to the definition of product attributes that are taken into consideration in evaluating the likelihood of recovery rates below cost. The reduction in the estimated allowance is reflected in the results of operations for the six months ended May 30, 2004. For the three months and six months ended May 25, 2003, improvements in the process of estimating potential excess inventory resulted in a reduction of inventory valuation reserves of approximately $6 million and $11 million, respectively.
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 plant closures and reorganization initiatives. Reductions consist of payments for severance and employee benefits, other restructuring costs, and foreign exchange differences. Reversals are recorded as a result of changes in the amount of the estimated future cash outflows based upon quarterly review of restructuring activities. The balance of severance and employee benefits and other restructuring costs are included in restructuring reserves on the accompanying balance sheets.
The total balance of the restructuring reserves at May 30, 2004 was $66.4 million compared to $96.4 million at November 30, 2003. The Company expects to utilize the majority of the reserve balances during fiscal year 2004. For the three and six months ended May 30, 2004, the Company recognized restructuring charges, net of reversals, of $25.7 million and $80.0 million, respectively. The restructuring charges include a charge of $42.8 million related to the indefinite suspension of the installation of a worldwide enterprise resource planning system, which was recorded during the first quarter of fiscal 2004. Additionally, the restructuring charges, net of reversals, for the three and six months ended May 30, 2004 include $25.7 million and $37.2 million, respectively, related to other restructuring activities that became probable and estimable or were expensed as incurred.
The following table summarizes the activities and liability balances associated with restructuring initiatives from 2001 through the second quarter of fiscal 2004:
Restructuring
Reductions
Reversals
2004 Reorganization Initiatives
2004 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 ERP** Asset Write-offs
2003 North America Plant Closures—Asset Write-offs
Total
In December 2003, the Company retained the management consulting firm Alvarez & Marsal, Inc. to work with the Company’s leadership team to further assist in analyzing the Company’s business strategies, plans and operations. As a result of this review, during the second quarter of fiscal 2004, the Company commenced the following additional reorganization initiatives described in this section.
2004 Spain Plant Closures
During the three months ended May 30, 2004, the Company commenced the process of closing its two owned and operated manufacturing plants in Spain. The Company is engaged in negotiations with local representatives for the plant employees and expects the plants to cease operations by the end of fiscal 2004. During the three months ended May 30, 2004, the Company recorded severance costs of approximately $10.3 million related to the anticipated displacement of approximately 460 employees associated with this initiative. The amount of the initial charge was determined based upon the estimated minimum severance benefits for this action under local statutory requirements. As negotiations progress, the Company expects to incur additional employee-related restructuring costs for termination benefits and other restructuring costs which will be recorded as they become probable and estimable. As of May 30, 2004, no employees had yet been displaced. In addition, while preliminary analysis indicates that there does not appear to exist an impairment issue relating to the carrying amounts of the related property, plant and equipment, the Company is in the process of obtaining formal appraisals which could result in additional restructuring charges as a result of the decision to close the plants.
2004 U.S. Organizational Changes
During the three months ended May 30, 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 will result in the displacement of approximately 175 employees. During the three months ended May 30, 2004, the Company recorded a charge for severance and lease termination costs of approximately $12.5 million related to this initiative. As of May 30, 2004, approximately 60 individuals had been displaced. The Company will continue to identify actions intended to further reduce costs, and will record additional employee-related restructuring costs for termination benefits and other restructuring costs, as appropriate, when they become probable and estimable.
2004 Europe Organizational Changes
During the three months ended May 30, 2004, the Company commenced additional reorganization actions which resulted in the displacement of three employees in its European operations. As of May 30, 2004, the Company recorded a charge for severance costs and related benefits of approximately $0.9 million related to this initiative. The Company will continue to identify actions intended to further reduce costs, and will record additional employee-related restructuring costs for termination benefits and other restructuring costs, as appropriate, when they become probable and estimable.
The table below displays the restructuring activity for the six months ended May 30, 2004, and the balance of the restructuring reserves as of May 30, 2004, for the 2004 reorganization initiatives discussed above.
Charges
Severance and employee benefits
Other restructuring costs
Subtotal – 2004 Spain Plant Closures
Subtotal – 2004 U.S. Organizational Changes
Subtotal – 2004 Europe Organizational Changes
Total – 2004 Reorganization Initiatives
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 the first quarter of fiscal 2004 related to this initiative. The charge was comprised of approximately $2.7 million related to the displacement of approximately 40 employees, $6.6 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 May 30, 2004, approximately 40 employees had been displaced.
During the remainder of fiscal year 2004, the Company expects to incur no additional restructuring costs in connection with this action.
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 three and six months ended May 30, 2004 of $0.7 million and $8.2 million, respectively, for additional severance and benefits related to the displacement of approximately 185 employees, and $0.3 million and $0.9 million, respectively, for other restructuring costs. As of May 30, 2004, approximately 535 employees had been displaced, and the remainder will be displaced during 2004.
During the remainder of fiscal year 2004, the Company expects to incur additional employee-related restructuring costs related to this initiative of approximately $2.5 million for termination benefits and other restructuring costs, which will be recorded as they become estimable and probable.
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. Production from the San Antonio and Canadian facilities has been shifted to third-party contractors located primarily outside the U.S. and Canada. During the third quarter of 2003, the Company recorded a charge of $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 three and six months ended May 30, 2004 of $4.1 million and $7.4 million, respectively, net of reversals, for additional severance and employee benefits, facility closure costs and asset write-offs related to these initiatives. As of May 30, 2004, a total of approximately 2,000 employees had been displaced in connection with these plant closures.
During the remainder of fiscal year 2004, the Company expects to incur additional employee-related restructuring costs of approximately $1.1 million for termination benefits, and $4.8 million relating to the closures and other restructuring costs, such as contract termination costs, 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 310 employees. The Company recorded charges during the three and six months ended May 30, 2004 of $1.0 million and $1.8 million, respectively, for additional severance and employee benefits and legal fees associated with severance negotiations, and reversals of $1.2 million and $1.6 million, respectively, associated with lower than anticipated severance and employee benefits. As of May 30, 2004, approximately 273 employees had been displaced and the remainder are to be displaced in 2004.
The table below displays the activity and liability balance of the reserve for this European 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 Belgium, France and Holland distribution centers during the first half of 2004. During 2002, the Company recorded an initial charge of $1.6 million reflecting the estimated displacement of 40 employees. During 2003, the Company recorded in selling, general and administrative expenses charges of $6.1 million reflecting the estimated displacement of 89 employees. As of May 30, 2004, all of the employees had been displaced.
For the three and six months ended May 30, 2004 the Company recorded charges of $0.2 million and $0.4 million, respectively, for additional severance and benefits and other restructuring costs, such as lease termination costs.
During the remainder of fiscal year 2004, the Company expects to incur additional other restructuring costs, such as contract termination costs, of approximately $1.0 million related to this initiative, 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 Company announced in April 2002 the closure of six U.S. manufacturing plants. The Company recorded an initial charge in the second quarter of 2002 of $120.0 million consisting of $16.3 million for asset write-offs, $86.0 million for severance and employee benefits and $17.7 million for other restructuring costs. The Company closed the six manufacturing plants in 2002, displacing 3,540 employees. For the three and six months ended May 30, 2004, the Company reversed $3.1 million of employee benefit costs due to less than anticipated claims volume.
The table below displays the activity and liability balance of this reserve.
2001 Corporate Reorganization Initiatives
In November 2001, the Company instituted various reorganization initiatives in the U.S. that included simplifying product lines and realigning its resources to those product lines. The Company recorded an initial charge of $20.3 million in November 2001. In connection with these initiatives, approximately 325 employees were displaced.
NOTE 4: INCOME TAXES
Effective Tax Rate for Six Months Ended May 30, 2004. The effective tax rate for the six months ended May 30, 2004 was (42.1%), and differs from the Company’s estimated annual effective tax rate of (215.1%) described below, due primarily to losses in certain foreign jurisdictions for which no tax benefit can be recognized. In accordance with FASB Interpretation No. 18, the Company adjusts its annual estimated effective tax rate of (215.1%) to exclude the impact of these foreign losses. The adjusted estimated annual effective tax rate is then applied to the year-to-date pre-tax operating results, exclusive of the results in these foreign jurisdictions, to compute tax expense for the six-month period ended May 30, 2004. This calculation results in a (42.1%) effective rate for the six months ended May 30, 2004. Tax expense of $2.6 million was recorded in the three month period ended May 30, 2004 to bring the year-to-date accrual for income taxes to the (42.1%) effective tax rate.
Estimated Annual Effective Tax Rate. As indicated above, the Company is projecting an annual 2004 effective tax rate of (215.1%). Income taxes are provided on an interim basis based upon this projection. For the fiscal year ended November 30, 2003, the effective tax rate was (1, 016.3%). The estimated annual effective tax rate of (215.1%) is based on current full-year forecasts of income or losses, as adjusted by the following:
The estimated annual effective tax rate for 2004 differs from the U.S. federal statutory income tax rate of 35% as follows:
Income tax expense at U.S. federal statutory rate
State income taxes, net of U.S. federal impact
Impact of foreign operations
Interest and taxes accrued for federal, state and international tax issues
Increase in valuation allowance
Nondeductible expenses
The “state income taxes, net of U.S. federal impact” item above reflects the state tax benefit generated by domestic tax losses in the U.S., 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 estimated annual effective tax rate through an increase in the valuation allowance, which is discussed in more detail below. The rate of 33.7% reflects the state income tax expense or benefit as a percentage of consolidated earnings before taxes.
The “impact of foreign operations” item above reflects additional benefit generated by foreign losses incurred in jurisdictions with rates in excess of the U.S. federal statutory rate. As not all federal losses meet the more likely than not standard for realization, the Company reverses a portion of this benefit from the estimated annual effective tax rate through an increase in the valuation allowance, which is discussed in more detail below. This item also reflects the Company’s expectation that foreign income taxes will be deducted rather than claimed as a credit in the U.S. federal income tax return.
The “interest and taxes accrued for federal, state, and international issues” item above reflects the accrual for current year interest on outstanding tax reserves and any changes during the year to these accruals.
The “increase in valuation allowance” relates primarily to projected additional current year losses in foreign and state jurisdictions in which the Company has previously decided it is unlikely to utilize its existing operating loss carry forwards. The current year losses arise in part due to projections of increased restructuring expenses (see Note 3 to the Consolidated Financial Statements). The Company continues to believe it is more likely than not its U.S. federal net operating loss carryover will be utilized before it expires. Projected repatriations of significant unremitted foreign earnings support utilization of the U.S. federal net operating loss carry forwards.
The Company’s total valuation allowance relates primarily to deferred tax assets for foreign tax credits, state and foreign net operating loss carry forwards and other foreign deferred tax assets. Realization of the Company’s deferred tax assets is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain. Accordingly, the Company evaluates 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 “nondeductible expenses” relate primarily to items that are deductible for determining book income but that will not be deductible in determining U.S. federal and state taxable income.
Examination of Tax Returns. The Company has income tax returns under examination by various regulatory tax authorities. The Company continuously reviews issues raised in connection with these on-going examinations to evaluate the adequacy of its reserves. During the period ended May 30, 2004, the Company received unfavorable advice from the National Office of the Internal Revenue Service with regard to certain tax positions taken by the Company on prior returns. On June 14, 2004, the Company also received a Revenue Agent’s Report (“RAR”) relating to the IRS’s examination of the FY 90-94 U.S. federal income tax returns of the Company. While the Company agrees with the majority of the adjustments proposed by the tax authorities in the RAR, a number of unagreed technical issues will be protested and moved to the Appeals Division of the Internal Revenue Service to be resolved at that level.
The Company believes that its accrued tax liabilities are adequate to cover its domestic and foreign tax loss contingencies.
Reclassifications. During the second quarter of fiscal 2004, the Company reclassified approximately $35 million from long term tax liabilities to accrued taxes to reflect the expected payments during the next 12 months of tax and interest related to the resolution of tax issues with various tax authorities. In addition, for the six months ended May 25, 2003, the Company has reclassified in its statement of cash flows prior year interim changes in deferred tax assets to changes in current tax liabilities, to reflect the current year presentation. There was no change in the reported cash used in operating activities for the six months ended May 25, 2003 as a result of such reclassification.
NOTE 5: DEBT AND LINES OF CREDIT
Debt and lines of credit at May 30, 2004 and November 30, 2003 are summarized below:
Long-Term Debt:
Secured:
Term Loan due 2009
Customer Service Center Equipment Financing due December 2004
Notes payable, at various rates, due in installments through 2006
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
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
Cash and Cash Equivalents
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 and uses the borrowings under these agreements to refinance the January 2003 senior secured credit facility and 2001 domestic receivables securitization agreement and for working capital and general corporate purposes. Both the term loan and the revolving credit facility contain a consolidated fixed charge coverage ratio covenant:
Under the credit agreements, EBITDA is generally defined as consolidated net income plus (i) consolidated interest charges, (ii) the current 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.
In connection with the Company’s exploration of the sale of the Dockers® business, the Company intends to seek amendments to its current agreements to facilitate any proposed sale (see Note 1 to the Consolidated Financial Statements).
Other Debt Matters
Debt Issuance Costs. The Company capitalizes debt issuance costs, which are included in other assets in the accompanying consolidated balance sheet. Debt issuance costs outstanding at May 30, 2004 and November 30, 2003 aggregated $50.2 million and $54.8 million, respectively. Amortization of debt issuance costs, which is included in interest expense, was $2.6 million and $2.9 million for the three months ended May 30, 2004 and May 25, 2003, respectively and $5.2 million and $6.7 million for the six months ended May 30, 2004 and May 25, 2003, respectively.
Accrued Interest. At May 30, 2004 and November 30, 2003, accrued interest related to debt amounted to $65.5 million and $65.5 million, respectively, and was included in accrued liabilities.
Principal Short-term and Long-term Debt Payments
As of May 30, 2004, the required aggregate short-term and long-term debt principal payments for the next five fiscal years and thereafter are as follows:
Fiscal Year
Principal Payments
as of May 30, 2004
2004 (remaining six months)
2005
2006
2007
2008
Thereafter
The 2004 and 2005 payments include required payments of $2.5 million and $5.0 million, respectively, under the Company’s senior secured term loan. Additional payments in 2004 relate to short-term borrowings of $20.0 million and $4.2 million for the Company’s customer service center equipment financing. Additional payments in 2005 include a required payment under the Company’s customer service center equipment financing of $55.9 million. The 2006 payments include the payment of 7.00% notes due November 1, 2006 of $450.0 million.
The 2006 and 2008 payments include the maturity of the 7.00% notes due November 1, 2006 and the maturity of the 11.625% notes due in January 2008, respectively. The Company’s senior secured term loan and senior secured revolving credit facility agreements contain early maturity provisions and covenants linked to the timing of refinancing or repayment of the 7.00% notes due 2006 and the 11.625% notes due 2008. Review of the table above should take into account the fact that the senior secured term loan requires the Company to repay or refinance both the 7.00% notes due 2006 and the 11.625% notes due 2008 no later than six months prior to their maturity date in order to prevent acceleration of the maturity date of the senior secured term loan to a date three months prior to the maturity date of the 2006 and 2008 notes, respectively. As a result, unless the Company has refinanced, repaid or otherwise provided for the 2006 notes by May 1, 2006, the term loan will become due on August 1, 2006 and unless the Company has refinanced, repaid of otherwise provided for the 2008 notes by July 15, 2007, the term loan will become due on October 15, 2007.
Short-Term Credit Lines and Stand-By Letters of Credit
At May 30, 2004, the Company had unsecured and uncommitted short-term credit lines available totaling $28.8 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.
At May 30, 2004 and November 30, 2003, the Company had $94.9 million and $144.0 million, respectively, of stand-by letters of credit with various international banks, of which $70.3 million and $64.0 million, respectively, serve as guarantees by the creditor banks to cover U.S. workers’ compensation claims. In addition, $22.6 million of these stand-by letters of credit under the senior secured revolving credit facility support short-term credit lines at May 30, 2004. The Company pays fees on the stand-by letters of credit. Borrowings against the letters of credit are subject to interest at various rates.
Interest Rates on Borrowings
The Company’s weighted average interest rate on average borrowings outstanding during the three months ended May 30, 2004 and May 25, 2003, including the amortization of debt issuance costs and interest rate swap cancellations, was 10.66% and 9.65%, respectively The Company’s weighted average interest rate on average borrowings outstanding during the six months ended May 30, 2004 and May 25, 2003, including the amortization of capitalized bank fees and interest rate swap cancellations, was 10.65% and 9.96%, 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 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.
NOTE 6: FAIR VALUE OF FINANCIAL INSTRUMENTS
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 considerable judgment in interpreting market data, which means that the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
The carrying amount and estimated fair value (in each case including accrued interest) of the Company’s financial instrument assets and (liabilities) at May 30, 2004 and November 30, 2003 are as follows:
DEBT INSTRUMENTS:
U.S. dollar notes offering
Euro notes offering
Yen-denominated Eurobond placement
Term loan
Customer service center equipment financing
Short-term and other borrowings
(1) Includes accrued interest of $65.5 million.
(2) Includes accrued interest of $65.5 million.
Foreign exchange forward contracts
Foreign exchange option contracts
Quoted market prices or dealer quotes are used to determine the estimated fair value of foreign exchange contracts, option contracts and interest rate swap 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, current assets, certain current and non-current maturities of long-term debt, short-term borrowings and taxes approximate fair value.
The fair value estimates presented herein are based on information available to the Company as of May 30, 2004 and November 30, 2003. These amounts have not been updated since those dates and, therefore, the current estimates of fair value at dates subsequent to May 30, 2004 and November 30, 2003 may differ substantially from these amounts. In addition, the aggregation of the fair value calculations presented herein do not represent and should not be construed to represent the underlying value of the Company.
NOTE 7: COMMITMENTS AND CONTINGENCIES
Foreign Exchange Contracts
At May 30, 2004, the Company had U.S. dollar spot and forward currency contracts to buy $553.1 million and to sell $280.5 million against various foreign currencies. The Company also had euro forward currency contracts to buy and sell 50 million Euros ($61.3 million equivalent) against Swedish Krona. These contracts are at various exchange rates and expire at various dates through June 2004.
The Company has entered into option contracts to manage its exposure to numerous foreign currencies. At May 30, 2004, the Company had bought U.S. dollar option contracts resulting in a net short position against various foreign currencies of $53.2 million 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 $3.5 million, should the options be exercised. The option contracts are at various strikes and expire at various dates through June 2004.
At the respective maturity dates of the outstanding spot, forward and option currency contracts, the Company will enter into various derivative transactions in accordance with its currency risk management policy, aimed at covering the spot risk at inception of the exposure.
The Company’s market risk is generally related to fluctuations in the currency exchange rates. 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.
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 the Company 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 on 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 auditors 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.
In a related administrative proceeding before the U.S. Department of Labor under Section 1107 of the Sarbanes-Oxley Act, the plaintiffs made a claim based on the same allegations made in the wrongful termination suit. On January 23, 2004, the plaintiffs withdrew their complaint just prior to the issuance by the Department of Labor of an initial determination. The Department of Labor has now closed its file on this matter.
On March 12, 2004, plaintiffs filed a federal complaint in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. 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 this Act. Plaintiffs seek a number of
remedies, including compensatory damages, interest lost on all earning 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.
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.
Class Action 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 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, its former chief financial officer, its corporate controller, its directors and 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 the Company’s 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 the Company’s 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 the Company’s 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.
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 8: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Foreign Exchange Management
The Company manages foreign currency exposures primarily to protect the U.S. dollar value of cash flows. The Company attempts to take a long-term view of managing exposures on an economic basis, using forecasts to develop exposure positions and engaging in active management of those exposures with the objective of protecting future cash flows and mitigating risks. To manage the volatility relating to these exposures, the Company evaluates them on a global basis to take advantage of the netting opportunities that exist. For the remaining exposures, the Company enters into various derivative transactions in accordance with its currency risk management policies, aimed at covering the spot risk at inception of the exposure. The Company does not currently manage the timing mismatch derived from forecasted exposures and their corresponding hedges. In 2003, the Company defined as part of its foreign currency risk management policy an open position ratio limit. The open position ratio is a measurement of the relationship between the notional amount of the hedging instrument and the hedged item. The Company’s foreign exchange policy allows a maximum open position ratio of 25%. At May 30, 2004, the Company’s open position ratio was 7.4%, while the maximum open position ratio during the three and six months ended May 30, 2004 was 21.4%.
The Company uses a variety of derivative instruments, including forward, swap and option contracts, to protect against foreign currency exposures related to sourcing, net investment positions, royalties, debt and cash management.
The Company does not apply hedge accounting to its foreign currency derivative transactions, except for certain net investment hedging activities.
The Company manages its net investment position in its subsidiaries in major currencies through a combination of derivative instruments, primarily swap contracts, and non-derivative instruments. Some of the contracts hedging these net investments qualify for hedge accounting and the related gains and losses are consequently included in the “Accumulated other comprehensive income (loss)” component of Stockholders’ Deficit. At May 30, 2004, the fair value of qualifying net investment hedges was a $0.2 million net
liability with the corresponding unrealized gain recorded in “Accumulated other comprehensive income (loss).” At May 30, 2004, a $4.1 million realized loss has been excluded from hedge effectiveness testing. In addition, the Company holds derivatives managing the net investment positions in major currencies that do not qualify for hedge accounting. The fair value of these derivatives at May 30, 2004 represented a $0.1 million net liability, and changes in their fair value are included in “Other expense, net.”
The Company designates a portion of its outstanding yen-denominated Eurobond as a net investment hedge. As of May 30, 2004, a $2.4 million unrealized loss related to the translation effects of the yen-denominated Eurobond was recorded in “Accumulated other comprehensive income (loss).”
The table below gives an overview of the realized and unrealized gains and losses associated with foreign exchange management activities reported in “Other expense, net.”
Other (income)expense, net
Other
expense, net
The table below gives an overview of the realized and unrealized gains and losses associated with foreign exchange management activities that are reported in “Accumulated other comprehensive income (loss)” (“Accumulated OCI”) balances. Accumulated OCI is a component of Stockholders’ Deficit.
Accumulated 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 recorded in “Accrued liabilities” on the consolidated balance sheets.
Interest Rate Management
The Company is exposed to interest rate risk. It is the Company’s policy and practice to manage and reduce interest rate exposures by using a mix of fixed and variable rate debt and, as necessary, derivative instruments. The Company currently has no derivative instruments managing interest rate risk outstanding as of May 30, 2004.
NOTE 9: OTHER EXPENSE, NET
The following table summarizes significant components of other expense, net:
Three MonthsEnded
Six Months
Ended
Foreign exchange management contract losses
Foreign currency transaction losses (gains)
Interest income
(Gain) loss on disposal of assets
Loss on early extinguishment of debt
The Company uses foreign exchange management contracts such as forward, swap and option contracts, to manage foreign currency exposures. These derivative instruments are recorded at fair value and the changes in fair value are 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 exchange rate are recorded in other expense, net.
NOTE 10: INCENTIVE COMPENSATION PLANS
Annual Incentive Plan
The Annual Incentive Plan (“AIP”) is intended to reward individual contributions to the Company’s performance during the year. In 2003, compensation under the plan was measured based on certain pre-established targets and all salaried employees were eligible. In 2004, the Company changed the qualification criteria and participation level terms of the plan including eliminating eligibility under the plan for a substantial portion of the Company’s U.S. employee population. Compensation under the short-term plan is based on a combination of Company performance against pre-established targets (principally relating to (i) earnings before interest, taxes, depreciation and amortization and (ii) cash flow) and individual performance. The Company periodically evaluates the adequacy of the recorded liability and makes adjustments as appropriate. The Company recorded AIP expense of $16.9 million and a net reversal of $5.1 million for the three months ended May 30, 2004 and May 25, 2003, respectively. The Company recorded AIP expense of $26.8 million for the six months ended May 30, 2004. For the six months ended May 25, 2003, there was no expense recorded. As of May 30, 2004 and November 30, 2003, the Company had accrued $30.9 million and $10.5 million, respectively, for the AIP plan, which was recorded in accrued salaries, wages and employee benefits.
Long-Term Incentive Compensation
In February 2004, the Company established a new long-term incentive plan for its management team, including its executive officers and most of its directors. The Company set a target amount for each participant based on job level. The plan, which covers a 19-month period, includes both performance and retention elements as conditions for payment:
The Company recorded long-term incentive compensation expense of $14.1 million and a net reversal of $8.0 million for the three months ended May 30, 2004 and May 25, 2003, respectively. The Company recorded long-term incentive compensation expense of $26.3 million and a net reversal of $10.1 million for the six months ended May 30, 2004 and May 25, 2003, respectively. The net reversal recorded in 2003 was attributable to lower expected payouts under the plan in place in 2003 due to changes in the Company’s forecasted financial performance. As of May 30, 2004, the Company had accrued $ 26.3 million for the long-term incentive plan. As of November 30, 2003, there were no such amounts accrued.
Dockers® Transaction Incentives
In connection with the Company’s exploration of the sale of its worldwide Dockers® casual clothing business, the Company has established programs to retain and motivate certain employees. The total estimated maximum payout under these programs is approximately $6.8 million. If the Dockers® business is withdrawn from sale, the estimated minimum guaranteed payout under these programs is approximately $1.4 million. These programs are summarized below.
Transaction Incentive. In June 2004, the Company adopted a bonus program providing incentive bonuses to three executives of the Company if a sale is successfully completed in fiscal 2004. The successful completion of a sale would take into account not only sale completion but also certain operating and performance metrics relating to the Dockers® business. The amount of the incentive bonus ranges from 100-125% of the individual’s current annual base salary, and would be payable within three months of completion of the transaction. The total estimated maximum payout under this program is approximately $1.2 million.
Retention Incentive. In June 2004, the Company adopted a bonus program providing retention bonuses to certain employees to maintain and motivate individuals through the completion of any proposed sale of the Dockers® business. The amount of the retention bonus varies depending upon the individual’s level in the organization and amount of time focused on the Dockers® business. The total estimated maximum payout under this program is approximately $5.6 million, to be paid within three months of completion of a sale. If the Dockers® business is withdrawn from sale, individuals eligible for this program would receive a minimum guaranteed payout of 25% of their sale bonus. The Company has accrued approximately $0.2 million as of May 30, 2004 for the minimum guaranteed payout under this program.
NOTE 11: EMPLOYEE BENEFIT PLANS
The components of net periodic benefit cost for the Company’s U.S. pension plans and postretirement plans were as follows:
Components of net periodic benefit cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of loss
Amortization of transition asset
Net curtailment gain
Termination benefits
Net periodic benefit cost (gain)
Postretirement Benefit Plans Curtailment
During the three and six months ended May 30, 2004, the Company recognized net curtailment gains of $7.4 million and $23.8 million, respectively, resulting from the Company’s restructuring initiatives (see Note 3 to the Consolidated Financial Statements) and their impact on its postretirement benefit plans. The events resulting in the net curtailment gains are discussed below.
As a result of the employee terminations and the amendment to the postretirement benefit plan, the Company’s postretirement plans benefit obligation was reduced to $369.0 million as of May 30, 2004, from $743.8 million as of November 30, 2003. Additionally, these actions resulted in an increase in the negative unrecognized prior service cost to $439.3 million as of May 30, 2004, from $108.7 million as of November 30, 2003. This negative unrecognized prior service cost represents the decreased benefits and obligations that were based on service previously rendered by employees, and is being amortized over 10.2 years, which represents the average years of future service to expected retirement age.
The following table summarizes the changes in the benefit obligation and plan assets of the Company’s postretirement benefit plans in accordance with SFAS 106, “Employer’s Accounting for Postretirement Benefits Other Than Pension.” The benefit obligation represents the actuarial present value of the Company’s postretirement medical benefits attributed to employee service.
Benefit obligation at beginning of period
Plan participants’ contributions
Plan amendments
Actuarial loss
Net curtailment (gain) loss
Special termination benefits
Benefits paid
Benefit obligation at end of period
Fair value of plan assets at beginning of period
Employer contribution
Fair value of plan assets at end of period
Funded status
Unrecognized actuarial loss
Unrecognized prior service cost
Net amount recognized
Amounts recognized in the consolidated balance sheets consist of:
Accrued benefit cost short-term
Accrued benefit cost long-term
Total accrued benefit cost
Discount rate
For postretirement benefits measurement purpose, a 14.0% and 7.0% annual rate of increase in the per capita cost of covered health care and Medicare Part B benefits, respectively, were assumed for 2003-2004, declining gradually to 5% by the year 2011-2012 and remaining at those rates thereafter.
NOTE 12: COMPREHENSIVE INCOME (LOSS)
The following is a summary of the components of total comprehensive income (loss), net of related income taxes:
Other comprehensive income (loss):
Net investment hedge gains (losses)
Foreign currency translation gains (losses)
Change in minimum pension liability
Total other comprehensive income (loss)
Total comprehensive income (loss)
The following is a summary of the components of accumulated other comprehensive loss balances, net of income taxes:
Net investment hedge gains
Foreign currency translation losses
Additional minimum pension liability
Accumulated other comprehensive loss, net of income taxes
The decrease in the Company’s minimum pension liability results primarily from an increase in the discount rate used to determine the benefit obligation, from 6.25% in 2003 to 6.5% in 2004. Other factors contributing to the decrease were an increase in the fair value of the plan assets and the impact of the Company’s headcount reductions on the benefit obligation calculation.
NOTE 13: BUSINESS SEGMENT INFORMATION
The Company manages its business based on geographic regions consisting of North America, which includes the U.S., Canada and Mexico; Europe, which includes Eastern and Western Europe; and Asia Pacific, which includes Asia Pacific, Middle East, Africa and South America. “All Other” primarily consists of corporate functions, intercompany eliminations and restructuring charges, net of reversals. Beginning in fiscal year 2004, the Company’s business activities in the following regions were transferred from the North America and Europe segments to the Asia Pacific segment: South America, the Middle East, including Turkey, and Africa. The data shown in the table below for prior periods reflects these changes.
The presentation below presents operating income (loss) rather than earnings contribution as shown in prior period presentations. Management has determined that this presentation more accurately reflects current management internal analyses and decision-making and provides a more useful comparison to the Consolidated Statements of Operations. Operating income (loss) differs from earnings contribution primarily due to the inclusion in operating income (loss) of licensing income and restructuring charges, net of reversals. The Company now evaluates performance and allocates resources based on regional operating income (loss), excluding restructuring charges, net of reversals, and excluding depreciation and amortization. Business segment information for the Company is as follows:
Three Months Ended May 30, 2004:
Income before income taxes
Three Months Ended May 25, 2003 (Restated):
Loss before income taxes
Six Months Ended May 30, 2004:
Six Months Ended May 25, 2003 (Restated):
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 items such as accessories, pants, tops, footwear and home products. We were founded in San Francisco in 1853 and, in 2003, celebrated our 150th year of business.
Our net sales for the three and six months ended May 30, 2004 were $958.8 million and $1.9 billion, respectively. Net sales for the second quarter and first half of 2004 by brand were as follows:
Our Levi’s® and Dockers® products are distributed 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 U.S. and through a small number of company-owned stores located in the U.S., Europe and Asia. We entered the mass channel in North America and Asia Pacific in 2003 and in Europe in early 2004 with our Levi Strauss Signature™ brand.
Our business is organized into three geographic regions. The following tables provide employee headcount, net sales and operating income for those regions:
Region and Geographies
Number of
Employees atMay 30,2004
(approx.)
Region
Net Sales
(millions)
% of total
Levi’s®
Brand
Dockers®
Levi Strauss
Signature™
Operating
Income (Loss)
North America (U.S., Canada and Mexico)
Europe
Asia Pacific (Asia Pacific, Middle East, Africa and South America)
Corporate
Number ofEmployeesat May 30,2004
The information in the tables above reflect the 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. For more information, see Note 12 to the Consolidated Financial Statements.
Our Markets and Business. We focused in the first half of the year 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.
Key developments and results in our business in the three months ended May 30, 2004 included the following:
Our Organization. In the three months ended May 30, 2004, we took a number of actions relating to our organization, management and cost structure:
We believe these and other actions will deliver more competitive selling, general and administrative expenses as a percentage of net sales and will deliver more competitive operating margins in fiscal 2005. We expect to continue to identify actions intended to further reduce costs, increase cash flow and strengthen our capital structure and will record additional restructuring charges, as appropriate, in future periods. As we pursue these various actions, we plan to do so in a way that allows us to maintain sufficient liquidity and remain in compliance with our term loan and revolving credit facility covenants.
Our Liquidity. As of July 11, 2004, our total availability under our senior secured revolving credit facility was approximately $390.5 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 $264.5 million. In addition, we had highly liquid short-term investments in the U.S. totaling approximately $287.3 million, leaving us with total U.S. liquidity (availability and liquid short-term investments) of $551.8 million.
Results of Operations
Three and Six Months Ended May 30, 2004 as Compared to Same Periods in 2003
The following tables summarize, for the periods indicated, items in our unaudited consolidated statements of operations, the changes in such items from 2003 to 2004 and such items expressed as a percentage of net sales (amounts may not total due to rounding).
$ Increase
(Decrease)
May 25,
% of Net Sales
% Increase
Consolidated net sales for the three and six months ended May 30, 2004 increased 2.9% and 6.2%, respectively, and on a constant currency basis for the three and six months ended May 30, 2004 decreased 1.1% and increased 1.1%, respectively.
The following tables present our net sales for our North America, Europe and Asia Pacific businesses, the changes in these results for the three and six months ended May 30, 2004 compared to the same periods of 2003 and these results presented as a percentage of net sales.
Constant
Currency
North America
Asia Pacific
Total net sales
For the three months ended May 30, 2004, the primary factors contributing to the 1.1% decrease in our net sales on a constant currency basis as compared to the same period of 2003 were the decrease in sales of our Levi’s® and Dockers® brands in the U.S. and Europe, partially offset by sales of our Levi Strauss Signature™ brand and the continuing strength in our Asia Pacific business. For the six months ended May 30, 2004, the primary factors contributing to the 1.1% increase in our net sales on a constant currency basis as compared to the same period of 2003 were the launch of our Levi Strauss Signature™ brand in mid 2003 and the continuing strength in our Asia Pacific business, partially offset by a decrease in sales of our Levi’s®and Dockers® brands in the U.S. and Europe.
North America net sales decreased 2.1% and increased 3.4% for the three and six months ended May 30, 2004, respectively, and on a constant currency basis for the three and six months ended May 30, 2004 decreased 2.1% and increased 3.2%, respectively.
The following table shows 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 the three and six months ended May 30, 2004 compared to the same periods of 2003.
U.S. Levi’s® brand
U.S. Dockers® brand
U.S. Levi Strauss Signature™ brand
Canada and Mexico
Total North America net sales
The decrease in North America net sales for the three months ended May 30, 2004 reflected decreases in sales of our Levi’s® and Dockers® products in the U.S., partially offset by sales of our Levi Strauss Signature™ brand in the U.S. and sales performance in Canada and Mexico. Our businesses have faced and will continue to face the challenge of obtaining raw materials and achieving replenishment on demand, due in large part to mill capacity constraints and the shift in the apparel industry of production to Mexico, Central and South America.
The following summarizes performance during the three and six months ended May 30, 2004 of our U.S. brands:
We are focused on driving consumer awareness and demand with our marketing programs. In late March 2004, we launched a new print media advertising campaign titled “A Style for Every Story™”. It features people from different professions wearing their favorite style of Levi’s® jeans. We will continue this campaign through national television advertising commencing in July 2004 with the initial focus on our flagship 501® jean and our 569®loose straight jean.
We resumed radio advertising in February, followed by a television campaign beginning in March. Two key men’s product lines, proStyle™ pants and original khaki with the Dockers® Individual Fit® Waistband, are being supported by a new advertising campaign called “Innovations”, which focuses on the performance benefits of these products. For the Fall season, we will be introducing other product innovations such as our new Never Iron™ cotton pants, engineered with a specially designed fabric and finish that allows the pants to come out of the dryer with a dry-cleaned look.
We are focusing on driving consumer awareness of the Levi Strauss Signature™ brand through our promotional strategies, including our sponsorship of NASCAR and Jimmie Johnson, a leading NASCAR driver, and our Levi Strauss Signature™ “Fit Pit” program. We have also launched our Fall 2004 print media campaign. We believe these promotional strategies are successfully increasing consumer awareness. Looking forward, we expect to report lower brand revenue in the third quarter compared with the same period in 2003 because of the substantial volume we shipped in the third quarter of 2003 when we filled retail fixtures in approximately 3000 Wal-Mart stores in connection with the launch of the brand.
Europe net sales increased 2.1% and 2.2% for the three and six months ended May 30, 2004, respectively, and on a constant currency basis decreased 8.2% and 10.7 % for the same periods, respectively .
The following tables show our net sales in our Europe region broken out for our brands, including changes in these results for the three and six months ended May 30, 2004 compared to the same periods of 2003.
Europe Levi’s® brand
Europe Dockers® brand
Europe Levi Strauss Signature™ brand
Total Europe net sales
The sales decreases in the Levi’s® brand in the second quarter and first half of the year were driven externally by weak market and retail conditions and internally by poor customer service performance. We are addressing the service problem but do not expect improvement until the fourth quarter. The sales decline was primarily in our men’s segment, with the largest decreases occurring in France, Germany, U.K., and the Benelux countries. Our businesses in Spain, Italy and the Scandinavian countries reported sales increases. We are repositioning our European Levi’s® business with a new brand architecture and premium price positioning. This repositioning is being supported with an upgraded product offering, including a new collection in the Red Tab™ products for Fall 2004 and a 501® jeans advertising campaign. The campaign, which includes cinema, television, print, digital and outdoor advertising, represents our first advertising for 501® jeans in Europe since 1996.
The sales decreases in the Dockers® brand in the second quarter and first half were driven by a weak retail replenishment business due to soft consumer demand. Poor customer service performance, including low order fulfillment rates, was also a major issue for our Dockers® business in Europe. All countries except the United Kingdom reported sales declines. We are focusing our efforts to address the customer service problem and improve our performance in the region.
As part of our efforts to turn around the Levi’s® and Dockers® brands across Europe, in February 2004, we appointed a new president of the region, Paul Mason, and are working to strengthen local country management.
The Levi Strauss Signature™ brand is performing well in the launch markets of France, Germany and the U.K. Customers continue to show interest in the brand, as evidenced by the roll-out to new retailers in the U.K. We intend to focus on establishing a strong presence in these markets before expanding the brand across other countries of Europe.
Asia Pacific net sales increased 25.5% and 28.0% for the three and six months ended May 30, 2004, respectively, and on a constant currency basis increased 16.9% and 18.1% for the same periods, respectively.
The following tables show our net sales in our Asia Pacific region broken out for our brands, including changes in these results for the three and six months ended May 30, 2004 compared to the same periods of 2003.
Asia Pacific Levi’s® brand
Asia Pacific Dockers® brand
Asia Pacific Levi Strauss Signature™ brand
Total Asia Pacific net sales
The positive overall Asia Pacific performance is broad-based, with virtually all markets reporting growth against prior year. Increases for the second quarter and the first half of 2004 were driven by a number of factors. Political and social conditions are relatively stable, most currencies have appreciated to some degree against the U.S. dollar, and markets such as Taiwan, Hong Kong, Singapore, China and to a lesser extent Japan and South Korea have avoided a repeat of the SARS crisis which seriously impacted retail last year. Sales of high margin premium products increased, driven by new fits and finishes, upgraded retail concepts and generally high brand equity. Within the super premium segment, Red Loop™ products sold well, and the Type 1™ products performed strongly in South Korea, our fastest growing business within Asia Pacific. We re-launched the Levi’s® 501® jean across the region with a new fit and new finishes, and our launch of the Levi Strauss Signature™ brand in the fourth quarter of 2003 continues to build momentum.
Japan remains our largest business in Asia Pacific, accounting for 45% of net sales through the first half. During this period our Japanese business grew 24%, with a 28% increase in the second quarter. On a constant currency basis, these growth rates are 12% and 8%, respectively. In addition to consumer right product, the results in Japan reflect improving economic conditions and the opening of additional independently owned retail stores dedicated to the Levi’s® brand in 2003.
Gross profit increased 5.0% and 9.0% for the three and six months ended May 30, 2004. Gross margin was 43.0% and 42.7% for the three and six months ended May 30, 2004, reflecting increases of 0.8 percentage points and 1.1 percentage points, respectively.
Factors that increased our gross profit included the following:
These factors were partially offset by lower net sales in the U.S. and Europe for our Levi’s® and Dockers® products and the impact of wholesale price reductions taken principally in mid-2003 on our U.S. Levi’s® and Dockers® products.
Our gross margin increased primarily due to lower sourcing costs, reflecting our continuing shift away from self-manufacturing and cut-make-trim arrangements with contractors to outsourced package sourcing, and changes in our incentive program for U.S. retailers of our Levi’s® and Dockers® products. 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.
Selling, general and administrative expenses decreased 7.6% and 4.5% in the three and six months ended May 30, 2004, respectively. As a percentage of net sales, selling, general and administrative expenses were 33.3% and 32.3% in the three and six months ended May 30, 2004, reflecting decreases of 3.8 and 3.6 percentage points, respectively.
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 $50.1 million (5.2% of net sales) and $52.0 million (5.6% of net sales) for the three months ended May 30, 2004 and May 25, 2003, respectively. The decrease is due to several factors including cost reductions at our U.S. third-party distribution centers and start up costs that were incurred in the three months ended May 25, 2003 associated with our initial shipments of Levi Strauss Signature™ products in the U.S. Distribution expenses totaled $105.4 million (5.5% of net sales) and $97.3 million (5.4% of net sales) for the six months ended May 30, 2004 and May 25, 2003, respectively. The increase in these expenses primarily reflect costs incurred in the first quarter of 2004 to streamline our product distribution activities in Europe offset by the cost savings incurred in the three months ended May 30, 2004.
Other operating income decreased 2.4% and increased 5.7% for the three and six months ended May 30, 2004.
Other operating income is primarily comprised of royalty income we generate through licensing our trademarks in connection with the manufacturing, advertising, distribution and sale of products by licensees. For the three months ended May 30, 2004, royalty income was relatively flat as compared to the same period in the prior year. For the six months ended May 30, 2004, royalty income increased approximately $0.9 million as compared to the same period in prior year, which was primarily attributable to an increase in the number of licensees, and increased sales by licensees of accessories, sportswear, and products for the home, partially offset by decreased sales by licensees of footwear, and the termination of a licensee in Europe
Restructuring charges, net of reversals, were $25.7 million and $80.0 million for the three and six months ended May 30, 2004, as compared to reversals of $5.4 million and $8.4 million for the same periods in the prior year.
For the three and six months ended May 30, 2004, we recorded restructuring charges, net of reversals, of $25.7 million and $80.0 million, respectively. The net charges included reversals of $4.6 million and $5.0 million for the three and six months ended May 30, 2004, respectively, as a result of changes in our estimates for our 2003 organizational changes in Europe, our 2003 North America plant closures and our 2002 U.S. plant closures. Our restructuring charges for the six months ended May 30, 2004 included the following activities:
Operating income increased 23.2% and 7.4% for the three and six months ended May 30, 2004. Operating margin was 8.1% and 7.2%, reflecting an increase of 1.4 and 0.1 percentage points for the three and six months ended May 30, 2004, respectively.
The following tables show our operating income broken out by region, the changes in results for the three and six months ended May 30, 2004, compared to the same periods in 2003 and these results presented as a percentage of net sales:
% of Region’s
Total operating income
%Increase
For the three and six months ended May 30, 2004, higher gross profit and lower selling, general and administrative expenses resulted in an increase in operating income which was partially offset by restructuring charges.
Region. The following summarizes the changes in operating income by region:
Corporate Expense. We reflect restructuring charges, net of reversals, annual and long-term incentive compensation plan costs, U.S. depreciation and amortization, and corporate staff costs, in corporate expense. The increases in total corporate expense of $42.7 and $98.6 million for the three and six months ended May 30, 2004, respectively, were primarily attributable to restructuring charges, net of reversals, and expenses associated with our annual and long-term incentive compensation plans. These items were partially offset by the curtailment gain related to one of our postretirement medical plans in the U.S. and a decrease in other corporate expense. Other corporate expense decreased primarily as a result of lower expenses related to our employee benefit plans and lower salaries.
The following table summarizes significant components of corporate expense.
Annual incentive plan
Long term incentive plan
Postretirement benefit plan net curtailment gain
Other corporate expense
Total corporate expense
Interest expense increased 2.9% and 8.5% for the three and six months ended May 30, 2004.
Interest expense for the three months ended May 30, 2004 increased 2.9% to $65.2 million compared to $63.3 million for the same period in 2003. Interest expense for the six months ended May 30, 2004 increased 8.5% to $133.4 million compared to $123.0
million for the same period in 2003. The higher interest expense was primarily due to higher effective interest rates in 2004. For the three month period ended May 30, 2004, the impact of higher effective interest rates was partially offset by lower average debt balances.
The weighted average interest rate on average borrowings outstanding during the three months ended May 30, 2004 and May 25, 2003, including the amortization of debt issuance costs and interest rate swap cancellations, was 10.66% and 9.65%, respectively. The weighted average interest rate on average borrowings outstanding during the six months ended May 30, 2004 and May 25, 2003, including the amortization of capitalized bank fees and interest rate swap cancellations, was 10.65% and 9.96%, respectively. The weighted average interest rate on average borrowings outstanding excludes interest payable to participants under deferred compensation plans and other miscellaneous items.
Other expense, net, for three and six months ending May 30, 2004 was $4.0 million and $2.4 million, respectively, compared to $20.2 million and $54.8 million for the same periods in 2003.
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 from $20.9 million to $0.6 million in foreign exchange management contract losses is due to changes in outstanding exposure under management and changes in foreign currency exchange rates.
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. For the three months ended May 30, 2004 and May 25, 2003, the net loss of $3.5 million and the net gain of $3.2 million, respectively, and for the six months ended May 30, 2004 and May 25, 2003, the net gains of $12.1 million and $12.6 million, respectively, were caused by remeasurement of foreign currency denominated balances at the exchange rates existing at the balance sheet dates.
The decrease in interest income for the three months ended May 30, 2004 was primarily due to lower effective interest rates. The decrease in interest income for the six months ended May 30, 2004 was primarily due to a higher average cash investment balance in 2003 as a result of our refinancing activities. We also incurred a loss on early extinguishment of debt in 2003 relating to our January 2003 refinancing and our repurchases of our 6.80% notes.
Income tax expense was $2.6 million for the three months ended May 30, 2004, compared to $21.2 million for the same period in 2003. Income tax benefit was $1.0 million for the six months ended May 30, 2004, compared to an income tax expense of $50.7 million for the same period in 2003.
We provide for income taxes on an interim basis based upon our estimate of our annual effective tax rate. The estimated annual effective tax rate for 2004 is (215.1%) and is based on current full-year forecasts of income or losses, as adjusted by the following:
The effective tax rate for the six months ended May 30, 2004 is (42.1%), and differs from the estimated annual effective tax rate of (215.1%) due primarily to losses in certain foreign jurisdictions for which no tax benefit can be recognized. In accordance with FASB Interpretation No. 18, we adjust our annual estimated effective tax rate of (215.1%) to eliminate the impact of these foreign losses. We then apply our adjusted estimated annual effective tax rate to our year-to-date pre-tax operating results, exclusive of the results in these foreign jurisdictions, to compute our tax expense for the six month period ended May 30, 2004. This calculation results in a (42.1%) effective rate for the six months ended May 30, 2004. We apply the (42.1%) effective rate to our pre-tax year-to-date income of $2.3 million to generate a total tax benefit of $1.0 million.
At year-end, we restated the effective tax rate for the period ended May 25, 2003 to be (103.1%). As discussed more fully in Note 4 to the Consolidated Financial Statements, the effective tax rate for the period ended May 30, 2004 was (42.1%). These rates differ from the statutory rate of 35% due primarily to international operations and changes in valuation allowances. Due to our inability to benefit losses in certain jurisdictions, the mix of income and loss by jurisdiction is a key driver in determining our ultimate effective tax rate.
The effective tax rate applied to pre-tax income for the period ended February 29, 2004 was 60.1%. Our projection of the annual effective tax rate changed during the three month period ending May 30, 2004 due primarily to changes in estimated annual pre-tax earnings for domestic and foreign affiliates. Given the relative magnitude of the estimated annual pre-tax loss to estimated annual income tax expense, relatively small changes in pre-tax operating results during the remainder of the year could substantially impact our projected annual effective tax rate.
Net income was $5.6 million for the three months ended May 30, 2004 compared to a net loss of $41.8 million in 2003 and net income was $3.3 million for the six months ended May 30, 2004 compared to a net loss of $100.0 million in 2003 .
The increases in net income for the three and six months ended May 30, 2004 were due primarily to higher operating income, lower losses related to our foreign exchange management contracts, substantially lower income tax expense for the three months ended May 30, 2004 compared to the same period in 2003, and an income tax benefit for the six months ended May 30, 2004 compared to an income tax expense for the same period in 2003.
Liquidity and Capital Resources
Our principal cash requirements include working capital, capital expenditures, cash restructuring costs, and payments of interest on our debt, payments of taxes and payments for U.S. pension and postretirement health benefit plans. We expect to have the following additional cash requirements in fiscal year 2004:
Select Cash Requirements
Paid in six
months ended
Projected for
remaining six
months of 2004
Total Projected for
Projected
for first six
months of fiscal
twelve monthsended May2005
Restructuring activities
Federal, foreign and state taxes (net of refunds)
Postretirement health benefit plans
Capital expenditures
U.S. pension plans
Total select cash requirements
These amounts reflect actions taken as a result of our work with Alvarez & Marsal, Inc., including eliminating staff and open positions in the North America region and commencing the process to close our plants in Spain.
Our key sources of cash include operating income and borrowing availability under our senior secured revolving credit facility. We expect working capital improvements, in the form of reduced raw materials and work-in-process inventories, from our shift away
from self-manufacturing and cut-make-trim arrangements with contractors to outsourced package sourcing. In addition, we expect improvements in finished goods inventory management as a result of better planning. We believe we will have adequate liquidity to operate our business and that we will be in compliance with our financial covenants during the next twelve months.
Cash and Cash Equivalents; Available Borrowing Capacity
Available Liquidity. As of May 30, 2004, total cash and cash equivalents was $347.2 million, a $143.3 million increase from the $203.9 million cash balance reported as of November 30, 2003. The increase was primarily due to lower inventory, higher gross profits and lower operating expenses, partially offset by higher interest payments and payments for our restructuring initiatives. Net available borrowing capacity under our revolving credit facility was approximately $236.0 million as of May 30, 2004. This gave us available liquidity resources of approximately $583.2 million.
Revolving Credit Facility. As of May 30, 2004, our calculated availability of $365.7 million under our senior secured revolving credit facility was reduced by $129.7 million of letters of credit and miscellaneous reserves allocated under our senior secured revolving credit facility, yielding a net availability of $236.0 million. Included in the $129.7 million of letters of credit and miscellaneous reserves at May 30, 2004 were $15.0 million trade letters of credit, $19.7 million miscellaneous reserves and $94.9 million of stand-by letters of credit with various international banks, of which $70.3 million serve as guarantees by the creditor banks to cover U.S. workers’ compensation claims.
Debt Principal and Operating Lease Payments
Our total short-term and long-term debt principal payments as of May 30, 2004 and minimum operating lease payments for facilities, office space and equipment as of November 30, 2003 for the next five fiscal years and thereafter are as follows:
as of 05/30/04
Minimum Operating Lease
Payments as of 11/30/03
The 2004 and 2005 payments include required payments of $2.5 million and $5.0 million, respectively, under our senior secured term loan. Additional payments in 2004 relate to short-term borrowings of $20.0 million and required payments of $4.2 million for our customer service center equipment financing. Additional payments in 2005 include a required payment under our customer service center equipment financing of $55.9 million. The 2006 payments include the payment of our 7.00% notes due November 1, 2006 of $450.0 million.
The 2006 and 2008 payments include the maturity of the 7.00% notes due November 1, 2006 and the maturity of the 11.625% notes due in January 2008, respectively. The Company’s senior secured term loan and senior secured revolving credit facility agreements contain early maturity provisions and covenants linked to the timing of refinancing or repayment of the 7.00% notes due 2006 and the 11.625% notes due 2008. Review of the table above should take into account the fact that the senior secured term loan requires the Company to repay or refinance both the 7.00% notes due 2006 and the 11.625% notes due 2008 no later than six months prior to their maturity date in order to prevent acceleration of the maturity date of the senior secured term loan to a date three months prior to the maturity date of the 2006 and 2008 notes, respectively. As a result, unless the Company has refinanced, repaid of otherwise provided for the 2006 notes by May 1, 2006, the term loan will become due on August 1, 2006 and unless the Company has refinanced, repaid of otherwise provided for the 2008 notes by July 15, 2007, the term loan will become due on October 15, 2007.
Restructuring and Benefit Plan Payments
Restructuring Charges. We expect to make net cash payments of approximately $160 million in 2004, including $75 million made during the six months ended May 30, 2004, in respect of plant closures, organizational changes, the enterprise resource planning system suspension and other restructuring activities. These amounts reflect actions taken as a result of our work with Alvarez & Marsal, Inc. We will continue to explore additional ways to further reduce our cost structure, create cash flow and enhance our capital structure.
Postretirement Health Benefits. We maintain two plans that provide postretirement benefits, principally health care, to qualified U.S. retirees and their qualified dependents. The plans are contributory and contain certain cost-sharing features, such as deductibles and coinsurance. Our policy is to fund postretirement benefits as claims and premiums are paid. We amended these plans in August
2003 and February 2004 to change the benefits coverage for certain employees and retired participants. As a result of these amendments, we recorded a net curtailment gain of $23.8 million in the six months ended May 30, 2004. These amendments also resulted in a reduction in our benefit obligation from $744.0 million as of November 30, 2003 to $384.0 million as of February 29, 2004. The postretirement medical benefits liability on our balance sheet does not reflect the magnitude of this reduction in obligation, as such a reduction must be amortized over the remaining service life of our employee base, which is approximately ten years. We made cash contributions to the plan of approximately $21 million in the first half of 2004. We anticipate that our total 2004 cash payments will be approximately $41 million, and that our total cash payments for the five year period 2004 through 2008 will be approximately $200 million. While our cash payments are not expected to be materially reduced over the next five years as a result of the plan amendments, we anticipate lower levels of cash payouts longer term as the impact of eligibility changes and annual payment limits begin to reduce our ongoing cash obligations.
Pension Plans. We have numerous noncontributory pension plans covering substantially all of our employees. Our pension plan assets are principally invested in equity securities and fixed income securities. We expect to make pre-tax contributions of approximately $140 million to our pension plans in 2004 to 2008, including expected payments of approximately $9 million in 2004, none of which was paid during the first half of 2004. Our expectations reflect lower market interest rates in recent years, which have resulted in both an increase in present value of the future pension benefits and a decrease in our return assumptions for pension assets. In addition, our expectations for these future payments reflect our anticipation of adoption by the U.S. Department of Labor of a new mortality table. These expected payments are not in addition to the pension expense recorded for the applicable year and are based on estimates and are subject to change.
Off-Balance Sheet Arrangements, Guarantees and Other Contingent Obligations
Off-Balance Sheet Arrangements. We have no material off-balance sheet debt obligations or unconditional purchase commitments other than operating lease commitments.
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. 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 our board of directors adopted resolutions making clear that officers and directors of our foreign subsidiaries are covered by these indemnification provisions.
These contractual and other indemnification amounts are generally not readily quantifiable: the maximum possible liability or amount of potential payments that could arise out of an indemnification claim depends 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.
Cash Flows
The following table summarizes, for the six months ended May 30, 2004, 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
Cash provided by operating activities was $152.4 million for the six months ended May 30, 2004 compared to cash used for operating activities of $344.3 million for the same period in 2003.
The increase in cash provided by operating activities was primarily due to the following factors:
Interest payments of $117.9 million and restructuring payments of $75.3 million during the six months ended May 30, 2004, compared to $78.4 million and $35.0 million, respectively for the same period in the prior year, partly offset these factors.
Cash used for investing activities was $3.6 million for the six months ended May 30, 2004 compared to $46.3 million for the same period in 2003.
The decrease 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 lower realized losses on net investment hedges, partially offset by lower proceeds from sale of property, plant and equipment.
Cash used for financing activities was $7.6 million for the six months ended May 30, 2004 compared to cash provided by financing activities of $412.1 million for the same period in 2003.
Cash used for financing activities primarily reflected required payments on our customer service center equipment financing and term loan in addition to repayments on short-term borrowings. Cash provided by financing activities for the six months ended May 25, 2003 was $412.1 million, primarily due to our issuance in December 2002 and January 2003 of our 12.25% senior unsecured notes due 2012 and our entry in January 2003 into a new senior secured credit facility, which we replaced in September 2003.
Financial Condition
Debt was $2.3 billion as of May 30, 2004, virtually unchanged from November 30, 2003. Our debt and cash as of May 30, 2004 are summarized below:
7.00% $450.0 million, due 2006
11.625% $380.0 million Dollar denominated, due 2008
11.625% €125.0 million Euro denominated, due 2008
12.25% $575.0 million, due 2012
Yen-denominated Eurobond 4.25% ¥20.0 billion, due 2016
The borrower of substantially all of our debt is Levi Strauss & Co., our parent and U.S. operating company.
Both our term loan and our revolving credit facility contain a consolidated fixed coverage ratio covenant. As of May 30, 2004, we were in compliance with our consolidated fixed charge coverage ratio for the term loan and were not required to perform the calculation for the revolving credit agreement.
In connection with our exploration of the sale of the Dockers® business, we are seeking amendments to our current agreements to facilitate any proposed sale. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Markets and Business”.
Other Sources of Financing
We are a privately held corporation and consequently the public equity markets are not readily accessible to us as a source of funds. Historically, we have primarily relied on cash flow from operations, borrowings under our credit facilities, issuances of notes and other forms of debt financing to fund our operations. Our operations and liquidity have been adversely affected in the last several years by numerous business developments, which were exacerbated by significant competitive and industry changes and adverse economic conditions. These challenges and conditions have negatively impacted our cash flow and caused our total debt to increase, which together have led to credit rating downgrades.
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.”
Note 1 to the Consolidated Financial Statements summarizes recent accounting standards. Statement of Financial Accounting Standards No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (“SFAS 132”), requires additional disclosures for pensions and other postretirement plans, with no effect on our consolidated financial position or results of operations. We have adopted the interim reporting disclosure requirements of SFAS 132 for the period ended May 30, 2004. Financial Interpretation No. 46 (revised 2003), “Consolidation of Variable Interest Entities,” did not have any impact on our financial position or results of operations, as we do not have any variable interest entities. We are currently evaluating the impact of FASB Staff Position 106-2 on our financial position, results of operations and cash flows. FASB Staff Position 106-2, provides final guidance on accounting for the Medicare Prescription Drug, Improvement and Modernization Act of 2003, and is effective for our fourth quarter of fiscal 2004.
Amended Agreement with Alvarez & Marsal, Inc.
On May 18, 2004, we amended our December 2003 engagement agreement with Alvarez & Marsal, Inc. 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 James P. Fogarty’s role as our Chief Financial Officer. We paid $500,000 of this minimum bonus in May 2004 and will pay an additional $500,000 in each of October 2004 and February 2005. In addition, we agreed to pay Alvarez & Marsal, Inc. an additional incentive bonus of $1.0 million, payable in February 2005 upon our achievement of certain financial performance, financial reporting and control and planning activities. As of May 30, 2004, we have accrued approximately $0.7 million for these bonuses, and the remaining amounts will be accrued ratably through February 2005.
FORWARD-LOOKING STATEMENTS
STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
This report includes forward-looking statements about:
We have based these forward-looking statements on our current assumptions, expectations and projections about future events. When used in this document, the words “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these words.
These forward-looking statements are subject to risks and uncertainties including, without limitation:
Our actual results might differ materially from historical performance or current expectations. 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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Derivative Financial Instruments
We are exposed to market risk primarily related to foreign exchange, interest rates and, indirectly through fabric prices, the price of cotton. We actively manage foreign currency risks with the objective of reducing fluctuations in actual and anticipated cash flows by entering into a variety of instruments including spot, forwards, options and swaps. We hold derivative positions only in currencies to which we have exposure. We currently do not hold any interest rate derivatives. In addition, we have not historically, and do not currently, manage exposure related to commodities.
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. In addition, we have ISDA master agreements in place with the main counterparties to mitigate the credit risk related to the outstanding derivatives.
The tables below give an overview of the fair values of derivative instruments reported as an asset or liability and the realized and unrealized gains and losses associated with our foreign exchange and interest rate management activities reported in “Other expense, net”. The derivatives expire at various dates until June 2004.
At May 30, 2004
Fair value asset (liability)
At November 30, 2003
Other (income)
Foreign Exchange Risk
We manage foreign currency exposures primarily to protect the U.S. dollar value of cash flows. We attempt to take a long-term view of managing exposures on an economic basis, using forecasts to develop exposure positions and engaging in active management of those exposures with the objective of protecting future cash flows and mitigating risks. To manage the volatility relating to these exposures, we evaluate them on a global basis to take advantage of the netting opportunities that exist. For the remaining exposures, we enter into various derivative transactions in accordance with our currency risk management policies, aimed at covering the spot risk at inception of the exposure. We do not currently manage the timing mismatch derived from forecasted exposures and their corresponding hedges. In 2003, we defined as part of our foreign currency risk management policy an open position ratio limit. The open position ratio is a measurement of the relationship between the notional amount of the hedging instrument and the hedged item. Our foreign exchange policy allows a maximum open position ratio of 25%. At May 30, 2004, our open position ratio was 7.4%, while the maximum open position ratio during the quarter was 21.4%.
At May 30, 2004, we had U.S. dollar spot and forward currency contracts to buy $553.1 million and to sell $280.5 million against various foreign currencies. We also had euro forward currency contracts to buy and sell 50 million Euros ($61.3 million equivalent) against Swedish Krona. These contracts are at various exchange rates and expire at various dates until June 2004.
We have entered into option contracts to manage our exposure to numerous foreign currencies. At May 30, 2004, we had bought U.S. dollar option contracts resulting in a net short position against various foreign currencies of $53.2 million should the options be exercised. To finance the premium related to bought options, we sold U.S. dollar options resulting in a net long position against various currencies of $3.5 million, should the options be exercised. The option contracts are at various strikes and expire at various dates until June 2004.
At the respective maturity dates of the outstanding spot, forward and option currency contracts, we will enter into various derivative transactions in accordance with our currency risk management policy, aimed at covering the spot risk at inception of the exposure.
For more information about market risk, see Notes 7 and 8 to the Consolidated Financial Statements.
Item 4. Controls and Procedures
As of May 30, 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. This controls evaluation was done under the supervision and with the participation of management, including our chief executive officer and our chief financial officer.
We conducted the evaluation of our disclosure controls and procedures taking into account a material weakness (as defined under standards established by the American Institute of Certified Public Accountants) identified in a letter we received in December 2003 from our independent auditors. Our independent auditors further discussed their concern over the material weakness in internal controls with our Audit Committee on April 9, 2004 and addressed it in their letter dated June 24, 2004 that was prepared in conjunction with their audit of our financial statements for the years ended November 30, 2003, November 24, 2002, and November 25, 2001. Finally, our evaluation of our disclosure controls and procedures took into account the measures we are taking in response to these communications from our independent auditors. The letter regarding the material weakness and related background information and other related matters are described in our Annual Report on Form 10-K filed with the SEC on March 1, 2004.
The letters included the following:
In response to the matters described in these communications from our independent auditors, we have taken actions to address these issues, including actions described in the Form 10-K, and these additional actions:
We believe these actions will strengthen our internal control over financial reporting and address the material weakness identified by our independent auditors.
Based on the controls evaluation, as of May 30, 2004, we have concluded that our disclosure controls and procedures are designed to ensure that material information relating to the Company and our consolidated subsidiaries is made known to management to allow timely decisions regarding required disclosure. As noted above, subsequent to May 30, 2004, we continue to evaluate our control environment and we are continuing to consider additional steps to strengthen these controls.
Item 1. Legal Proceedings
Wrongful Termination Litigation. During the six months ended May 30, 2004 and since the end of the period, there have been two developments in the wrongful termination litigation brought against us in California state court and other tribunals by two former employees of our tax department:
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.
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, our former chief financial officer, our corporate controller, our directors and 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 it 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.
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 6. Exhibits and Reports on Form 8-K:
(A) Exhibits:
(B) Reports on Form 8-K:
Current Report on Form 8-K dated March 1, 2004 and furnished under Items 9 and 12 of the report and containing a copy of the Company’s press release dated March 1, 2004 titled “Levi Strauss & Co. Announces Fiscal Year 2003 Financial Results.”
Current Report on Form 8-K dated April 13, 2004 and furnished under Items 9 and 12 of the report and containing a copy of the Company’s press release dated April 13, 2004 titled “Levi Strauss & Co. Announces First-Quarter 2004 Financial Results.”
Current Report on Form 8-K dated May 3, 2004 and furnished under Item 5 of the report and containing a copy of the Company’s press release dated May 3, 2004 titled “Levi Strauss & Co. Names Paul Smith as Head of Global Tax Department.”
Current Report on Form 8-K dated May 11, 2004 and furnished under Item 5 of the report and containing a copy of the Company’s press release dated May 11, 2004 titled “Levi Strauss & Co. Explores Sale of Dockers® Brand.”
Current Report on Form 8-K dated June 3, 2004 and furnished under Item 5 of the report and containing a copy of the Company’s press release dated June 3, 2004 titled “Levi Strauss & Co. Proposes Closure of Factories at Bonmati and Olvega”.
Current Report on Form 8-K dated July 2, 2004 and furnished under Item 5 of the report and containing a copy of the Company’s press release dated July 2, 2004 titled “Levi Strauss & Co. Names Miriam L. Haas to its Board of Directors”.
Pursuant to the requirements 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.
Date: July 12, 2004
(Registrant)
By:
/s/ GARY W. GRELLMAN