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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MAY 26, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 333-36234
LEVI STRAUSS & CO.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 94-0905160
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) 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 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 1, 2002
LEVI STRAUSS & CO.
INDEX TO FORM 10-Q
MAY 26, 2002
PAGE
NUMBER
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of May 26, 2002 and November 25, 2001.......................... 3
Consolidated Statements of Operations for the Three and Six Months Ended
May 26, 2002 and May 27, 2001................................................................ 4
Consolidated Statements of Cash Flows for the Six Months Ended
May 26, 2002 and May 27, 2001................................................................ 5
Notes to the Consolidated Financial Statements................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................................. 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................... 29
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................................................. 31
SIGNATURE................................................................................................ 32
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
May 26, November 25,
2002 2001
---- ----
ASSETS (Unaudited)
Current Assets:
Cash and cash equivalents...................................................... $ 115,603 $ 102,831
Trade receivables, net of allowance for doubtful accounts of $25,565 in 2002
and $26,666 in 2001......................................................... 473,006 621,224
Inventories:
Raw materials.............................................................. 98,344 97,261
Work-in-process............................................................ 80,194 50,499
Finished goods............................................................. 494,998 462,417
---------- ----------
Total inventories....................................................... 673,536 610,177
Deferred tax assets............................................................ 187,069 189,958
Other current assets........................................................... 94,721 110,252
---------- ----------
Total current assets............................................... 1,543,935 1,634,442
Property, plant and equipment, net of accumulated depreciation of $484,769 in
2002 and $527,647 in 2001......................................................... 469,559 514,711
Goodwill and other intangibles, net of accumulated amortization of $180,927 in
2002 and $175,603 in 2001......................................................... 248,842 254,233
Non-current deferred tax assets...................................................... 546,345 484,260
Other assets......................................................................... 88,004 95,840
---------- ----------
Total Assets....................................................... $2,896,685 $2,983,486
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current maturities of long-term debt and short-term borrowings................. $ 178,588 $ 162,944
Accounts payable............................................................... 188,050 234,199
Restructuring reserves......................................................... 135,065 45,220
Accrued liabilities............................................................ 297,082 301,620
Accrued salaries, wages and employee benefits.................................. 273,666 212,728
Accrued taxes.................................................................. 146,510 26,475
---------- ----------
Total current liabilities.......................................... 1,218,961 983,186
Long-term debt, less current maturities.............................................. 1,683,209 1,795,489
Postretirement medical benefits...................................................... 540,749 544,476
Long-term employee related benefits.................................................. 364,296 384,751
Long-term tax liability.............................................................. 23,467 174,978
Other long-term liabilities.......................................................... 18,769 16,402
Minority interest.................................................................... 19,862 20,147
---------- ----------
Total liabilities.................................................. 3,869,313 3,919,429
---------- ----------
Stockholders' Deficit:
Common stock--$.01 par value; 270,000,000 shares authorized; 37,278,238
shares issued and outstanding............................................... 373 373
Additional paid-in capital..................................................... 88,808 88,808
Accumulated deficit............................................................ (1,058,210) (1,020,860)
Accumulated other comprehensive income (loss).................................. (3,599) (4,264)
---------- ----------
Total stockholders' deficit........................................ (972,628) (935,943)
---------- ----------
Total Liabilities and Stockholders' Deficit........................ $2,896,685 $2,983,486
========== ==========
The accompanying notes are an integral part of these financial statements.
3
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
Three Months Ended Six Months Ended
------------------ ----------------
May 26, May 27, May 26, May 27,
2002 2001 2002 2001
---- ---- ---- ----
Net sales.................................................. $ 923,518 $1,043,937 $1,858,802 $2,040,320
Cost of goods sold......................................... 553,974 591,442 1,090,674 1,147,891
---------- ---------- ---------- ----------
Gross profit............................................ 369,544 452,495 768,128 892,429
Marketing, general and administrative expenses............. 318,804 336,128 617,739 662,224
Other operating (income)................................... (8,511) (7,365) (14,624) (14,539)
Restructuring charges, net of reversals.................... 141,078 - 141,078 -
---------- ---------- ---------- ----------
Operating income (loss)................................. (81,827) 123,732 23,935 244,744
Interest expense........................................... 42,510 53,898 90,533 123,103
Other (income) expense, net................................ 19,569 899 8,104 5,767
---------- ---------- ---------- ----------
Income (loss) before taxes.............................. (143,906) 68,935 (74,702) 115,874
Income tax expense (benefit)............................... (62,957) 25,507 (37,351) 42,874
---------- ---------- ---------- ----------
Net income (loss)....................................... $ (80,949) $ 43,428 $ (37,351) $ 73,000
========== ========== ========== ==========
Earnings (loss) per share--basic and diluted............... $ (2.17) $ 1.16 $ (1.00) $ 1.96
========== ========== ========== ==========
Weighted-average common shares outstanding................. 37,278,238 37,278,238 37,278,238 37,278,238
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
4
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six Months Ended
----------------
May 26, May 27,
2002 2001
---- ----
Cash Flows from Operating Activities:
Net income (loss)............................................................. $ (37,351) $ 73,000
Adjustments to reconcile net cash provided by (used for) operating activities:
Depreciation and amortization......................................... 36,238 42,255
Asset write-offs associated with 2002 restructuring charge............ 25,708 -
Gain on dispositions of property, plant and equipment................. (771) (1,012)
Unrealized foreign exchange (gains) losses............................ 14,161 (18,250)
Decrease in trade receivables......................................... 151,729 99,252
Increase in inventories............................................... (58,141) (129,637)
(Increase) decrease in other current assets........................... (8,721) 19,216
Decrease (increase) in other long-term assets......................... 6,201 (20,604)
(Increase) decrease in net deferred tax assets........................ (59,846) 1,546
Decrease in accounts payable and accrued liabilities.................. (57,472) (134,943)
Increase (decrease) in restructuring reserves......................... 89,846 (14,780)
Increase (decrease) in accrued salaries, wages and employee benefits.. 60,060 (79,184)
Increase (decrease) in accrued taxes.................................. 121,697 (32,188)
(Decrease) increase in long-term employee benefits.................... (22,202) 31,922
(Decrease) increase in long-term tax and other liabilities............ (148,762) 8,259
Other, net............................................................ 1,186 2,418
--------- ----------
Net cash provided by (used for) operating activities............... 113,560 (152,730)
--------- ----------
Cash Flows from Investing Activities:
Purchases of property, plant and equipment............................ (18,804) (8,547)
Proceeds from sale of property, plant and equipment................... 7,802 2,688
Realized gains on net investment hedges............................... 4,786 5,169
-------- ----------
Net cash (used for) investing activities........................... (6,216) (690)
-------- ----------
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt.............................. 356,999 1,505,772
Repayments of long-term debt.......................................... (456,465) (1,393,747)
Net increase (decrease) in short-term borrowings...................... 4,598 (1,555)
-------- ----------
Net cash (used for) provided by financing activities............... (94,868) 110,470
-------- ----------
Effect of exchange rate changes on cash....................................... 296 5,871
-------- ----------
Net increase (decrease) in cash and cash equivalents............... 12,772 (37,079)
Beginning cash and cash equivalents........................................... 102,831 117,058
-------- ----------
Ending Cash and Cash Equivalents.............................................. $115,603 $ 79,979
======== ==========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest.............................................................. $ 81,485 $ 87,797
Income taxes.......................................................... 35,543 66,023
Restructuring initiatives............................................. 25,525 14,780
The accompanying notes are an integral part of these financial statements.
5
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The unaudited consolidated financial statements of Levi Strauss & Co. and
subsidiaries ("LS&CO." or "Company") are prepared in conformity with generally
accepted accounting principles for interim financial information. In the opinion
of management, all adjustments necessary for a fair presentation of the
financial position and 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 25, 2001 included in the annual report on Form 10-K filed by
LS&CO. with the Securities and Exchange Commission (the "SEC") on February 7,
2002.
The consolidated financial statements include the accounts of LS&CO. and
its subsidiaries. All intercompany transactions have been eliminated. Management
believes that, along with the following information, 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 and six months ended May 26, 2002 may not be
indicative of the results to be expected for the year ending November 24, 2002.
Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
related notes to the financial statements. Changes in such estimates, based on
more accurate future information, may affect amounts reported in future periods.
The Company's most critical accounting policies upon which its financial
position and results of operations depend are those relating to revenue
recognition, inventory valuation, restructuring reserves, income tax assets and
liabilities, and derivatives and foreign exchange management activities. Since
the end of the first quarter of fiscal year 2002, the Company added the policy
for income tax assets and liabilities to its list of critical accounting
policies. During the second quarter, the Company did not change those policies
or adopt any new policies. The Company summarizes its most critical accounting
policies below.
o Revenue recognition. The Company recognizes revenue from the sale of a
product upon its shipment to the customer. The Company recognizes
allowances for estimated returns, discounts and retailer promotions and
incentives when the sale is recorded. Allowances principally relate to
the Company's U.S. operations and are primarily comprised of volume-based
incentives and other returns and discounts. For volume-based retailer
incentive programs, reserves for volume allowances are calculated based on
a fixed formula applied to sales volumes. The Company estimates
non-volume-based allowances using historical customer claim rates as a
percentage of accounts receivable, adjusted as necessary for special
customer and product-specific circumstances. Actual allowances may differ
from estimates due primarily to changes in sales volume based on retailer
or consumer demand. Actual returns and allowances have not materially
differed from estimates.
o Inventory valuation. The Company values inventories at the lower of cost
or market value. Inventory costs are based on standard costs, 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 based on
historical recovery rates. In determining its expected selling prices, the
Company considers various factors including estimated quantities of slow-
moving 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 inventory through various channels and other factors, such as market
conditions and current consumer preferences. Estimates may differ from
actual results due to the quantity and quality and mix of products in
inventory, consumer and retailer preferences and economic conditions.
6
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
o 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. Such costs are recorded as a current liability
and primarily include employee severance, certain employee termination
benefits, including out-placement services and career counseling, and
contractual obligations. The principal components of the reserves relate to
employee severance and termination benefits, which the Company 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. Inherent in the estimation of these costs are assessments
related to the most likely expected outcome of the significant actions to
accomplish the restructuring. 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.
o 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 that are
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 realizable amounts. The likelihood of a material
change in the Company's expected realization of these assets is dependent
on future taxable income, its ability to use foreign tax credit
carryforwards and carrybacks, final U.S. and foreign tax settlements, and
the effectiveness of its tax planning strategies in the various relevant
jurisdictions. The Company is also subject to examination of its income tax
returns for multiple years by the Internal Revenue Service and other tax
authorities. The Company periodically assesses the likelihood of adverse
outcomes resulting from these examinations to determine the adequacy of its
provision for income taxes. Changes to the Company's income tax provision
or in the valuation of the deferred tax assets and liabilities may affect
its annual effective income tax rate.
o Derivatives 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 Company actively manages foreign currency exposures on an
economic basis, using forecasts to develop exposure positions to maximize
the U.S. dollar value over the long-term. 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 (income) expense" in
the consolidated statement of income. 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 income (loss)" section
of Stockholders' Deficit. The carrying 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.
7
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 2: COMPREHENSIVE INCOME
The following is a summary of the components of total comprehensive income,
net of related income taxes:
Three Months Ended Six Months Ended
------------------ ----------------
May 26, May 27, May 26, May 27,
2002 2001 2002 2001
---- ---- ---- -----
(Dollars in Thousands)
Net income (loss)............................................. $(80,949) $43,428 $(37,351) $73,000
-------- ------- -------- -------
Other comprehensive income (loss):
Transition adjustments:
Unrealized losses on cash flow hedges...................... - - - (522)
Reclassification of cash flow hedges to other
(income) expense......................................... - 261 - 261
-------- ------- -------- -------
Net cash flow hedges....................................... - 261 - (261)
Net investment hedges...................................... - - - 76
-------- ------- -------- -------
Total transition adjustments............................ - 261 - (185)
-------- ------- -------- -------
Foreign currency translation adjustments:
Net investment hedges...................................... (6,919) 9,440 (1,884) 2,322
Foreign currency translations.............................. 13,347 (10,797) 3,121 7,381
-------- ------- -------- -------
Total foreign currency translation adjustments.......... 6,428 (1,357) 1,237 9,703
-------- ------- -------- -------
Unrealized gains on cash flow hedges......................... - 1,599 - 3,527
Reclassification of cash flow hedges to other
(income) expense........................................... - (852) (572) (1,005)
-------- ------- -------- -------
Net cash flow hedges...................................... - 747 (572) 2,522
-------- ------- -------- -------
Total other comprehensive income (loss)................. 6,428 (349) 665 12,040
-------- ------- -------- -------
Total comprehensive income (loss)............................ $(74,521) $43,079 $(36,686) $85,040
======== ======= ======== =======
The following is a summary of the components of Accumulated other
comprehensive income (loss) balances, net of related income taxes:
May 26, November 25,
2002 2001
---- ----
(Dollars in Thousands)
Cumulative transition adjustments:
Beginning balance of cash flow hedges.......................... $ - $ -
Unrealized losses on cash flow hedges........................ - (522)
Reclassification of cash flow hedges to other
(income) expense........................................... - 522
------- -------
Ending balance of cash flow hedges............................... - -
Net investment hedges............................................ - 76
------- -------
Total cumulative transition adjustments.................. - 76
------- -------
Cumulative translation adjustments:
Net investment hedges.......................................... 48,010 49,818
Foreign currency translations.................................. (51,609) (54,730)
------- -------
Total cumulative translation adjustments................. (3,599) (4,912)
------- -------
Beginning balance of cash flow hedges............................ - -
Unrealized gains on cash flow hedges........................... 572 3,052
Reclassification of cash flow hedges to other
(income) expense............................................. (572) (2,480)
------- -------
Ending balance of cash flow hedges............................... - 572
------- -------
Accumulated other comprehensive income (loss)...................... $(3,599) $(4,264)
======= =======
8
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 3: RESTRUCTURING RESERVES
The following is a description of the actions taken associated with the
Company's reorganization initiatives. Severance and employee benefits relate to
severance packages, out-placement services and career counseling for employees
affected by the plant closures and reorganization initiatives. Reductions
consist of payments for severance and employee benefits, other restructuring
costs and foreign exchange differences. The balance of severance and employee
benefits and other restructuring costs are included under restructuring reserves
on the balance sheet.
2002 PLANT CLOSURES
The Company announced in March 2002 the closure of two manufacturing plants
in Scotland in order to reduce average production costs in Europe. The Company
recorded an initial charge in the second quarter of 2002 of $20.5 million
consisting of $3.1 million for asset write-offs, $15.7 million for severance and
employee benefits and $1.7 million for other restructuring costs. The charge
reflected an estimated displacement of 650 employees. The two manufacturing
plants were closed by the end of the second quarter of 2002. As of May 26, 2002,
approximately 620 employees have been displaced. The table below displays the
activity and liability balance of this reserve.
The Company announced in April 2002 the closure of six U.S. manufacturing
plants. The decision reflected the Company's continuing shift from a
manufacturing to a marketing and product-driven organization. The Company
recorded an initial charge in the second quarter of 2002 of $129.7 million
consisting of $22.7 million for asset write-offs, $89.6 million for severance
and employee benefits and $17.4 million for other restructuring costs. The
charge reflects an estimated displacement of 3,300 employees at the affected
plants and approximately 250 employees at the remaining U.S. finishing facility.
The Company plans to close the six manufacturing plants in three phases: two
plants were closed by the end of June 2002, two plants are scheduled to close by
the end of July 2002 and the final two plants are scheduled to close by the end
of September 2002. As of May 26, 2002, no employees had been displaced. The
table below displays the activity and liability balance of this reserve.
2002 Scotland Plant Closures
Balance Balance
At At
11/25/01 Charges Reductions 5/26/02
-------- ------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits...................................... $ -- $15,691 $(12,741) $2,950
Other restructuring costs............................................ -- 1,732 (33) 1,699
----- ------- -------- ------
Total........................................................... $ -- $17,423 $(12,774) $4,649
===== ======= ======== ======
2002 U.S. Plant Closures
Balance Balance
At At
11/25/01 Charges Reductions 5/26/02
-------- ------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits...................................... $ -- $ 89,625 $(609) $ 89,016
Other restructuring costs............................................ -- 17,397 (199) 17,198
----- -------- ----- --------
Total........................................................... $ -- $107,022 $(808) $106,214
===== ======== ===== ========
9
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
2001 REORGANIZATION INITIATIVES
In November 2001, the Company instituted various reorganization initiatives
in the U.S. that included simplifying product lines and realigning the Company's
resources to those product lines. The Company recorded an initial charge of
$20.3 million in November 2001 reflecting a displacement of approximately 500
employees. As of May 26, 2002, approximately 270 employees have been displaced.
The table below displays the activity and liability balance of this reserve.
In November 2001, the Company instituted various reorganization initiatives
in Japan. These initiatives were prompted by business declines as a result of
the prolonged economic slowdown, political uncertainty, major retail
bankruptcies and dramatic shrinkage of the core denim jeans market in Japan. The
Company recorded an initial charge of $2.0 million in November 2001. The charge
reflected an estimated displacement of 22 employees, all of whom have been
displaced. The table below displays the activity and liability balances of this
reserve.
U.S. Reorganization Initiatives
Balance Balance
At At
11/25/01 Reductions 5/26/02
-------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits.................................... $19,989 $(8,422) $11,567
------- ------- -------
Total......................................................... $19,989 $(8,422) $11,567
======= ======= =======
Japan Reorganization Initiatives
Balance Balance
At At
11/25/01 Reductions 5/26/02
-------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits.................................... $1,657 $(1,632) $ 25
Other restructuring costs.......................................... 349 (66) 283
------ ------- ----
Total......................................................... $2,006 $(1,698) $308
====== ======= ====
1997 - 1999 PLANT CLOSURES AND RESTRUCTURING INITIATIVES
From 1997 to 1999 we closed 29 of our owned and operated production and
finishing facilities in North America and Europe and instituted restructuring
initiatives to reduce costs, eliminate excess capacity and align our sourcing
strategy with changes in the industry and in consumer demand. In the second
quarter of 2002, the Company reversed charges of $9.1 million related to plant
closures in 1998 and 1999 due to updated estimates associated with lower
anticipated employee benefits and other plant closure related costs. As of May
26, 2002, the remaining balance for the 1999 North America plant closures
represents estimates for remaining employee benefits and contractual
obligations.
SUMMARY
The total balance of the reserves at May 26, 2002 was $135.1 million
compared to $45.2 million at November 25, 2001. The majority of the balances for
the 1997 - 2001 reserves and the 2002 Scotland plant closures reserve are
expected to be utilized by the end of 2002, while the 2002 U.S. plant closures
reserve balance is expected to be utilized by the end of 2003. The following
table summarizes the activities and liability balances associated with the 1997
- - 2002 plant closures and restructuring initiatives:
10
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Balance as of Balance as of
November 25, May 26,
2001 Charges Reversals Reductions 2002
---- ------- --------- ---------- ----
(Dollars in Thousands)
2002 Scotland Plant Closures...................... $ -- $ 17,423 $ -- $12,774 $ 4,649
2002 U.S. Plant Closures.......................... -- 107,022 -- 808 106,214
2001 Corporate Restructuring Initiatives.......... 19,989 -- -- 8,422 11,567
2001 Japan Restructuring Initiative............... 2,006 -- -- 1,698 308
1999 Europe Restructuring and Plant Closures...... 2,449 -- 570 188 1,691
1999 North America Plant Closures................. 18,659 -- 8,415 1,129 9,115
1999 Corporate Restructuring Initiatives.......... 113 -- -- 113 --
1998 Corporate Restructuring Initiatives.......... 1,508 -- -- 80 1,428
1998 North America Plant Closures................. 223 -- 90 109 24
1998 European Restructuring and Plant Closures.... 225 -- -- 156 69
1997 North America Plant Closures................. 48 -- -- 48 --
------- -------- ------ ------- --------
Restructuring Reserves....................... $45,220 124,445 $9,075 $25,525 $135,065
======= -------- ====== ======= ========
2002 Plant Closures - Asset Write-offs............ 25,708
--------
2002 Restructuring Charges................... $150,153
========
NOTE 4: FINANCING
CREDIT FACILITY AMENDMENT
Effective January 29, 2002, the Company completed an amendment to its
principal credit agreement. The amendment has three principal features. First,
the amendment excludes from the computation of earnings for covenant compliance
purposes certain cash expenses, as well as certain non-cash costs, relating to
the 2002 plant closures in the U.S. and Scotland. The amendment also excludes
from those computations the non-cash portion of the Company's long-term
incentive compensation plans. Second, the amendment reduces by 0.25 the amount
of the required tightening of the leverage ratio beginning with the fourth
quarter of 2002. Third, the amendment tightens the senior secured leverage
ratio. The amendment did not change the interest rate, size of the facility or
required payment provisions of the facility.
Amendment of Domestic Receivables Securitization Agreements
Under its domestic receivables securitization arrangement, the Company is
required to maintain the level of net eligible U.S. trade receivables at a
certain targeted amount. If the targeted amount of net eligible U.S. trade
receivables is not met, the trustee under the arrangement retains cash
collections in an amount covering the deficiency. Under the agreements, the
retention of cash by the trustee has the effect of reducing the deficiency.
Amounts retained in this manner are not available to the Company until released
by the trustee. The trustee receives daily reports comparing the net eligible
receivables with the targeted amount and, if appropriate, releases retained cash
accordingly. The amount of cash held by the trustee to cover any deficiency
would be shown as "Restricted cash" on the balance sheet.
On April 25, 2002 the Company obtained an amendment to the domestic
receivables securitization agreements. Before the amendment, the manner in which
sales incentives were treated in the calculation of net eligible U.S. trade
receivables decreased net eligible receivables as well as substantially
increased the targeted amount. As a result, at the end of the first quarter of
2002, the trustee held cash, resulting in restricted cash of $43.0 million. The
amendment revises the way sales incentives are treated in calculating the amount
of net eligible receivables. This permits the Company greater flexibility in
offering sales incentives without affecting the securitization calculations and
reduces the likelihood and amount of cash being retained. As of May 26, 2002,
there was no deficiency and as a result, no restricted cash on the balance
sheet.
11
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
INTEREST RATE CONTRACTS
The Company is exposed to interest rate risk. It is the Company's policy
and practice to use derivative instruments, primarily interest rate swaps and
options, to manage and reduce interest rate exposures. The Company currently has
no derivative instruments managing interest rate risk outstanding as of May 26,
2002.
INTEREST RATES ON BORROWINGS
The Company's weighted average interest rate on average borrowings
outstanding during the three and six months ended May 26, 2002, including the
amortization of capitalized bank fees, interest rate swap cancellations and
underwriting fees, was 8.33% and 8.82%, respectively. The weighted average
interest rate on average borrowings outstanding excludes interest payable to
participants under deferred compensation plans and other miscellaneous items.
NOTE 5: FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of certain financial instruments has been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required in
interpreting market data. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that the Company could realize in a
current market exchange.
The carrying value and estimated fair value (in each case including accrued
interest) of the Company's financial instrument assets and (liabilities) are as
follows:
May 26, 2002 November 25, 2001
------------- -----------------
Carrying Estimated Carrying Estimated
Value(1) Fair Value Value(2) Fair Value
-------- ---------- -------- ----------
(Dollars in Thousands)
DEBT INSTRUMENTS:
U.S. dollar notes offering......................... $(1,190,538) $(1,151,851) $(1,193,012) $ (932,138)
Euro notes offering................................ (118,219) (119,273) (114,378) (85,719)
Yen-denominated eurobond placement................. (156,706) (117,188) (164,413) (113,115)
Credit facilities.................................. (153,168) (153,168) (252,748) (252,748)
Domestic receivables-backed securitization......... (110,079) (110,079) (110,081) (110,081)
Customer service center equipment financing........ (76,767) (80,363) (80,278) (81,970)
European receivables-backed securitization......... (46,396) (46,396) (41,366) (41,366)
Industrial development revenue refunding bond...... (10,014) (10,014) (10,015) (10,015)
Short-term and other borrowings.................... (23,744) (23,744) (19,395) (19,395)
----------- ----------- ----------- -----------
Total $(1,885,631) $(1,812,076) $(1,985,686) $(1,646,547)
=========== =========== =========== ===========
(1) Includes accrued interest of $23.8 million.
(2) Includes accrued interest of $27.3 million.
CURRENCY AND INTEREST RATE CONTRACTS:
Foreign exchange forward contracts................. $(24,554) $(24,554) $13,797 $13,797
Foreign exchange option contracts.................. 49 49 4,328 4,328
-------- -------- ------- -------
Total $(24,505) $(24,505) $18,125 $18,125
======== ======== ======= =======
Interest rate option contracts..................... -- -- $(2,266) $(2,266)
======== ======== ======= =======
12
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
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 26, 2002 and November 25, 2001. These amounts
have not been updated since those dates and, therefore, the current estimates of
fair value at dates subsequent to May 26, 2002 and November 25, 2001 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 6: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted Statement of Financial Accounting Standards No.
("SFAS") 133, "Accounting for Derivative Instruments and Hedging Activities," on
the first day of fiscal year 2001. SFAS 133 requires all derivatives to be
recognized as assets or liabilities at fair value. Due to the adoption of SFAS
133, the Company reported a net transition gain of $87 thousand in "Other
(income) expense" for the three months ended February 25, 2001. The transition
amount was not recorded on a separate line item as a change in accounting
principle, net of tax, due to the minimal impact on the Company's results of
operations. In addition, the Company recorded a transition amount of $0.7
million (or $0.4 million net of related income taxes) that reduced "Accumulated
other comprehensive income (loss)."
Foreign Exchange Management
The Company manages foreign currency exposures primarily to maximize the
U.S. dollar value over the long term. 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. As a result, not
all exposure management activities and foreign currency derivative instruments
will qualify for hedge accounting treatment. For derivative instruments utilized
in these transactions, changes in fair value are classified into earnings. The
Company holds derivative positions only in currencies to which it has exposure.
The Company has established a policy for a maximum allowable level of losses
that may occur as a result of its currency exposure management activities. The
maximum level of loss is based on a percentage of the total forecasted currency
exposure being managed.
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 and cash management.
The derivative instruments used to manage sourcing exposures do not qualify
for hedge accounting treatment and are recorded at their fair value. Any changes
in fair value are included in "Other (income) expense."
The Company manages its net investment position in its subsidiaries in
major currencies by using forward, swap and option contracts. Some of the
contracts hedging these net investments qualify for hedge accounting and the
related gains and losses are consequently categorized in the cumulative
translation adjustment in the "Accumulated other comprehensive income (loss)"
section of Stockholders' Deficit. At May 26, 2002, the fair value of qualifying
net investment hedges was a $6.2 million net liability with the corresponding
unrealized loss recorded in the cumulative translation adjustment section of
"Accumulated other comprehensive income (loss)." There were no gains or losses
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 26,
2002 represented a $2.8 million net liability.
13
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
The Company designates a portion of its outstanding yen-denominated
eurobond as a net investment hedge. As of May 26, 2002, a $11.0 million net
asset related to the translation effects of the eurobond was recorded in the
cumulative translation adjustment section of "Accumulated other comprehensive
income (loss)."
As of May 26, 2002, the Company holds no derivatives hedging forecasted
intercompany royalty flows that qualify as cash flow hedges. During the second
quarter no cash flow hedges have been reclassified from "Accumulated other
comprehensive income (loss)" to "Other (income) expense." The Company also
enters into contracts managing forecasted intercompany royalty flows that do not
qualify as cash flow hedges, and are recorded at their fair value. Any changes
in fair value are included in "Other (income) expense."
The derivative instruments utilized in transactions managing cash
management exposures are currently marked to market at their fair value and any
changes in fair value are recorded in "Other (income) expense."
The Company also entered into transactions managing the exposure related to
the Euro notes issued on January 18, 2001. These derivative instruments are
currently marked to market at their fair value and any changes in fair value are
recorded in "Other (income) expense."
Interest Rate Management
The Company is exposed to interest rate risk. It is the Company's policy
and practice to use derivative instruments, primarily interest rate swaps and
options, to manage and reduce interest rate exposures using a mix of fixed and
variable rate debt. The Company currently has no derivative instruments managing
interest rate risk outstanding as of May 26, 2002.
The tables below give an overview of the realized and unrealized gains and
losses reported in "Other (income) expense," realized and unrealized other
comprehensive income ("OCI") balances, realized and unrealized cumulative
translation adjustments ("CTA") balances, and the fair values of derivative
instruments reported as an asset or liability. OCI and CTA are components of the
"Accumulated other comprehensive income (loss)" section of Stockholders'
Deficit.
14
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
------------------------- ------------------------- ------------------------- ----------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
May 26, 2002 May 27, 2001 May 26, 2002 May 27, 2001
- ------------------------------ ------------------------- ------------------------- ------------------------- ----------------------
Other (income) expense Other (income) expense Other (income) expense Other (income) expense
- ------------------------------ ------------------------- ------------------------- ------------------------- ----------------------
(Dollars in Thousands) Realized Unrealized Realized Unrealized Realized Unrealized Realized Unrealized
- ------------------------------ ------------ ------------ ------------- ----------- ------------- ----------- ----------- ----------
Foreign Exchange Management:
Sourcing $ 7,229 $23,252 $(11,672) $ 806 $ 1,749 $28,788 $(2,497) $ 6,756
Net Investment (904) 6,723 (149) 1,682 (250) 3,068 645 2,552
Yen Bond -- 2,131 -- (4,415) -- (3,458) -- (9,398)
Royalties (13,020) 3,806 (5,685) 3,269 (9,578) 442 (6,462) 5,025
Cash Management 3,700 (3,821) 8,328 (5,463) 6,370 (3,745) 1,427 (4,603)
Transition Adjustments -- -- 414 -- -- -- 414 (1,333)
Euro Notes Offering (4,855) (1,318) 4,554 619 (3,536) (2,154) 8,236 1,159
------- ------- -------- ------- ------- ------- ------- -------
Total $(7,850) $30,773 $ (4,210) $(3,502) $(5,245) $22,941 $ 1,763 $ 158
======= ======= ======== ======= ======= ======= ======= =======
- ------------------------------ ------------ ------------ ------------- ----------- ------------- ----------- ----------- ----------
Interest Rate Management $ -- $ -- $ -- $1,391 $2,266(1) $(2,266) $ -- $4,862
Transition Adjustments -- -- -- -- -- -- -- 1,246
---- ---- ---- ------ ------ ------- ----- ------
Total $ -- $ -- $ -- $1,391 $2,266 $(2,266) $ -- $6,108
==== ==== ==== ====== ====== ======= ===== ======
- ------------------------------ ------------ ------------ ------------- ----------- ------------- ----------- ----------- ----------
(1) Recorded as an increase to interest expense.
------------------------------------------- ------------------------------------------
At May 26, 2002 At November 25, 2001
------------------------------------------- ------------------------------------------
OCI gain (loss) CTA gain (loss) OCI gain (loss) CTA gain (loss)
- ------------------------------------- -------- ---------- ---------- ------------ --------- ---------- ---------- ----------
(Dollars in Thousands) Realized Unrealized Realized Unrealized Realized Unrealized Realized Unrealized
- ------------------------------------- -------- ---------- ---------- ------------ --------- ---------- ---------- ----------
Foreign Exchange Management:
Net Investment $ -- $ -- $58,101 $(6,219) $ -- $ -- $53,314 $ 5,664
Yen Bond -- -- -- 11,006 -- -- -- 6,780
Royalties -- -- -- -- -- 908 -- --
Transition Adjustments -- -- -- -- -- -- -- 120
---- ---- ------- ------- ---- ---- ------- -------
Total $ -- $ -- $58,101 $ 4,787 $ -- $908 $53,314 $12,564
==== ==== ======= ======= ==== ==== ======= =======
- ------------------------------------- -------- ---------- ---------- ------------ --------- ---------- ---------- ----------
15
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
---------------- -----------------
At May 26, At November 25,
2002 2001
---------------- -----------------
Fair value Fair value
asset (liability) asset (liability)
------------------------------------ ----------------- -----------------
(Dollars in Thousands)
------------------------------------ ----------------- -----------------
Foreign Exchange Management:
Sourcing $(19,662) $10,976
Net Investment (9,004) 6,068
Royalties 71 729
Cash Management 3,104 1,521
Euro Notes Offering 986 (1,169)
-------- -------
Total $(24,505) $18,125
======== =======
------------------------------------ ----------------- -----------------
Interest Rate Management $ -- $(2,266)
======== =======
------------------------------------ ----------------- -----------------
16
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 7: COMMITMENTS AND CONTINGENCIES
FOREIGN EXCHANGE CONTRACTS
At May 26, 2002, the Company had U.S. dollar forward currency contracts to
buy $1.2 billion and to sell $510.4 million against various foreign currencies.
The Company also had euro forward currency contracts to buy 234.5 million euro
against various foreign currencies and to sell 14.5 million euro against various
foreign currencies. In addition, the Company had U.S. dollar option contracts to
buy $212.9 million and to sell $111.9 million against various foreign
currencies. The Company also had euro option currency contracts to sell 30.0
million euro against various foreign currencies. These contracts are at various
exchange rates and expire at various dates through August 2003.
The Company has entered into option contracts to manage its exposure to
numerous foreign currencies. Option transactions included in the amounts above
are principally for the exchange of the euro and U.S. dollar. At May 26, 2002,
the Company had bought U.S. dollar options resulting in a net short position
against the euro of $47.6 million should the options be exercised. To finance
the premiums related to the options bought, the Company sold options resulting
in a net long position against the euro of $148.6 million should the options be
exercised.
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
In the ordinary course of its business, the Company has pending various
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 the Company's financial position or results of
operations.
The operations and properties of the Company comply with all applicable
federal, state and local laws enacted for the protection of the environment, and
with permits and approvals issued in connection therewith, except where the
failure to comply would not reasonably be expected to have a material adverse
effect on the Company's financial position or business operations. Based on
currently available information, the Company does not consider there to be any
circumstances existing that would be reasonably likely to form the basis of an
action against the Company and that could have a material adverse effect on the
Company's financial position or business operations.
17
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 8: BUSINESS SEGMENT INFORMATION
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
THREE MONTHS ENDED MAY 26, 2002:
Net sales....................................... $596,697 $241,373 $85,448 $ -- $ 923,518
Earnings contribution........................... 84,215 45,304 15,189 -- 144,708
Interest expense................................ -- -- -- 42,510 42,510
Corporate and other expense, net................ -- -- -- 246,104 246,104
Income (loss) before income taxes............ -- -- -- -- (143,906)
THREE MONTHS ENDED MAY 27, 2001:
Net sales....................................... $682,073 $276,737 $85,127 $ -- $1,043,937
Earnings contribution........................... 90,167 57,141 12,671 -- 159,979
Interest expense................................ -- -- -- 53,898 53,898
Corporate and other expense, net................ -- -- -- 37,146 37,146
Income before income taxes................... -- -- -- -- 68,935
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
SIX MONTHS ENDED MAY 26, 2002:
Net sales....................................... $1,198,037 $501,998 $158,767 $ -- $1,858,802
Earnings contribution........................... 164,202 105,328 29,264 -- 298,794
Interest expense................................ -- -- -- 90,533 90,533
Corporate and other expense, net................ -- -- -- 282,963 282,963
Income (loss) before income taxes............ -- -- -- -- (74,702)
SIX MONTHS ENDED MAY 27, 2001:
Net sales....................................... $1,344,279 $534,010 $162,031 $ -- $2,040,320
Earnings contribution........................... 196,210 114,376 25,051 -- 335,637
Interest expense................................ -- -- -- 123,103 123,103
Corporate and other expense, net................ -- -- -- 96,660 96,660
Income before income taxes................... -- -- -- -- 115,874
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
report.
CRITICAL ACCOUNTING POLICIES
Our most critical accounting policies upon which our financial position
and results of operations depend are those relating to revenue recognition,
inventory valuation, restructuring reserves, income tax assets and liabilities,
and derivatives and foreign exchange management activities. Since the end of the
first quarter of fiscal year 2002, we added the policy for income tax assets and
liabilities to our list of critical accounting policies. During the second
quarter, we did not change those policies or adopt any new policies. We
summarize our most critical accounting policies below.
o Revenue recognition. We recognize revenue from the sale of a product upon
its shipment to the customer. We recognize allowances for estimated
returns, discounts and retailer promotions and incentives when the sale
is recorded. Our allowances principally relate to our U.S. operations and
are primarily comprised of volume-based incentives and other returns and
discounts. For volume-based retailer incentive programs, reserves for
volume allowances are calculated based on a fixed formula applied to sales
volumes. We estimate non-volume-based allowances using our historical
customer claim rates as a percentage of accounts receivable, adjusted as
necessary for special customer and product-specific circumstances. Actual
allowances may differ from our estimates due primarily to changes in sales
volume based on retailer or consumer demand. Our actual returns and
allowances have not materially differed from our estimates.
o Inventory valuation. We value inventories at the lower of cost or market
value. Inventory costs are based on standard costs, which are updated
periodically and supported by actual cost data. We include materials,
labor and manufacturing overhead in the cost of inventories. In determining
inventory market values, we give substantial consideration to the expected
product selling price based on historical recovery rates. In determining
our expected selling prices, we consider various factors including
estimated quantities of slow-moving inventory by reviewing on-hand
quantities, outstanding purchase obligations and forecasted sales. We then
estimate expected selling prices based on our historical recovery rates for
sale of slow-moving inventory through various channels and other factors,
such as market conditions and current consumer preferences. Our estimates
may differ from actual results due to the quantity and quality and mix of
products in inventory, consumer and retailer preferences and economic
conditions.
o Restructuring reserves. Upon approval of a restructuring plan by management
with the appropriate level of authority, we record restructuring reserves
for certain costs associated with plant closures and business
reorganization activities. Such costs are recorded as a current liability
and primarily include employee severance, certain employee termination
benefits, including out-placement services and career counseling, and
contractual obligations. The principal components of the reserves relate
to employee severance and termination benefits, which we estimate based on
agreements with the relevant union representatives or plans adopted by us
that are applicable to employees not affiliated with unions. These costs
are not associated with nor do they benefit continuing activities. Inherent
in the estimation of these costs are assessments related to the most likely
expected outcome of the significant actions to accomplish the
restructuring. Changing business conditions may affect the assumptions
related to the timing and extent of facility closure activities. We review
the status of restructuring activities on a quarterly basis and, if
appropriate, record changes based on updated estimates.
19
o Income tax assets and liabilities. In establishing our deferred income tax
assets and liabilities, we make judgments and interpretations based on the
enacted tax laws and published tax guidance that are applicable to our
operations. We record deferred tax assets and liabilities and evaluate the
need for valuation allowances to reduce the deferred tax assets to
realizable amounts. The likelihood of a material change in our expected
realization of these assets is dependent on future taxable income, our
ability to use foreign tax credit carryforwards and carrybacks, final
U.S. and foreign tax settlements, and the effectiveness of our tax planning
strategies in the various relevant jurisdictions. We are also subject to
examination of our income tax returns for multiple years by the Internal
Revenue Service and other tax authorities. We periodically assess the
likelihood of adverse outcomes resulting from these examinations to
determine the adequacy of our provision for income taxes. Changes to our
income tax provision or in the valuation of the deferred tax assets and
liabilities may affect our annual effective income tax rate.
o Derivatives and foreign exchange management activities. We recognize all
derivatives as assets and liabilities at their fair values. The fair values
are determined using widely accepted valuation models and reflect
assumptions about currency fluctuations based on current market conditions.
We actively manage foreign currency exposures on an economic basis, using
forecasts to develop exposure positions to maximize the U.S. dollar value
over the long-term. 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 (income) expense" in
the consolidated statement of income. As a result, our net income may be
subject to volatility. The derivative instruments that do qualify for hedge
accounting currently hedge our net investment position in our subsidiaries.
For these instruments, we document the hedge designation, by identifying
the hedging instrument, the nature of the risk being hedged and the
approach for measuring hedge effectiveness. Changes in fair values of
derivative instruments that do qualify for hedge accounting are recorded in
the "Accumulated other comprehensive income (loss)" section of
Stockholders' Deficit. The carrying 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.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, selected items
in our consolidated statements of operations, expressed as a percentage of net
sales (amounts may not total due to rounding).
Three Months Ended Six Months Ended
------------------ ----------------
May 26, May 27, May 26, May 27,
2002 2001 2002 2001
---- ---- ---- ----
MARGIN DATA:
Net sales...................................................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold............................................. 60.0 56.7 58.7 56.3
----- ----- ----- -----
Gross profit................................................... 40.0 43.3 41.3 43.7
Marketing, general and administrative expenses................. 34.5 32.2 33.2 32.5
Other operating (income)....................................... (0.9) (0.7) (0.8) (0.7)
Restructuring charges, net of reversals........................ 15.3 -- 7.6 --
----- ----- ----- -----
Operating income (loss)........................................ (8.9) 11.9 1.3 12.0
Interest expense............................................... 4.6 5.2 4.9 6.0
Other (income) expense, net.................................... 2.1 0.1 0.4 0.3
----- ----- ----- -----
Income (loss) before taxes..................................... (15.6) 6.6 (4.0) 5.7
Income tax expense (benefit)................................... (6.8) 2.4 (2.0) 2.1
----- ----- ----- -----
Net income (loss).............................................. (8.8)% 4.2% (2.0)% 3.6%
===== ===== ===== =====
20
Three Months Ended Six Months Ended
------------------ ----------------
May 26, May 27, May 26, May 27,
2002 2001 2002 2001
---- ---- ---- ----
NET SALES SEGMENT DATA:
Geographic
Americas.............................................. 64.6% 65.3% 64.5% 65.9%
Europe................................................ 26.1 26.5 27.0 26.2
Asia Pacific.......................................... 9.3 8.2 8.5 7.9
Net sales. Net sales for the three months ended May 26, 2002 decreased
11.5% to $923.5 million, as compared to $1,043.9 million for the same period in
2001. Net sales for the six months ended May 26, 2002 decreased 8.9% to $1,858.8
million, as compared to $2,040.3 million for the same period in 2001. If
currency exchange rates were unchanged from the prior year periods, net sales
would have declined approximately 10.6% and 7.5% for the three and six months
ended May 26, 2002, respectively. These decreases primarily reflect the
challenging retail and economic climates in which we operate, and the
introduction of our new volume-based U.S. sales promotions and incentives that
offset recorded sales.
Although the first half of 2002 net sales reflected continuing declines,
especially in the second quarter, we believe we will slow the rate of decline
for our full year 2002 constant currency net sales to the low single digits. We
anticipate an improved sales performance in the second half of 2002 based on:
o current bookings and product orders,
o the expected impact of new product introductions,
o actions we are taking to improve margins for our retailers, and
o our intended use of targeted promotional initiatives.
In the Americas, net sales for the three months ended May 26, 2002
decreased 12.5% to $596.7 million, as compared to $682.1 million for the same
period in 2001. Net sales for the six months ended May 26, 2002 decreased 10.9%
to $1,198.0 million, as compared to $1,344.3 million for the same period in
2001. Unit volumes for both periods of 2002 decreased slightly compared to the
same periods in 2001. The net sales decreases were primarily attributable to:
o the introduction of our new volume-based sales promotions and incentives,
o lower wholesale prices for selected core Dockers(R) products, and
o wholesale price reductions on selected existing products as we transition
to new product lines in the Levi's(R) brand.
Although retailers appear to remain cautious in their buying habits and continue
to maintain tight inventory levels, we believe that the strength of our planned
promotions and new products, such as low-rise Levi's(R) jeans for men and women
and the Dockers(R) Go Khaki(TM) pant, will generate improved results during the
second half of the year.
In Europe, net sales for the three months ended May 26, 2002 decreased
12.8% to $241.4 million, as compared to $276.7 million for the same period in
2001. Net sales for the six months ended May 26, 2002 decreased 6.0% to $502.0
million, as compared to $534.0 million for the same period in 2001. On a
constant currency basis, net sales would have decreased by approximately 11.2%
and 3.1% for the three and six months ended May 26, 2002, respectively, compared
to the same periods in 2001.
These decreases reflect volume declines as a result of weak consumer
demand, high retail inventories and increasing apparel price deflation. These
conditions resulted in the first quarterly decline in constant currency net
sales since the first quarter of 2001. The decrease in net sales during the
second quarter of 2002 was primarily attributable to lower volume and price
reductions we took to sell slow-moving products. We believe retailers are
remaining cautious and are managing their inventories more conservatively due to
an uncertain economic environment. This is most prevalent in key markets such as
Germany, Italy and the United Kingdom.
We believe that we will generate improved results in the second half of
2002 based on our product, pricing and promotional strategies. These strategies
include:
o the introduction of entry-price-point product lines in the Levi's(R) and
Dockers(R) brands,
o selective wholesale price reductions,
o promotions in core finishes of 501(R) jeans, and
o a Levi's(R) girls jeans presence and publicity campaign.
21
In our Asia Pacific region, net sales for the three months ended May 26,
2002 increased 0.4% to $85.4 million, as compared to $85.1 million for the same
period in 2001. Net sales for the six months ended May 26, 2002 decreased 2.0%
to $158.8 million, as compared to $162.0 million. If exchange rates were
unchanged from the prior year periods, net sales would have increased
approximately 4.7% and 4.0% for the three and six months ended May 26, 2002,
respectively. In some countries we reported double-digit net sales increases for
the three and six months ended May 26, 2002 from the same periods last year
reflecting our product upgrades and retail distribution strategies, while other
countries were affected by weak economic climates and price deflation.
In Japan, which accounted for approximately 51% of our business in Asia for
the first half of 2002, net sales for the three months ended May 26, 2002
increased approximately 1.7% on a constant currency basis compared to the same
period last year. For the six months ended May 26, 2002, Japan's net sales were
flat compared to last year on a constant currency basis. Japan's recent sales
results for both periods reflect a price increase on our premium and
super-premium product lines and upgraded core product offerings.
Gross profit. Gross profit for the three months ended May 26, 2002 totaled
$369.5 million compared with $452.5 million for the same period in 2001. Gross
profit as a percentage of net sales, or gross margin, for the three months ended
May 26, 2002 decreased to 40.0%, as compared to 43.3% for the same period in
2001. Gross profit for the six months ended May 26, 2002 totaled $768.1 million
compared to $892.4 million in the first half of 2001. Gross margin decreased for
the six months ended May 26, 2002 to 41.3%, as compared to 43.7% for the same
period in 2001.
Gross margin for both periods of 2002 was adversely affected by expenses of
$30.1 million associated with plant closures in the U.S. and Scotland, primarily
for workers' compensation and pension enhancements in the U.S. Excluding these
restructuring related expenses, gross margin for the second quarter of 2002
would have been flat compared to the same period in 2001. In addition, gross
margin for the six-month period of 2002 would have been slightly lower compared
to the same period in 2001. The effect of introducing retailer promotions and
incentives on gross margin was largely offset by lower sourcing and fabric
costs. Over the next 12 - 18 months, we expect to incur an additional $20 - $25
million in restructuring related expenses such as maintenance costs prior to
sale or other disposition of the closed plants.
Our largest supplier, Cone Mills Corporation, supplies various fabrics to
us and is the sole supplier of the denim used worldwide for our 501(R) jeans. On
May 13, 2002, we amended the exclusivity and requirements features of our supply
agreement with Cone Mills. The amendment provides that, after March 30, 2003, we
may purchase these denims from other suppliers and Cone Mills may sell these
denims to other customers. The amendment also allows us to purchase these denims
for our European business from non-U.S. sources prior to March 30, 2003 if the
European Union implements material tariffs against U.S. produced denim. The
amendment does not change any other provisions of the supply agreement.
Marketing, general and administrative expenses. Marketing, general and
administrative expenses for the three months ended May 26, 2002 decreased 5.2%
to $318.8 million as compared to $336.1 million for the same period in 2001.
Marketing, general and administrative expenses as a percentage of sales for the
three months ended May 26, 2002 increased to 34.5% as compared to 32.2% for the
same period in 2001. Marketing, general and administrative expenses for the six
months ended May 26, 2002 decreased 6.7% to $617.7 million as compared to $662.2
million for the same period in 2001. Marketing, general and administrative
expenses as a percentage of sales for the six months ended May 26, 2002
increased to 33.2% as compared to 32.5% for the same period in 2001.
The dollar decrease in marketing, general and administrative expenses for
the three and six months ended May 26, 2002 was primarily due to lower
advertising expenses, our continuing cost containment efforts and the effect of
currency exchange rates. In addition, the second quarter of 2001 includes a
$12.5 million reversal to an employee long-term incentive plan accrual as a
result of forfeitures. The increase as a percentage of sales for the three and
six months ended May 26, 2002 reflects the lower net sales base compared to the
same periods in 2001.
22
Advertising expense for the three months ended May 26, 2002 decreased 20.7%
to $69.6 million, as compared to $87.8 million for the same period in 2001.
Advertising expense as a percentage of sales for the three months ended May 26,
2002 decreased to 7.5%, as compared to 8.4% for the same period in 2001.
Advertising expense for the six months ended May 26, 2002 decreased 19.0% to
$135.7 million, as compared to $167.4 million for the same period in 2001.
Advertising expense as a percentage of sales for the six months ended May 26,
2002 decreased to 7.3%, as compared to 8.2% for the same period in 2001. The
decrease in advertising expense reflects lower media costs and our strategic
decision to shift some of our U.S. advertising spending into sales incentive
programs with retailers.
Other operating income. Licensing income for the three months ended May 26,
2002 of $8.5 million increased 15.6%, as compared to $7.4 million for the same
period in 2001. Licensing income for the six months ended May 26, 2002 of $14.6
million was relatively flat compared to $14.5 million for the same period in
2001. The increase for the second quarter of 2002 was primarily due to expansion
of licensed accessory categories.
Restructuring charges, net of reversals. In the second quarter of 2002, we
recorded charges of $150.2 million associated with plant closures in the U.S.
and Scotland. These charges were offset by a $9.1 million reversal of prior
years' restructuring charges primarily due to updated estimates. We present
below and in the consolidated financial statements more data about these
charges.
Operating income (loss). Operating loss for the three months ended May 26,
2002 was $81.8 million compared to operating income of $123.7 million for the
same period in 2001. Operating income for the six months ended May 26, 2002 was
$23.9 million compared to $244.7 million from the same period in 2001. The
operating loss and decrease in operating income compared to the prior year
periods was primarily attributable to the net restructuring charge of $141.1
million and related expenses of $30.1 million recorded in the second quarter of
2002 and the impact of lower sales. This was partially offset by lower
marketing, general and administrative expenses.
Interest expense. Interest expense for the three months ended May 26, 2002
decreased 21.1% to $42.5 million, as compared to $53.9 million for the same
period in 2001. Interest expense for the six months ended May 26, 2002 decreased
26.5% to $90.5 million, as compared to $123.1 million for the same period in
2001. The lower interest expense for both the three and six months ended May 26,
2002 was primarily due to lower average debt levels combined with lower market
interest rates. In addition, interest expense for the six months of 2001
included the write-off of fees totaling $10.8 million related to our prior
credit agreement dated January 31, 2000. We replaced that credit agreement with
a new credit facility on February 1, 2001. The weighted average cost of
borrowings for the three months ended May 26, 2002 and May 27, 2001 were 8.33%
and 9.04%, respectively. The weighted average cost of borrowings for the six
months ended May 26, 2002 and May 27, 2001 were 8.82% and 9.64%, respectively,
excluding the write-off of fees.
Other (income) expense, net. Other (income) expense, net for the three
months ended May 26, 2002 was an expense of $19.6 million compared to an expense
of $0.9 million for the same period in 2001. Other (income) expense, net for the
six months ended May 26, 2002 was an expense of $8.1 million compared to an
expense of $5.8 million for the same period in 2001. The increases in expense
for the three and six months ended May 26, 2002 were primarily due to unrealized
net losses from derivative instruments used for foreign currency management
activities that do not qualify for hedge accounting.
Income tax expense (benefit). Income tax benefit for the three months ended
May 26, 2002 was $63.0 million compared to an income tax expense of $25.5
million for the same period in 2001. Income tax benefit for the six months ended
May 26, 2002 was $37.4 million compared to an income tax expense of $42.9
million for the same period in 2001. The income tax benefit for both periods of
2002 was due to a loss reported in the second quarter of 2002 as a result of the
net restructuring charges of $141.1 million and related expenses of $30.1
million. Our effective tax rate for the six-month period of 2002 is 50% compared
to 37% for the same period in 2001. The increase in our annual effective tax
rate is primarily due to projected lower earnings for 2002 resulting from the
restructuring charges and related expenses. The higher tax rate for 2002
reflects the computational effect of expenses not deductible for tax purposes on
the lower earnings base expected for the full year of 2002.
23
We reached a tentative settlement with the Internal Revenue Service during
2002 in connection with the examination of our income tax returns for the years
1990 - 1994. We are in the process of evaluating the realizability of our
deferred tax assets and the likelihood of unfavorable outcomes resulting from
examinations of subsequent years by the Internal Revenue Service and other tax
authorities. We expect to complete our evaluation process by November 2002 and
our deferred tax assets and effective tax rate may change at that time.
Net income (loss). Net loss for the three months ended May 26, 2002 was
$80.9 million compared to net income of $43.4 million for the same period in
2001. Net loss for the six months ended May 26, 2002 was $37.4 million compared
to net income of $73.0 million for the same period in 2001. The net loss for the
three and six months ended May 26, 2002 was primarily attributed to the net
restructuring charges and related expenses, and lower sales, partially offset by
lower marketing, general and administrative expenses, lower interest expense and
an income tax benefit.
RESTRUCTURING CHARGES, NET OF REVERSALS
During the second quarter of 2002 we announced our decision to close two
manufacturing plants in Scotland and six manufacturing plants in the U.S. The
U.S. closures reflect our continuing shift from a manufacturing to a marketing
and product-driven organization. We closed the plants in Scotland in order to
reduce average production costs in Europe.
We believe these actions will improve our competitiveness and enable us to
invest more resources in product, marketing and retail initiatives. These
actions increase the variable nature of our cost structure. We believe these
actions will help us maintain strong gross margins in a highly-competitive and
price deflationary environment.
For the plant closures in Scotland, we recorded an initial charge in the
second quarter of 2002 of $20.5 million that included a non-cash asset write-off
of $3.1 million. The charge reflects an estimated displacement of 650 employees.
The two manufacturing plants were closed by the end of the second quarter of
2002. We expect to utilize the majority of the Scotland plant closures reserve
balance by the end of 2002.
For the U.S. plant closures, we recorded an initial charge in the second
quarter of 2002 of $129.7 million that included a non-cash asset write-off of
$22.7 million. The charge reflects an estimated displacement of 3,300 employees
at the affected plants and approximately 250 employees at our remaining U.S.
finishing facility. We plan to close the six manufacturing plants in three
phases: two plants were closed by the end of June 2002, two plants are scheduled
to close by the end of July 2002 and the final two plants are scheduled to close
by the end of September 2002. We expect to utilize the majority of the U.S.
plant closures reserve balance by the end of 2003.
From 1997 to 2001 we closed 29 of our owned and operated production and
finishing facilities in North America and Europe and instituted restructuring
initiatives to reduce costs, eliminate excess capacity and align our sourcing
strategy with changes in the industry and in consumer demand. We expect to
utilize the majority of the 1997 - 2001 reserve balances by the end of 2002.
24
The total balance of the reserves at May 26, 2002 was $135.1 million
compared to $45.2 million at November 25, 2001. The following table summarizes
the balances associated with the plant closures and restructuring initiatives:
Balance as of Balance as of
May 26, November 25,
2002 2001
---- ----
(Dollars in Thousands)
2002 Scotland Plant Closures......................................... $ 4,649 $ --
2002 U.S. Plant Closures............................................. 106,214 --
2001 Corporate Restructuring Initiatives............................. 11,567 19,989
2001 Japan Restructuring Initiative.................................. 308 2,006
1999 Europe Restructuring and Plant Closures......................... 1,691 2,449
1999 North America Plant Closures.................................... 9,115 18,659
1999 Corporate Restructuring Initiatives............................. -- 113
1998 Corporate Restructuring Initiatives............................. 1,428 1,508
1998 North America Plant Closures.................................... 24 223
1998 Europe Restructuring and Plant Closures......................... 69 225
1997 North America Plant Closures.................................... -- 48
-------- -------
Total........................................................... $135,065 $45,220
======== =======
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements have been to fund working capital and
capital expenditures. As of May 26, 2002, total cash and cash equivalents were
$115.6 million, a $12.8 million increase from the $102.8 million cash balance
reported as of November 25, 2001.
Total debt, other cash obligations and commitments. Total debt as of May
26, 2002 was $1,861.8 million, a $96.6 million decrease from the $1,958.4
million reported as of November 25, 2001. We have no off-balance sheet debt
obligations or unconditional purchase commitments. Our aggregate short-term and
long-term debt principal payments as of May 26, 2002 and minimum operating lease
payments for facilities, office space and equipment as of November 25, 2001 for
the next five years and thereafter are as follows:
Minimum
Principal Operating Lease
Payments Payments
-------- --------
(Dollars in Thousands)
Year
----
2002.......................................................... $ 68,907 $ 61,974
2003.......................................................... 524,024 57,310
2004.......................................................... 118,521 54,803
2005.......................................................... 56,202 50,472
2006.......................................................... 447,939 48,249
Thereafter.................................................... 646,204 209,502
---------- --------
Total.................................................... $1,861,797 $482,310
========== ========
We have other current cash obligations for various liabilities categorized
on the balance sheet as accounts payable, accrued liabilities, accrued salaries,
wages and employee benefits and accrued taxes for our normal business
operations. During 2002, we reclassified approximately $148.5 million from
long-term tax liability into accrued taxes due to a tentative settlement on most
issues with the Internal Revenue Service in connection with the examination of
our income tax returns for the years 1990 - 1994. We anticipate paying the
Internal Revenue Service after the examination is completed during the second
quarter of 2003. In addition, we increased restructuring reserves due to the
announced plant closures in the second quarter of 2002 and reclassified from
long-term employee benefits to accrued salaries, wages and employee benefits
expected payments in 2003 under our long-term incentive compensation plan.
25
As of May 26, 2002, our credit facility consisted of $153.0 million of term
loans and a $617.6 million revolving credit facility. There were no outstanding
borrowings under the revolving credit facility. Total availability under the
revolving credit facility was reduced by $139.0 million of letters of credit
allocated under the revolving credit facility, yielding a net availability of
$478.6 million. We believe this is sufficient for our cash needs.
Our credit facility matures in August 2003 and the unsecured 6.80% notes
become due in November 2003. We are exploring alternatives for repayment or
refinancing of those obligations.
At May 26, 2002, we had unsecured and uncommitted short-term credit lines
available totaling $14.9 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 26, 2002 and November 25, 2001, we had $119.5 million and $131.7
million, respectively, of standby letters of credit with various international
banks, of which $48.5 million and $52.5 million, respectively, serve as
guarantees by the creditor banks to cover U.S. workers' compensation claims. We
pay fees on standby letters of credit and borrowings against letters of credit
are subject to interest at various rates.
We do not have any long-term raw materials supply contracts except for our
supply agreement with Cone Mills Corporation relating to the denim used in
501(R) jeans. The supply agreement does not obligate us to purchase any minimum
amount of goods. We typically conduct business with our garment manufacturing
and finishing contractors on an order-by-order basis.
Plant closures. During the second quarter of 2002 we announced our
decision to close two manufacturing plants in Scotland and six manufacturing
plants in the U.S. We recorded a total initial charge in the second quarter of
2002 of $150.2 million that included a non-cash asset write-off of $25.7
million. We expect to make cash payments of approximately $65.0 million for the
restructuring charges and related expenses during the latter half of 2002. We
expect to utilize the majority of the U.S. plant closures reserve balance by the
end of 2003. We expect to utilize the majority of the balances for the Scotland
plant closures reserve and the 1997 - 2001 reserves by the end of 2002. Once the
2002 closures are complete, we believe we will generate approximately $100
million in annual pre-tax savings. We intend to use these expected savings to
reinvest in the business, primarily for product, marketing and retail
initiatives. In addition, we believe the variable nature of our cost structure
will help us maintain strong gross margins and cash flow, facilitating future
debt reduction over the long-term.
Cash provided by/used for operations. Cash provided by operating
activities for the six months ended May 26, 2002 was $113.6 million, as compared
to a use of cash of $152.7 million for the same period in 2001. Trade
receivables decreased during the six months ended May 26, 2002 primarily due to
lower net sales. Inventories increased during the six months ended May 26, 2002
primarily due to new product introductions for the fall/holiday season. Net
deferred tax assets increased during the six months ended May 26, 2002 primarily
due to the restructuring charges and related expenses. Accounts payable and
accrued liabilities decreased during the six months ended May 26, 2002 primarily
due to lower raw material purchases and lower advertising costs than at November
25, 2001.
Restructuring reserves increased during the six months ended May 26, 2002
due to the restructuring charges associated with the U.S. and Scotland plant
closures. Accrued salaries, wages and employee benefits increased and long-term
employee benefits decreased during the six months ended May 26, 2002 primarily
due to expected payments in 2003 under our long-term incentive compensation
plan. Accrued taxes increased and long-term tax liability decreased during the
six months ended May 26, 2002 due to a reclassification of approximately $148.5
million for a tentative settlement with the Internal Revenue Service in
connection with the examination of our income tax returns for the years 1990 -
1994. We anticipate paying the Internal Revenue Service after the examination is
completed during the second quarter of 2003.
26
Cash used for investing activities. Cash used for investing activities
during the six months ended May 26, 2002 was $6.2 million as compared to $0.7
million during the same period in 2001. Cash used for investing activities for
the six months ended May 26, 2002 resulted primarily from purchases of property,
plant and equipment, partially offset by proceeds received on sales of property,
plant and equipment and realized gains on net investment hedges. The purchases
of property, plant and equipment were primarily attributable to sales office
capital improvements and systems upgrades. The proceeds received on the sale of
property, plant and equipment arose mainly from the sale during the first
quarter of 2002 of an idle distribution center located in Nevada. We expect
capital spending of approximately $50.0 to $70.0 million for fiscal year 2002,
primarily for systems upgrades.
Cash used for/provided by financing activities. Cash used for financing
activities for the six months ended May 26, 2002 was $94.9 million, as compared
to cash provided by financing activities of $110.5 million for the same period
in 2001. Cash used for financing activities during the six months ended May 26,
2002 was primarily for repayment of existing debt.
Financial Condition
Credit agreement. Effective January 29, 2002, we completed an amendment to
our principal credit agreement. The amendment has three principal features.
First, the amendment excludes from the computation of earnings for covenant
compliance purposes certain cash expenses, as well as certain non-cash costs,
relating to the 2002 plant closures in the U.S. and Scotland. The amendment also
excludes from those computations the non-cash portion of our long-term incentive
compensation plans. Second, the amendment reduces by 0.25 the amount of the
required tightening of the leverage ratio beginning with the fourth quarter of
2002. Third, the amendment tightens the senior secured leverage ratio. The
amendment did not change the interest rate, size of the facility or required
payment provisions of the facility.
Amendment of domestic receivables securitization agreements. Under our
domestic receivables securitization arrangement, we are required to maintain the
level of net eligible U.S. trade receivables at a certain targeted amount. If
the targeted amount of net eligible U.S. trade receivables is not met, the
trustee under the arrangement retains cash collections in an amount covering the
deficiency. Under the agreements, the retention of cash by the trustee has the
effect of reducing the deficiency. Amounts retained in this manner are not
available to us until released by the trustee. The trustee receives daily
reports comparing the net eligible receivables with the targeted amount and, if
appropriate, releases retained cash accordingly. The amount of cash held by the
trustee to cover any deficiency would be shown as "Restricted cash" on the
balance sheet.
On April 25, 2002 we obtained an amendment to the domestic receivables
securitization agreements. Before the amendment, the manner in which sales
incentives were treated in the calculation of net eligible U.S. trade
receivables decreased net eligible receivables as well as substantially
increased the targeted amount. As a result, at the end of the first quarter of
2002, the trustee held cash, resulting in restricted cash of $43.0 million. The
amendment revises the way sales incentives are treated in calculating the amount
of net eligible receivables. This permits us greater flexibility in offering
sales incentives without affecting the securitization calculations and reduces
the likelihood and amount of cash being retained. As of May 26, 2002, there was
no deficiency and as a result, no restricted cash on the balance sheet.
Credit ratings. On July 2, 2002, Moody's Investors Service ("Moody's")
issued a press release regarding its decision to place both our senior secured
credit facility and our senior unsecured notes on review for a possible
downgrade. According to the press release, Moody's based this decision on its
concerns relating to our declining sales, our level of cash generation, our
ability to reduce debt, including the upcoming 2003 debt maturities, and our
ability to pay costs associated with the 2002 plant closures. This action by
Moody's does not trigger any obligations or other provisions under our financing
agreements or our other contractual relationships.
27
STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
This Form 10-Q includes forward-looking statements about:
o sales performance and trends;
o new product introductions;
o incentive and promotional activities;
o retailer margins;
o marketing and advertising initiatives;
o retail conditions;
o wholesale price reductions;
o debt repayment and liquidity;
o gross margins;
o amendments to the U.S. receivables securitization arrangement and its
impact on our liquidity and sales incentives;
o capital expenditures;
o income tax audit settlements;
o restructuring charges and related expenses;
o plant closures and their impact on our competitiveness, costs and
resources;
o workforce reductions;
o asset sales;
o general economic and retail conditions; and
o other matters.
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:
o risks related to the impact of consumer and customer reactions to new
products and retailers;
o order completion by retailers;
o the effectiveness of our promotion and incentive programs with
retailers;
o changing domestic and international retail environments;
o plant closure execution and consequences;
o changes in the level of consumer spending or preferences in apparel;
o dependence on key distribution channels, customers and suppliers;
o the impact of competitive products;
o changing fashion trends;
o our supply chain executional performance;
o the nature and amount of sales incentives, the amount of dilutive
items, the net eligible receivables balance and the credit quality of
our domestic receivables in any one period;
o ongoing price and other competitive pressures in the apparel industry;
o trade restrictions;
o political or financial instability in countries where our products are
manufactured; and
o other risks detailed in our annual report on Form 10-K for the year
ended November 25, 2001, registration statements and other filings with
the Securities and Exchange Commission.
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.
28
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 and interest rate risks with the objective of
reducing fluctuations in actual and anticipated cash flows by entering into a
variety of derivative instruments including spot, forwards, options and swaps.
We are exposed to credit loss in the event of nonperformance by the
counterparties to the foreign exchange contracts. However, we believe these
counterparties are creditworthy financial institutions and do not anticipate
nonperformance. We currently do not manage our exposure to the price of cotton
with derivative instruments.
The table below gives an overview of the fair values of derivative
instruments reported as an asset or liability. These contracts expire at various
dates through August 2003.
--------------------------------------- ------------------ -------------------
At May 26, At November 25,
2002 2001
--------------------------------------- ------------------ -------------------
Fair value Fair value
Risk Exposures asset (liability) asset (liability)
--------------------------------------- ------------------ -------------------
(Dollars in Thousands)
--------------------------------------- ------------------ -------------------
Foreign Exchange Management:
Sourcing $(19,662) $10,976
Net Investment (9,004) 6,068
Royalties 71 729
Cash Management 3,104 1,521
Euro Notes Offering 986 (1,169)
-------- -------
Total $(24,505) $18,125
======== =======
--------------------------------------- ------------------ -------------------
Interest Rate Management $ -- $(2,266)
======== =======
--------------------------------------- ------------------ -------------------
FOREIGN EXCHANGE RISK
Foreign exchange market risk exposures are primarily related to cash
management activities, raw material and finished goods purchases (sourcing), net
investment positions and royalty flows from affiliates.
We use forward contracts to manage our foreign currency sourcing and net
investment exposures and to maximize the U.S. dollar over the long term. A
weakening U.S. dollar against major currencies positively affects the underlying
foreign currency exposure, while having an opposite effect on the forward
contracts used to manage these exposures. As a result, we reported a fair value
liability on our derivative instruments of $24.5 million as of May 26, 2002.
At May 26, 2002, we had U.S. dollar forward currency contracts to buy $1.2
billion and to sell $510.4 million against various foreign currencies. We also
had euro forward currency contracts to buy 234.5 million euro against various
foreign currencies and to sell 14.5 million euro against various foreign
currencies. In addition, we had U.S. dollar option contracts to buy $212.9
million and to sell $111.9 million against various foreign currencies. We also
had euro option currency contracts to sell 30.0 million euro against various
foreign currencies. These contracts are at various exchange rates and expire at
various dates through August 2003.
29
We enter into option contracts to manage our exposure to numerous foreign
currencies. Option transactions included in the amounts above are principally
for the exchange of the euro and U.S. dollar. At May 26, 2002, we had bought
U.S. dollar options resulting in a net short position against the euro of $47.6
million should the options be exercised. To finance the premiums related to the
options bought, we sold options resulting in a net long position against the
euro of $148.6 million should the options be exercised.
Interest Rate Risk
We have an interest rate risk management policy designed to manage the
interest rate risk on our borrowings by entering into a variety of interest rate
derivatives. We currently have no derivative instruments managing interest rate
risk outstanding as of May 26, 2002.
For more information about market risk, see Notes 5, 6 and 7 to the
Consolidated Financial Statements.
30
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(A) EXHIBITS:
10.1 Second Amendment to Supply Agreement dated as of May 13,
2002, between the Registrant and Cone Mills Corporation dated
as of March 30, 1992. Filed herewith.
10.2 Amendment to Employee Investment Plan signed May 17, 2002.
Filed herewith.
(B) REPORTS ON FORM 8-K:
Current Report on Form 8-K on March 19, 2002 filed pursuant to Item 5
of the report and containing a copy of the Company's press release
titled "Levi Strauss & Co. Announces First-Quarter 2002 Financial
Results."
Current Report on Form 8-K on April 25, 2002 filed pursuant to Item 5
of the report relating to the U.S. and Scotland plant closures and
containing a copy of the Company's press release dated April 8, 2002
titled "Levi Strauss & Co. Names Six U.S. Plants to Close."
Current Report on Form 8-K on May 6, 2002 filed pursuant to Item 4 of
the report relating to a change in certifying accountant and containing
a copy of a letter from the previous independent accountants to the
Securities and Exchange Commission. In addition, the report was filed
pursuant to Item 5 of the report and described, and included a copy of,
an amendment to the Company's domestic receivables securitization
agreements.
Current Report on Form 8-K on June 20, 2002 filed pursuant to Item 5 of
the report and containing a copy of the Company's press release titled
"Levi Strauss & Co. Announces Second-Quarter 2002 Financial Results."
31
SIGNATURE
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 3, 2002 Levi Strauss & Co.
------------------
(Registrant)
By: /s/ William B. Chiasson
-----------------------
William B. Chiasson
Senior Vice President and Chief Financial Officer
32
EXHIBIT 10.1
SECOND AMENDMENT TO SUPPLY AGREEMENT
------------------------------------
THIS IS A SECOND AMENDMENT TO SUPPLY AGREEMENT dated as of May 13,
2002 (the "Second Amendment"), between CONE MILLS CORPORATION, a North Carolina
corporation ("Cone"), and LEVI STRAUSS & CO., a Delaware corporation ("LS&CO.").
B A C K G R O U N D
-------------------
Cone and LS&CO. are parties to a Supply Agreement, dated as of
March 30, 1992, as amended by a First Amendment to Supply Agreement dated as of
April 15, 1992 (as amended, the "1992 Agreement"). In view of the increasing
globalization of fabric and apparel product manufacturing, potential changes in
duty and tariff policies and other developments in their respective businesses,
they wish to amend the 1992 Agreement to modify the requirements and exclusivity
features of the 1992 Agreement. This Second Amendment is intended to be and is
an "instrument in writing signed by both parties" as contemplated by Section 9
of the 1992 Agreement.
CONE AND LS&CO. AGREE AS FOLLOWS:
1. Amendment to Section 1
----------------------
1.1 Amendment to Section 1.6. Section 1.6 of the Agreement is
-------------------------
amended by replacing "XXX Denim" with "01 Denim." As a result of this amendment
to a defined term, all uses in the Agreement of "XXX Denim" are now changed to
"01 Denim."
2. Amendments to Section 2
-----------------------
2.1 Amendment to Heading. The heading of Section 2 of the
--------------------
Agreement is amended by replacing "Requirements Agreement" with "01 Denim
Supply".
2.2 Amendment to Section 2.1. Section 2.1 of the Agreement is
------------------------
amended in its entirety as follows:
(a) Cone agrees to manufacture and sell to LS&CO. all 01 Denim
LS&CO. may order from Cone.
(b) From the date of this Second Amendment until March 30,
2003, Cone shall sell 01 Denim only to LS&CO. After March
30, 2003, Cone may sell 01 Denim to customers other than
LS&CO.
(c) From the date of this Second Amendment until March 30,
2003, LS&CO. shall purchase from Cone all 01 Denim that
LS&CO. may require in its worldwide businesses. After
March 30, 2003, LS&CO. may purchase and accept deliveries
of 01 Denim from suppliers other than Cone, and use such
denim in 501(R)jeans and other products for sale in any or
all of its worldwide businesses. In addition, if at any
time prior to March 30, 2003 material additional tariffs,
duties, imposts or other charges are imposed on the import
of 01 Denim from the United States to locations
where denim is imported for use in producing 501(R) jeans
to be sold in LS&CO.'s European, Middle East and Africa
region, LS&CO. may purchase and accept deliveries of 01
Denim from suppliers other than Cone, and use such denim
in 501(R)jeans and other products for sale in that region.
(d) Notwithstanding Sections 2.1(a) and 2.1(c), and for
clarity, LS&CO. may at any time engage in identifying
alternative suppliers in all regions of 01 Denim or other
denims for 501(R) jeans ("Alternative Suppliers"),
developing with and evaluating fabrics from those
Alternative Suppliers, purchasing and accepting deliveries
of fabric from Alternative Suppliers for pre-production
and production testing, constructing prototype and other
jeans of such fabric during such evaluation and testing
processes and ultimately distributing those test products
through whatever means LS&CO. may choose. In addition,
LS&CO. may at any time pre-book capacity and place orders
with Alternative Suppliers; the limitations on alternative
sourcing described in Sections 2.1(a) and 2.1(c) limit
only acceptance of deliveries from Alternative Suppliers
for commercial production purposes.
(e) Affiliates and licensees of LS&CO., including, without
limitation, Levi Strauss & Co. Europe S.A., buy 01 Denim
from Cone. In addition, Cone may create subsidiaries or
enter into joint ventures, alliances or other arrangements
through which entities other than Cone Mills Corporation
produce and/or sell 01 Denim. For example, Cone and LS&CO.
are concurrently with this Second Amendment concluding
arrangements relating to production of 01 Denim by a party
in Europe with whom Cone intends to enter into a joint
venture. For clarity, it is understood that, for purposes
of this Section 2, "LS&CO." means LS&CO. and its
affiliates, and "Cone" means Cone and any subsidiaries or
other third parties who produce and sell 01 Denim under
agreement with Cone.
3. Representations and Warranties
------------------------------
3.1 By LS&CO. LS&CO. represents and warrants to Cone that:
---------
(i) LS&CO. has full corporate power and authority to
enter into and perform its obligations under this Second Amendment and the
Agreement; (ii) each of this Second Amendment and the Agreement as amended by
this Second Amendment has been duly executed and delivered by LS&CO. and
constitutes the legal, valid and binding obligation of LS&CO., enforceable
against it in accordance with its terms; and (iii) LS&CO. is not a party to,
subject to or bound by any agreement, contract, lease, mortgage, indenture or
other document of any kind (including any credit, note purchase, stock purchase,
receivables purchase, receivables servicing or other financing agreement) or any
law, judgment, order, writ, prohibition, injunction or decree of any court or
other governmental body that would prevent, or that would be breached or
violated by, or require the consent of any third party to, the execution and
delivery of this Second Amendment or the consummation of the transactions
contemplated by the Agreement as amended by this Second Amendment.
3.2 By Cone. Cone represents and warrants to LS&CO. that: (i)
-------
Cone has full corporate power and authority to enter into and perform its
obligations under this Second Amendment and the Agreement; (ii) each of this
Second Amendment and the Agreement as amended by this Second Amendment has been
duly executed and delivered by Cone and constitutes the legal, valid and binding
obligation of Cone enforceable against it in accordance with its terms; and
(iii) Cone is not a party to, subject to or bound by any agreement, contract,
lease, mortgage, indenture or other document of any kind (including any credit,
note purchase, stock purchase, receivables purchase, receivables servicing or
other financing agreement) or any law, judgment, order, writ, prohibition,
injunction or decree
2
of any court or other governmental body that would prevent, or that would be
breached or violated by, or require the consent of any third party to, the
execution and delivery of this Second Amendment or the consummation of the
transactions contemplated by the Agreement as amended by this Second Amendment.
Cone acknowledges that nothing in this Agreement commits LS&CO. to order or buy
from Cone any 01 Denim or any other product, in any quantity or at any time, in
the future, or to continue to produce and market products containing 01 Denim.
4. No Other Modifications
----------------------
Except as expressly described in this Second Amendment, Cone
and LS&CO. do not intend to and are not modifying any other provisions of the
Agreement, and the Agreement, as amended by this Second Amendment, remains in
full force and effect.
* * * *
IN WITNESS WHEREOF, the parties have caused this Second
Amendment to be executed by their duly authorized officers as of the date and
year first above written.
CONE MILLS CORPORATION
By: ------------------------------------------
Gary L. Smith
Executive Vice President
and Chief Financial Officer
LEVI STRAUSS & CO.
By: ------------------------------------------
William B. Chiasson
Senior Vice President
and Chief Financial Officer
3
EXHIBIT 10.2
FIRST AMENDMENT
EMPLOYEE INVESTMENT PLAN OF
LEVI STRAUSS & CO.
------------------
WHEREAS, LEVI STRAUSS & CO. (the "Company") maintains the Employee
Investment Plan of Levi Strauss & Co. (the "EIP"); and
WHEREAS, pursuant to Section 18.1 of the EIP, the Board of Directors of
the Company is authorized to amend the EIP at any time and for any reason; and
WHEREAS, the Company desires to amend the EIP, effective as of the
dates specified herein, to reflect certain provisions of the Economic Growth and
Tax Relief Reconciliation Act of 2001 ("EGTRRA"), including clarifications and
technical corrections under EGTRRA made pursuant to the Job Creation and Worker
Assistance Act of 2002; and
WHEREAS, the Company desires to amend the EIP, effective as of November
26, 2001, by waiving the active employment as of the last working day of the
Plan Year requirement (for purposes of eligibility to receive any Company match)
with respect to any employee who is laid-off by the Company;
WHEREAS, the Company desires to amend the EIP, effective as of February
1, 2000, to conform the loan repayment requirements with the record-keeper's
automated loan system;
WHEREAS, by resolutions duly adopted on June 22, 2000, the Board of
Directors of the Company authorized Philip A. Marineau, President and Chief
Executive Officer, to take certain actions with respect to the EIP and to
further delegate to certain officers of the Company the authority to take
certain actions with respect to the EIP; and
WHEREAS, on June 22, 2000, Philip A. Marineau delegated to any Senior
Vice President, Human Resources, including Fred D. Paulenich, Senior Vice
President of Worldwide Human Resources, the authority to take certain actions
with respect to the EIP and such delegation has not been amended, rescinded or
superseded as of the date hereof; and
WHEREAS, the amendment herein is within the delegated authority of Fred
D. Paulenich; and
NOW THEREFORE, effective as of the dates specified herein, the EIP is
hereby amended as follows:
1. Effective as of November 26, 2001, paragraph (b) of Section
5.1 of the EIP is hereby amended in its entirety to read as follows:
"(b) Employment at End of Accumulation Period.
-----------------------------------------------
Effective for Plan Years beginning on or after November 26, 2001
(including any pay period ending during such Plan Years), no Matching
Contribution will be allocated on behalf of a Member during the
applicable Accumulation Period unless he or she is an Employee as of
the last working day of such Accumulation Period with respect to which
his or her Member Contributions are eligible for a Matching
Contribution; provided that such requirement of being an Employee as of
the last working day of an Accumulation Period shall not apply in the
event a Member retires or is laid
off by the Company, as determined by the Administrative Committee,
before such date or to the extent that the Board of Directors waives
such requirement in accordance with the exceptions prescribed under
section 1.401(a)(4)-2(b)(4)(iii) of the Code."
2. Effective as of February 1, 2000, paragraph (d) of Section 10.2
of the EIP is hereby amended by replacing the "; or" appearing at the
end of subparagraph (ii) with a period ("."), and by deleting all text
appearing thereafter.
3. Effective for distributions from the EIP on or after January 1,
2002, paragraph (d) of Section 11.4 of the EIP is hereby amended by
adding the following language to the end of the first paragraph therein
(i.e., after the word "apply."):
"In the case of a direct transfer of a Member's Post-Tax Account: (1)
subparagraphs (v) and (vi) shall not apply, and (2) an eligible
retirement plan described in subparagraphs (i) and (iv) must agree to
separately account for amounts so transferred, including separately
accounting for the portion of such distribution which is includible in
gross income and the portion of such distribution which is not so
includible."
4. Effective for Plan Years beginning on or after January 1, 2002,
paragraph (h) of Section 19.1 of the EIP is hereby amended by replacing
the all references to the phrase "separation from Service", which
appear therein, with the phrase "severance from employment".
* * *
IN WITNESS WHEREOF, the undersigned has caused this Amendment to be
executed this 17 day of May, 2002.
LEVI STRAUSS & CO.
By: _________________________________________
Fred D. Paulenich
Senior Vice President of Worldwide Human Resources