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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 AUGUST 25, 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 October 1, 2002
LEVI STRAUSS & CO.
INDEX TO FORM 10-Q
AUGUST 25, 2002
PAGE
NUMBER
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of August 25, 2002 and November 25, 2001................ 3
Consolidated Statements of Operations for the Three and Nine Months Ended
August 25, 2002 and August 26, 2001................................................... 4
Consolidated Statements of Cash Flows for the Nine Months Ended
August 25, 2002 and August 26, 2001................................................... 5
Notes to the Consolidated Financial Statements......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................ 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................. 32
Item 4. Controls and Procedures................................................................ 33
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................................................... 34
SIGNATURE......................................................................................... 35
CERTIFICATIONS.................................................................................... 36
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
August 25, November 25,
2002 2001
---- ----
ASSETS (Unaudited)
Current Assets:
Cash and cash equivalents...................................................... $ 62,258 $ 102,831
Trade receivables, net of allowance for doubtful accounts of $25,077 in 2002
and $26,666 in 2001......................................................... 593,546 621,224
Inventories:
Raw materials.............................................................. 95,131 97,261
Work-in-process............................................................ 106,490 50,499
Finished goods............................................................. 526,409 462,417
---------- ----------
Total inventories....................................................... 728,030 610,177
Deferred tax assets............................................................ 181,836 189,958
Other current assets........................................................... 112,204 110,252
---------- ----------
Total current assets............................................... 1,677,874 1,634,442
Property, plant and equipment, net of accumulated depreciation of $477,753 in
2002 and $527,647 in 2001......................................................... 472,213 514,711
Goodwill and other intangibles, net of accumulated amortization of $183,601 in
2002 and $175,603 in 2001......................................................... 246,156 254,233
Non-current deferred tax assets...................................................... 538,591 484,260
Other assets......................................................................... 85,297 95,840
---------- ----------
Total Assets....................................................... $3,020,131 $2,983,486
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current maturities of long-term debt and short-term borrowings................. $ 165,134 $ 162,944
Accounts payable............................................................... 178,546 234,199
Restructuring reserves......................................................... 98,087 45,220
Accrued liabilities............................................................ 305,841 301,620
Accrued salaries, wages and employee benefits.................................. 300,383 212,728
Accrued taxes.................................................................. 137,713 26,475
---------- ----------
Total current liabilities.......................................... 1,185,704 983,186
Long-term debt, less current maturities.............................................. 1,795,995 1,795,489
Postretirement medical benefits...................................................... 542,072 544,476
Long-term employee related benefits.................................................. 381,345 384,751
Long-term tax liability.............................................................. 23,467 174,978
Other long-term liabilities.......................................................... 24,953 16,402
Minority interest.................................................................... 21,309 20,147
---------- ----------
Total liabilities.................................................. 3,974,845 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............................................................ (1,040,360) (1,020,860)
Accumulated other comprehensive income (loss).................................. (3,535) (4,264)
---------- ----------
Total stockholders' deficit........................................ (954,714) (935,943)
---------- ----------
Total Liabilities and Stockholders' Deficit........................ $3,020,131 $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 Nine Months Ended
------------------ -----------------
August 25, August 26, August 25, August 26,
2002 2001 2002 2001
---- ---- ---- ----
Net sales.................................................. $1,017,744 $ 983,508 $2,876,546 $3,023,828
Cost of goods sold......................................... 603,249 584,279 1,693,923 1,732,170
---------- ---------- ---------- ----------
Gross profit............................................ 414,495 399,229 1,182,623 1,291,658
Marketing, general and administrative expenses............. 340,390 314,482 958,129 976,706
Other operating (income)................................... (6,015) (8,377) (20,640) (22,916)
Restructuring charges, net of reversals.................... (16,565) - 124,513 -
---------- ---------- ---------- ----------
Operating income........................................ 96,685 93,124 120,621 337,868
Interest expense........................................... 48,476 55,429 139,009 178,532
Other (income) expense, net................................ 20,791 13,850 20,613 19,617
---------- ---------- ---------- ----------
Income (loss) before taxes.............................. 27,418 23,845 (39,001) 139,719
Income tax expense (benefit)............................... 13,709 8,822 (19,500) 51,696
---------- ---------- ---------- ----------
Net income (loss)....................................... $ 13,709 $ 15,023 $ (19,501) $ 88,023
========== ========== ========== ==========
Earnings (loss) per share--basic and diluted................ $ 0.37 $ 0.40 $ (0.52) $ 2.36
========== ========== ========== ==========
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)
Nine Months Ended
-----------------
August 25, August 26,
2002 2001
---- ----
Cash Flows from Operating Activities:
Net income (loss)............................................................. $ (19,501) $ 88,023
Adjustments to reconcile net cash provided by (used for) operating activities:
Depreciation and amortization......................................... 54,267 60,810
Asset write-offs associated with 2002 restructuring charge............ 25,708 -
(Gain) loss on dispositions of property, plant and equipment.......... (1,171) 1,167
Unrealized foreign exchange (gains) losses............................ 14,859 (5,143)
Decrease in trade receivables......................................... 62,863 84,532
Increase in inventories............................................... (86,914) (135,120)
Decrease in other current assets...................................... 18 31,151
Decrease (increase) in other long-term assets......................... 10,494 (35,189)
(Increase) decrease in net deferred tax assets........................ (42,679) 18,310
Decrease in accounts payable and accrued liabilities.................. (112,120) (100,729)
Increase (decrease) in restructuring reserves......................... 52,868 (18,184)
Increase (decrease) in accrued salaries, wages and employee benefits.. 83,693 (78,315)
Increase (decrease) in accrued taxes.................................. 113,992 (54,418)
(Decrease) increase in long-term employee benefits.................... (4,563) 38,070
(Decrease) increase in long-term tax and other liabilities............ (141,930) 8,251
Other, net............................................................ 6,870 3,440
--------- ----------
Net cash provided by (used for) operating activities............... 16,754 (93,344)
--------- ----------
Cash Flows from Investing Activities:
Purchases of property, plant and equipment............................ (33,771) (14,621)
Proceeds from sale of property, plant and equipment................... 8,312 2,903
Realized losses on net investment hedges.............................. (11,135) (1,664)
-------- ----------
Net cash (used for) investing activities........................... (36,594) (13,382)
-------- ----------
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt.............................. 570,308 1,801,702
Repayments of long-term debt.......................................... (594,238) (1,744,955)
Net increase (decrease) in short-term borrowings...................... 1,302 (6,439)
-------- ----------
Net cash (used for) provided by financing activities............... (22,628) 50,308
-------- ----------
Effect of exchange rate changes on cash....................................... 1,895 3,125
-------- ----------
Net decrease in cash and cash equivalents.......................... (40,573) (53,293)
Beginning cash and cash equivalents........................................... 102,831 117,058
-------- ----------
Ending Cash and Cash Equivalents.............................................. $ 62,258 $ 63,765
======== ==========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest.............................................................. $117,866 $ 138,702
Income taxes.......................................................... 59,572 78,664
Restructuring initiatives............................................. 45,938 18,184
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 condensed 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 condensed 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 condensed 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 nine months ended
August 25, 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 third 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, 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 fair values of derivative instruments used to manage
currency exposures are sensitive to changes in market conditions and to
changes in the timing and amounts of forecasted exposures. The Company
actively manages foreign currency exposures on an economic basis, using
forecasts to develop exposure positions to 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 operations. As a result, net income may be
subject to volatility. The derivative instruments that do qualify for hedge
accounting currently hedge the Company's net investment position in its
subsidiaries. For these instruments, the Company documents the hedge
designation, by identifying the hedging instrument, the nature of the risk
being hedged and the approach for measuring hedge effectiveness. Changes in
fair values of derivative instruments that do qualify for hedge accounting
are recorded in the "Accumulated other comprehensive income (loss)" section
of Stockholders' Deficit.
7
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
New Accounting Standards
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," dated June 2001. SFAS 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized but
instead be reviewed annually for impairment using a fair-value based approach.
Intangible assets that have a finite life will continue to be amortized over
their respective estimated useful lives. The Company will adopt the provisions
of SFAS 142 on the first day of fiscal year 2003. Amortization expense for
fiscal year 2001 was $10.7 million. The Company is currently evaluating the
impact adoption may have on its financial position and results of operations.
The FASB issued SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," dated August 2001. This statement supercedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions of Accounting
Principles Board ("APB") Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS 144 requires
that the same accounting model be used for long-lived assets to be disposed of
by sale, whether previously held and used or newly acquired, and it broadens the
presentation of discontinued operations to include more disposal transactions.
The Company will adopt the provisions of SFAS 144 on the first day of fiscal
year 2003 and is currently evaluating the impact SFAS 144 may have on its
financial position and results of operations.
The FASB issued SFAS 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," dated April
2002. SFAS 145 states that gains and losses from extinguishment of debt that do
not meet the criteria for classification as extraordinary items in APB Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," should not be classified as extraordinary
items. Accordingly, SFAS 145 rescinds SFAS 4 "Reporting Gains and Losses from
Extinguishment of Debt," and SFAS 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." SFAS 145 is effective for the Company on the first
day of fiscal year 2003.
The FASB issued SFAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities," dated June 2002. SFAS 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. In summary, SFAS 146
requires that the liability shall be recognized and measured initially at its
fair value in the period in which the liability is incurred, except for one-time
termination benefits that meet certain requirements. SFAS 146 is effective
prospectively for exit or disposal activities initiated after December 31, 2002.
8
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 Nine Months Ended
------------------ -----------------
August 25, August 26, August 25, August 26,
2002 2001 2002 2001
---- ---- ---- ----
(Dollars in Thousands)
Net income (loss)............................................. $13,709 $15,023 $(19,501) $ 88,023
------- ------- -------- --------
Other comprehensive income (loss):
Transition adjustments:
Unrealized losses on cash flow hedges....................... - - - (522)
Reclassification of cash flow hedges to other
(income) expense.......................................... - 130 - 391
------- ------- -------- --------
Net cash flow hedges........................................ - 130 - (131)
Net investment hedges....................................... - - - 76
------- ------- -------- --------
Total transition adjustments.............................. - 130 - (55)
------- ------- -------- --------
Foreign currency translation adjustments:
Net investment hedges..................................... (10,765) (5,403) (12,649) (3,081)
Foreign currency translations............................. 19,110 10,628 13,950 18,009
------- ------- -------- --------
Total foreign currency translation adjustments.......... 8,345 5,225 1,301 14,928
------- ------- -------- --------
Unrealized gains on cash flow hedges....................... - (2,163) - 1,364
Reclassification of cash flow hedges to other
(income) expense......................................... - (953) (572) (1,958)
------- ------- -------- --------
Net cash flow hedges.................................... - (3,116) (572) (594)
------- ------- -------- --------
Total other comprehensive income (loss)............... 8,345 2,239 729 14,279
------- ------- -------- --------
Total comprehensive income (loss)............................. $22,054 $17,262 $(18,772) $102,302
======= ======= ======== ========
The following is a summary of the components of Accumulated other
comprehensive income (loss) balances, net of related income taxes:
August 25, 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........................................ 28,854 41,427
Foreign currency translations................................ (32,389) (46,339)
------- -------
Total cumulative translation adjustments................... (3,535) (4,912)
------- -------
Beginning balance of cash flow hedges........................ 572 -
Unrealized gains on cash flow hedges....................... - 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).................. $(3,535) $(4,264)
======= =======
9
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, all of whom have been
displaced. The two manufacturing plants were closed by the end of the second
quarter of 2002. During the third quarter of 2002 the remaining reserve balance
of $2.1 million was reversed due to the earlier than anticipated sale of the
manufacturing plants. The table below displays the activity 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 closed the six manufacturing plants in three phases: two plants were
closed in June 2002, two plants were closed in July 2002 and the final two
plants were closed in September 2002. As of August 25, 2002, approximately 1,610
employees had been displaced at the manufacturing plants and approximately 245
employees had been displaced at the finishing facility. 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 Reversals 8/25/02
-------- ------- ---------- --------- -------
(Dollars in Thousands)
Severance and employee benefits.............................. $ -- $15,691 $(14,703) $ (988) $ --
Other restructuring costs.................................... -- 1,732 (621) (1,111) --
----- ------- -------- ------- -----
Total................................................... $ -- $17,423 $(15,324) $(2,099) $ --
===== ======= ======== ======= =====
2002 U.S. Plant Closures
Balance Balance
At At
11/25/01 Charges Reductions 8/25/02
-------- ------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits.............................. $ -- $ 89,625 $(15,202) $74,423
Other restructuring costs.................................... -- 17,397 (1,890) 15,507
----- -------- -------- -------
Total................................................... $ -- $107,022 $(17,092) $89,930
===== ======== ======== =======
10
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 an estimated displacement of 500
employees. During the third quarter of fiscal year 2002, the Company reversed a
charge of $5.5 million from the initial charge of $20.3 million. This reversal
was due to a change in the estimate of the number of employees to be affected
from approximately 500 to approximately 340 resulting from changing business
needs. As of August 25, 2002, approximately 275 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 Reversals 8/25/02
-------- ---------- --------- -------
(Dollars in Thousands)
Severance and employee benefits.................................... $19,989 $(9,829) $(5,520) $4,640
------- ------- ------- ------
Total......................................................... $19,989 $(9,829) $(5,520) $4,640
======= ======= ======= ======
Japan Reorganization Initiatives
Balance Balance
At At
11/25/01 Reductions 8/25/02
-------- ---------- -------
(Dollars in Thousands)
Severance and employee benefits.................................... $1,657 $(1,618) $ 39
Other restructuring costs.......................................... 349 (60) 289
------ ------- ----
Total......................................................... $2,006 $(1,678) $328
====== ======= ====
1997 - 1999 PLANT CLOSURES AND RESTRUCTURING INITIATIVES
From 1997 to 1999 the Company closed 29 of its 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. For
the three and nine months ended August 25, 2002, the Company reversed aggregate
charges of $8.9 million and $18.0 million, respectively, from initial charges of
$530.9 million. These reversals were primarily due to lower than anticipated
employee benefits and other plant closure related costs.
SUMMARY
The total balance of the reserves at August 25, 2002 was $98.1 million
compared to $45.2 million at November 25, 2001. The majority of the balances are
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:
11
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Balance as of Balance as of
November 25, August 25,
2001 Charges Reversals Reductions 2002
---- ------- --------- ---------- ----
(Dollars in Thousands)
2002 Scotland Plant Closures...................... $ -- $ 17,423 $ 2,099 $15,324 $ --
2002 U.S. Plant Closures.......................... -- 107,022 -- 17,092 89,930
2001 Corporate Restructuring Initiatives.......... 19,989 -- 5,520 9,829 4,640
2001 Japan Restructuring Initiative............... 2,006 -- -- 1,678 328
1997 - 1999 Plant Closures and Restructuring
Initiatives....................................... 23,225 -- 18,021 2,015 3,189
------- -------- ------- ------- -------
Restructuring Reserves....................... $45,220 124,445 $25,640 $45,938 $98,087
======= -------- ======= ======= =======
2002 Plant Closures - Asset Write-offs............ 25,708
--------
2002 Restructuring Charges................... $150,153
========
NOTE 4: INCOME TAXES
Our effective income tax rate for the fiscal year 2002 is 50% compared to
37% for 2001. The increase in our annual effective income tax rate is primarily
due to the combined effects of the computational impact of expenses not
deductible for tax purposes and lower projected earnings for 2002, resulting
from the restructuring charges and related expenses.
Income tax expense for the three months ended August 25, 2002 was $13.7
million compared to $8.8 million for the same period in 2001. Income tax benefit
for the nine months ended August 25, 2002 was $19.5 million compared to income
tax expense of $51.7 million for the same period in 2001. The income tax benefit
for the nine months ended August 25, 2002 was due to the reported loss resulting
from net restructuring charges of $124.5 million and related expenses of $33.9
million.
We reached a tentative settlement on most issues with the Internal Revenue
Service during 2002 in connection with the examination of our income tax returns
for the years 1990 - 1994. As a result, we reclassified approximately $148.5
million from long-term tax liability into accrued taxes.
NOTE 5: 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.
12
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
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. 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 August 25, 2002, there was no deficiency and as a result,
no restricted cash on the balance sheet.
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 August
25, 2002.
INTEREST RATES ON BORROWINGS
The Company's weighted average interest rate on average borrowings
outstanding during the three and nine months ended August 25, 2002, including
the amortization of capitalized bank fees, interest rate swap cancellations and
underwriting fees, was 9.11% and 9.06%, respectively. The weighted average
interest rate on average borrowings outstanding excludes interest payable to
participants under deferred compensation plans and other miscellaneous items.
13
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 6: 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:
August 25, 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......................... $(1,195,633) $ (947,476) $(1,193,012) $ (932,138)
Euro notes offering................................ (123,998) (93,788) (114,378) (85,719)
Yen-denominated eurobond placement................. (173,255) (102,564) (164,413) (113,115)
Credit facilities.................................. (233,259) (233,259) (252,748) (252,748)
Domestic receivables-backed securitization......... (110,071) (110,071) (110,081) (110,081)
Customer service center equipment financing........ (74,998) (76,794) (80,278) (81,970)
European receivables-backed securitization......... (47,086) (47,086) (41,366) (41,366)
Industrial development revenue refunding bond...... (10,012) (10,012) (10,015) (10,015)
Short-term and other borrowings.................... (20,062) (20,062) (19,395) (19,395)
----------- ----------- ----------- -----------
Total $(1,988,374) $(1,641,112) $(1,985,686) $(1,646,547)
=========== =========== =========== ===========
(1) Includes accrued interest of $27.2 million.
(2) Includes accrued interest of $27.3 million.
CURRENCY AND INTEREST RATE CONTRACTS:
Foreign exchange forward contracts................. $2,348 $2,348 $13,797 $13,797
Foreign exchange option contracts.................. 202 202 4,328 4,328
------ ------ ------- -------
Total $2,550 $2,550 $18,125 $18,125
====== ====== ======= =======
Interest rate option contracts..................... -- -- $(2,266) $(2,266)
====== ====== ======= =======
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 August 25, 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 August 25, 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.
14
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 7: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company adopted 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 August 25, 2002, the fair value of
qualifying net investment hedges was a $1.6 million net asset 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
August 25, 2002 represented a $2.3 million net asset.
The Company designates a portion of its outstanding yen-denominated
eurobond as a net investment hedge. As of August 25, 2002, a $2.9 million net
asset related to the translation effects of the yen-denominated eurobond was
recorded in the cumulative translation adjustment section of "Accumulated other
comprehensive income (loss)."
As of August 25, 2002, the Company holds no derivatives hedging forecasted
intercompany royalty flows that qualify as cash flow hedges. During the third
quarter no cash flow hedges were 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."
15
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
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 August 25, 2002.
The tables below give an overview of the realized and unrealized gains and
losses associated with our foreign exchange management activities and reported
in "Other (income) expense," "Other comprehensive income ("OCI")" balances,
"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.
-------------------------- ------------------------ --------------------------- -----------------------
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
August 25, 2002 August 26, 2001 August 25, 2002 August 26, 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 $49,903 $(19,181) $12,985 $12,387 $51,651 $9,608 $10,488 $19,143
Net Investment 11,079 (5,102) 1,736 (3,970) 10,829 (2,034) 2,381 (1,419)
Royalties (8,222) (956) (323) (1,290) (17,800) (514) (6,785) 3,734
Cash Management (7,421) 6,117 (10,179) 5,597 (1,052) 2,372 (8,751) 994
Transition Adjustments -- -- 207 -- -- -- 621 --
Euro Notes Offering (6,743) 523 (6,307) (315) (10,280) (1,632) 1,929 845
------- -------- ------- ------- ------- ------ ------ -------
Total $38,596 $(18,599) $(1,881) $12,409 $33,348 $7,800 $ (117) $23,297
======= ========= ======= ======= ======= ====== ====== =======
- --------------------------- ------------ ------------- ------------ ----------- -------------- ------------ ----------- -----------
Interest Rate Management $ -- $ -- $ -- $(1,008) $ 2,266 (1) $(2,266) $ -- $ 3,854
Transition Adjustments -- -- -- -- -- -- -- 1,246
------- -------- ------- ------- ------- ------ ------ -------
Total $ -- $ -- $ -- $(1,008) $(2,266) $(2,266) $ -- $ 5,100
======= ======== ======= ======= ======= ====== ====== =======
- --------------------------- ------------ ------------- ------------ ----------- -------------- ------------ ----------- -----------
(1) Recorded as an increase to interest expense.
16
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
------------------------------------------- ------------------------------------------
At August 25, 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 $-- $-- $42,180 $1,622 $-- $ -- $53,314 $ 5,664
Yen Bond -- -- -- 2,927 -- -- -- 6,780
Royalties -- -- -- -- -- 908 -- --
Transition Adjustments -- -- -- -- -- -- -- 120
--- --- ------- ------ --- ---- ------- -------
Total $-- $-- $42,180 $4,549 $-- $908 $53,314 $12,564
=== === ======= ====== === ==== ======= =======
- ------------------------------------- -------- ---------- ---------- ------------ --------- ---------- ---------- ----------
----------------- ----------------
At August 25, At November 25,
2002 2001
----------------- ----------------
Fair value Fair value
asset (liability) asset (liability)
- ------------------------------------- ----------------- -----------------
(Dollars in Thousands)
- -------------------------------------
Foreign Exchange Management:
Sourcing $ 593 $10,976
Net Investment 3,939 6,068
Royalties 738 729
Cash Management (3,183) 1,521
Euro Notes Offering 463 (1,169)
------ -------
Total $2,550 $18,125
====== =======
- ------------------------------------- ----------------- -----------------
Interest Rate Management $ -- $(2,266)
====== =======
- ------------------------------------- ----------------- -----------------
17
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 8: COMMITMENTS AND CONTINGENCIES
FOREIGN EXCHANGE CONTRACTS
At August 25, 2002, the Company had U.S. dollar forward currency contracts
to buy $1.4 billion and to sell $669.6 million against various foreign
currencies. The Company also had euro forward currency contracts to buy 147.0
million euro against various foreign currencies and to sell 18.8 million euro
against various foreign currencies. In addition, the Company had U.S. dollar
option contracts to buy $89.5 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 August 25,
2002, the Company had bought U.S. dollar options resulting in a net long
position against the euro of $51.6 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 $37.9 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.
18
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 9: BUSINESS SEGMENT INFORMATION
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
THREE MONTHS ENDED AUGUST 25, 2002:
Net sales....................................... $683,967 $254,930 $78,847 $ -- $1,017,744
Earnings contribution........................... 95,678 28,958 12,511 -- 137,147
Interest expense................................ -- -- -- 48,476 48,476
Corporate and other expense, net................ -- -- -- 61,253 61,253
Income before income taxes................... -- -- -- -- 27,418
THREE MONTHS ENDED AUGUST 26, 2001:
Net sales....................................... $689,892 $222,515 $71,101 $ -- $ 983,508
Earnings contribution........................... 74,161 33,530 6,027 -- 113,718
Interest expense................................ -- -- -- 55,429 55,429
Corporate and other expense, net................ -- -- -- 34,444 34,444
Income before income taxes................... -- -- -- -- 23,845
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
NINE MONTHS ENDED AUGUST 25, 2002:
Net sales....................................... $1,882,005 $756,927 $237,614 $ -- $2,876,546
Earnings contribution........................... 259,880 134,286 41,775 -- 435,941
Interest expense................................ -- -- -- 139,009 139,009
Corporate and other expense, net................ -- -- -- 335,933 335,933
Income (loss) before income taxes............ -- -- -- -- (39,001)
NINE MONTHS ENDED AUGUST 26, 2001:
Net sales....................................... $2,034,171 $756,524 $233,133 $ -- $3,023,828
Earnings contribution........................... 270,370 147,905 31,078 -- 449,353
Interest expense................................ -- -- -- 178,532 178,532
Corporate and other expense, net................ -- -- -- 131,102 131,102
Income before income taxes................... -- -- -- -- 139,719
19
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 third
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, 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.
20
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.
The fair values of derivative instruments used to manage currency exposures
are sensitive to changes in market conditions and to changes in the timing
and amounts of forecasted exposures. 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 operations. 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.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, items in our
consolidated statements of operations, expressed as a percentage of net sales
(amounts may not total due to rounding).
Three Months Ended Nine Months Ended
------------------ -----------------
August 25, August 26, August 25, August 26,
2002 2001 2002 2001
---- ---- ---- ----
MARGIN DATA:
Net sales................................................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold.......................................... 59.3 59.4 58.9 57.3
----- ----- ----- -----
Gross profit................................................ 40.7 40.6 41.1 42.7
Marketing, general and administrative expenses.............. 33.4 32.0 33.3 32.3
Other operating (income).................................... (0.6) (0.9) (0.7) (0.8)
Restructuring charges, net of reversals..................... (1.6) -- 4.3 --
----- ---- ----- -----
Operating income (loss)..................................... 9.5 9.5 4.2 11.2
Interest expense............................................ 4.8 5.6 4.8 5.9
Other (income) expense, net................................. 2.0 1.4 0.7 0.6
----- ----- ----- -----
Income (loss) before taxes.................................. 2.7 2.4 (1.4) 4.6
Income tax expense (benefit)................................ 1.3 0.9 (0.7) 1.7
----- ----- ----- -----
Net income (loss)........................................... 1.3% 1.5% (0.7)% 2.9%
===== ===== ===== =====
21
Three Months Ended Nine Months Ended
------------------ -----------------
August 25, August 26, August 25, August 26,
2002 2001 2002 2001
---- ---- ---- ----
NET SALES SEGMENT DATA:
Geographic
Americas........................................... 67.2% 70.1% 65.4% 67.3%
Europe............................................. 25.0 22.6 26.3 25.0
Asia Pacific....................................... 7.8 7.2 8.3 7.7
Net sales. Net sales for the three months ended August 25, 2002 increased
3.5% to $1,017.7 million, as compared to $983.5 million for the same period in
2001. Net sales for the nine months ended August 25, 2002 decreased 4.9% to
$2,876.5 million, as compared to $3,023.8 million for the same period in 2001.
If currency exchange rates were unchanged from the prior year periods, net sales
would have increased approximately 1.2% and decreased approximately 4.7% for the
three and nine months ended August 25, 2002, respectively.
We believe the increase for the three months ended August 25, 2002 compared
to the same period last year is a continuing reflection that our key turnaround
strategies are taking hold in the Americas, European and Asia Pacific
marketplaces where we compete. These key strategies include:
o product innovation;
o revitalization of retailer relationships;
o better product presentation at retail;
o broadened product availability; and
o improved operational performance.
The decrease for the nine months ended August 25, 2002 compared to the
prior year period reflects the impact of the weak retail and economic climates
in which we operate. We also in the first half of the year were in the early
stages of introducing many of the products and programs whose marketplace impact
we believe will increase over time.
We expect weak economic and retail conditions to continue in most major
markets around the world. Despite these conditions, we believe continued
execution of our strategies will enable us to stabilize our net sales for the
full year 2002 with a sales decline in the low single digits on a constant
currency basis, and that we will grow our sales in 2003. Further deterioration
in economic and retail conditions, due to hostilities in the Persian Gulf region
or other events, as well as other factors, could adversely affect our sales and
business for the balance of 2002 and 2003.
In the Americas, net sales for the three months ended August 25, 2002 were
essentially unchanged at $684.0 million, as compared to $689.9 million for the
same period in 2001. Unit volumes for the three-month period of 2002 increased
slightly compared to the same period in 2001. Net sales for the nine months
ended August 25, 2002 decreased 7.5% to $1,882.0 million, as compared to
$2,034.2 million for the same period in 2001.
The net sales performance for the three and nine months ended August 25,
2002 reflected:
o positive reactions from both retailers and consumers to our overhauled
product lines, including fresh fits, fabrics and finishes in core
products;
o a revitalized women's jeans product line, including Levi's(R)
Superlow(TM) jeans;
o new market leading innovations, such as Dockers(R)Go! Khakis(TM) with
Stain Defender;
o more effective product-focused advertising; and
o new retailer programs resulting in improved economics for our
customers, including lower wholesale prices, volume incentives, and
better service.
The net sales decrease for the nine months ended August 25, 2002 reflects
the challenging U.S. retail and economic climate and the early stages of product
and program roll-outs in the first half of the year.
22
We regularly explore entry into new customers and development of new brands
and products for both existing and potential customers. For example, during 2002
we entered Pacific Sunwear, a multi-brand specialty store. We also entered a
number of image department stores including the Bloomingdales unit of Federated
Department Stores, Inc., Neiman Marcus Group Inc., Nordstrom Inc. and Saks
Incorporated. As part of our ongoing effort to build our business, we continue
to evaluate participation in the mass merchant channel in the United States
through a new jeanswear brand. Our interest reflects the importance of that
channel to consumers, the rapid growth of the channel and its large share of
jeanswear and casual apparel sales. We currently are exploring the opportunity
carefully and are engaged in discussions with retailers in the channel and
related activities to support these efforts should we decide to go forward.
We import into the U.S. primarily tops products from Asia. In response to
the longshoremen's labor dispute in U.S. west coast ports, we are now using
other ports to avoid disruption of deliveries to our customers. We are factoring
additional transit time into our production planning, as appropriate. We expect
our arrangements with carriers will continue to mitigate the impact of higher
transit costs resulting from these actions.
In Europe, net sales for the three months ended August 25, 2002 increased
14.6% to $254.9 million, as compared to $222.5 million for the same period in
2001. Net sales for the nine months ended August 25, 2002 was essentially flat
at $756.9 million, as compared to $756.5 million for the same period in 2001. On
a constant currency basis, net sales would have increased by approximately 2.4%
and decreased 1.7% for the three and nine months ended August 25, 2002,
respectively, compared to the same periods in 2001.
European market conditions reflect increasing price pressures in the jeans
segment and an uncertain economic and retail environment, particularly in key
countries such as Germany, Italy and the United Kingdom. We returned to sales
growth in this environment in the third quarter, after substantial second
quarter sales declines, in part through these actions:
o sales of new products and finishes, such as the "Shaped and Worn"
vintage-inspired jean finish products;
o the roll-out of entry-priced products in both the Levi's(R) and
Dockers(R) brands;
o improved performance in the Levi's jeans business for girls;
o further selective wholesale price reductions;
o aggressive promotions of 501(R) jeans in core finishes and promotions
for 501(R) jeans and 525(TM) jeans; and
o the continued roll-out of our program to upgrade the presentation of
our products at retail.
Our performance in Europe for the first nine months ended August 25, 2002
reflected weak consumer demand, high retail inventories and increasing apparel
price deflation and, as in the Americas, the fact that, in the first half of the
year, we were in the early stages of executing new programs.
In our Asia Pacific region, net sales for the three months ended August 25,
2002 increased 10.9% to $78.8 million, as compared to $71.1 million for the same
period in 2001. Net sales for the nine months ended August 25, 2002 increased
1.9% to $237.6 million, as compared to $233.1 million. If exchange rates were
unchanged from the prior year periods, net sales would have increased
approximately 7.2% and 5.0% for the three and nine months ended August 25, 2002,
respectively. In some countries, we reported double-digit net sales increases
for the three and nine months ended August 25, 2002 compared to the same periods
last year. Sales growth reflected the positive impact of our product innovation,
marketing programs and improved retail distribution in an environment of
economic weakness and apparel price deflation across much of the region.
In Japan, which accounted for approximately 50% of our business in Asia
during 2002, net sales for the three months ended August 25, 2002 increased
approximately 10.0% on a constant currency basis compared to the same period in
2001. For the nine months ended August 25, 2002, net sales in Japan increased
3.0% compared to the prior year on a constant currency basis. The results in
Japan reflect the impact of our premium and super premium product lines, entry
into the standard or lower priced segment, and the opening of additional
franchised retail stores dedicated to the Levi's(R) brand.
23
Gross profit. Gross profit for the three months ended August 25, 2002 was
$414.5 million compared with $399.2 million for the same period in 2001. Gross
profit as a percentage of net sales, or gross margin, for the three months ended
August 25, 2002 increased to 40.7%, as compared to 40.6% for the same period in
2001. Gross profit for the nine months ended August 25, 2002 was $1,182.6
million compared to $1,291.7 million for the same period in 2001. Gross margin
decreased for the nine months ended August 25, 2002 to 41.1%, as compared to
42.7% for the same period in 2001.
Gross margin for the three and nine months ended August 25, 2002 was
adversely affected by expenses of $3.8 million and $33.9 million, respectively,
associated with plant closures in the U.S. and Scotland. Most of those expenses
were for workers' compensation and pension enhancements in the U.S. Excluding
these restructuring related expenses, gross margin for the three months ended
August 25, 2002 would have been 41.1% compared to 40.6% for the same period in
2001. In addition, gross margin for the nine-month period of 2002 would have
been 42.3% compared to 42.7% for the same period in 2001.
Our gross margins are benefiting from our lower sourcing and fabric costs
and the favorable impact of foreign currency movements as well as lower
inventory markdown expenses. Negatively affecting our margins are retailer
promotions and incentives in the U.S., which are recorded as a reduction of net
sales, selective wholesale price reductions in the U.S. and Europe, entry into
lower priced segments in all regions, and more expensive finishes, particularly
in Europe. Over the next 12 - 18 months, we expect to incur an additional $20
million in restructuring related expenses. These expenses include items such as
estimated increased costs for pension enhancements and maintenance and occupancy
costs before sale or other disposition of 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 August 25, 2002 increased
8.2% to $340.4 million as compared to $314.5 million for the same period in
2001. These expenses as a percentage of sales for the three months ended August
25, 2002 increased to 33.4% as compared to 32.0% for the same period in 2001.
Marketing, general and administrative expenses for the nine months ended August
25, 2002 decreased 1.9% to $958.1 million compared to $976.7 million for the
same period in 2001. These expenses as a percentage of sales for the nine months
ended August 25, 2002 increased to 33.3% compared to 32.3% for the same period
in 2001.
The dollar increase in marketing, general and administrative expenses for
the three months ended August 25, 2002 was primarily due to higher employee
incentive plan accruals as our results compared favorably to our performance
targets under the employee incentive plan and the effects of currency
fluctuations. This increase was partially offset by lower advertising expenses
and our continuing cost containment efforts. The dollar decrease in marketing,
general and administrative expenses for the nine months ended August 25, 2002
was primarily due to lower advertising expense and our continuing cost
containment efforts, partially offset by higher employee incentive plan
accruals. In addition, marketing, general and administrative expenses for the
three and nine months ended August 26, 2001 included a reversal of prior period
accruals associated with an employee long-term incentive plan as a result of
changes in employee turnover assumptions. Those reversals were in the amounts of
$12.0 million and $18.0 million, respectively.
24
Advertising expense for the three months ended August 25, 2002 decreased
9.6% to $76.4 million, as compared to $84.5 million for the same period in 2001.
Advertising expense as a percentage of sales for the three months ended August
25, 2002 decreased to 7.5%, as compared to 8.6% for the same period in 2001.
Advertising expense for the nine months ended August 25, 2002 decreased 15.8% to
$212.1 million, as compared to $252.0 million for the same period in 2001.
Advertising expense as a percentage of sales for the nine months ended August
25, 2002 decreased to 7.4%, as compared to 8.3% 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. The cost of those programs is recorded as a reduction
of net sales.
Other operating income. Licensing income for the three months ended August
25, 2002 of $6.0 million decreased 28.2%, as compared to $8.4 million for the
same period in 2001. Licensing income for the nine months ended August 25, 2002
of $20.6 million decreased 9.9% as compared to $22.9 million for the same period
in 2001. The decrease for the three and nine months ended August 25, 2002
reflects the impact of weak retail and economic conditions on licensee sales,
offset in part by an 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 reversals of $16.6 million and $25.6
million for the three and nine months ended August 25, 2002, respectively, for
previously recorded restructuring charges based on updated estimates. We present
below and in the consolidated financial statements more data about these charges
and reversals.
Operating income. Operating income for the three and nine months ended
August 25, 2002 was $96.7 million and $120.6 million, as compared to operating
income of $93.1 million and $337.9 million for the same periods in 2001,
respectively. The increase in operating income for the three months ended August
25, 2002 was primarily attributable to the impact of higher sales and a $16.6
million reversal of previously recorded restructuring charges. The decrease in
operating income for the nine months ended August 25, 2002 was primarily due to
the impact of lower sales and the net restructuring charge of $124.5 million and
related expenses of $33.9 million recorded during the first nine months of 2002.
This decrease was partially offset by lower marketing, general and
administrative expenses.
Interest expense. Interest expense for the three months ended August 25,
2002 decreased 12.5% to $48.5 million, as compared to $55.4 million for the same
period in 2001. Interest expense for the nine months ended August 25, 2002
decreased 22.1% to $139.0 million, as compared to $178.5 million for the same
period in 2001. The lower interest expense for both the three and nine months
ended August 25, 2002 was primarily due to lower average debt levels combined
with lower market interest rates. In addition, interest expense for the nine
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 August 25, 2002 and August 26,
2001 were 9.11% and 9.40%, respectively. The weighted average cost of borrowings
for the nine months ended August 25, 2002 and August 26, 2001 were 9.06% and
9.56%, respectively, excluding the write-off of fees.
Other (income) expense, net. Other (income) expense, net for the three and
nine months ended August 25, 2002 was an expense of $20.8 million and $20.6
million, as compared to an expense of $13.8 million and $19.6 million for the
same periods in 2001, respectively. The increases in expense for the three and
nine months ended August 25, 2002 were primarily due to net losses from
derivative instruments used for foreign currency management activities that do
not qualify for hedge accounting.
Income tax expense (benefit). Our effective income tax rate for the fiscal
year 2002 is 50% compared to 37% for 2001. The increase in our annual effective
income tax rate is primarily due to the combined effects of the computational
impact of expenses not deductible for tax purposes and lower projected earnings
for 2002 resulting from the restructuring charges and related expenses.
Income tax expense for the three months ended August 25, 2002 was $13.7
million compared to $8.8 million for the same period in 2001. Income tax benefit
for the nine months ended August 25, 2002 was $19.5 million compared to an
income tax expense of $51.7 million for the same period in 2001. The income tax
benefit for the nine months ended August 25, 2002 was due to the reported loss
resulting from the net restructuring charges of $124.5 million and related
expenses of $33.9 million.
25
We reached a tentative settlement on most issues 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 impact of
this settlement on our deferred tax assets and on the adequacy of our provision
for income taxes. We expect to complete our evaluation process by the end of our
fiscal year and our deferred tax assets, provision for income taxes and our
effective income tax rate as a result of this evaluation.
Net income (loss). Net income for the three months ended August 25, 2002
was $13.7 million compared to $15.0 million for the same period in 2001. Net
loss for the nine months ended August 25, 2002 was $19.5 million compared to net
income of $88.0 million for the same period in 2001. The decrease in net income
for the three months ended August 25, 2002 as compared to the same period in
2001 was primarily due to higher employee incentive plan accruals, higher
effective income tax rate and the impact of currency volatility on our foreign
exchange management. These amounts were partly offset by lower interest expense,
higher sales and a $16.6 million reversal of previously recorded restructuring
charges. The loss for the nine months ended August 25, 2002 was primarily
attributable 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,
all of whom have been displaced. The two manufacturing plants were closed by the
end of the second quarter of 2002. During the third quarter of 2002 the
remaining reserve balance of $2.1 million was reversed due to the earlier than
anticipated sale of the manufacturing plants.
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. The six manufacturing plants were closed in three phases:
two plants were closed in June 2002, two plants were closed in July 2002 and the
final two plants were closed in September 2002. We expect to utilize the
majority of the U.S. plant closures reserve balance by the end of 2003.
In November 2001, we instituted various reorganization initiatives in the
U.S. and Japan. In the U.S. these initiatives included simplifying product lines
and realigning resources to those product lines. 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. During the third quarter of 2002, we reversed a charge
of $5.5 million from the initial U.S. charge of $20.3 million. This reversal was
due to a change, resulting from changing business needs, in the estimate of the
number of employees to be affected.
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. For the three and
nine months ended August 25, 2002, we reversed aggregate charges of $8.9 million
and $18.0 million, respectively, from initial charges of $530.9 million. These
reversals were primarily due to lower than anticipated employee benefits and
other plant closure related costs. We expect to utilize the majority of the
remaining 1997 - 1999 reserve balances by the end of 2003.
26
The total balance of the reserves at August 25, 2002 was $98.1 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
August 25, November 25,
2002 2001
---- ----
(Dollars in Thousands)
2002 Scotland Plant Closures......................................... $ -- $ --
2002 U.S. Plant Closures............................................. 89,930 --
2001 Corporate Restructuring Initiatives............................. 4,640 19,989
2001 Japan Restructuring Initiative.................................. 328 2,006
1997 - 1999 Plant Closures and Restructuring Initiatives............. 3,189 23,225
------- -------
Total........................................................... $98,087 $45,220
======= =======
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements have been to fund working capital and
capital expenditures. As of August 25, 2002, total cash and cash equivalents
were $62.3 million, a $40.6 million decrease from the $102.8 million cash
balance reported as of November 25, 2001.
Total debt, other cash obligations and commitments. Total debt as of August
25, 2002 was $1,961.1 million, a $2.7 million increase from the $1,958.4 million
reported as of November 25, 2001. We have no off-balance sheet debt obligations
or material unconditional purchase commitments. Our total short-term and
long-term debt principal payments as of August 25, 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
-------- --------
Year (Dollars in Thousands)
----
2002........................................................ $ 24,344 $ 61,974
2003........................................................ 643,972 57,310
2004........................................................ 118,521 54,803
2005........................................................ 56,203 50,472
2006........................................................ 448,056 48,249
Thereafter.................................................. 670,033 209,502
---------- --------
Total.................................................. $1,961,129 $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 the first and second quarters of 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 during the second
quarter of 2003. In addition, in the second quarter of 2002 we increased
restructuring reserves due to the announced plant closures 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.
Credit arrangements. As of August 25, 2002, our credit facility consisted
of $133.0 million of term loans and a $617.6 million revolving credit facility,
of which $100.0 million of borrowings under the revolving credit facility was
outstanding. Total availability under the revolving credit facility was reduced
by $146.1 million of letters of credit allocated under the revolving credit
facility, yielding a net availability of $371.5 million. Included in the $146.1
million of letters of credit at August 25, 2002 are $116.6 million of standby
letters of credit with various international banks, of which $48.5 million serve
as guarantees by the creditor banks to cover U.S. workers' compensation claims.
We pay fees on the standby letters of credit and borrowings against letters of
credit are subject to interest at various rates. We believe this is sufficient
for our cash needs through August of 2003.
27
Our credit facility matures in August 2003 and our unsecured 6.80% notes
become due in November 2003. We are holding discussions with our financial
partners and are exploring alternatives for repayment or refinancing of those
obligations. We believe we can address these debt maturities and finance the
evolving needs of our business in a timely manner.
At August 25, 2002, we had unsecured and uncommitted short-term credit
lines available totaling $13.5 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.
Supply contracts. We do not have any material 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 $30.0 million in
connection with the closures during the fourth quarter of 2002. We expect to use
the majority of the remaining reserve balances by the end of 2003. 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 nine months ended August 25, 2002 was $16.8 million, as
compared to a use of cash of $93.3 million for the same period in 2001. As the
fourth quarter is typically our highest sales quarter, trade receivables
decreased during the nine months ended August 25, 2002 primarily due to the
seasonality of sales. Inventories increased during the nine months ended August
25, 2002 primarily due to preparations for our holiday season and projected
retailer orders. Net deferred tax assets increased during the nine months ended
August 25, 2002 primarily due to the restructuring charges and related expenses
as well as accruals for long-term employee incentive compensation and benefit
plans. Accounts payable and accrued liabilities decreased during the nine months
ended August 25, 2002 primarily due to lower raw material purchases and lower
advertising costs than at November 25, 2001.
Restructuring reserves increased during the nine months ended August 25,
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 nine months ended August 25,
2002 primarily due to expected payments in 2003 under our long-term employee
incentive compensation plan. Accrued taxes increased and long-term tax liability
decreased during the nine months ended August 25, 2002 due to a reclassification
of approximately $148.5 million for 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 during the second quarter of 2003.
Cash used for investing activities. Cash used for investing activities
during the nine months ended August 25, 2002 was $36.6 million as compared to
$13.4 million during the same period in 2001. Cash used for investing activities
for the nine months ended August 25, 2002 resulted primarily from purchases of
property, plant and equipment and realized losses on net investment hedges,
partially offset by proceeds received on sales of property, plant and equipment.
The purchases primarily related to sales office capital improvements and systems
upgrades. The proceeds received on the sale of property, plant and equipment
arose mainly from the sale during the first quarter of 2002 of an idle
distribution center located in Nevada. 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 nine months ended August 25, 2002 was $22.6 million, as
compared to cash provided by financing activities of $50.3 million for the same
period in 2001. Cash used for financing activities during the nine months ended
August 25, 2002 was primarily for repayment of existing debt.
28
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. 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 August 25, 2002, there was no deficiency and as a result, no
restricted cash on the balance sheet.
Credit ratings. On August 14, 2002, Moody's Investors Service ("Moody's")
issued a press release regarding its decision to downgrade both our senior
secured credit facility and our senior unsecured notes. The senior secured
credit facility was downgraded to "B1" from "Ba3" and the senior unsecured notes
were downgraded to "Caa1" from "B2." According to the press release, Moody's
based this decision on its concerns relating to 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.
New Accounting Standards
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets," dated June 2001, which requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized but instead be
reviewed annually for impairment using a fair-value based approach. Intangible
assets that have a finite life will continue to be amortized over their
respective estimated useful lives. We will adopt the provisions of SFAS 142 on
the first day of fiscal year 2003. Amortization expense for fiscal year 2001 was
$10.7 million. We are currently evaluating the impact adoption may have on our
financial position and results of operations.
The FASB issued SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," dated August 2001. This statement supercedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions of Accounting
Principles Board ("APB") Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS 144 requires
that one accounting model be used for long-lived assets to be disposed of by
sale, whether previously held and used or newly acquired, and it broadens the
presentation of discontinued operations to include more disposal transactions.
We will adopt the provisions of SFAS 144 on the first day of fiscal year 2003
and we are currently evaluating the impact SFAS 144 may have on our financial
position and results of operations.
29
The FASB issued SFAS 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections," dated April
2002. SFAS 145 states that gains and losses from extinguishment of debt that do
not meet the criteria for classification as extraordinary items in APB Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," should not be classified as extraordinary
items. Accordingly, SFAS 145 rescinds SFAS 4 "Reporting Gains and Losses from
Extinguishment of Debt," and SFAS 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." SFAS 145 is effective for us on the first day of
fiscal year 2003.
The FASB issued SFAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities," dated June 2002. SFAS 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity is recognized when the liability is incurred. In summary, SFAS 146
requires that the liability shall be recognized and measured initially at its
fair value in the period in which the liability is incurred, except for one-time
termination benefits that meet certain requirements. SFAS 146 is effective
prospectively for exit or disposal activities initiated after December 31, 2002.
30
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 our ability to repay and refinance our debt obligations;
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 and payments;
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 conditions in the bank loan and capital markets;
o changes in credit ratings;
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 and tariffs;
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.
31
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 August 25, At November 25,
2002 2001
- --------------------------------------- ----------------- -----------------
Fair value Fair value
Risk Exposures asset (liability) asset (liability)
- --------------------------------------- ----------------- -----------------
(Dollars in Thousands)
- ---------------------------------------
Foreign Exchange Management:
Sourcing $ 593 $10,976
Net Investment 3,939 6,068
Royalties 738 729
Cash Management (3,183) 1,521
Euro Notes Offering 463 (1,169)
------ -------
Total $2,550 $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. We hold
derivative positions only in currencies to which we have exposure. We have
established a policy for a maximum allowable level of losses that may occur as a
result of our currency exposure management activities. The maximum level of loss
is based on a percentage of the total forecasted currency exposure being
managed. 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.
At August 25, 2002, we had U.S. dollar forward currency contracts to buy
$1.4 billion and to sell $669.6 million against various foreign currencies. We
also had euro forward currency contracts to buy 147.0 million euro against
various foreign currencies and to sell 18.8 million euro against various foreign
currencies. In addition, we had U.S. dollar option contracts to buy $89.5
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.
32
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 August 25, 2002, we had bought
U.S. dollar options resulting in a net long position against the euro of $51.6
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 $37.9 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 August 25, 2002.
For more information about market risk, see Notes 6, 7 and 8 to the
Consolidated Financial Statements.
ITEM 4. CONTROLS AND PROCEDURES
Not Applicable.
33
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(A) EXHIBITS:
3.1 Restated Certificate of Incorporation. Previously filed as
Exhibit 3.3 to Registrant's Quarterly Report on Form 10-Q
filed with the Commission on April 6, 2001.
3.2 Amended and Restated By-Laws. Previously filed as Exhibit
3.4 to Registrant's Quarterly Report on Form 10-Q filed with
the Commission on April 6, 2001.
10.1 Third Amendment to Credit Agreement and Consent dated as of
July 26, 2002. Filed herewith.
10.2 Second Amendment to Pledge and Security Agreement dated as
of July 26, 2002. Filed herewith.
10.3 Second Amendment to Subsidiary Guaranty dated as of July 26,
2002. Filed herewith.
10.4 Employee Loan Agreement, dated as of April 16, 2002 between
the Registrant and Joe Middleton. Filed herewith.
10.5 First Amendment to the Revised Home Office Pension Plan of
Levi Strauss & Co. effective as of May 31, 2002. Filed
herewith.
10.6 First Amendment to the Employee Investment Plan of Levi
Strauss & Co. primarily effective as of January 1, 2002.
Filed herewith.
(B) REPORTS ON FORM 8-K:
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."
Current Report on Form 8-K on August 16, 2002 filed pursuant to Item 5
of the report relating to a press release issued by Moody's Investors
Service on August 14, 2002 downgrading our senior secured credit
facility and our senior unsecured notes.
Current Report on Form 8-K on September 19, 2002 filed pursuant to Item
9 of the report relating to filing our Amended Quarterly Reports on
Form 10-Q/A for the quarterly periods ended February 24, 2002 and May
26, 2002; and containing a copy of the Section 906 of the
Sarbanes-Oxley Act of 2002 certifications.
Current Report on Form 8-K on September 23, 2002 filed pursuant to Item
5 of the report and containing a copy of the Company's press release
titled "Levi Strauss & Co. Announces Third-Quarter 2002 Financial
Results."
34
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: October 8, 2002
Levi Strauss & Co.
------------------
(Registrant)
By: /s/ William B. Chiasson
-----------------------
William B. Chiasson
Senior Vice President and Chief Financial Officer
35
CERTIFICATIONS
I, Philip A. Marineau, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Levi Strauss & Co.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
Date: October 8, 2002
/s/ Philip A. Marineau
----------------------
President and Chief
Executive Officer
I, William B. Chiasson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Levi Strauss & Co.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
Date: October 8, 2002
/s/ William B. Chiasson
-----------------------
Senior Vice President
and Chief Financial Officer
36