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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MAY 25, 2003
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 by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock $.01 par value ------ 37,278,238 shares outstanding on July 1, 2003
LEVI STRAUSS & CO.
INDEX TO FORM 10-Q
MAY 25, 2003
PAGE
NUMBER
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of May 25, 2003 and November 24, 2002................................3
Consolidated Statements of Operations for the Three and Six Months Ended
May 25, 2003 and May 26, 2002......................................................................4
Consolidated Statements of Cash Flows for the Six Months Ended
May 25, 2003 and May 26, 2002......................................................................5
Notes to the Consolidated Financial Statements......................................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................................24
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........................................40
Item 4. Controls and Procedures............................................................................42
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K...................................................................43
SIGNATURE.....................................................................................................44
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
May 25, November 24,
2003 2002
---- ----
ASSETS
Current Assets:
Cash and cash equivalents...................................................... $ 120,965 $ 96,478
Restricted cash................................................................ 23,427 -
Trade receivables, net of allowance for doubtful accounts of $22,127 in 2003
and $24,857 in 2002......................................................... 499,104 660,516
Inventories:
Raw materials.............................................................. 89,286 98,987
Work-in-process............................................................ 68,491 74,048
Finished goods............................................................. 676,559 418,679
---------- ----------
Total inventories....................................................... 834,336 591,714
Deferred tax assets............................................................ 325,204 221,574
Other current assets........................................................... 108,520 88,611
---------- ----------
Total current assets............................................... 1,911,556 1,658,893
Property, plant and equipment, net of accumulated depreciation of $490,030 in
2003 and $478,447 in 2002......................................................... 496,322 482,446
Goodwill ............................................................................ 199,905 199,905
Other intangible assets.............................................................. 43,705 43,505
Non-current deferred tax assets...................................................... 571,683 573,844
Other assets......................................................................... 87,303 58,691
---------- ----------
Total Assets....................................................... $3,310,474 $3,017,284
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Current maturities of long-term debt and short-term borrowings................. $ 45,686 $ 95,225
Accounts payable............................................................... 324,873 292,383
Restructuring reserves......................................................... 24,079 65,576
Accrued liabilities............................................................ 246,719 211,834
Accrued salaries, wages and employee benefits.................................. 283,432 314,385
Accrued taxes.................................................................. 19,754 105,387
---------- ----------
Total current liabilities.......................................... 944,543 1,084,790
Long-term debt, less current maturities.............................................. 2,268,730 1,751,752
Postretirement medical benefits...................................................... 560,545 548,930
Long-term employee related benefits.................................................. 448,925 527,418
Long-term tax liability.............................................................. 66,879 66,879
Other long-term liabilities.......................................................... 34,897 11,558
Minority interest.................................................................... 22,043 21,541
---------- ----------
Total liabilities.................................................. $4,346,562 $4,012,868
========== ==========
Stockholders' Deficit:
Common stock--$.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............................................................ (1,033,748) (995,881)
Accumulated other comprehensive (loss)......................................... (91,521) (88,884)
---------- ----------
Total stockholders' deficit........................................ (1,036,088) (995,584)
---------- ----------
Total Liabilities and Stockholders' Deficit........................ $3,310,474 $3,017,284
========== ==========
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 Share Data)
(Unaudited)
Three Months Ended Six Months Ended
------------------ -----------------
May 25, 2003 May 26, 2002 May 25, 2003 May 26, 2002
------------ ------------ ------------ ------------
Net sales...................................................... $ 930,030 $ 923,518 $1,805,119 $1,858,802
Cost of goods sold............................................. 545,480 553,974 1,061,121 1,090,674
---------- ---------- ---------- ----------
Gross profit.............................................. 384,550 369,544 743,998 768,128
Marketing, general and administrative expenses................. 343,399 318,804 666,932 617,739
Other operating (income)....................................... (9,752) (8,511) (17,068) (14,624)
Restructuring charges, net of reversals........................ (5,509) 141,078 (9,719) 141,078
---------- ---------- ---------- ----------
Operating income (loss)................................... 56,412 (81,827) 103,853 23,935
Interest expense............................................... 63,346 42,510 123,026 90,533
Other (income) expense, net.................................... 14,994 9,499 42,904 (178)
---------- ---------- ---------- ----------
Income (loss) before taxes................................ (21,928) (133,836) (62,077) (66,420)
Income tax expense (benefit)................................... (8,552) (58,154) (24,210) (33,210)
---------- ---------- ---------- ----------
Net income (loss)....................................... $ (13,376) $ (75,682) $ (37,867) $ (33,210)
========== ========== ========== ==========
Earnings (loss) per share--basic and diluted................... $ (0.36) $ (2.03) $ (1.02) $ (0.89)
========== ========== ========== ==========
Weighted-average common shares outstanding..................... 37,278,238 37,278,238 37,278,238 37,278,238
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
4
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six Months Ended
----------------
May 25, 2003 May 26, 2002
------------ ------------
Cash Flows from Operating Activities:
Net income (loss)............................................................. $ (37,867) $ (33,210)
Adjustments to reconcile net cash provided by (used for) operating activities:
Depreciation and amortization......................................... 31,276 36,238
Asset write-offs associated with 2002 restructuring charge............ - 25,708
(Gain) on dispositions of property, plant and equipment............... (6,109) (771)
Unrealized foreign exchange losses.................................... 17,409 14,161
Decrease in trade receivables......................................... 169,852 151,729
(Increase) in inventories............................................. (170,606) (58,141)
(Increase) in other current assets.................................... (13,981) (8,721)
(Increase) decrease in other long-term assets......................... (24,640) 6,201
(Increase) in net deferred tax assets................................. (93,797) (59,846)
(Decrease) in accounts payable and accrued liabilities................ (9,441) (65,754)
(Decrease) increase in restructuring reserves......................... (41,497) 89,846
(Decrease) increase in accrued salaries, wages and employee benefits.. (39,173) 60,060
(Decrease) increase in accrued taxes.................................. (75,136) 125,838
(Decrease) in long-term employee benefits............................. (74,225) (22,202)
Increase (decrease) in long-term tax and other liabilities............ 22,947 (148,762)
Other, net............................................................ 733 1,186
--------- ---------
Net cash provided by (used for) operating activities............... (344,255) 113,560
--------- ---------
Cash Flows from Investing Activities:
Purchases of property, plant and equipment............................ (35,435) (18,804)
Proceeds from sale of property, plant and equipment................... 7,604 7,802
Cash (outflow) inflow from net investment hedges...................... (18,468) 4,786
--------- ---------
Net cash (used for) investing activities........................... (46,299) (6,216)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt.............................. 1,114,060 356,999
Repayments of long-term debt.......................................... (675,012) (456,465)
Net (decrease) increase in short-term borrowings...................... (3,474) 4,598
Increase in restricted cash........................................... (23,427) -
--------- ---------
Net cash (used for) provided by financing activities............... 412,147 (94,868)
--------- ---------
Effect of exchange rate changes on cash....................................... 2,894 296
--------- ---------
Net increase in cash and cash equivalents.......................... 24,487 12,772
Beginning cash and cash equivalents........................................... 96,478 102,831
--------- ---------
Ending Cash and Cash Equivalents.............................................. $ 120,965 $ 115,603
========= =========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest.............................................................. $ 78,427 $ 81,485
Income taxes.......................................................... 159,319 42,733
Restructuring initiatives............................................. 35,024 25,525
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: PREPARATION OF FINANCIAL STATEMENTS
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 24, 2002 included in the annual report on
Form 10-K filed by LS&CO. with the Securities and Exchange Commission on
February 12, 2003.
The condensed consolidated financial statements include the accounts of
Levi Strauss & Co. and its subsidiaries. All intercompany transactions have been
eliminated. Management believes that, along with the following information, the
disclosures are adequate to make the information presented herein not
misleading. Certain prior year amounts have been reclassified to conform to the
current presentation. The results of operations for the three and six months
ended May 25, 2003 may not be indicative of the results to be expected for the
year ending November 30, 2003.
Restricted Cash
Under the senior secured credit facility, the Company is required to have
funds segregated in an amount sufficient to repay the Company's 6.80% notes due
November 1, 2003 at maturity (including any interim scheduled interest
payments). As of May 25, 2003, this amount was $23.4 million, which includes
$0.8 million of accrued interest, and is separately identified on the balance
sheet as "Restricted cash."
Estimates and Critical Accounting Policies
Estimates. 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 information, may affect amounts reported in future periods. The
estimated liability for the Company's long-term incentive compensation plan is
based upon various factors including employee forfeitures and the Company's
performance. The Company periodically evaluates the adequacy of the recorded
liability and makes adjustments as appropriate. The Company reduced the
estimated liability by approximately $27 million and $49 million for the three
and six months ended May 25, 2003, respectively, reflecting the aggregate change
in expected payouts for the outstanding grants. The liability also includes
accruals for the estimated expense for the three and six months ended May 25,
2003 of $19 million and $38 million, respectively, which was recorded in
marketing, general and administrative expenses. As a result, we recognized a net
expense reduction of $8 million and $11 million for the three and six months
ended May 25, 2003, respectively.
The Company estimates annual employee incentive compensation based upon
various factors, including the Company's forecasted performance measured against
pre-established full-year targets. The Company periodically evaluates the
adequacy of the recorded liability and makes adjustments as appropriate. The
Company reduced the estimated liability by approximately $7 million and $4
million for the three and six months ended May 25, 2003, respectively,
reflecting the aggregate change in expected payouts. The liability includes
accruals for the estimated expense for the three and six months ended May 25,
2003 of $2 million and $4 million, respectively, which was recorded in
marketing, general and administrative expenses. As a result, we recognized a net
expense reduction of $5 million for the three months ended May 25, 2003, causing
a net expense of $0 for the six months ended May 25, 2003.
6
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Critical accounting policies. As of May 25, 2003, the Company identified
the critical accounting policies upon which its financial position and results
of operations depend as those relating to revenue recognition, inventory
valuation, restructuring reserves, income tax assets and liabilities, and
derivatives and foreign exchange management activities. The Company has
summarized its critical accounting policies below.
Revenue recognition. The Company recognizes revenue when the goods are
shipped and title passes to the customer provided that: there are no
uncertainties regarding customer acceptance; persuasive evidence of an
arrangement exists; the sales price is fixed or determinable; and collectibility
is probable. Revenue is recognized net of an allowance for estimated returns,
discounts and retailer promotions and incentives when the sale is recorded.
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 allowances have not materially
differed from estimates.
Historically, the Company entered into cooperative advertising programs
with certain customers, but most of these programs were discontinued by the
first fiscal quarter of 2002, reflecting the Company's strategic shift of some
advertising spending to sales incentive programs. The Company recorded payments
to customers under cooperative advertising programs as marketing, general and
administrative expenses because an identifiable benefit was received in return
for the consideration and the Company could reasonably estimate the fair value
of the advertising received. Cooperative advertising expense for the three and
six months ended May 25, 2003 was $0.7 million and $0.8 million, respectively.
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. 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,
quality and mix of products in inventory, consumer and retailer preferences and
economic conditions. Improvements in the process of estimating potential excess
inventory resulted in a reduction of inventory valuation reserves by
approximately $6 million and $11 million for the three and six months ended May
25, 2003, respectively.
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 resolution
of 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. (See "New Accounting Standards" below on the
Company's adoption of Statement of Financial Accounting Standards No. ("SFAS")
146, "Accounting for Costs Associated with Exit or Disposal Activities.")
7
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Income tax assets and liabilities. In establishing its deferred income
tax assets and liabilities, the Company makes judgments and interpretations
based on the enacted tax laws and published tax guidance applicable to its
operations. The Company records deferred tax assets and liabilities and
evaluates the need for valuation allowances to reduce the deferred tax assets to
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.
Derivatives, foreign exchange, and interest rate 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, net" 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.
The Company is exposed to interest rate risk. It is the Company's
policy and practice to use derivative instruments to manage and reduce interest
rate exposures using a mix of fixed and variable rate debt. For transactions
that do not qualify for hedge accounting or in which management has elected not
to designate transactions for hedge accounting, changes in fair value are
recorded in earnings.
New Accounting Standards
The Financial Accounting Standards Board ("FASB") issued SFAS 141,
"Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets" in
July 2001. SFAS 141 requires that all business combinations be accounted for
using the purchase method. SFAS 141 also specifies criteria for recognizing and
reporting intangible assets apart from goodwill. SFAS 142 requires that goodwill
and indefinite lived intangible assets not be amortized but instead tested for
impairment in accordance with the provisions of SFAS 142 at least annually and
more frequently upon the occurrence of certain events (see "Impairment of
Long-Lived Assets" below). SFAS 142 also requires that all other intangible
assets be amortized over their useful lives.
The Company adopted SFAS 141 and SFAS 142 effective November 25, 2002. SFAS
141 and SFAS 142 required the Company to perform the following upon adoption:
(i) assess the classification of certain amounts between goodwill and other
intangible assets; (ii) reassess the useful lives of intangible assets; (iii)
perform a transitional impairment test; and (iv) discontinue the amortization of
goodwill and indefinite lived intangible assets.
The Company has reviewed the balances of goodwill and other intangible
assets and determined that the Company does not have any amounts that are
required to be reclassified between goodwill and other intangible assets. The
Company has determined that the useful lives of the majority of its trademarks
are indefinite. The Company has also assessed the useful lives of its remaining
identifiable intangible assets and determined that the estimated useful lives
range from 5 to 12 years.
8
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
The Company has completed the transitional impairment tests and has
determined that the Company did not have a transitional impairment of goodwill
or indefinite lived intangible assets. Goodwill and indefinite lived intangible
assets will be subject to impairment testing during the fourth quarter of each
fiscal year, or earlier if circumstances indicate, using a fair value-based
approach as required by SFAS 142. Beginning November 25, 2002, the Company
discontinued the amortization of goodwill and indefinite lived intangible
assets. Prior to November 25, 2002, goodwill and trademarks were amortized over
an estimated useful life of 40 years.
As of May 25, 2003 and November 25, 2002, the Company's goodwill for both
periods was $199.9 million, net of accumulated amortization of $151.6 million.
As of May 25, 2003 and November 25, 2002, the Company's trademarks were $43.0
million, net of accumulated amortization of $34.6 million and $42.8 million, net
of accumulated amortization of $34.5 million, respectively. The Company's
remaining identifiable intangible assets as of May 25, 2003 were not material.
Amortization expense for goodwill and trademarks for 2002 was $8.8 million and
$1.9 million, respectively. Future amortization expense with respect to the
Company's intangible assets as of May 25, 2003 is not expected to be material.
As of November 25, 2002, the Company's net book value for goodwill, trademarks,
and other identifiable intangibles was $199.9 million, $42.8 million and $0.7
million, respectively.
A reconciliation of previously reported net income and earnings per share
to amounts adjusted for the exclusion of goodwill and trademark amortization,
net of related income tax effect is as follows:
Three Months Ended Six Months Ended
------------------ ----------------
May 25, May 26, May 25, May 26,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in Millions,
except per share amounts)
Reported income (loss)........................................ $(13.4) $(75.7) $(37.9) $(33.2)
Goodwill and trademark amortization, net of tax............... - 1.5 - 2.7
------ ------ ------ ------
Adjusted net income (loss).................................... $(13.4) $(74.2) $(37.9) $(30.5)
====== ====== ====== ======
Reported earnings (loss) per share............................ $(0.36) $(2.03) $(1.02) $(0.89)
Goodwill and trademark amortization, net of tax per share..... - 0.04 - 0.07
------ ------ ------ ------
Adjusted earnings (loss) per share............................ $(0.36) $(1.99) $(1.02) $(0.82)
====== ====== ====== ======
The Company adopted the provisions of SFAS 143, "Accounting for Asset
Retirement Obligations," effective November 25, 2002. SFAS 143 changes the way
companies recognize and measure retirement obligations that are legal
obligations and result from the acquisition, construction, development or
operation of long-lived tangible assets. The Company's primary asset retirement
obligations relate to certain leasehold improvements in its Americas business
for which an asset retirement obligation has been recorded. The adoption of SFAS
143 did not have a material impact on the Company's consolidated financial
condition or results of operations.
The Company adopted the provisions of SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," effective November 25, 2002. 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. At May 25, 2003, the Company
had approximately $3.8 million of long-lived assets held for sale. The adoption
of SFAS 144 did not have a material impact on the Company's consolidated
financial condition or results of operations.
9
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
The Company adopted the provisions of SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," effective November 25, 2002. SFAS 145 prohibits presentation of
gains and losses from extinguishment of debt as extraordinary items unless such
items meet the criteria for classification as extraordinary items pursuant to
APB Opinion No. 30. As a result, for the three and six months ended May 25,
2003, the Company presented losses of $5.7 million and $14.4 million,
respectively, on early extinguishment of its debt in "Other (income) expense,
net" in the accompanying 2003 consolidated statements of operations. The losses
primarily relate to unamortized bank fees associated with refinancing of the
Company's 2001 bank credit facility and the repurchase of $327 million of the
6.80% notes due November 2003.
SFAS 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was effective prospectively for qualifying exit or disposal
activities initiated after December 31, 2002, and nullifies Emerging Issues Task
Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity." The timing of expense
recognition under SFAS 146 for restructuring initiatives in 2003 differs from
that which was required under EITF Issue 94-3. The adoption of SFAS 146 did not
have a material impact on the Company's consolidated financial condition or
results of operations.
The FASB issued Interpretation No. ("FIN") 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34," dated November 2002. FIN 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
disclosure requirements are effective for financial statements of interim or
annual periods ending after December 31, 2002. The initial recognition and
measurement provisions of the interpretation are applicable to guarantees issued
or modified after December 31, 2002, and did not have a material effect on the
Company's consolidated financial condition or results of operations.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51." FIN 46 addresses the
consolidation by business enterprises of variable interest entities, as defined
in the Interpretation. FIN 46 expands existing accounting guidance regarding
when a company should include in its financial statements the assets,
liabilities and activities of another entity. Many variable interest entities
have commonly been referred to as special-purpose entities or off-balance sheet
structures. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. Certain of the
disclosure requirements apply in all financial statements issued after January
31, 2003. Since the Company does not have any variable interests in variable
interest entities, the adoption of FIN 46 did not have any effect on the
Company's consolidated financial condition or results of operations.
The FASB issued SFAS 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," dated April 2003. The purpose of SFAS 149
is to amend and clarify financial accounting and reporting for derivative
instruments and hedging activities under SFAS 133. SFAS 149 amends SFAS 133 for
decisions made: (i) as part of the Derivatives Implementation Group process that
require amendment to SFAS 133, (ii) in connection with other FASB projects
dealing with financial instruments, and (iii) in connection with the
implementation issues raised related to the application of the definition of a
derivative. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003 and for designated hedging relationships after June 30, 2003. SFAS
149 will be applied prospectively. The Company does not expect SFAS 149 to have
a material effect on its consolidated financial condition or results of
operations.
10
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 2: COMPREHENSIVE INCOME (LOSS)
The following is a summary of the components of total comprehensive income
(loss), net of related income taxes:
Three Months Ended Six Months Ended
------------------ ----------------
May 25, May 26, May 25, May 26,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in Thousands)
Net income (loss)............................................. $(13,376) $(75,682) $(37,867) $(33,210)
-------- -------- -------- --------
Other comprehensive income (loss):
Reclassification of cash flow hedges to other
(income) expense, net.................................... - - - (572)
Net investment hedges...................................... (11,115) (6,919) (18,100) (1,884)
Foreign currency translations............................. 6,314 3,278 15,463 (5,160)
-------- -------- -------- --------
Total other comprehensive (loss)........................ (4,801) (3,641) (2,637) (7,616)
-------- -------- -------- --------
Total comprehensive (loss).................................... $(18,177) $(79,323) $(40,504) $(40,826)
======== ======== ======== ========
The following is a summary of the components of accumulated other
comprehensive income (loss) balances:
May 25, November 24,
2003 2002
---- ----
(Dollars in Thousands)
Net investment hedges......................................... $ 10,250 $ 28,350
Foreign currency translations................................. (15,818) (31,281)
Additional minimum pension liability.......................... (85,953) (85,953)
-------- --------
Accumulated other comprehensive (loss)................ $(91,521) $(88,884)
======== ========
NOTE 3: RESTRUCTURING RESERVES
The following describes the activities associated with the Company's
reorganization initiatives. Severance and employee benefits relate to items such
as severance packages, out-placement services and career counseling for
employees affected by the plant closures and reorganization initiatives.
Reductions consist of payments for severance and employee benefits, 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.
2003 Europe Distribution Center Reorganization Initiative
As of May 25, 2003, the Company evaluated the impact of a reorganization
initiative in Europe to streamline the distribution center activity and reduce
operating costs in France, Belgium and Holland. During the second quarter of
2003, the Company reached an agreement for the severance packages of the French
employees impacted by the initiative. The Company recorded in marketing, general
and administrative expenses an initial charge of $1.9 million associated with
the displacement of approximately 45 employees. The table below displays the
activity and liability balance of this reserve.
For fiscal years 2003 and 2004, the Company expects to incur additional
employee-related restructuring costs associated with this initiative of
approximately $2.0 million to $3.0 million, reflecting an estimated displacement
of approximately 25 employees. Additionally, the Company expects to incur other
restructuring costs, such as contract termination costs, of approximately $2.0
million to $4.0 million.
11
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
Severance and employee benefits.......................... $ -- $1,907 $ -- $ -- $1,907
===== ====== ===== ===== ======
2002 Europe Reorganization Initiative
In November 2002, the Company announced a reorganization initiative in
Europe to realign the Company's resources with its European sales strategy to
improve customer service and reduce operating costs. This initiative affects the
Company's operations in several countries and involves moving from a country or
regional-based sales organization to a key account structure.
The Company recorded an initial charge of $1.6 million reflecting an
estimated displacement of 40 employees. As of May 25, 2003, approximately 39
employees have been displaced. The table below displays the activity and
liability balance of this reserve.
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
Severance and employee benefits.......................... $1,366 $ -- $(777) $ -- $589
======= ===== ====== ===== ====
2003 Europe Reorganization Initiative
During the second quarter of 2003, the Company finalized an additional
multi-country reorganization initiative in Europe to complete the realignment of
the Company's resources with its European sales strategy and further improve
customer service and reduce operating costs. During the second quarter of 2003,
the Company recorded in marketing, general and administrative expenses an
initial charge of $1.3 million reflecting the displacement of approximately 15
employees who were terminated as of May 25, 2003. The table below displays the
activity and liability balance of this reserve.
For 2003, the Company expects to incur additional employee-related costs
associated with this initiative of approximately $2.0 million to $4.0 million,
reflecting an estimated displacement of 20 employees.
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
Severance and employee benefits.......................... $ -- $1,339 $(414) $ -- $925
====== ====== ===== ===== ====
12
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
2002 U.S. PLANT CLOSURES
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
Company closed six manufacturing plants in 2002, displacing 3,540 employees.
For the six months ended May 25, 2003, the Company reversed charges of $9.5
million due to lower than anticipated costs associated with providing employee
benefits, lower than anticipated costs to sell or exit facilities and updated
estimates and assumptions related to the Company's contractors. The table below
displays the activity and liability balance of this reserve.
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
Severance and employee benefits............................ $48,891 $ -- $(29,567) $(1,401) $17,923
Other restructuring costs.................................. 13,198 -- (2,761) (8,108) 2,329
------- ----- -------- ------- -------
Total................................................. $62,089 $ -- $(32,328) $(9,509) $20,252
======= ===== ======== ======= =======
2001 Corporate 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. During the first quarter of 2003, the Company
reversed $0.2 million for lower than anticipated severance and benefit costs due
to attrition. The Company displaced approximately 325 employees as of May 25,
2003. The table below displays the activity and liability balance of this
reserve.
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
Severance and employee benefits............................ $2,121 $ -- $(1,505) $(210) $406
====== ===== ======= ===== ====
SUMMARY
The total balance of the reserves at May 25, 2003 was $24.1 million
compared to $65.6 million at November 24, 2002. The majority of the reserves are
expected to be utilized by the end of 2003. The following table summarizes the
activities and liability balances associated with the 2001 - 2003 plant closures
and reorganization initiatives:
November 24, May 25,
2002 Charges Reductions Reversals 2003
---- ------- ---------- --------- ----
(Dollars in Thousands)
2003 Europe Distribution Center Reorganization
Initiative............................................... $ -- $1,907 $ -- $ -- $ 1,907
2003 Europe Reorganization Initiative...................... -- 1,339 (414) -- 925
2002 Europe Reorganization Initiative...................... 1,366 -- (777) -- 589
2002 U.S. Plant Closures................................... 62,089 -- (32,328) (9,509) 20,252
2001 Corporate Restructuring Initiatives................... 2,121 -- (1,505) (210) 406
------- ------ -------- ------- -------
Restructuring Reserves................................ $65,576 $3,246 $(35,024) $(9,719) $24,079
======= ====== ======== ======= =======
13
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 4: FINANCING
Senior Notes Due 2012
On December 4, 2002, January 22, 2003 and January 23, 2003, the Company
issued a total of $575.0 million in notes to qualified institutional buyers in
reliance on Rule 144A under the Securities Act. These notes are unsecured
obligations that rank equally with all of the Company's other existing and
future unsecured and unsubordinated debt. They are 10-year notes maturing on
December 15, 2012 and bear interest at 12.25% per annum, payable semi-annually
in arrears on December 15 and June 15, commencing on June 15, 2003. The notes
are callable beginning December 15, 2007. These notes were offered at a net
discount of $3.7 million, which is being amortized over the term of the notes
using an approximate effective-interest rate method. Costs representing
underwriting fees and other expenses of approximately $18.0 million are recorded
as other assets and are being amortized over the term of the notes.
The Company used approximately $125.0 million of the net proceeds from the
notes offering to repay remaining indebtedness under its 2001 bank credit
facility and approximately $327.0 million of the net proceeds to purchase the
majority of the 6.80% notes due November 1, 2003. The Company intends to use the
remaining net proceeds to refinance (whether through payment at maturity,
repurchase or otherwise) the remainder of the 6.80% notes due November 1, 2003
and other outstanding indebtedness or for working capital or other general
corporate purposes. At May 25, 2003, $22.6 million were outstanding on the
notes.
The indenture governing these notes contain covenants that limit the
Company's and its subsidiaries' ability to incur additional debt; pay dividends
or make other restricted payments; consummate specified asset sales; enter into
transactions with affiliates; incur liens; impose restrictions on the ability of
a subsidiary to pay dividends or make payments to the Company and its
subsidiaries; merge or consolidate with any other person; and sell, assign,
transfer, lease, convey or otherwise dispose of all or substantially all of the
Company's assets or its subsidiaries' assets.
If the Company experiences a change in control as defined in the indenture
governing the notes, then the Company will be required under the indenture to
make an offer to repurchase the notes at a price equal to 101% of the principal
amount plus accrued and unpaid interest, if any, to the date of repurchase. If
these notes receive and maintain an investment grade rating by both Standard and
Poor's and Moody's and the Company and its subsidiaries are and remain in
compliance with the indenture, then the Company and its subsidiaries will not be
required to comply with specified covenants contained in the indenture.
Senior Notes Exchange Offer
In April 2003, the Company, as required under the registration rights
agreement it entered into when it issued the 12.25% notes due 2012, filed a
registration statement on Form S-4 under the Securities Act with the Securities
and Exchange Commission relating to an exchange offer for the Notes. The
exchange offer gave holders the opportunity to exchange the unregistered old
notes for new notes. The new notes are identical in all material respects to the
old notes except that the new notes are registered under the Securities Act. The
exchange offer closed on June 17, 2003. As a result of the exchange offer, all
but $9.1 million of the $575.0 million aggregate principal amount of old notes
were exchanged for new notes.
14
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Senior Secured Credit Facility
On January 31, 2003, the Company entered into a new $750.0 million senior
secured credit facility to replace the 2001 credit facility due August 2003. The
senior secured credit facility consists of a $375.0 million revolving credit
facility and a $375.0 million Tranche B term loan facility. As of May 25, 2003,
there were no outstanding borrowings under the revolving credit facility. Total
availability under the revolving credit facility was reduced by $168.6 million
of letters of credit allocated under the revolving credit facility, yielding a
net availability of $206.4 million. As of May 25, 2003, the principal balance of
the Tranche B term loan was $368.0 million. The Company uses the borrowings
under the senior secured credit facility for working capital and general
corporate purposes.
The $375.0 million revolving credit facility matures on March 31, 2006. The
Tranche B term loan facility is subject to repayment based on a specified
scheduled amortization, with the final payment of all amounts outstanding
thereunder due on July 31, 2006. The Company is required to make principal
amortization payments on the Tranche B term loan facility at a quarterly rate
beginning in May 2003, with the substantial majority of the quarterly payments
due from the quarter ending in November 2005. The senior secured credit facility
also requires mandatory prepayments in certain events, such as asset sales. The
interest rate for the revolving credit facility varied: for Eurodollar Rate
Loans, from 3.25% to 4.00% over the Eurodollar Rate (as defined in the credit
agreement) or, for Base Rate Loans, from 2.25% to 3.00% over the higher of (i)
the Citibank base rate and (ii) the Federal Funds rate plus 0.50% (the "Base
Rate"), with the exact rate depending upon performance under specified financial
criteria. The interest rate for the Tranche B term loan facility was 4.00% over
the Eurodollar Rate or 3.00% over the Base Rate. (See Note 11, "Subsequent
Event" for a description of an amendment to the credit facility.)
The senior secured credit facility requires that the Company segregates
sufficient funds to satisfy all principal and interest payments on the
outstanding 6.80% notes due November 2003 and allows for repurchase of these
bonds prior to their maturity. As of May 25, 2003, the segregated amount was
$23.4 million, which includes $0.8 million of accrued interest, and is
separately identified on the balance sheet as "Restricted cash."
The senior secured credit facility is guaranteed by certain of the
Company's material domestic subsidiaries and is secured by domestic inventories,
certain domestic equipment, trademarks, other intellectual property, 100% of the
stock in certain domestic subsidiaries, 65% of the stock of certain foreign
subsidiaries and other assets. Excluded from the assets securing the senior
secured credit facility are certain of the Company's real property interests and
all of the capital stock and debt of its affiliates in Germany and the United
Kingdom and any other affiliates that become restricted subsidiaries under the
indenture governing the Company's notes due 2003 and 2006.
The senior secured credit facility contains customary covenants restricting
the Company's activities as well as those of its subsidiaries, including
limitations on the Company's and its subsidiaries' ability to sell assets;
engage in mergers; enter into capital leases or certain leases not in the
ordinary course of business; enter into transactions involving related parties
or derivatives; incur indebtedness or grant liens or negative pledges on the
Company's assets; make loans or other investments; pay dividends or repurchase
stock or other securities; guaranty third party obligations; make capital
expenditures; and make changes in the Company's corporate structure. The senior
secured credit facility also contains financial covenants that the Company must
satisfy on an ongoing basis, including maximum leverage ratios and minimum
coverage ratios. As of May 25, 2003, the Company was in compliance with the
financial covenants under the senior secured credit facility. (See Note 11,
"Subsequent Event" for a description of an amendment to the credit facility.)
15
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
The senior secured credit facility contains customary events of default,
including payment failures; failures to satisfy other obligations under the
senior secured credit facility; material judgments; pension plan terminations or
specified underfunding; substantial voting trust certificate or stock ownership
changes; specified changes in the composition of the Company's board of
directors; and invalidity of the guaranty or security agreements. If an event of
default occurs, the Company's lenders could terminate their commitments, declare
immediately payable all borrowings under the credit facilities and foreclose on
the collateral, including the Company's trademarks.
6.80% Notes due November 1, 2003
During the first half of 2003, the Company purchased approximately $327
million in principal amount of the 6.80% notes due November 1, 2003 using
proceeds from the senior notes offering due 2012. Approximately $184 million of
this amount resulted from a tender offer made by the Company on April 8, 2003 to
purchase for cash any and all of the outstanding 6.80% notes at a purchase price
of $1,024.24 per $1,000.00 principal amount. The tender offer expired on May 7,
2003. At May 25, 2003, $22.6 million in principal amount of these notes were
outstanding. The senior secured credit facility requires that the Company
segregate funds in an amount sufficient to repay the notes at maturity
(including any interim scheduled interest payments). As of May 25, 2003, the
segregated amount was $23.4 million, which includes $0.8 million of accrued
interest, and is separately identified on the balance sheet as "Restricted
cash."
European Receivables Financing
On March 14, 2003, the Company terminated its European receivables
securitization agreements and repaid the outstanding of the then equivalent
amount of $54.3 million.
Short-Term Credit Lines and Stand-By Letters of Credit
At May 25, 2003, the Company had unsecured and uncommitted short-term
credit lines available totaling $35.3 million at various rates. These credit
arrangements may be canceled by the bank lenders upon notice and generally have
no compensating balance requirements or commitment fees.
At May 25, 2003 and November 24, 2002, the Company had $130.3 million and
$213.3 million, respectively, of stand-by letters of credit with various
international banks, of which $52.1 million and $48.5 million, respectively,
serve as guarantees by the creditor banks to cover U.S. workers' compensation
claims and $66.1 million of these stand-by letters of credit were issued under
the senior secured credit facility support short-term credit lines at May 25,
2003. The Company pays fees on the stand-by letters of credit. Borrowings
against the letters of credit are subject to interest at various rates.
Interest Rates on Borrowings
The Company's weighted average interest rate on average borrowings
outstanding during the three and six months ended May 25, 2003, including the
amortization of capitalized bank fees, interest rate swap cancellations and
underwriting fees, was 9.65% and 9.96%, respectively. The weighted average
interest rate on average borrowings outstanding excludes interest payable to
participants under deferred compensation plans and other miscellaneous items.
Dividends and Restrictions
Under the terms of the Company's senior secured credit facility, the
Company is prohibited from paying dividends to its stockholders. In addition,
the terms of certain of the indentures relating to the Company's unsecured
senior notes limit the Company's ability to pay dividends. There are no
restrictions under the Company's senior secured credit facility or its
indentures on the transfer of the assets of the Company's subsidiaries to the
Company in the form of loans, advances or cash dividends.
16
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 5: FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has determined the estimated fair value of certain financial
instruments using available market information and reasonable valuation
methodologies. However, this determination involves application of considerable
judgment in interpreting market data, which means that the estimates presented
herein are not necessarily indicative of the amounts that the Company could
realize in a current market exchange.
The carrying amount and estimated fair value (in each case including
accrued interest) of the Company's financial instrument assets and (liabilities)
at May 25, 2003 and November 24, 2002 are as follows:
May 25, 2003 November 24, 2002
------------ -----------------
Carrying Estimated Carrying Estimated
Value (1) Fair Value (1) Value (2) Fair Value (2)
----- ---------- ----- ----------
(Dollars in Thousands)
DEBT INSTRUMENTS:
U.S. dollar notes offering $(1,470,898) $(1,136,363) $(1,193,806) $(1,110,650)
Euro notes offering (147,856) (116,316) (130,933) (114,414)
Yen-denominated eurobond placement (172,897) (113,793) (167,134) (116,667)
Credit facilities (368,819) (368,819) (115,210) (115,210)
Domestic receivables-backed securitization (110,055) (110,055) (110,052) (110,052)
Customer service center equipment financing (69,441) (73,558) (73,203) (74,765)
European receivables-backed securitization -- -- (51,161) (51,161)
Industrial development revenue refunding bond (10,011) (10,011) (10,015) (10,015)
Short-term and other borrowings (24,564) (24,564) (22,150) (22,150)
----------- ----------- ----------- -----------
Total $(2,374,541) $(1,953,479) $(1,873,664) $(1,725,084)
=========== =========== =========== ===========
(1) Includes accrued interest of $60.1 million.
(2) Includes accrued interest of $26.7 million.
CURRENCY AND INTEREST RATE CONTRACTS:
Foreign exchange forward contracts $ (12,460) $ (12,460) $ (2,851) $ (2,851)
Foreign exchange option contracts -- -- -- --
----------- ----------- ----------- -----------
Total $ (12,460) $ (12,460) $ (2,851) $ (2,851)
=========== =========== =========== ===========
Quoted market prices or dealer quotes are used to determine the estimated
fair value of foreign exchange contracts, option contracts and interest rate
swap contracts. Dealer quotes and other valuation methods, such as the
discounted value of future cash flows, replacement cost and termination cost
have been used to determine the estimated fair value for long-term debt and the
remaining financial instruments. The carrying values of cash and cash
equivalents, trade receivables, current assets, certain current and non-current
maturities of long-term debt, short-term borrowings and taxes approximate fair
value.
The fair value estimates presented herein are based on information
available to the Company as of May 25, 2003 and November 24, 2002. These amounts
have not been updated since those dates and, therefore, the current estimates of
fair value at dates subsequent to May 25, 2003 and November 24, 2002 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.
17
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 6: COMMITMENTS AND CONTINGENCIES
FOREIGN EXCHANGE CONTRACTS
At May 25, 2003, the Company had U.S. dollar spot and forward currency
contracts to buy $728.2 million and to sell $297.3 million against various
foreign currencies. The Company also had euro forward currency contracts to buy
0.5 million euro against various foreign currencies and to sell 0.5 million euro
against various foreign currencies. These contracts are at various exchange
rates and expire at various dates until August 2003. The Company had no option
contracts outstanding at May 25, 2003.
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 consolidated financial position or
results of operations.
The operations and properties of the Company are designed to comply with
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 reasonably likely
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 7: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
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 recorded in 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 on
financial instruments 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, net."
The Company manages its net investment position in its subsidiaries in
major currencies by using swap contracts. Some of the contracts hedging these
net investments qualify for hedge accounting and the related gains and losses
are consequently included in the "Accumulated other comprehensive income (loss)"
section of Stockholders' Deficit. At May 25, 2003, the fair value of qualifying
net investment hedges was a $7.2 million net liability with the corresponding
unrealized loss recorded in "Accumulated other comprehensive income (loss)." At
May 25, 2003, $0.4 million realized loss has been excluded from hedge
effectiveness testing. In addition, the Company holds derivatives managing the
net investment positions in major currencies that do not qualify for hedge
accounting. The fair value of these derivatives at May 25, 2003 represented a
$0.4 million net liability, and changes in their fair value are included in
"Other (income) expense, net."
The Company designates a portion of its outstanding yen-denominated
Eurobond as a net investment hedge. As of May 25, 2003, a $2.1 million
unrealized gain related to the translation effects of the yen-denominated
Eurobond was recorded in "Accumulated other comprehensive income (loss)."
As of May 25, 2003, the Company holds no derivatives hedging forecasted
intercompany royalty flows that qualify as cash flow hedges. The Company does
enter 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, net."
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, net." The Company
offsets relevant daily cash flows by currency among its affiliates. As a result,
the Company hedges only its net foreign currency exposures with external
parties.
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, net."
19
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
Interest Rate Management
The Company is exposed to interest rate risk. It is the Company's policy
and practice to use derivative instruments to manage and reduce interest rate
exposures using a mix of fixed and variable rate debt. The Company currently has
no derivative instruments managing interest rate risk outstanding as of May 25,
2003.
The table below gives an overview of the realized and unrealized gains and
losses associated with foreign exchange and interest rate management activities
reported in "Other (income) expense, net."
Three Months Ended Six Months Ended
------------------ ----------------
May 25, 2003 May 26, 2002 May 25, 2003 May 26, 2002
------------ ------------ ------------ ------------
Other (income) expense, net Other (income) expense, net Other (income) expense, net Other (income) expense,net
--------------------------- --------------------------- --------------------------- --------------------------
Realized Unrealized Realized Unrealized Realized Unrealized Realized Unrealized
-------- ---------- -------- ---------- -------- ---------- -------- ----------
(Dollars in Thousands) (Dollars in Thousands)
Foreign Exchange
Management $18,615 $2,318 $(7,850) $28,642 $54,751 $2,564 $(5,245) $26,399
======= ====== ======= ======= ======= ====== ======= =======
Interest Rate
Management $ - $ - $ - $ - $ - $ - $2,266 (1) $(2,266)
======= ====== ======= ======= ======= ====== ======= =======
(1) Recorded as an increase to interest expense
The table below gives an overview of the realized and unrealized gains and
losses associated with foreign exchange management activities that are reported
in "Accumulated other comprehensive income (loss)" ("Accumulated OCI") balances.
Accumulated OCI is a section of Stockholders' Deficit.
May 25, 2003 November 24, 2002
------------ -----------------
Accumulated OCI gain (loss) Accumulated OCI gain (loss)
--------------------------- ---------------------------
Realized Unrealized Realized Unrealized
-------- ---------- -------- ----------
(Dollars in Thousands)
Foreign Exchange Management
Net Investment Hedges
Derivative Instruments $21,295 $(7,140) $39,818 $ (96)
Yen Bond - 2,116 - 5,277
Cumulative income taxes (7,879) 1,858 (14,732) (1,917)
------- ------- ------- ------
Total $13,416 $(3,166) $25,086 $3,264
======= ======= ======= ======
The table below gives an overview of the fair values of derivative
instruments associated with our foreign exchange management activities that are
reported as an asset or (liability).
May 25, November 24,
2003 2002
---- ----
Fair value Fair value
asset (liability) asset (liability)
----------------- -----------------
(Dollars in Thousands)
Foreign Exchange Management $(12,460) $(2,851)
======== =======
20
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 8: GUARANTEES
In the ordinary course of business, the Company enters into agreements
containing indemnification provisions pursuant to which the Company agrees to
indemnify the other party for specified claims and losses. For example, the
Company's trademark license agreements, real estate leases, consulting
agreements, logistics outsourcing agreements, securities purchase agreements and
credit agreements typically contain such provisions. This type of
indemnification provision obligates the Company to pay certain amounts
associated with claims brought against the other party as the result of
trademark infringement, negligence or willful misconduct of Company employees,
breach of contract by the Company including inaccuracy of representations and
warranties, specified lawsuits in which the Company and the other party are
co-defendants, product claims and other matters. These amounts are generally not
readily quantifiable: the maximum possible liability or amount of potential
payments that could arise out of an indemnification claim depends entirely on
the specific facts and circumstances associated with the claim. The Company has
insurance coverage that minimizes the potential exposure to certain of such
claims. The Company also believes that the likelihood of significant payment
obligations to third parties is remote and that any such amounts would be
immaterial.
The Company is party to agreements containing guarantee provisions related
to profit levels of certain European franchise retail stores over a five-year
period ending in November 2005. Under the agreements, the Company must make a
payment to the franchisee if the aggregate income before taxes in any year for
the particular retail stores, as defined in the agreement, is less than
approximately $0.5 million. The maximum potential payment under the agreement
for each fiscal year through November 2005 is based on the maximum annual fixed
costs of the store's operations and is estimated to be approximately $3 million.
Amounts paid to date related to this agreement are immaterial.
NOTE 9: DEFERRED COMPENSATION PLAN
On January 1, 2003, the Company adopted a nonqualified deferred
compensation plan ("Plan") for executives and outside directors. As of May 25,
2003, Plan liabilities totaled $25.8 million, a portion of which approximately
$3.5 million is funded by an irrevocable grantor's trust ("Rabbi Trust")
established on January 1, 2003. The Plan obligations are payable in cash upon
retirement, termination of employment and/or certain other times in a lump-sum
distribution or in installments, as elected by the participant in accordance
with the Plan.
The obligations of the Company under the Rabbi Trust consist of the
Company's unsecured contractual commitment to deliver, at a future date, any of
the following: (i) deferred compensation credited to an account under the Rabbi
Trust, (ii) additional amounts, if any, that the Company may, from time to time,
credit to the Rabbi Trust, and (iii) notional earnings on the foregoing amounts.
In the event that the fair market value of the Rabbi Trust assets as of any
valuation date before a change of control is less than 90% of the Rabbi Trust
funding requirements on such date, the Company must make an additional
contribution to the Rabbi Trust in an amount sufficient to bring the fair market
value of the assets in the Rabbi Trust up to 90% of the trust funding
requirement. The Rabbi Trust assets are subject to the claims of the Company's
creditors in the event of the Company's insolvency. The assets of the Rabbi
Trust and the Company's liability to the Plan participants are reflected in
"Other long-term assets" and "Long-term employee related benefits,"
respectively, on the Company's consolidated balance sheet. The securities that
comprise the assets of the Rabbi Trust are designated as trading securities
under SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities." Changes in the fair value of the securities are recorded in "Other
(income) expense, net." Changes in the liabilities are included in "Marketing,
general and administrative expenses."
21
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 10: BUSINESS SEGMENT INFORMATION
The Company manages its apparel business, based on geographic regions
consisting of the Americas, which includes the U.S., Canada and Latin America;
Europe, the Middle East and Africa; and Asia Pacific. All Other consists of
functions that are directed by the corporate office and are not allocated to a
specific geographic region.
The Company evaluates performance and allocates resources based on regional
profits or losses. Regional profits, or earnings contribution, exclude net
interest expense, special compensation program expenses, restructuring charges,
net of reversals and expenses that are controlled at the corporate level.
Management financial information for the Company is as follows:
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
THREE MONTHS ENDED MAY 25, 2003:
Net sales....................................... $560,610 $261,161 $108,259 $ -- $930,030
Earnings contribution........................... 27,200 26,500 17,700 -- 71,400
Interest expense................................ -- -- -- 63,346 63,346
Corporate and other expense, net................ -- -- -- 29,982 29,982
Income (loss) before income taxes............ -- -- -- -- (21,928)
THREE MONTHS ENDED MAY 26, 2002:
Net sales....................................... $596,697 $241,373 $ 85,448 $ -- $923,518
Earnings contribution........................... 84,215 45,304 15,189 -- 144,708
Interest expense................................ -- -- -- 42,510 42,510
Corporate and other expense, net................ -- -- -- 236,034 236,034
Income (loss) before income taxes............ -- -- -- -- (133,836)
Asia All
Americas Europe Pacific Other Consolidated
-------- ------ ------- ----- ------------
(Dollars in Thousands)
SIX MONTHS ENDED MAY 25, 2003:
Net sales....................................... $1,074,777 $535,531 $194,811 $ -- $1,805,119
Earnings contribution........................... 49,700 69,200 34,900 -- 153,800
Interest expense................................ -- -- -- 123,026 123,026
Corporate and other expense, net................ -- -- -- 92,851 92,851
Income (loss) before income taxes............ -- -- -- -- (62,077)
SIX MONTHS ENDED MAY 26, 2002:
Net sales....................................... $1,198,037 $501,998 $158,767 $ -- $1,858,802
Earnings contribution........................... 164,202 105,328 29,264 -- 298,794
Interest expense................................ -- -- -- 90,533 90,533
Corporate and other expense, net................ -- -- -- 274,681 274,681
Income (loss) before income taxes............ -- -- -- -- (66,420)
22
LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(Unaudited)
NOTE 11: SUBSEQUENT EVENT
On June 25, 2003, the Company amended its senior secured credit facility to
increase the maximum permitted consolidated leverage ratio for the third quarter
of 2003 and delay the scheduled tightening of the consolidated interest coverage
ratio, consolidated leverage ratio and consolidated fixed charge coverage ratio
covenants as follows:
o the maximum permitted consolidated leverage ratio is 6.25 times
Consolidated EBITDA (as defined in the credit agreement) ("EBITDA") on
the last day of June and July 2003, decreases progressively to 5.10
times EBITDA as of the end of November 2003 and decreases progressively
thereafter to be 3.00 times EBITDA as of the end of March 2006 and
thereafter;
o the minimum consolidated interest coverage ratio is 1.75 times EBITDA
through the fiscal quarter ended February 2004, 1.90 times EBITDA for
the fiscal quarter ended May 2004, 2.00 times EBITDA for the fiscal
quarters ended August and November 2004, 2.25 times EBITDA for all four
fiscal quarters in 2005 and 2.50 times EBITDA for the fiscal quarters
ended February, May and August 2006;
o the minimum consolidated fixed charge coverage ratio is 1.00 times
EBITDA for the fiscal quarters ended February and May 2003, 1.20 times
EBITDA for the fiscal quarters ending August and November 2003 and is
then reduced to 1.10 times EBITDA through the fiscal quarter ended
February 2004; the ratio increases to 1.25 times EBITDA for the
remaining fiscal quarters of 2004 and the first three fiscal quarters
of 2005 and thereafter through the fiscal quarter ending August 2006 is
1.00 times EBITDA; and
o no change was made to the senior secured leverage ratio.
The amendment to the senior secured credit facility increased the Company's
interest rates by 25 basis points. The interest rate for the revolving credit
facility varies: for Eurodollar Rate Loans and Letters of Credit, from 3.50% to
4.25% over the Eurodollar Rate (as defined in the credit agreement) or, for Base
Rate Loans, from 2.50% to 3.25% over the higher of (i) the Citibank base rate
and (ii) the Federal Funds rate plus 0.50% (the "Base Rate"), with the exact
rate in each case depending upon performance under specified financial criteria.
The interest rate for the Tranche B term loan facility is 4.25% over the
Eurodollar Rate or 3.25% over the Base Rate. The amendment also altered certain
definitions relative to the financial ratios, including amending the definition
of Consolidated EBITDA to revise the treatment of restructuring and
restructuring related charges.
23
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.
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 Six Months Ended
------------------ ----------------
May 25, May 26, May 25, May 26,
2003 2002 2003 2002
---- ---- ---- ----
Net sales...................................................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold............................................. 58.7 60.0 58.8 58.7
----- ----- ----- -----
Gross profit................................................... 41.3 40.0 41.2 41.3
Marketing, general and administrative expenses................. 36.9 34.5 36.9 33.2
Other operating (income)....................................... (1.0) (0.9) (0.9) (0.8)
Restructuring charges, net of reversals........................ (0.6) 15.3 (0.5) 7.6
----- ----- ----- -----
Operating income (loss)........................................ 6.1 (8.9) 5.8 1.3
Interest expense............................................... 6.8 4.6 6.8 4.9
Other (income) expense, net.................................... 1.6 1.0 2.4 0.0
----- ----- ----- -----
Income (loss) before taxes..................................... (2.4) (14.5) (3.4) (3.6)
Income tax expense (benefit)................................... (0.9) (6.3) (1.3) (1.8)
----- ----- ----- -----
Net income (loss).............................................. (1.4)% (8.2)% (2.1)% (1.8)%
==== ==== ==== ====
Three Months Ended Six Months Ended
------------------ ----------------
May 25, May 26, May 25, May 26,
2003 2002 2003 2002
---- ---- ---- ----
NET SALES SEGMENT DATA:
Geographic
Americas................................................ 60.3% 64.6% 59.5% 64.5%
Europe.................................................. 28.1 26.1 29.7 27.0
Asia Pacific............................................ 11.6 9.3 10.8 8.5
Consolidated net sales. Net sales for the three months ended May 25, 2003
increased 0.7% to $930.0 million, as compared to $923.5 million for the same
period in 2002. Net sales for the six months ended May 25, 2003 decreased 2.9%
to $1,805.1 million, as compared to $1,858.8 million for the same period in
2002. If currency exchange rates were unchanged from the prior year periods, net
sales would have decreased approximately 4.7% and 8.0% for the three and six
months ended May 25, 2003, respectively. The decreases in constant currency
sales for the three and six months ended May 25, 2003 compared to the prior year
periods reflect the weak economic and retail climates, reduced consumer
confidence and pricing pressures in most markets in which we operate.
As a result of the weak economic and retail conditions in most major
markets around the world, with no indication of improvement in the near future,
we anticipate that full year 2003 net sales on a constant currency basis will be
approximately flat compared to 2002. We expect sales growth in the second half
of 2003 to offset the sales decrease in the first half of 2003. We expect our
sales growth for the second half of 2003 to be driven primarily by our
introduction of the Levi Strauss Signature(TM) brand in Wal-Mart Stores, Inc. in
the United States. Later in 2003, we will introduce the Levi Strauss
Signature(TM) brand into the mass channel in Canada and several countries in the
Asia Pacific region, and we plan to launch in Europe in 2004.
24
Americas net sales. In the Americas, net sales for the three months ended
May 25, 2003 decreased 6.0% to $560.6 million, as compared to $596.7 million for
the same period in 2002. Net sales for the six months ended May 25, 2003
decreased 10.3% to $1,074.8 million, as compared to $1,198.0 million for the
same period in 2002. If currency exchange rates were unchanged from 2002, net
sales would have declined 5.5% and 9.8% for the three and six months ended May
25, 2003, respectively, compared to the same periods in 2002.
We believe the decline in Americas net sales was driven by a number of
factors, including the following:
o persistently soft market conditions, particularly in men's apparel,
which accounts for a large part of our business;
o depressed retail sales due to sagging consumer spending;
o inventory reduction initiatives following a poor first quarter for
retailers;
o cancellations of both Levi's(R) and Dockers(R) sales orders attributable
to adverse retail conditions;
o weaker than anticipated response to Levi's(R) Type 1(TM) jeans in the
United States; and
o the impact of selective wholesale price reductions and higher sales
promotions and incentives offered to our retail customers to improve
their economics.
In this difficult retail environment, we continue to focus on providing
innovative product to consumers in every channel of distribution. We have nearly
completed our product line transitions and overhauls in our core Levi's(R) and
Dockers(R) brands, and in the Dockers(R) brand, our Go Khaki! with Stain
Defender(TM) products are performing well. With the rollout of the Levi Strauss
Signature(TM) brand, our products will be available to consumers in nearly all
channels of distribution, from high-end specialty stores to department and chain
stores, as well as to mass merchants.
Europe net sales. In Europe, net sales for the three months ended May 25,
2003 increased 8.2% to $261.2 million, as compared to $241.4 million for the
same period in 2002. Net sales for the six months ended May 25, 2003 increased
6.7% to $535.5 million, as compared to $502.0 million for the same period in
2002. On a constant currency basis, net sales would have decreased by
approximately 10.3% and 10.7% for the three and six months ended May 25, 2003,
respectively, compared to the same periods in 2002.
Europe net sales have been impacted by similar market conditions to those
in the United States. In some European markets, conditions have been more severe
than in the United States. These market conditions include weak economies, low
consumer confidence, price deflation in apparel, and a depressed retail
environment. These conditions particularly impacted our core replenishment
business in the region, specifically replenishment of the 501(R) jeans, as
retailers have adopted more conservative purchasing patterns to reduce high
inventory levels. A less favorable product mix also contributed to our constant
currency sales decrease in the second quarter of 2003 as retail customers turned
to a higher proportion of lower priced products.
In Europe, we are introducing product and marketing initiatives to drive
demand in our business. The Levi's(R) Type 1(TM) jeans product line and a new
updated fit for Levi's(R) 501(R) jeans have received positive response from
European consumers.
Asia Pacific net sales. In our Asia Pacific region, net sales for the three
months ended May 25, 2003 increased 26.7% to $108.3 million, as compared to
$85.4 million for the same period in 2002. Net sales for the six months ended
May 25, 2003 increased 22.7% to $194.8 million, as compared to $158.8 million
for the same period in 2002. If exchange rates were unchanged from the prior
year periods, net sales would have increased approximately 17.2% and 14.6% for
the three and six months ended May 25, 2003, respectively.
In some countries in the region, we continued to report double-digit net
sales increases for the three and six months ended May 25, 2003 compared to the
same periods in 2002, and these increases more than offset lower sales in other
countries in the region that are facing difficult retail conditions. In Japan,
which accounted for approximately 55% of our business in the Asia Pacific region
for the first half of 2003, net sales for the three and six months ended May 25,
2003 increased approximately 20% and 22%, respectively, on a constant currency
basis compared to the same periods in 2002. Sales growth reflected the positive
impact of our new products, improved retail presentation and our ability to
reach more consumers with a broader range of price points. The results in Japan
also reflected the opening of additional independently owned retail stores
dedicated to the Levi's(R) brand. Levi's(R) Type 1(TM) products and the
revitalized 501(R) jeans have performed well in the region.
25
Gross profit. Gross profit for the three months ended May 25, 2003 was
$384.6 million compared with $369.5 million for the same period in 2002. Gross
profit for the six months ended May 25, 2003 was $744.0 million compared with
$768.1 million for the same period in 2002. For the three and six months ended
May 25, 2003, gross profit benefited from the translation impact of the stronger
foreign currency of approximately $27 million and $48 million, respectively.
Gross profit as a percentage of net sales, or gross margin, for the three months
ended May 25, 2003 increased to 41.3% compared to 40.0% for the same period in
2002. Gross margin for the six months ended May 25, 2003 was 41.2%, essentially
flat compared to 41.3% for the same period in 2002.
Factors impacting our gross margin included the following:
o gross margin does not include, as in prior periods, postretirement
medical benefits related to manufacturing employees: because we
have closed most of our manufacturing plants in the U.S., these
costs, which totaled approximately $13 million and $23 million for
the three and six months ended May 25, 2003, respectively, are now
reflected in marketing, general and administrative expenses;
o gross margin benefited from improvements in the process of
estimating potential excess inventory, resulting in a reduction of
inventory valuation reserves by approximately $6 million and $11
million for the three and six months ended May 25, 2003,
respectively; at May 25, 2003, inventory valuation reserves were
$61.5 million;
o stronger foreign currency resulted in lower sourcing costs than in
2002 because the majority of our cost of fabric is
dollar-denominated;
o cost savings from our 2002 plant closures were invested in
retailer sales promotions and incentives, and product innovation;
and
o for the three and six months ended May 26, 2002, expenses of $30.1
million, representing 3.3% and 1.6%, respectively, of sales, were
incurred primarily for workers' compensation and pension
enhancements in the U.S. associated with plant closures in the
U.S. and Scotland, and these expenses adversely impacted gross
margin.
Taking all of the above factors into account, gross margins for the three
and six months ended May 25, 2003, were lower compared to the same periods last
year. In response to demanding market conditions, we plan to continue to invest
in product innovation and better economics for our retail customers. However, we
continue to expect that our gross margin for the full year 2003 will be
approximately 40% to 42%.
Cost of goods sold is primarily comprised of cost of materials, labor and
manufacturing overhead, and also includes the cost of inbound freight, internal
transfers, and receiving and inspection at manufacturing facilities as these
costs vary with product volume. We include substantially all the costs related
to receiving and inspection at distribution centers, warehousing and other
activities associated with our distribution network in marketing, general and
administrative expenses. Our gross margins may not be comparable to those of
other companies in our industry, since some companies may include costs related
to their distribution network in cost of goods sold.
Marketing, general and administrative expenses. Marketing, general and
administrative expenses for the three months ended May 25, 2003 increased 7.7%
to $343.4 million compared to $318.8 million for the same period in 2002, and
for the six months ended May 25, 2003 increased 8.0% to $666.9 million compared
to $617.7 million for the same period in 2002. As a percentage of sales, these
expenses increased to 36.9% for the three months ended May 25, 2003 compared to
34.5% for the same period in 2002, and to 36.9% for the six months ended May 25,
2003 compared to 33.2% for the same period last year.
The following factors impacted the increase in marketing, general and
administrative expenses for the three and six months ended May 25, 2003:
o the foreign currency translation impact of approximately $21
million and $36 million for the three and six months ended May
25, 2003, respectively;
o postretirement medical benefits related to manufacturing employees
as discussed above under "Gross profit;" and
o expenses associated with our entry into the mass channel.
26
In addition, for the six months ended May 25, 2003, we recorded a
cumulative adjustment to recognize rent expense on a straight-line basis over
the lease terms, which resulted in a non-recurring, non-cash charge of
approximately $21 million. We believe that the cumulative effect of the
non-recurring, non-cash charge is not material to our historical operations in
any period or to the trend of reported results of operations.
For the three and six months ended May 25, 2003, marketing, general and
administrative expenses also included long-term incentive compensation expense
of $19 million and $38 million, respectively. Offsetting these items were
reversals of expenses recognized in prior periods of approximately $27 million
and $49 million for the three and six months ended May 25, 2003, respectively,
reflecting the aggregate change in expected payouts. As a result, we recognized
a net expense reduction of $8 million and $11 million for the three and six
months ended May 25, 2003, respectively. For the three and six months ended May
26, 2002, long-term incentive compensation expense was $20 million and $40
million, respectively. For the three and six months ended May 25, 2003,
marketing, general and administrative expenses also include annual incentive
compensation expense of $2 million and $4 million, respectively. Offsetting
these items were reversals of expenses recognized in prior periods of
approximately $7 million and $4 million for the three and six months ended May
25, 2003, respectively, reflecting the aggregate change in expected payouts. As
a result, we recognized a net expense reduction of $5 million for the three
months ended May 25, 2003, causing a net expense of $0 for the six months ended
May 25, 2003. For the three and six months ended May 26, 2002, annual incentive
compensation expense was $6.9 million and $17.4 million, respectively.
Advertising expense for the three months ended May 25, 2003 increased 24.5%
to $86.7 million, compared to $69.6 million for the same period in 2002.
Advertising expense for the six months ended May 25, 2003 increased 14.5% to
$155.5 million, compared to $135.7 million for the same period in 2002.
Advertising expense as a percentage of sales for the three months ended May 25,
2003 increased to 9.3%, compared to 7.5% for the same period in 2002, and for
the six months ended May 25, 2003 increased to 8.6%, compared to 7.3% for the
same period in 2002. Advertising expense for the three and six months ended May
25, 2003 reflected a foreign currency translation impact of approximately $8
million and $12 million, respectively. In addition, we accelerated our marketing
initiatives for Levi's(R) Type 1(TM) jeans to support the launch of this line in
Europe, which resulted in costs of approximately $15 million during the second
quarter of 2003. We continue to expect that full year 2003 advertising expense
as a percentage of sales will be in the range of 7% to 8%.
Marketing, general and administrative expenses also include distribution
costs, such as costs related to receiving and inspection at distribution
centers, warehousing, shipping, handling and certain other activities associated
with our distribution network. These expenses for the three and six months ended
May 25, 2003 were $52.0 million and $97.3 million, respectively, compared to
$44.7 million and $87.8 million for the same periods last year. The increases
were primarily due to expenses associated with our entry into the mass channel.
We expect full year 2003 marketing, general and administrative expenses as
a percentage of sales to be in the range of 32% to 34%.
Other operating income. Licensing income for the three months ended May 25,
2003 increased 14.6% to $9.8 million compared to $8.5 million for the same
period in 2002. Licensing income for the six months ended May 25, 2003 increased
16.7% to $17.1 million compared to $14.6 million for the same period in 2002.
The increases reflect a higher number of licensees, higher sales of licensed
accessories such as hosiery, footwear and sleepwear, and the introduction of
licensed bed and bath products.
Restructuring charges, net of reversals. For the three and six months ended
May 25, 2003 we had reversals of $5.5 million and $9.7 million, respectively, of
previously recorded restructuring charges relating to prior years'
reorganization initiatives. For the three and six months ended May 26, 2002 we
had restructuring charges, net of reversals, of $141.1 million, primarily
associated with the closure of manufacturing plants in 2002. (See "Restructuring
charges, net of reversals" below.)
Operating income (loss). Operating income for the three months ended May
25, 2003 was $56.4 million compared to an operating loss of $(81.8) million for
the same period in 2002. Operating income for the six months ended May 25, 2003
was $103.9 million compared to $23.9 million for the same period in 2002.
Operating income as a percentage of sales, or operating margin, was 6.1% for the
three months ended May 25, 2003 compared to (8.9)% for the same period last
year, and 5.8% for the six months ended May 25, 2003 compared to 1.3% for the
same period last year.
27
For the three and six months ended May 26, 2002, operating income (loss)
included restructuring charges, net of reversals of $141.1 million and
restructuring related expenses of $30.1 million primarily associated with the
closure of manufacturing plants that year. For the three and six months ended
May 25, 2003, operating income included a reversal of $5.5 million and $9.7
million, respectively, associated with restructuring charges relating to prior
years' restructuring initiatives. Excluding the restructuring charges, net of
reversals and related expenses, operating income for the three months ended May
25, 2003 was $51 million, resulting in a 5.5% operating margin, and $89 million,
resulting in a 9.7% operating margin for the same period last year. Excluding
the restructuring charges, net of reversals and related expenses, operating
income for the six months ended May 25, 2003 was $94 million, resulting in a
5.2% operating margin, compared to $195 million, and a 10.5% operating margin,
for the same period last year.
The decrease in operating income for the three and six months ended May 25,
2003 was primarily attributable to lower sales, lower gross margin and an
increase in marketing, general and administrative expenses. We expect full year
2003 operating margin to be in the range of 8% to 10%. In addition, depreciation
and amortization expense for the full year 2003 is expected to be in the range
of $60 million to $65 million.
Interest expense. Interest expense for the three months ended May 25, 2003
increased 49.0% to $63.3 million compared to $42.5 million for the same period
in 2002. Interest expense for the six months ended May 25, 2003 increased 35.9%
to $123.0 million compared to $90.5 million for the same period in 2002. The
higher interest expense was primarily due to higher average debt balances and
higher effective interest rates in 2003.
The weighted average cost of borrowings for the three months ended May 25,
2003 and May 26, 2002 was 9.65% and 8.33%, respectively. The weighted average
cost of borrowings for the six months ended May 25, 2003 and May 26, 2002 was
9.96% and 8.82%, respectively, excluding the write-off of fees. The increase in
the weighted average interest rate reflects the issuance during the first
quarter of 2003 of $575 million of senior notes due 2012 at an interest rate of
12.25%. The weighted average interest rate on average borrowings outstanding
excludes interest payable to participants under unfunded deferred compensation
plans and other items.
Other (income) expense, net. Significant components of other (income)
expense, net are summarized below:
Three Months Ended Six Months Ended
------------------ ----------------
May 25, May 26, May 25, May 26,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in Thousands)
Currency transaction (gains) losses, net............ $14,151 $11,495 $40,602 $ 5,564
Interest (income)................................... (1,168) (608) (2,659) (1,057)
(Gains) losses on disposal of assets, net........... (1,950) (975) (6,109) (771)
Loss on early extinguishment of debt................ 5,568 -- 14,395 --
Other............................................... (1,607) (413) (3,325) (3,914)
------- ------- ------- -------
Total............................................. $14,994 $ 9,499 $42,904 $ (178)
======= ======= ======= =======
Currency transaction (gains) losses include net losses of our foreign
exchange management contracts of $20.9 million and $20.8 million for the three
months ended May 25, 2003 and May 26, 2002, respectively. For the six months
ended May 25, 2003 and May 26, 2002, net losses on foreign exchange management
contracts were $57.3 million and $21.2 million, respectively. The remaining
amounts primarily reflect net gains resulting from remeasurement of foreign
currency transactions. The increase in interest income for the three and six
months ended May 25, 2003 was predominately due to an increase in cash
investments as a result of our 2003 refinancing activities. The net gain on
disposal of assets for the three and six months ended May 25, 2003 was primarily
related to the sale of fixed assets associated with our 2002 U.S. plant
closures. The loss on early extinguishment of debt for the three months ended
May 25, 2003 primarily related to the purchase of $327 million of our 6.80%
notes due November 1, 2003. The loss on early extinguishment of debt for the six
months ended May 25, 2003 primarily related to unamortized bank fees associated
with refinancing our 2001 bank credit facility and the purchase of $327 million
of the 6.80% notes.
28
Income tax expense (benefit). Income tax benefit was $(8.6) million for the
three months ended May 25, 2003 compared to $(58.2) million for the same period
in 2002. Income tax benefit was $(24.2) million for the six months ended May 25,
2003 compared to $(33.2) million for the same period in 2002. Our effective
income tax rate was 39.0% for the three and six months ended May 25, 2003
compared to 43.5% for the three months ended May 26, 2002 and 50.0% for the six
months ended May 26, 2002. The higher effective income tax rate in 2002
reflected the computational effect of expenses not deductible for tax purposes
on the lower earnings base for the full year 2002 due to restructuring charges,
net of reversals and related expenses.
Net income (loss). Net loss for the three months ended May 25, 2003 was
$(13.4) million compared to $(75.7) million for the same period in 2002. Net
loss for the six months ended May 25, 2003 was $(37.9) million compared to
$(33.2) million for the same period in 2002. The net loss for the three and six
months ended May 25, 2003 primarily reflected lower sales, lower gross margin,
higher marketing, general and administrative expenses, higher interest expense
and the impact of currency volatility on our foreign exchange management
activities. The net loss for the three and six months ended May 26, 2002
reflected significant restructuring charges, net of reversals and related
expenses.
RESTRUCTURING CHARGES, NET OF REVERSALS
Europe Distribution Center Reorganization Initiative
As of May 25, 2003, we evaluated the impact of a reorganization initiative
in Europe to streamline the distribution center activity and reduce operating
costs in France, Belgium and Holland. During the second quarter of 2003, we
reached an agreement for the severance packages of the French employees impacted
by the initiative and recorded in marketing, general and administrative expenses
an initial charge of $1.9 million associated with the displacement of
approximately 45 employees. For fiscal years 2003 and 2004, we expect to incur
additional employee-related restructuring costs associated with this initiative
of approximately $2.0 million to $3.0 million, reflecting an estimated
displacement of approximately 25 employees. We also expect to incur other
restructuring costs, such as contract termination costs, of approximately $2.0
million to $4.0 million.
Europe Reorganization Initiative
In November 2002, we announced a reorganization initiative in Europe that
includes realigning our resources with our European sales strategy to improve
customer service and reduce operating costs. This strategy affects our
operations in several countries and involves moving from a country or
regional-based sales organization to a key account structure. We recorded an
initial charge of $1.6 million reflecting an estimated displacement of 40
employees.
During the second quarter of 2003, we finalized an additional
multi-country reorganization initiative in Europe to complete the realignment of
our resources with our European sales strategy and further improve customer
service and reduce operating costs. During the second quarter of 2003, we
recorded in marketing, general and administrative expenses an initial charge of
$1.3 million reflecting the displacement of approximately 15 employees who were
terminated as of May 25, 2003. For 2003, we expect to incur additional
employee-related costs associated with this initiative of approximately $2.0
million to $4.0 million, reflecting an estimated displacement of 20 employees.
U.S. Plant Closures
For the six 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 six manufacturing plants were closed in 2002.
For the three and six months ended May 25, 2003, we reversed charges of $5.5
million and $9.5 million, respectively, due to lower than anticipated costs
associated with providing employee benefits, lower than anticipated costs to
sell or exit facilities, and updated estimates and assumptions relating to our
sewing and finishing contractors.
29
Corporate Restructuring Initiative
In November 2001, we instituted various reorganization initiatives in the
U.S. to simplify product lines and realign resources to those product lines.
During the first quarter of 2003, we reversed $0.2 million for lower than
anticipated severance and benefit costs due to attrition.
The total balance of the reserves at May 25, 2003 was $24.1 million
compared to $65.6 million at November 24, 2002. The majority of the reserves are
expected to be utilized by the end of 2003. The following table summarizes the
activities and liability balances associated with the plant closures and
restructuring initiatives:
May 25, November 24,
2003 2002
---- ----
(Dollars in Thousands)
2003 Europe Distribution Center Reorganization Initiative............ $ 1,907 $ --
2003 Europe Reorganization Initiative................................ 925 --
2002 Europe Reorganization Initiative................................ 589 1,366
2002 U.S. Plant Closures............................................. 20,252 62,089
2001 Corporate Restructuring Initiatives............................. 406 2,121
------ -------
Total........................................................... $24,079 $65,576
======= =======
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements have been to fund working capital and
capital expenditures. As of May 25, 2003, total cash and cash equivalents,
including restricted cash, was $144.4 million, a $47.9 million increase from the
$96.5 million cash balance reported as of November 24, 2002. The increase
reflected the issuance in the first quarter of 2003 of the 12.25% senior
unsecured notes due 2012 and entry into the senior secured credit facility. The
increase was partially offset by purchases of the 6.80% notes due November 2003.
Under the senior secured credit facility, we are required to have funds
segregated in an amount sufficient to repay the 6.80% notes due November 1, 2003
at maturity (including any interim scheduled interest payments). As of May 25,
2003, this amount was $23.4 million and is separately identified on the balance
sheet as "Restricted cash."
As of May 25, 2003, our senior secured credit facility consisted of $368.0
million of term loans and a $375.0 million revolving credit facility. There were
no outstanding borrowings under the revolving credit facility. Total
availability under the revolving credit facility was reduced by $168.6 million
of letters of credit allocated under the revolving credit facility, yielding a
net availability of $206.4 million. Included in the $168.6 million of letters of
credit at May 25, 2003 were $130.3 million of standby letters of credit with
various international banks, of which $52.1 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.
At May 25, 2003, we had unsecured and uncommitted short-term credit lines
available totaling $35.3 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.
Debt, net of cash on hand was $2.2 billion as of May 25, 2003. This
reflected an increase of $420 million since November 24, 2002. The main reasons
for this increase in debt were as follows:
o we made payments to employees for our annual and long-term incentive
compensation programs of approximately $100 million;
o we paid $159 million for income taxes that included $110 million for
the settlement of most issues related to tax years 1990 - 1995 as
discussed below;
o our cash outlay for restructuring initiatives was $35 million;
o we made interest payments of $78 million;
o we paid $35 million for capital expenditures;
o the foreign currency translation impact of our Yen and Euro
denominated debt increased our debt level by approximately $22
million; and
o net working capital was primarily unchanged, reflecting increases in
inventories, offset by lower accounts receivable and accounts
payable.
30
We expect 2003 year-end debt less cash on hand to be approximately $250
to $300 million higher than the 2002 year-end debt less cash on hand, in light
of continuing weak economic and retail conditions worldwide. We expect our 2003
debt less cash on hand to peak in the third quarter at approximately $600
million higher than the 2002 year-end level, less cash on hand. The anticipated
peak debt level principally results from seasonal working capital needs, an
increase in accounts receivable and inventories, and growth associated with our
entry into the mass channel in the United States, as well as the factors listed
above. We expect third quarter 2003 cash from operations will not be sufficient
to cover the expected increases in working capital, but that we will have
adequate liquidity to absorb increased debt during the second half of 2003.
During 2002, we reached a settlement with the Internal Revenue Service on
most of the issues in connection with the examination of our income tax returns
for the years 1990 through 1995. As a result, we made a net payment of
approximately $110 million to the Internal Revenue Service in March 2003. Our
consolidated U.S. income tax returns for the years 1996 to 1999, and certain
open issues relating to earlier years, are presently under examination by the
Internal Revenue Service. We cannot assure you that we will be able to reach a
settlement for 1996 to 1999, and for other open issues, on terms that are
acceptable to us. In addition, our income tax returns for other years may be the
subject of future examination by tax authorities. An adverse outcome resulting
from any settlement or future examination may lead to a deficiency in our
provision for income taxes on our income statement and may adversely affect our
liquidity. In addition, 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.
We have numerous noncontributory pension plans covering substantially all
of our employees. Our pension plan assets are principally invested in equity
securities and fixed income securities. Based on the fair value of plan assets
and interest rates estimated as of November 24, 2002, we recorded a charge of
$86.0 million, net of tax of $49.9 million, to stockholders' deficit. This
charge reflects the after tax additional minimum pension liability due to
pension obligations exceeding assets. As a result of the projected deficit, we
expect to make additional pre-tax contributions to the pension plans during the
next four years, including expected cash contributions of approximately $20 to
$25 million in December 2003.
We have no material off-balance sheet debt obligations or unconditional
purchase commitments other than operating lease commitments. Our total
short-term and long-term debt principal payments as of May 25, 2003 and minimum
operating lease payments for facilities, office space and equipment as of
November 24, 2002 for the next five years and thereafter are as follows:
Principal Minimum Operating
Payments* Lease Payments
--------- --------------
Year (Dollars in Thousands)
- ----
2003.............................................................. $ 38,505 $ 64,211
2004.............................................................. 146,055 58,375
2005.............................................................. 150,422 55,051
2006.............................................................. 716,586 52,646
2007.............................................................. -- 47,887
Thereafter........................................................ 1,262,848 189,832
---------- --------
Total................................................. $2,314,416 $468,002
========== ========
*The principal payments include $22.6 million of the outstanding 6.80% notes due
November 1, 2003. Under the senior secured credit facility, we are required to
have funds segregated in an amount sufficient to repay the 6.80% notes due
November 1, 2003 at maturity (including any interim scheduled interest
payments). As of May 25, 2003, this amount was $23.4 million, which includes
$0.8 million of accrued interest, and is separately identified on the balance
sheet as "Restricted cash."
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 raw material suppliers, garment manufacturing and finishing
contractors on an order-by-order basis.
31
Cash used for/provided by operating activities. Cash used for operating
activities for the six months ended May 25, 2003 was $344.3 million, as compared
to cash provided by operating activities of $113.6 million for the same period
in 2002. Trade receivables decreased from November 24, 2002 primarily due to
lower sales. Inventories increased from November 24, 2002 primarily due to the
preparation for our entry into the mass channel, seasonal needs and excess
Levi's(R) and Dockers(R) core products, which we believe has minimal markdown
risk. Net working capital was largely unchanged, with increases in inventories
largely offset by lower accounts receivable. Net deferred tax assets increased
from November 24, 2002 primarily due to tax benefits associated with the 2003
six-month loss and the tax effects of the interest expense deduction from the
audit settlement paid in March 2003 to the Internal Revenue Service. Other
long-term assets increased from November 24, 2002 reflecting capitalized bank
and underwriting fees relating to our first quarter 2003 debt financing
transactions. Accounts payable and accrued liabilities increased on a reported
basis from November 24, 2002. However, after taking into account currency
fluctuations for the same period, accounts payable and accrued liabilities
decreased.
Restructuring reserves decreased from November 24, 2002 due to payments
primarily related to prior years' restructuring initiatives. Accrued salaries,
wages and employee benefits decreased from November 24, 2002 primarily due to
payments in the first quarter of 2003 under our employee incentive compensation
plans. This was partially offset by a reclassification from long-term employee
benefits to accrued salaries, wages and employee benefits for expected payments
in 2004 under our long-term employee incentive compensation plan. Accrued taxes
decreased from November 24, 2002 primarily due to the tax audit settlement
payment and other tax payments. Other long-term liabilities increased primarily
due to a non-cash charge relating to a cumulative effect of a change in
accounting for rent expense.
Cash used for investing activities. Cash used for investing activities for
the six months ended May 25, 2003 was $46.3 million compared to cash used for
investing activities of $6.2 million during the same period in 2002. Cash used
for investing activities for the six months ended May 25, 2003 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 systems
enhancements. The proceeds received on the sale of property, plant and equipment
arose mainly from the sale of assets associated with the U.S. plant closures. We
expect capital spending of approximately $70 million in fiscal year 2003,
primarily for systems enhancements.
Cash provided by/used for financing activities. Cash provided by financing
activities for the six months ended May 25, 2003 was $412.1 million, compared to
cash used for financing activities of $94.9 million for the same period in 2002.
Cash provided by financing activities during the six months ended May 25, 2003
primarily reflected the issuance of the 12.25% senior unsecured notes due 2012
and the 2003 Tranche B term loan facility, partially offset by the purchase of
$327 million of the 6.80% notes due November 1, 2003 and the retirement of our
European securitization.
Financial Condition
Senior Secured Credit Facility. On January 31, 2003, we entered into a
$750.0 million senior secured credit facility to replace our then existing 2001
credit facility. Our senior secured credit facility consists of a $375.0 million
revolving credit facility expiring on March 31, 2006 and a $375.0 million
Tranche B term loan facility expiring on July 31, 2006. We intend to use the
borrowings under our senior secured credit facility for working capital or
general corporate purposes. As of May 25, 2003, there were no outstanding
borrowings under the revolving credit facility. Total availability under the
revolving credit facility was reduced by $168.6 million of letters of credit
allocated under the revolving credit facility, yielding a net availability of
$206.4 million. As of May 25, 2003, the principal balance of the Tranche B term
loan was $368.0 million.
Our Tranche B term loan facility is subject to repayment based on a
specified scheduled amortization, with the final payment of all amounts
outstanding due on July 31, 2006. We are required to make principal amortization
payments on the Tranche B term loan facility at a quarterly rate beginning in
May 2003, with the substantial majority of the quarterly payments being due
beginning in the quarter ending in November 2005.
32
As of May 25, 2003, the interest rate for our revolving credit facility
varied: for eurodollar rate loans, from 3.25% to 4.00% over the eurodollar rate
(as defined in the credit agreement) or, for base rate loans, from 2.25% to
3.00% over the higher of the Citibank base rate and the Federal Funds rate plus
0.50%, with the exact rate depending upon our performance under specified
financial criteria. As of May 25, 2003, the interest rate for our Tranche B term
loan facility was 4.00% over the eurodollar rate or 3.00% over the base rate. On
June 25, 2003, we amended our senior secured credit facility as discussed below.
The senior secured credit facility also requires that we segregate
sufficient funds to satisfy all principal and interest payments on the
outstanding 6.80% notes due November 2003 and allows for repurchase of these
bonds prior to their maturity. As of May 25, 2003, this amount was $23.4
million, which includes $0.8 million of accrued interest, and is separately
identified on the balance sheet as "Restricted cash."
Our senior secured credit facility is guaranteed by certain of our
material domestic subsidiaries and is secured by domestic inventories, certain
domestic equipment, trademarks, other intellectual property, 100% of the stock
in certain domestic subsidiaries, 65% of the stock of certain foreign
subsidiaries and other assets. Excluded from the assets securing the senior
secured credit facility are certain of our real property interests and all of
the capital stock and debt of our affiliates in Germany and the United Kingdom
and any other affiliates that become restricted subsidiaries under the indenture
governing our notes due 2003 and 2006. Our senior secured credit facility also
requires mandatory prepayments in certain events, such as asset sales.
The senior secured credit facility contains customary covenants
restricting our activities as well as those of our subsidiaries, including
limitations on our and our subsidiaries' ability to sell assets; engage in
mergers; enter into capital leases or certain leases not in the ordinary course
of business; enter into transactions involving related parties or derivatives;
incur indebtedness or grant liens or negative pledges on our assets; make loans
or other investments; pay dividends or repurchase stock or other securities;
guaranty third party obligations; make capital expenditures; and make changes in
our corporate structure. The senior secured credit facility also contains
financial covenants that we must satisfy on an ongoing basis, including maximum
leverage ratios and minimum coverage ratios. As of May 25, 2003, we were in
compliance with the financial covenants under the senior secured credit
facility.
The senior secured credit facility contains customary events of default,
including payment failures; failures to satisfy other obligations under the
senior secured credit facility; material judgments; pension plan terminations or
specified underfunding; substantial voting trust certificate or stock ownership
changes; specified changes in the composition of our board of directors; and
invalidity of the guaranty or security agreements. If an event of default
occurs, our lenders could terminate their commitments, declare immediately
payable all borrowings under the credit facilities and foreclose on the
collateral, including our trademarks.
On June 25, 2003, we amended our senior secured credit facility to increase
the maximum permitted consolidated leverage ratio for the third quarter of 2003
and delay the scheduled tightening of the consolidated interest coverage ratio,
consolidated leverage ratio and consolidated fixed charge coverage ratio
covenants as follows:
o the maximum permitted consolidated leverage ratio is 6.25 times
Consolidated EBITDA (as defined in the credit agreement) ("EBITDA") on
the last day of June and July 2003, decreases progressively to 5.10
times EBITDA as of the end of November 2003 and decreases progressively
thereafter to be 3.00 times EBITDA as of the end of March 2006 and
thereafter;
o the minimum consolidated interest coverage ratio is 1.75 times EBITDA
through the fiscal quarter ended February 2004, 1.90 times EBITDA for
the fiscal quarter ended May 2004, 2.00 times EBITDA for the fiscal
quarters ended August and November 2004, 2.25 times EBITDA for all four
fiscal quarters in 2005 and 2.50 times EBITDA for the fiscal quarters
ended February, May and August 2006;
o the minimum consolidated fixed charge coverage ratio is 1.00 times
EBITDA for the fiscal quarters ended February and May 2003, 1.20 times
EBITDA for the fiscal quarters ending August and November 2003 and is
then reduced to 1.10 times EBITDA through the fiscal quarter ended
February 2004; the ratio increases to 1.25 times EBITDA for the
remaining fiscal quarters of 2004 and the first three fiscal quarters
of 2005 and thereafter through the fiscal quarter ending August 2006 is
1.00 times EBITDA; and
o no change was made to the senior secured leverage ratio.
33
The amendment to the senior secured credit facility increased our interest
rates by 25 basis points. The interest rate for the revolving credit facility
varies: for Eurodollar Rate Loans and Letters of Credit, from 3.50% to 4.25%
over the Eurodollar Rate (as defined in the credit agreement) or, for Base Rate
Loans, from 2.50% to 3.25% over the higher of (i) the Citibank base rate and
(ii) the Federal Funds rate plus 0.50% (the "Base Rate"), with the exact rate in
each case depending upon performance under specified financial criteria. The
interest rate for the Tranche B term loan facility is 4.25% over the Eurodollar
Rate or 3.25% over the Base Rate. The amendment also altered certain definitions
relative to the financial ratios, including amending the definition of
Consolidated EBITDA to revise the treatment of restructuring and restructuring
related charges.
Senior Unsecured Notes Due November 1, 2003. Our 6.80% notes mature on
November 1, 2003. During the first half of 2003, we purchased approximately $327
million in principal amount of the 6.80% notes using proceeds from the senior
notes offering due 2012. Approximately $184 million of these repurchases
resulted from a tender offer made by us on April 8, 2003 to purchase for cash
any and all of the outstanding 6.80% notes, at a purchase price of $1,024.24 per
$1,000.00 principal amount. The debt tender offer expired on May 7, 2003.
At May 25, 2003, $22.6 million of these notes were outstanding. Under the
senior secured credit facility, we are required to have funds segregated in an
amount sufficient to repay the 6.80% notes at maturity (including any interim
scheduled interest payments). As of May 25, 2003, the segregated amount was
$23.4 million, which includes $0.8 million of accrued interest, and is
separately identified on the balance sheet as "Restricted cash."
Senior Unsecured Notes Due 2012. On December 4, 2002, January 22, 2003 and
January 23, 2003, we issued a total of $575.0 million in notes to qualified
institutional buyers in reliance on Rule 144A under the Securities Act. These
notes are unsecured obligations that rank equally with all of our other existing
and future unsecured and unsubordinated debt. They are 10-year notes maturing on
December 15, 2012 and bear interest at 12.25% per annum, payable semi-annually
in arrears on December 15 and June 15, commencing on June 15, 2003. The notes
are callable beginning December 15, 2007. These notes were offered at a net
discount of $3.7 million, which is amortized over the term of the notes using an
approximate effective-interest rate method. Costs representing underwriting fees
and other expenses of approximately $18.0 million are amortized over the term of
the notes.
We used approximately $125.0 million of the net proceeds from the notes
offering to repay remaining indebtedness under our 2001 bank credit facility and
approximately $327.0 million of the net proceeds to purchase the majority of the
6.80% notes due November 1, 2003. We intend to use the remaining net proceeds to
refinance (whether through payment at maturity, repurchase or otherwise) the
remainder of the 6.80% notes due November 1, 2003 and other outstanding
indebtedness or for working capital or other general corporate purposes. At May
25, 2003, $22.6 million of the 6.80% notes were outstanding.
The indenture governing these notes contain covenants that limit our and
our subsidiaries' ability to incur additional debt; pay dividends or make other
restricted payments; consummate specified asset sales; enter into transactions
with affiliates; incur liens; impose restrictions on the ability of a subsidiary
to pay dividends or make payments to us and our subsidiaries; merge or
consolidate with any other person; and sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all of our assets or our subsidiaries'
assets.
If we experience a change in control as defined in the indenture governing
the notes, then we will be required under the indenture to make an offer to
repurchase the notes at a price equal to 101% of the principal amount plus
accrued and unpaid interest, if any, to the date of repurchase. If these notes
receive and maintain an investment grade rating by both Standard and Poor's and
Moody's and we and our subsidiaries are and remain in compliance with the
indenture, then we and our subsidiaries will not be required to comply with
specified covenants contained in the indenture.
Senior Notes Exchange Offer. In April 2003, as required under the
registration rights agreement we entered into when we issued the $575.0 million
aggregate principal amount of 12.25% notes due 2012, we filed a registration
statement on Form S-4 under the Securities Act with the Securities and Exchange
Commission relating to an exchange offer for the Notes (old notes). The exchange
offer gave holders the opportunity to exchange the old notes for new notes. The
new notes are identical in all material respects to the old notes except that
the new notes are registered under the Securities Act. The exchange offer ended
on June 17, 2003. As a result of the exchange offer, all but $9.1 million of the
$575.0 million aggregate principal amount of old notes were exchanged for new
notes.
European Receivables Financing. On March 14, 2003, we terminated our
European receivables securitization agreements and repaid the outstanding of the
then equivalent amount of $54.3 million.
34
Industrial Development Revenue Refunding Bond. On June 3, 2003 we repaid
the outstanding amount of $10.0 million on the industrial development revenue
refunding bond relating to our Canton, Mississippi customer serve center.
Credit Ratings. On July 8, 2003, Fitch Ratings lowered our senior secured
credit facility rating to "BB-" from "BB," our senior unsecured debt rating to
"B" from "B+" and maintained a negative outlook. On July 3, 2003, Moody's
Investors Service changed our rating outlook to negative from stable while
confirming our senior unsecured debt rating of "B3," our senior implied rating
of "B2" and our senior secured credit facility rating of "B1." These actions do
not trigger any obligations or other provisions under our financing agreements
or our other contractual relationships.
LITIGATION
Wrongful Termination Litigation
On April 14, 2003, two former employees of our tax department filed
a complaint in the Superior Court of the State of California for San Francisco
County in which they allege that they were wrongfully terminated in December
2002. Plaintiffs allege, among other things, that Levi Strauss & Co. engaged in
a variety of fraudulent tax-motivated transactions over several years, that we
manipulated tax reserves to inflate reported income and that we fraudulently
failed to set appropriate valuation allowances on deferred tax assets. They also
allege that, as a result of these and other tax-related transactions, our
financial statements for several years violate generally accepted accounting
principles and Securities and Exchange Commission regulations and are fraudulent
and misleading, that reported net income for these years was overstated and that
these various activities resulted in our paying excessive and improper bonuses
to management for fiscal year 2002. Plaintiffs in this action further allege
that they were instructed by us to withhold information concerning these matters
from our auditors and the Internal Revenue Service, that they refused to do so
and, because of this refusal, they were wrongfully terminated. We plan to
vigorously defend this litigation and filed our formal answer to the lawsuit in
California Superior Court on May 23, 2003. In our answer we categorically deny
all the allegations and spell out the reasons that led to the dismissal of these
two employees. We also filed a cross complaint against them. We do not expect
this litigation will have a material impact on our financial condition or
results of operations.
We have initiated a review concerning the tax issues raised in the
lawsuit and the related allegations with respect to our financial statements.
Our audit committee has retained independent counsel to conduct this review.
This review is ongoing, and we expect that it will be completed in the next
several weeks. In connection with the foregoing, we have communicated with the
Securities and Exchange Commission on an informal basis.
Other Litigation
In the ordinary course of business, we have various other pending cases
involving contractual matters, employee-related matters, distribution questions,
product liability claims, trademark infringement and other matters. We do not
believe there are any pending legal proceedings that will have a material impact
on our financial condition or results of operations.
Critical Accounting Policies
Our 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. We summarize our
most critical accounting policies below.
Revenue recognition. We recognize revenue when the goods are shipped and
title passes to the customer provided that: there are no uncertainties regarding
customer acceptance; persuasive evidence of an arrangement exists; the sales
price is fixed or determinable; and collectibility is probable. Revenue is
recognized net of an allowance for estimated returns, discounts and retailer
promotions and incentives when the sale is recorded.
35
We recognize allowances for estimated returns, discounts and retailer
promotions and incentives when the sale is recorded. 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
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 allowances have not materially differed from estimates.
We entered into cooperative advertising programs with certain customers.
The majority of cooperative advertising programs were discontinued in the first
quarter of fiscal 2002. We recorded payments to customers under cooperative
advertising programs as marketing, general and administrative expenses because
an identifiable benefit was received in return for the consideration and we
could reasonably estimate the fair value of the advertising received.
Cooperative advertising expense for the three months and six months ended May
25, 2003 was $0.7 million and $0.8 million, respectively.
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. 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.
Improvements in the process of estimating potential excess inventory resulted in
a reduction of inventory valuation reserves by approximately $6 million and $11
million for the three and six months ended May 25, 2003, respectively.
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 resolution of
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. We adopted Statement of Financial Accounting Standards No. ("SFAS")
146 "Accounting for Costs Associated with Exit or Disposal Activities," as
discussed in the section below.
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.
36
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, net"
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.
We are exposed to interest rate risk. It is our 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. For
transactions that do not qualify for hedge accounting or in which management has
elected not to designate transactions for hedge accounting, changes in fair
value are recorded in earnings.
New Accounting Standards
The Financial Accounting Standards Board ("FASB") issued SFAS 141,
"Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets" in
July 2001. SFAS 141 requires that all business combinations be accounted for
using the purchase method. SFAS 141 also specifies criteria for recognizing and
reporting intangible assets apart from goodwill. SFAS 142 requires that goodwill
and indefinite lived intangible assets not be amortized but instead tested for
impairment in accordance with the provisions of SFAS 142 at least annually and
more frequently upon the occurrence of certain events (see SFAS 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets" below). SFAS 142 also
requires that all other intangible assets be amortized over their useful lives.
We adopted SFAS 141 and SFAS 142 effective November 25, 2002. Beginning November
25, 2002, we discontinued the amortization of goodwill and indefinite lived
intangible assets. Prior to November 25, 2002, goodwill and trademarks were
amortized over an estimated useful life of 40 years.
As of May 25, 2003 and November 25, 2002, our goodwill for both periods was
$199.9 million, net of accumulated amortization of $151.6 million. As of May 25,
2003 and November 25, 2002, our trademarks were $43.0 million, net of
accumulated amortization of $34.6 million and $42.8 million, net of accumulated
amortization of $34.5 million, respectively. Our remaining identifiable
intangible assets as of May 25, 2003 were not material. Amortization expense for
goodwill and trademarks for 2002 was $8.8 million and $1.9 million,
respectively. Future amortization expense with respect to our intangible assets
as of May 25, 2003 is not expected to be material. As of November 25, 2002, our
net book value for goodwill, trademarks, and other identifiable intangibles was
$199.9 million, $42.8 million and $0.7 million, respectively.
We adopted the provisions of SFAS 143, "Accounting for Asset Retirement
Obligations," effective November 25, 2002. SFAS 143 changes the way companies
recognize and measure retirement obligations that are legal obligations and
result from the acquisition, construction, development or operation of
long-lived tangible assets. Our primary asset retirement obligations relate to
certain leasehold improvements in our Americas business for which an asset
retirement obligation has been recorded. The adoption of SFAS 143 did not have a
material impact on our consolidated financial condition or results of
operations.
37
We adopted the provisions of SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," effective November 25, 2002. 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. At May 25, 2003, we had approximately $3.8
million of long-lived assets held for sale. The adoption of SFAS 144 did not
have a material impact on our consolidated financial condition or results of
operations.
We adopted the provisions of SFAS 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,"
effective November 25, 2002. SFAS 145 prohibits presentation of gains and losses
from extinguishment of debt as extraordinary items unless such items meet the
criteria for classification as extraordinary items pursuant to APB Opinion No.
30. As a result, for the three and six months ended May 25, 2003, we presented
losses of $5.7 million and $14.4 million, respectively, on early extinguishment
of debt in "Other (income) expense, net" in the accompanying 2003 consolidated
statements of operations. The losses primarily relate to the 2001 bank credit
facility unamortized bank fees and the repurchase of our 6.80% notes due
November 2003.
SFAS 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was effective prospectively for qualifying exit or disposal
activities initiated after December 31, 2002 and nullifies Emerging Issues Task
Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity." The timing for
expense recognition for restructuring initiatives under SFAS 146 differs from
that required under EITF 94-3. The adoption of SFAS 146 will not have a material
impact on our consolidated financial condition or results of operations.
The FASB issued Financial Interpretation No. ("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an interpretation of FASB Statements No.
5, 57, and 107 and a rescission of FASB Interpretation No. 34," dated November
2002. FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. FIN 45 also clarifies that a guarantor is required to recognize, at
inception of a guarantee, a liability for the fair value of the obligation
undertaken. The disclosure requirements are effective for financial statements
of interim or annual periods ending after December 31, 2002. The initial
recognition and measurement provisions of the interpretation are applicable to
guarantees issued or modified after December 31, 2002, and did not have a
material effect on our consolidated financial condition or results of
operations.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51." FIN 46 addresses the
consolidation by business enterprises of variable interest entities, as defined
in the Interpretation. FIN 46 expands existing accounting guidance regarding
when a company should include in its financial statements the assets,
liabilities and activities of another entity. Many variable interest entities
have commonly been referred to as special-purpose entities or off-balance sheet
structures. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. Certain of the
disclosure requirements apply in all financial statements issued after January
31, 2003. Since we do not have any variable interests in variable interest
entities, the adoption of FIN 46 did not have any effect on our consolidated
financial condition or results of operations.
The FASB issued SFAS 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," dated April 2003. The purpose of SFAS 149
is to amend and clarify financial accounting and reporting for derivative
instruments and hedging activities under SFAS 133. SFAS 149 amends SFAS 133 for
decisions made: (i) as part of the Derivatives Implementation Group process that
require amendment to SFAS 133, (ii) in connection with other FASB projects
dealing with financial instruments, and (iii) in connection with the
implementation issues raised related to the application of the definition of a
derivative. SFAS 149 is effective for contracts entered into or modified after
June 30, 2003 and for designated hedging relationships after June 30, 2003. SFAS
149 will be applied prospectively. We do not expect SFAS 149 to have a material
effect on our consolidated financial condition or results of operations.
38
STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE
This Form 10-Q includes forward-looking statements about:
o general economic and retail conditions;
o sales performance and trends;
o new product introductions;
o incentive and promotional activities;
o retailer margins;
o retail conditions;
o wholesale price reductions;
o marketing and advertising initiatives;
o debt repayment and liquidity;
o gross margins;
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; 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 changing domestic and international retail environments;
o risks related to the impact of consumer and customer reactions to new
products including entry into mass channel;
o order completion by retailers;
o the effectiveness of our promotion and incentive programs with
retailers;
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 and pricing pressures;
o unanticipated adverse income tax audit settlements and related
payments;
o changing fashion trends;
o our supply chain executional performance;
o changes in credit ratings;
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 24, 2002, 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.
39
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. We hold derivative positions only in currencies to
which we have exposure.
The tables below give an overview of the fair values of derivative
instruments reported as an asset or liability and the realized and unrealized
gains and losses associated with our foreign exchange management activities
reported in "Other (income) expense, net." The derivatives expire at various
dates until August 2003.
May 25, November 24,
2003 2002
---- ----
Fair value Fair value
asset (liability) asset (liability)
----------------- -----------------
(Dollars in Thousands)
Risk Exposures
--------------
Foreign Exchange Management
Sourcing $ (4,790) $(3,636)
Net Investment (7,553) 303
Royalties (40) 1,189
Cash Management (696) (82)
Euro Notes Offering 619 (625)
-------- -------
Total $(12,460) $(2,851)
======== =======
40
----------------------- ------------------------ ----------------------- ----------------------
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
May 25, 2003 May 26, 2002 May 25, 2003 May 26, 2002
----------------------- ------------------------ ----------------------- ----------------------
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 $13,885 $ 2,403 $ 7,229 $23,252 $32,481 $1,151 $ 1,749 $28,788
Net Investment (143) 582 (904) 6,723 1,947 812 (250) 3,068
Yen Bond 23 -- -- -- 23 -- -- --
Royalties 1,454 89 (13,020) 3,806 3,130 1,229 (9,578) 442
Cash Management 5,647 646 3,700 (3,821) 13,637 614 6,370 (3,745)
Euro Notes Offering (2,251) (1,402) (4,855) (1,318) 3,533 (1,242) (3,536) (2,154)
------- ------- -------- ------- ------- ------- ------- -------
Total $18,615 $ 2,318 $ (7,850) $28,642 $54,751 $ 2,564 $(5,245) $26,399
======= ======= ======== ======= ======= ======= ======= =======
- -------------------------------- ----------------------- ------------------------ ----------------------- ----------------------
Interest Rate Management $ -- $ -- $ -- $ -- $ -- $ -- $ 2,266(1) $(2,266)
======= ======= ======== ======= ======= ======= ======= =======
- -------------------------------- ----------------------- ------------------------ ----------------------- ----------------------
(1) Recorded as an increase to interest expense.
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 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.
We calculate our maximum allowable level of loss based on a percentage of
the total forecasted currency exposures. The allowable percentage loss depends
on various elements including our leverage ratio as defined in our foreign
exchange policy. We implemented this policy in 2001. For 2002 and 2003, the
policy permitted a 6% loss against a set of benchmark rates. The allowable loss
for 2003 and 2002 was approximately $25 million and $45 million, respectively.
At May 25, 2003, we had U.S. dollar spot and forward currency contracts to
buy $728.2 million and to sell $297.3 million against various foreign
currencies. We also had euro forward currency contracts to buy 0.5 million euro
against various foreign currencies and to sell 0.5 million euro against various
foreign currencies. These contracts are at various exchange rates and expire at
various dates until August 2003. We had no option contracts outstanding at May
25, 2003.
For more information about market risk, see Notes 5, 6 and 7 to the
Consolidated Financial Statements.
41
ITEM 4. CONTROLS AND PROCEDURES
Our management, including the Chief Executive Officer and Chief Financial
Officer, have conducted an evaluation of the effectiveness of disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that
evaluation, as of the date hereof, the Chief Executive Officer and Chief
Financial Officer concluded that the disclosure controls and procedures are
effective in ensuring that all material information required to be filed in this
quarterly report has been made known to them in a timely manner. There have been
no significant changes in internal controls, or in factors that could
significantly affect internal controls, subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.
42
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(A) EXHIBITS:
31 Section 302 certification. Filed herewith.
32 Section 906 certification. Furnished herewith.
(B) REPORTS ON FORM 8-K:
Current Report on Form 8-K dated March 25, 2003 and filed pursuant to
Item 5 of the report and containing a copy of the Company's press release
dated March 25, 2003 titled "Levi Strauss & Co. Announces First-Quarter
2003 Financial Results."
Current Report on Form 8-K dated April 8, 2003 and filed pursuant to Item
9 of the report and containing a copy of the certifications of the
Principal Executive Officer, Philip A. Marineau, and the Principal
Financial Officer, William B. Chiasson, of Levi Strauss & Co. submitted
to the Securities and Exchange Commission pursuant to 18 U.S.C. ss. 1350,
as created by Section 906 of the Sarbanes-Oxley Act of 2002.
Current Report on Form 8-K dated April 8, 2003 and filed pursuant to Item
9 of the report and containing a copy of the Company's press release
dated April 8, 2003 titled "Levi Strauss & Co. Commences Cash Tender
Offer For Its Outstanding 6.80% Senior Notes."
Current Report on Form 8-K dated April 15, 2003 and filed pursuant to
Item 9 of the report and containing a copy of the Company's press release
dated April 15, 2003 titled "Levi Strauss & Co.: Allegations in Wrongful
Termination Case are False."
Current Report on Form 8-K dated May 9, 2003 and filed pursuant to Item 9
of the report and containing a copy of the Company's press release dated
May 9, 2003 titled "Levi Strauss & Co. Announces Successful Completion of
Cash Tender Offer - More Than 92% of Outstanding Tendered."
Current Report on Form 8-K dated June 10, 2003 and filed pursuant to Item
9 of the report and containing a copy of the Company's press release
dated June 10, 2003 titled "Levi Strauss & Co. Extends Exchange Offer for
Its 12 1/4% Dollar-denominated Notes Due 2012."
Current Report on Form 8-K dated June 25, 2003 and filed pursuant to Item
5 of the report and containing a copy of an amendment to the Company's
Credit Agreement.
Current Report on Form 8-K dated June 26, 2003 and furnished under Items
9 and 12 of the report and containing a copy of the Company's press
release dated June 26, 2003 titled "Levi Strauss & Co. Announces
Second-Quarter 2003 Financial Results."
Current Report on Form 8-K dated July 2, 2003 and filed under Item 5 of
the report and containing a copy of the Company's press release dated
July 2, 2003 titled "Levi Strauss & Co. Names Pat House to Board of
Directors."
43
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: July 8, 2003 Levi Strauss & Co.
------------------
(Registrant)
By: /s/ William B. Chiasson
-----------------------
William B. Chiasson
Senior Vice President and Chief Financial Officer
44