Levi posts "solid" quarterly earnings, anticipates further balance sheet improvements

By Paul Deckelman

New York, July 12 - Levi Strauss & Co. posted what its senior executives termed "solid" results for the fiscal second quarter ended May 29 - and said that priority Number One is to continue improving the company's profitability and then using the fruits of that improvement to continue strengthening its balance sheet.

Levi's president and chief executive officer, Phil Marineau, said as much on a conference call with analysts Tuesday following the release of the quarterly numbers.

Asked whether Levi might take a role in any consolidation trend among clothing manufacturers and retailers, Marineau bluntly answered that the venerable San Francisco-based maker of blue jeans and other casual clothing is "not in the market to buy businesses. We're in the market to use cash to pay down debt," as well as to try to improve Levi's own three businesses - its traditional blue jeans line, its Levi Strauss Signature line of denim clothing aimed at more value-conscious consumers who shop at discount chains and other mass-channel outlets, and its Dockers line of non-denim apparel.

"Our Number One goal is to improve our profitability - and to use that improved profitability to pay down debt and to continue to improve the capital structure of the company," he said, in answer to another question about whether Levi has any plans to issue equity.

There are, he said, "no plans to announce anything" at the present, although he did allow that an equity issue - Levi is currently privately held - could be considered a potential way to de-leverage the company.

But while reiterating Levi's intentions of continuing to improve its capital structure, Marineau and chief financial officer Hans Ploos van Amstel outlined no sweeping plans for bond buybacks or other debt repurchases, as occurred earlier in the year, and little detailed discussion about debt.

Van Amstel, for his part, said only that the $78 million of 7% notes due 2006 left outstanding after a tender offer earlier this year would be paid back at their maturity, using borrowings from its bank credit facility.

"We will use it to pay off debt, including the balance of the 2006 bonds, and all purposes consistent with our credit agreements, indentures and other agreements," he said about the credit facility.

Under the terms of the company's senior secured term loan, Levi must either fully "refinance, repay or otherwise irrevocably set aside funds" to finish taking out the 7s by May 1, 2006, six months ahead of their scheduled maturity date on Nov. 1, 2006. Otherwise, the maturity of the $500 million term loan is to be accelerated to Aug. 1, 2006 from the scheduled Dec. 31, 2006 maturity date.

Noting that fact, an analyst asked whether Levi has any intention of refinancing the facility and suggested mid-2006 as a possible time frame, but Marineau said flatly "we don't know yet. We're not giving you a prediction of when we will finance."

Meeting rating agencies

He said that van Amstel would soon be meeting with representatives of the major ratings agencies, such as Moody's Investors Service and Standard & Poor's, as well as the company's bankers in New York, to update them on the company's recent progress.

"We haven't had a meeting with them recently, but we will in the next week," he told an analyst who asked.

The second fiscal quarter was a relatively quiet one, certainly, compared with the big moves the company made in the fiscal first quarter ended Feb. 27.

First, it took out most of the 7% notes then outstanding via the tender offer, purchasing a total of $372.143 million of the notes, or some 83% of the originally outstanding $450 million, which left about 17% of the notes, or $77.857 million, still outstanding. That tender offer was funded using most of the proceeds from the company's upsized offering of $450 million of the new 9¾% notes, which priced on Dec. 16, 2004 via bookrunner Citigroup.

Toward the end of the first quarter, it announced plans to take out all of the outstanding $380 million of dollar-denominated and €125 million of euro-denominated 11 5/8% senior notes due 2008 via a tender offer, to be funded by a new multi-part offering of new bonds.

Just after the second quarter began, Levi priced the equivalent of $578 million of new notes in a two-part Rule 144A offering on March 7 via a syndicate led by joint bookrunning managers Banc of America Securities LLC and Citigroup. The deal consisted of $380 million of unsecured floating-rate notes due 2012, which have an interest rate of Libor plus 475 basis points, and €150 million of 8 5/8% unsecured notes due 2013. The company had originally planned a three-part offering that would have also included an add-on tranche to its existing 9¾% senior notes due 2015, but that third tranche was dropped, syndicate sources said, because of the strength of the two tranches of newly issued notes.

The proceeds of the bond deal were used to retire the entire issue of the 11 5/8% notes, most via the tender offer, which ended on March 23 and the remainder by the subsequent redemption of all remaining untendered notes, which took place on April 11. After that flurry of early activity, Levi stepped away from the capital markets, and turned its energies to reviving the sagging Dockers brand and trying to boost results for its other two lines of clothing.

Net income up on lower sales

It apparently succeeded; Levi reported Tuesday that while sales for the most recent quarter were lower than year-earlier levels, at $944 million to $959 million, net income for the quarter increased to $27 million, well up from $6 million a year ago. The company said that the improvement was due primarily to a $66 million increase in operating income, partially offset by a $43 million loss on early retirement of debt related to refinancing activities and higher income taxes.

Operating income for the quarter increased 84% to $145 million, or 15% of net sales, versus $79 million, or 8% of net sales, for the same period of 2004.

Gross profit increased $25 million to $437 million, versus $413 million in the second quarter of 2004. The gross margin improved 340 basis points to 46.4% of sales for the second quarter, an improvement from 43% of sales in the same quarter last year. The gross margin in the 2005 period benefited from sales of higher-margin premium products in Europe and Asia, a favorable mix of more profitable core products, lower sales allowances in the United States, lower product sourcing costs, lower inventory markdowns and stronger foreign currencies.

As of May 29, Levi's net debt - total debt, less cash - was $2.11 billion, little changed from the first quarter, and up somewhat from $2.02 billion at the end of fiscal year 2004 in November, an increase of approximately $84 million. The increased net debt is primarily attributable to costs associated with debt refinancing actions this year, interest and incentive payments, cash taxes and payments for restructuring actions, Levi Strauss said.

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