SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

For the fiscal year ended November 25, 2007

 

Commission file number: 002-90139

 

 

 

 

LEVI STRAUSS & CO.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

 

1155 BATTERY STREET, SAN FRANCISCO, CALIFORNIA 94111

(Address of Principal Executive Offices)

 

(415) 501-6000

 

 

 

 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes þ     No o

 

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 o     No þ

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “Large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The Company is privately held. Nearly all of its common equity is owned by members of the families of several descendants of the Company’s founder, Levi Strauss. There is no trading in the common equity and therefore an aggregate market value based on sales or bid and asked prices is not determinable.

 

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 February 7, 2008

 

Documents incorporated by reference: None

 

 

LEVI STRAUSS & CO.

 

TABLE OF CONTENTS TO FORM 10-K

 

FOR FISCAL YEAR ENDING NOVEMBER 25, 2007

 

 

 

Overview

 

From our California Gold Rush beginnings, we have grown into one of the world’s largest brand-name apparel companies. We have built our brands on a history of responsible business practices, bringing to life values that have engendered consumer trust around the world. Under our brand names, we design and market products that include jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories for men, women and children. We also license our trademarks for a wide array of products, including accessories, pants, tops, footwear, home and other products.

 

An Authentic American Icon

 

Our Levi’s^® brand has become one of the most widely recognized brands in the history of the apparel industry. Its broad distribution reflects its appeal across consumers of all ages and lifestyles. Today its merchandising and marketing reflect the brand’s core attributes: original, definitive and confident.

 

Our Dockers^® brand was at the forefront of the business casual trend in the United States. It has since grown to a global brand covering a wide range of wearing occasions for men and women with products that combine approachable style, relevant innovation and sustained quality. Our Signature by Levi Strauss & Co.^tm brand focuses on bringing our style, authenticity and quality to value-seeking consumers.

 

Our Global Reach

 

We operate our business through three geographic regions: North America, Europe and Asia Pacific. Our products are sold in over 60,000 retail locations in more than 110 countries. This includes more than 1,500 retail stores dedicated to our brands, including both franchised and company-operated stores.

 

We support our brands through a global infrastructure, as we both source and market our products around the world. We distribute our Levi’s^® and Dockers^® products primarily through chain retailers and department stores in the United States and primarily through department stores, specialty retailers and franchised stores abroad. We also distribute products under the Signature by Levi Strauss & Co.^tm brand primarily through mass channel retailers in the United States and mass and other value-oriented retailers and franchised stores abroad.

 

Although our brands are recognized around the world as authentically “American,” we derive approximately 42% of our net revenues from our European and Asia Pacific regions. Our Asia Pacific region includes both our established markets, which we refer to as “mature” markets, such as Japan and Korea, and emerging markets such as India and China, as well as our businesses in Latin America, the Middle East and Africa.

 

Levi Strauss & Co. was incorporated in Delaware in 1973. We conduct our operations outside the United States through foreign subsidiaries owned directly or indirectly by Levi Strauss & Co. We manage our regional operations through headquarters in San Francisco, Brussels and Singapore. Our global sourcing headquarters is in Singapore. Our corporate offices are located at Levi’s Plaza, 1155 Battery Street, San Francisco, California 94111, and our main telephone number is (415) 501-6000.

 

Our common stock is primarily owned by descendants of the family of Mr. Strauss and their relatives.

 

Our Web site — www.levistrauss.com — contains additional and detailed information about our history, our products and our commitments. Our Web site and the information contained on our Web site are not part of this annual report and are not incorporated by reference into this annual report.

Our Strategies for Business Development

 

Our management is pursuing strategies to develop our business, respond to marketplace dynamics and build on our competitive strengths. Our key strategies are:

 

 

Our Brands and Products

 

We offer a broad range of products, including jeans, casual and dress pants, tops, skirts and jackets. Pants — including jeans, casual pants and dress pants — represented approximately 87% of our total units sold in each of fiscal years 2007, 2006 and 2005. Men’s products generated approximately 72% of our total net sales in each of fiscal years 2007, 2006 and 2005.

 

Levi’s^® Brand

 

Consumers around the world recognize the distinctive traits of Levi’s^® jeans. The double arc of stitching, known as the Arcuate stitching design, and the Red Tab device, a fabric tab stitched into the back right pocket, are unique to Levi’s^® jeans and are instantly recognizable by consumers. We offer an extensive selection of men’s, women’s and kids’ products designed to appeal to a variety of consumer segments at a wide range of price points. We extend our Levi’s^® brand from more basic jeans to premium-priced styles to appeal to fashion leaders, reflecting what we believe is the broad consumer appeal of the brand across ages, genders and lifestyles. In the United States, our product architecture and strategy emphasize growth in more premium segments, including updating and driving our Red Tab^tm jeans business to a more premium position with our chain and department store customers. In Europe and Asia Pacific, the Levi’s^® brand is positioned mostly in the premium segment of the men’s and women’s markets.

Our current product range includes:

 

 

Our Levi’s^® brand products accounted for approximately 73%, 70% and 71% of our total net sales in fiscal 2007, 2006 and 2005, respectively. Although almost half of these net sales were generated in North America, Levi’s^® brand products are sold in more than 110 countries.

 

Dockers^® Brand

 

First introduced in 1986 as an alternative between jeans and dress pants, the Dockers^® brand has grown to include men’s and women’s apparel for a wide range of occasions. Marketed worldwide as “Dockers^® San Francisco,” to link the brand to its hometown roots, Dockers^® products combine approachable style, relevant innovation and consistent quality.

 

Our current Dockers^® product offerings in the United States include:

 

 

Our Dockers^® brand products accounted for approximately 21%, 21% and 19% of our total net sales in fiscal 2007, 2006 and 2005, respectively. Although a substantial majority of these net sales were in North America, Dockers^® brand products are sold in more than 50 countries.

 

Signature by Levi Strauss & Co.^tm Brand

 

Our Signature by Levi Strauss & Co.^tm brand, formerly marketed under the name Levi Strauss Signature^®, offers value-seeking consumers products with the style, authenticity and quality for which our company is recognized around the world. The product portfolio includes denim jeans, casual pants, tops and jackets in a variety of fits, fabrics and finishes for men, women and kids. The brand is distributed through the mass retail channel in North America and value-oriented retailers and franchised stores in Asia Pacific.

 

Signature by Levi Strauss & Co.^tm brand products accounted for approximately 6%, 9% and 10% of our total net sales in fiscal years 2007, 2006 and 2005. Although a substantial majority of these sales were in the United States, Signature by Levi Strauss & Co.^tm brand products are sold in seven additional countries in our North America and Asia Pacific regions. The brand exited the European market after the spring 2007 season.

Licensing

 

The appeal of our brands across consumer groups and our global reach enable us to license our Levi’s^®, Dockers^® and Signature by Levi Strauss & Co.^tm trademarks for a variety of product categories in multiple markets including footwear, hosiery, belts, outerwear, eyewear, sweaters, dress shirts, kidswear, loungewear and sleepwear, luggage and home bedding products.

 

We have licensees for our Levi’s^® and Dockers^® brands in each of our regions, and for our Signature by Levi Strauss & Co.^tm brand in North America. In addition, we enter into agreements with third parties to produce, market and distribute our products in several countries with smaller markets, including various Latin American and Middle Eastern countries.

 

We enter into licensing agreements with our licensees covering royalty payments, product design and manufacturing standards, marketing and sale of licensed products and protection of our trademarks. We require our licensees to comply with our code of conduct for contract manufacturing and engage independent monitors to perform regular on-site inspections and assessments of production facilities.

 

Sales, Distribution and Customers

 

We distribute our products in a wide variety of retail formats around the world, including chain and department stores, franchise and company-operated stores dedicated to our brands, multi-brand specialty stores, mass channel retailers and both company-operated and retailer Web sites.

 

Multi-brand Retailers

 

Our distribution strategy focuses on making our brands and products available where consumers shop. Our strategy includes product offerings and assortments that are tailored appropriately for our wholesale customers and their retail consumers. Our products are also sold through authorized third-party Internet sites. Sales to our top ten wholesale customers accounted for approximately 42% of our total net revenues in both fiscal years 2007 and 2006.

 

Dedicated Stores

 

We believe retail stores dedicated to our brands are important for the growth, visibility, availability and commercial success of our brands, and they are an increasingly important part of our strategy for expanding distribution of our products in all three of our regions. Our brand-dedicated stores are either operated by us or by independent franchisees and licensees. In addition to the dedicated stores, we consider dedicated shop-in-shops located within department stores as an important component of our retail network in international markets, and we maintain brand-dedicated Web sites that sell products directly to retail consumers.

 

Franchised stores.  Over 1,300 franchised or other licensed stores sell Levi’s^®, Dockers^® and Signature by Levi Strauss & Co.^tm products in markets outside the United States. These stores are a key element of our international distribution. The stores are operated by independent third parties. We also license third parties to operate outlet stores dedicated to our brands in the United States and abroad.

 

Company-operated stores.  Company-operated stores generated approximately 6% and 4% of our net revenues in fiscal 2007 and 2006, respectively. As of November 25, 2007, we had 200 company-operated retail stores, predominantly Levi’s^® stores, located in more than 22 countries across our three regions. We had 73 stores in North America, 71 stores in Europe and 56 stores in Asia Pacific. In 2007, we opened 67 company-operated stores and closed five stores.

 

Seasonality of Sales

 

In recent years, we have tended to achieve our largest quarterly revenues in the fourth quarter, reflecting the “holiday” season, generally followed by the third quarter, reflecting the “back to school” season. In 2007, our net revenues in the first, second, third and fourth quarters represented 24%, 23%, 24% and 29%, respectively, of our total net revenues for the year. In 2006, our net revenues in the first, second, third and fourth quarters represented 23%, 23%, 25% and 29%, respectively, of our total net revenues for the year.

Our fiscal year consists of 52 or 53 weeks, ending on the last Sunday in November each year. Fiscal years 2007, 2006 and 2005 consisted of 52 weeks each and ended on November 25, 2007, November 26, 2006, and November 27, 2005, respectively.

 

Marketing and Promotion

 

We support our brands with a diverse mix of marketing initiatives to drive consumer demand.

 

We advertise around the world through a broad mix of media, including television, national publications, the Internet, cinema, billboards and other outdoor vehicles. We use other marketing vehicles, including event and music sponsorships, product placement in major motion pictures, television shows, music videos and leading fashion magazines, and alternative marketing techniques, including street-level events and similar targeted “viral” marketing activities.

 

We execute region-specific marketing programs that are based on globally consistent brand values. We believe this approach allows us to achieve consistent global brand positioning while giving us flexibility to tailor marketing programs to local markets in order to maximize relevancy and effectiveness. We also tailor marketing programs to express the unique attributes of our brands. For example, our Levi’s^® marketing program is designed to communicate the authenticity of Levi’s^® jeans, the original and definitive jeans brand, among other characteristics. Our Dockers^® products are featured in lifestyle settings that show complete outfits in everyday situations. The Dockers^® brand is marketed worldwide under a branding platform, “Dockers^® San Francisco,” that links the brand to its hometown roots and provides a single umbrella for marketing communications for men and women.

 

We also maintain the Web sites www.levisstore.com and www.dockersstore.com in the United States and www.levi.com and www.dockers.com outside the United States which sell products directly to consumers in certain countries. We operate these Web sites, as well as www.levistrausssignature.com, as marketing vehicles to enhance consumer understanding of our brands and help consumers find and buy our products. This is consistent with our strategies of ensuring that our brands and products are available where consumers shop and that our product offerings and assortments are appropriately differentiated.

 

Sourcing and Logistics

 

Organization.  Our global sourcing and regional logistics organizations are responsible for taking a product from the design concept stage through production to delivery at retail. Our objective is to leverage our global scale to achieve product development and sourcing efficiencies and reduce total delivered product cost across brands and regions while maintaining our focus on local service levels and working capital management.

 

Product procurement.  We source nearly all of our products through independent contract manufacturers, with the balance sourced from our company-operated manufacturing plants. See “Item 2 — Properties” for more information about those manufacturing facilities.

 

Sourcing locations.  We use numerous independent manufacturers located throughout the world for the production and finishing of our garments. We conduct assessments of political, social, economic, trade, labor and intellectual property protection conditions in the countries in which we source our products before we place production in those countries and on an ongoing basis.

 

In 2007, we sourced products from contractors located in approximately 45 countries around the world. We sourced products in Asia Pacific, South and Central America (including Mexico and the Caribbean), Europe, the Middle East and Africa. We expect to increase our sourcing from contractors located in Asia in future years. No single country accounted for more than 20% of our sourcing in 2007.

 

Sourcing practices.  Our sourcing practices include these elements:

 

 

 

We disclose the names and locations of our contract manufacturers to encourage collaboration among apparel companies in factory monitoring and improvement. We regularly evaluate and refine our code of conduct processes.

 

Logistics.  We own and operate dedicated distribution centers in a number of countries and we also outsource logistics activities to third-party logistics providers. Distribution center activities include receiving finished goods from our contractors and plants, inspecting those products, preparing them for presentation at retail and shipping them to our customers and to our own stores.

 

Competition

 

The worldwide apparel industry is highly competitive and fragmented. It is characterized by low barriers to entry, brands targeted at specific consumer segments and regional and local competitors. Principal competitive factors include:

 

 

We face competition from a wide range of competitors both at the worldwide and regional levels in diverse channels across a wide range of retail price points. Worldwide, a few of our primary competitors include vertically integrated specialty stores such as Gap Inc.; jeanswear brands such as those marketed by VF Corporation, a competitor in multiple channels and product lines; and athletic wear companies such as adidas and Nike, Inc. who are emerging as pan-regional competitors. In addition, each region faces localized competition, such as G-Star in the Netherlands, Miss Sixty in Italy, Hugo Boss in Germany; UNIQLO in Asia Pacific, and retailers’ private or exclusive labels such as those from Wal-Mart Stores, Inc. (Faded Glory and George brands), Target Corporation (Mossimo and Cherokee brands) and Macy’s (INC. brand) in North America.

 

Trademarks

 

We have over 5,000 trademark registrations and pending applications in approximately 180 countries worldwide, and we create new trademarks on an ongoing basis. Substantially all of our global trademarks are owned by Levi Strauss & Co., the parent and U.S. operating company. We regard our trademarks as our most valuable assets and believe they have substantial value in the marketing of our products. The Levi’s^®, Dockers^® and 501^® trademarks, the Wings and Anchor Design, the Arcuate Stitching Design, the Tab Device and the Two Horse^® Design are among our core trademarks.

 

We protect these trademarks by registering them with the U.S. Patent and Trademark Office and with governmental agencies in other countries, particularly where our products are manufactured or sold. We work vigorously to enforce and protect our trademark rights by engaging in regular market reviews, helping local law enforcement authorities detect and prosecute counterfeiters, issuing cease-and-desist letters against third parties infringing or denigrating our trademarks, opposing registration of infringing trademarks and initiating litigation as necessary. We currently are pursuing over 300 infringement matters around the world. We also work with trade

groups and industry participants seeking to strengthen laws relating to the protection of intellectual property rights in markets around the world.

 

Employees

 

As of November 25, 2007, we employed approximately 11,550 people, approximately 4,550 of whom were located in North America, 3,500 in Europe, and 3,500 in Asia Pacific. We added approximately 870 employees in 2007, most of whom were associated with company-operated stores opened during the year. Approximately 4,100 of our employees were associated with manufacturing of our products and approximately 7,450 were non-production employees. Of the non-production employees, approximately 1,590 worked in distribution.

 

History and Corporate Citizenship

 

Our history and longevity are unique in the apparel industry. Our commitment to quality, innovation and corporate citizenship began with our founder, Levi Strauss, who infused the business with the principle of responsible commercial success that has been embedded in our business practices throughout our 155-year history. This mixture of history, quality, innovation and corporate citizenship contributes to our brands’ iconic reputation.

 

In 1853, during the California Gold Rush, Mr. Strauss opened a wholesale dry goods business in San Francisco that became known as “Levi Strauss & Co.” Seeing a need for work pants that could hold up under rough conditions, he and Jacob Davis, a tailor, created the first jean. In 1873, they received a U.S. patent for “waist overalls” with metal rivets at points of strain. The first product line designated by the lot number “501” was created in 1890.

 

During our first century, our work pants were worn primarily by cowboys, miners and other working men in the western United States. Then, in 1934, we introduced our first jeans for women, and after World War II, our jeans began to appeal to a wider market. By the 1960s they had become a symbol of American culture, representing a unique blend of history and youth. We opened our export and international businesses in the 1950s and 1960s. In 1986, we introduced the Dockers^® brand of casual apparel which revolutionized the concept of business casual.

 

Throughout this long history, we upheld our strong belief that we can help shape society through civic engagement and community involvement, responsible labor and workplace practices, philanthropy, ethical conduct, environmental stewardship and transparency. We have engaged in a “profits through principles” business approach from the earliest years of the business. Among our milestone initiatives over the years, we began to open integrated factories two decades prior to the U.S. civil rights movement and federally mandated desegregation, we developed a comprehensive supplier code of conduct requiring safe and healthy working conditions among our suppliers (a first of its kind for a multinational apparel company), and we offered full medical benefits to domestic partners of employees prior to other companies of our size, a practice most other companies now follow.

 

Our Web site — www.levistrauss.com — contains additional and detailed information about our history and corporate citizenship initiatives. Our Web site and the information contained on our Web site are not part of this annual report and are not incorporated by reference into this annual report.

 

 

Risks Relating to the Industry in Which We Compete

 

Our revenues are influenced by general economic cycles.

 

Apparel is a cyclical industry that is dependent upon the overall level of consumer spending. Our wholesale customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and canceling orders. As a result, factors that diminish consumer spending and confidence in any of the regions in which we compete, particularly deterioration in general economic conditions, increases in energy costs or interest rates, housing market downturns, and other factors such as acts of war, acts of nature or terrorist or political events that impact consumer confidence, could reduce our sales and adversely affect our business and financial condition. For example, the price of oil has risen in the recent past. A continued or sustained rise in oil prices could adversely affect consumer spending and demand for our products and also increase our operating costs, both of which could adversely affect our business and financial condition.

Intense competition in the worldwide apparel industry could reduce our sales and prices.

 

We face a variety of competitive challenges from jeanswear and casual apparel marketers, fashion-oriented apparel marketers, athletic and sportswear marketers, vertically integrated specialty stores and retailers of private-label products. Some of these competitors have greater financial and marketing resources than we do and may be able to adapt to changes in consumer preferences or retail requirements more quickly, devote greater resources to the building and sustaining of their brand equity and the marketing and sale of their products or adopt more aggressive pricing policies than we can. As a result, we may not be able to compete as effectively with them and may not be able to maintain or grow the equity of and demand for our brands. Increased competition in the worldwide apparel industry — including from international expansion of vertically integrated specialty stores, from department stores, chain stores and mass channel retailers developing exclusive labels, and from well-known and successful non-apparel brands (such as athletic wear marketers) expanding into jeans and casual apparel — could reduce our sales and adversely affect our business and financial condition.

 

The success of our business depends upon our ability to offer innovative and upgraded products at attractive price points.

 

The worldwide apparel industry is characterized by constant product innovation due to changing fashion trends and consumer preferences and by the rapid replication of new products by competitors. As a result, our success depends in large part on our ability to develop, market and deliver innovative and stylish products at a pace, intensity, and price competitive with other brands in our segments. In addition, we must create products that appeal to multiple consumer segments at a range of price points that appeal to the consumers of both our wholesale customers and our dedicated retail stores. Failure on our part to regularly and rapidly develop innovative and stylish products and update core products could limit sales growth, adversely affect retail and consumer acceptance of our products, negatively impact the consumer traffic in our dedicated retail stores, leave us with a substantial amount of unsold inventory which we may be forced to sell at discounted prices and impair the image of our brands. Moreover, our newer products may not produce as high a margin as our traditional products, which may have an adverse effect on our overall margins and profitability.

 

The worldwide apparel industry is subject to ongoing pricing pressure.

 

The apparel market is characterized by low barriers to entry for both suppliers and marketers, global sourcing through suppliers located throughout the world, trade liberalization, continuing movement of product sourcing to lower cost countries, and the ongoing emergence of new competitors with widely varying strategies and resources. These factors contribute to ongoing pricing pressure throughout the supply chain. This pressure has had and may continue to have the following effects:

 

 

Any of these factors could adversely affect our business and financial condition.

 

Increases in the price of raw materials or their reduced availability could increase our cost of goods and decrease our profitability.

 

The principal fabrics used in our business are cotton, blends, synthetics and wools. The prices we pay our suppliers for our products are dependent in part on the market price for raw materials — primarily cotton — used to produce them. The price and availability of cotton may fluctuate substantially, depending on a variety of factors, including demand, crop yields, weather, supply conditions, transportation costs, work stoppages, government regulation, economic climates and other unpredictable factors. Increases in raw material costs, together with other factors, will make it difficult for us to sustain the level of cost of goods savings we have achieved in recent years and

result in a decrease of our profitability unless we are able to pass higher prices on to our customers. Moreover, any decrease in the availability of cotton could impair our ability to meet our production requirements in a timely manner.

 

Our business is subject to risks associated with sourcing and manufacturing overseas.

 

We import finished garments and raw materials into all of our operating regions. Substantially all of our import operations are subject to customs and tax requirements and to tariffs and quotas set by governments through mutual agreements or bilateral actions. In addition, the countries in which our products are manufactured or imported may from time to time impose additional quotas, duties, tariffs or other restrictions on our imports or adversely modify existing restrictions. Adverse changes in these import costs and restrictions, or our suppliers’ failure to comply with customs regulations or similar laws, could harm our business.

 

Our operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, the Dominican-Republic Central America Free Trade Agreement, the Egypt Qualified Industrial Zone program and the activities and regulations of the World Trade Organization. Although generally these trade agreements have positive effects on trade liberalization, sourcing flexibility and cost of goods by reducing or eliminating the duties and/or quotas assessed on products manufactured in a particular country, trade agreements can also impose requirements that adversely affect our business, such as setting quotas on products that may be imported from a particular country into our key markets such as the United States or the European Union.

 

Our ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as port and shipping capacity, labor disputes and work stoppages, political unrest, severe weather or homeland security requirements in the United States and other countries. These issues could delay importation of products or require us to locate alternative ports or warehousing providers to avoid disruption to our customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on our business and financial condition.

 

Risks Relating to Our Business

 

Our net sales have not grown substantially for over ten years, we have substantial debt and actions we have taken, and may take in the future, to address these and other issues facing our business may not be successful over the long term.

 

Our net sales have declined from a peak of $7.1 billion in 1996 to $4.1 billion in 2003, and have remained roughly flat since 2003. We face intense competition, increased focus by retailers on private-label offerings, customer consolidation, growth in distribution sales channels where we traditionally have not had a strong presence, declining sales of traditional core products and continuing pressure on both wholesale and retail pricing. Our ability to successfully compete is impaired by our substantial debt and interest expense, which reduces our operating flexibility and limits our ability to respond to developments in the worldwide apparel industry as effectively as competitors that do not have comparable debt levels. In addition, the strategic, operations and management changes we have made in recent years to improve our business and drive future sales growth may not be successful over the long term.

 

We may be unable to maintain or increase our sales through our primary distribution channels.

 

In the United States, chain stores and department stores are the primary distribution channels for our Levi’s^® and Dockers^® products. We may be unable to increase sales of our products through these distribution channels for several reasons including the following:

 

 

 

Our ability to maintain retail floor space, market share and sales in these channels depends on our ability to offer differentiated and exclusive products and to increase retailer profitability on our products, which could have an adverse impact on our margins.

 

In Europe, department stores and independent jeanswear retailers are our primary distribution channels. These channels have experienced challenges competing against vertically integrated specialty stores. In Asia Pacific, some of our mature markets are facing challenges evidenced by slower performance by some wholesale customers. Further success by vertically integrated specialty stores in Europe and continued challenges in the mature markets of Asia Pacific may adversely affect the sales of our products in those regions.

 

We depend on a group of key customers for a significant portion of our revenues. A significant adverse change in a customer relationship or in a customer’s performance or financial position could harm our business and financial condition.

 

Net sales to our ten largest customers totaled approximately 42% of total net revenues in both 2007 and 2006. Our largest customer, J.C. Penney Company, Inc., accounted for approximately 9% of net revenues in both fiscal years 2007 and 2006. The retail industry in the United States has experienced substantial consolidation in recent years, such as the merger of Federated Department Stores, Inc. and May Department Stores Co., both of whom were leading department store chains and significant Levi’s^® and Dockers^® brand customers in 2005. This trend in consolidation may continue. Consolidation in the retail industry typically results in store closures, centralized purchasing decisions, increased customer leverage over suppliers, greater exposure for suppliers to credit risk and an increased emphasis by retailers on inventory management and productivity, any of which can, and have, adversely impacted our margins and ability operate efficiently.

 

Additionally, we believe that our customers are subject to the fluctuations in general economic cycles that diminish consumer spending which in turn affects their performance and our business and relationship with them.

 

A decision by a major customer, for any reason, to decrease its purchases from us, to reduce the floor space, assortments, fixtures or advertising for our products or to change its manner of doing business with us, could adversely affect our business and financial condition. In addition, while we have long-standing customer relationships, we do not have long-term contracts with any of our customers. As a result, purchases generally occur on an order-by-order basis, and the relationship, as well as particular orders, can generally be terminated by either party at any time.

 

To grow our business, we must increase brand awareness and sales to female consumers and younger consumers.

 

In the United States, our Levi’s^® and Dockers^® brand sales are weighted towards male consumers 35 years and older. This is due partly to the aging of our traditional consumer, the baby boomer generation, as well as the presence in the market of multiple brands that appeal to younger consumers. We are striving to increase our sales among women and younger consumers. If we are not successful in driving increased sales with these consumers, our results of operations and our ability to grow will be adversely affected.

 

Our inability to revitalize our business in certain markets or product lines could harm our financial results.

 

Given the global reach and nature of our business and the breadth of our product lines, we may experience business declines in certain markets even while experiencing growth in others. For example, our Signature by Levi Strauss & Co.^tm business declined significantly in 2007 and 2006, attributable to a variety of factors, primarily U.S. mass channel retailers’ efforts to expand their private-label offerings. In addition, the mature markets in our Asia Pacific, such as Japan and Korea, region are experiencing challenges. Declines in these areas impact our overall business performance despite growth in other areas such as Europe, and the cumulative effect of these

declines could adversely affect our results of operations. Although we have taken, and continue to take, product, marketing, distribution and organizational actions to reverse such declines, if our actions are not successful on a sustained basis, our results of operations and our ability to grow may be adversely affected.

 

During the past several years, we have experienced significant changes in senior management. The success of our business depends on our ability to attract and retain qualified and effective senior management and board leadership.

 

We have had substantial change in our senior management team. Our new president and chief executive officer, R. John Anderson, assumed his position in November 2006. In October 2006, we promoted the president of our U.S. Levi’s^® business to also serve as president of our North America region, and we named a new leader of our Asia Pacific region. In February 2007, we filled the position of president of our European region, which had been vacant for a year. We replaced our senior human resources executive in June 2007. Robert D. Haas stepped down as our Chairman of the Board at our recent annual stockholders’ meeting and board member Gary Rogers took his place in that role. Continuing changes in our senior management group and board leadership could have an adverse effect on our ability to determine and implement our strategies and on our results of operations.

 

Increasing the number of company-operated stores will require us to develop new capabilities and increase our expenditures.

 

We plan to continue to expand the number of company-operated retail stores dedicated to our brands. Although we currently operate 200 retail stores, we are primarily a wholesaler and an increase in the number of company-operated stores will require us to further develop our retailing skills and capabilities. We will be required to enter into additional leases, increase our rental expenses and make capital expenditures for these stores. These commitments may be costly to terminate, and these investments may be difficult to recapture if we decide to close a store or change our strategy. We must find ways to maintain or increase the consumer traffic to our existing and new company-operated stores. We must also offer a broad product assortment (especially women’s and tops), appropriately manage retail inventory levels, install and operate effective retail systems, execute effective pricing strategies and integrate our stores into our overall business mix. Finally, we will need to hire and train additional qualified employees and incur additional costs to operate these stores, which will increase our operating expenses. These factors, including those relating to securing retail space and management talent, are exacerbated by the fact that many of our competitors either have large company-operated retail operations today or are seeking to expand substantially their retail presence.

 

We must successfully maintain and/or upgrade our information technology systems.

 

We rely on various information technology systems to manage our operations. We are currently implementing modifications and upgrades to our systems, including replacing legacy systems with successor systems, making changes to legacy systems and acquiring new systems with new functionality. For example, we are implementing an SAP enterprise resource planning system, which we have been implementing in Asia Pacific since 2006 and plan to have implemented in the United States and our global sourcing organization in Spring 2008. This implementation subjects us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, demands on management time and other risks of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. Our systems implementations may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. Any information technology system disruptions, if not anticipated and appropriately mitigated, could have an adverse effect on our business and operations.

 

We rely on contract manufacturing of our products. Our inability to secure production sources meeting our quality, cost, working conditions and other requirements, or failures by our contractors to perform, could harm our sales, service levels and reputation.

 

We source approximately 95% of our products from independent contract manufacturers who purchase fabric and other raw materials and may also provide us with design and development services. As a result, we must locate

and secure production capacity. We depend on independent manufacturers to maintain adequate financial resources, secure a sufficient supply of raw materials, and maintain sufficient development and manufacturing capacity in an environment characterized by continuing cost pressure and demands for product innovation and speed-to-market. In addition, we do not have material long-term contracts with any of our independent manufacturers, and these manufacturers generally may unilaterally terminate their relationship with us at any time. Finally, we may experience capability-building and infrastructure challenges as we expand our sourcing to new contractors in Asia Pacific.

 

Our dependence on contract manufacturing could subject us to difficulty in obtaining timely delivery of products of acceptable quality. A contractor’s failure to ship products to us in a timely manner or to meet our quality standards could cause us to miss the delivery date requirements of our customers. In addition, any interference with our ability to receive shipments from those contractors, such as conditions at ports or issues that otherwise affect transportation and warehousing providers, could cause delayed delivery of product. Failing to make timely deliveries may cause our customers to cancel orders, refuse to accept deliveries, impose non-compliance charges through invoice deductions or other charge-backs, demand reduced prices or reduce future orders, any of which could harm our sales and margins.

 

We require contractors to meet our standards in terms of working conditions, environmental protection, security and other matters before we are willing to place business with them. As such, we may not be able to obtain the lowest-cost production. In addition, the labor and business practices of apparel manufacturers have received increased attention from the media, non-governmental organizations, consumers and governmental agencies in recent years. Any failure by our independent manufacturers to adhere to labor or other laws or appropriate labor or business practices, and the potential litigation, negative publicity and political pressure relating to any of these events, could harm our business and reputation.

 

We are a global company with nearly half our revenues coming from our international operations, which exposes us to political and economic risks.

 

We generated approximately 42% of our net revenues from our European and Asia Pacific businesses in 2007 and 2006. A substantial amount of our products came from sources outside of the country of distribution. As a result, we are subject to the risks of doing business abroad, including:

 

 

The functional currency for most of our foreign operations is the applicable local currency. As a result, fluctuations in foreign currency exchange rates affect the results of our operations and the value of our foreign assets, which in turn may adversely affect reported earnings and the comparability of period-to-period results of operations. In addition, we engage in hedging activities to manage our foreign currency exposures resulting from certain product sourcing activities, some intercompany sales, foreign subsidiaries’ royalty payments, earnings repatriations, net investment in foreign operations and funding activities. However, our earnings may be subject to volatility since we do not fully hedge our foreign currency exposures and we are required to record in income the changes in the market values of our exposure management instruments that do not qualify for hedge accounting treatment. Changes in currency exchange rates may also affect the relative prices at which we and foreign competitors sell products in the same market. In addition, changes in the value of the relevant currencies may affect the cost of certain items required in our operations, and foreign policies and actions regarding currency valuation could result in actions by the United States and other countries to offset the effects.

 

Furthermore, due to our global operations, we are subject to numerous domestic and foreign laws and regulations affecting our business, such as those related to labor, employment, worker health and safety, antitrust and competition, environmental protection, consumer protection, import/export and anti-corruption, including but

not limited to the Foreign Corrupt Practices Act which prohibits giving anything of value intended to influence the awarding of government contracts. Although we have put into place policies and procedures aimed at ensuring legal and regulatory compliance, our employees, subcontractors and agents could take actions that violate these requirements. Violations of these regulations could subject us to criminal or civil enforcement actions, any of which could have a material adverse effect on our business.

 

We have made changes in our logistics operations in recent years and continue to look for opportunities to increase efficiencies.

 

We have closed several of our distribution centers in recent years and continually work to identify additional opportunities to optimize our distribution network and reduce total delivered product cost. Changes in logistics and distribution activities could result in temporary shipping disruptions and expense as we bring new arrangements to full operation, which could have an adverse effect on our results of operations.

 

Most of the employees in our production and distribution facilities are covered by collective bargaining agreements, and any material job actions could negatively affect our results of operations.

 

In North America, most of our distribution employees are covered by various collective bargaining agreements, and outside North America, most of our production and distribution employees are covered by either industry-sponsored and/or state-sponsored collective bargaining mechanisms. Any work stoppages or other job actions by these employees could harm our business and reputation.

 

Our licensees may not comply with our product quality, manufacturing standards, marketing and other requirements.

 

We license our trademarks to third parties for manufacturing, marketing and distribution of various products. While we enter into comprehensive agreements with our licensees covering product design, product quality, sourcing, manufacturing, marketing and other requirements, our licensees may not comply fully with those agreements. Non-compliance could include marketing products under our brand names that do not meet our quality and other requirements or engaging in manufacturing practices that do not meet our supplier code of conduct. These activities could harm our brand equity, our reputation and our business.

 

Our success depends on the continued protection of our trademarks and other proprietary intellectual property rights.

 

Our trademarks and other intellectual property rights are important to our success and competitive position, and the loss of or inability to enforce trademark and other proprietary intellectual property rights could harm our business. We devote substantial resources to the establishment and protection of our trademark and other proprietary intellectual property rights on a worldwide basis. Our efforts to establish and protect our trademark and other proprietary intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products. Unauthorized copying of our products or unauthorized use of our trademarks or other proprietary rights may not only erode sales of our products but may also cause significant damage to our brand names and our ability to effectively represent ourselves to our customers, contractors, suppliers and/or licensees. Moreover, others may seek to assert rights in, or ownership of, our trademarks and other proprietary intellectual property, and we may not be able to successfully resolve those claims. In addition, the laws and enforcement mechanisms of some foreign countries may not allow us to protect our proprietary rights to the same extent as we are able to in the United States and other countries.

 

We have substantial liabilities and cash requirements associated with postretirement benefits, pension and deferred compensation plans, and with our restructuring activities.

 

Our postretirement benefits, pension, and deferred compensation plans, and our restructuring activities result in substantial liabilities on our balance sheet. In addition, these plans and activities have and will generate substantial cash requirements for us. These liabilities may impair our liquidity, have an unfavorable impact on our ability to obtain financing and place us at a competitive disadvantage compared to some of our competitors who do not have such liabilities and cash requirements.

Earthquakes or other events outside of our control may damage our facilities or the facilities of third parties on which we depend.

 

Our corporate headquarters are located in California near major geologic faults that have experienced earthquakes in the past. An earthquake or other natural disaster could disrupt our operations. Additionally, the loss of electric power, such as the temporary loss of power caused by power shortages in the grid servicing our headquarters, could disrupt operations or impair critical systems. Any of these disruptions or other events outside of our control could affect our business negatively, harming our operating results. In addition, if any of our other facilities, including our manufacturing, finishing or distribution facilities or our company-operated or franchised stores, or the facilities of our suppliers or customers are affected by earthquakes, power shortages, floods, monsoons, terrorism, epidemics or other events outside of our control, our business could suffer.

 

We will be required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. Failure to timely comply with the requirements of Section 404 or any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on the credit ratings and trading price of our debt securities.

 

We are not currently an “accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Beginning with our Annual Report for the year ending November 30, 2008, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to include an internal control report with our Annual Report on Form 10-K. That report must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year. The report must also include disclosure of any material weaknesses in internal control over financial reporting that we have identified. Beginning with our Annual Report for the year ending November 29, 2009, our independent registered public accounting firm will also be required to issue a report on their evaluation of the effectiveness of our internal control over financial reporting. Our assessment requires us to make subjective judgments and our independent registered public accounting firm may not agree with our assessment.

 

Achieving compliance with Section 404 within the prescribed period may require us to incur significant costs and expend significant time and management resources. We cannot assure you that we will be able to complete the work necessary for our management to issue its management report in a timely manner, or that we will be able to complete any work required for our management to be able to conclude that our internal control over financial reporting is operating effectively. If we are not able to complete the assessment under Section 404 in a timely manner, we and our independent registered public accounting firm would be unable to conclude that our internal control over financial reporting is effective as of the relevant period. As a result, investors could lose confidence in our reported financial information, which could have an adverse effect on the trading price of our debt securities, negatively affect our credit rating, and affect our ability to borrow funds on favorable terms.

 

Risks Relating to Our Debt

 

We have debt and interest payment requirements at a level that may restrict our future operations.

 

As of November 25, 2007, we had approximately $2.0 billion of debt, of which all but approximately $250 million was unsecured, and we had approximately $368.6 million of additional borrowing capacity under our senior secured revolving credit facility. Our substantial debt requires us to dedicate a major portion of any cash flow from operations to the payment of interest and principal due under our debt, which will reduce funds available for other business purposes, and result in us having lower net income than we would otherwise have had. It could also have important adverse consequences to holders of our securities. For example, it could:

 

 

In addition, borrowings under our senior secured revolving credit facility are at variable rates of interest. Our unsecured term loan also bears interest at a variable rate. As a result, increases in market interest rates would require a greater portion of our cash flow to be used to pay interest, which could further hinder our operations and affect the trading price of our debt securities. Our ability to satisfy our obligations and to reduce our total debt depends on our future operating performance and on economic, financial, competitive and other factors, many of which are beyond our control.

 

Restrictions in our notes indentures, unsecured term loan and senior secured revolving credit facility may limit our activities, including dividend payments, share repurchases and acquisitions.

 

The indentures relating to our senior unsecured notes, our Yen-denominated Eurobonds, our unsecured term loan and our senior secured revolving credit facility contain restrictions, including covenants limiting our ability to incur additional debt, grant liens, make acquisitions and other investments, prepay specified debt, consolidate, merge or acquire other businesses, sell assets, pay dividends and other distributions, repurchase stock and enter into transactions with affiliates. These restrictions, in combination with our leveraged condition, may make it more difficult for us to successfully execute our business strategy, grow our business or compete with companies not similarly restricted.

 

If our foreign subsidiaries are unable to distribute cash to us when needed, we may be unable to satisfy our obligations under our debt securities, which could force us to sell assets or use cash that we were planning to use elsewhere in our business.

 

We conduct our international operations through foreign subsidiaries, and therefore we depend upon funds from our foreign subsidiaries for a portion of the funds necessary to meet our debt service obligations. We only receive the cash that remains after our foreign subsidiaries satisfy their obligations. Any agreements our foreign subsidiaries enter into with other parties, as well as applicable laws and regulations limiting the right and ability of non-U.S. subsidiaries and affiliates to pay dividends and remit cash to affiliated companies, may restrict the ability of our foreign subsidiaries to pay dividends or make other distributions to us. If those subsidiaries are unable to pass on the amount of cash that we need, we will be unable to make payments on our debt obligations, which could force us to sell assets or use cash that we were planning on using elsewhere in our business, which could hinder our operations and affect the trading price of our debt securities.

 

Our approach to corporate governance may lead us to take actions that conflict with our creditors’ interests as holders of our debt securities.

 

All of our common stock is owned by a voting trust described under “Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” Four voting trustees have the exclusive ability to elect and remove directors, amend our by-laws and take other actions which would normally be within the power of stockholders of a Delaware corporation. Although the voting trust agreement gives the holders of two-thirds of the outstanding voting trust certificates the power to remove trustees and terminate the voting trust, three of the trustees, as a group based on their ownership of voting trust certificates, have the ability to block all efforts by the two-thirds of the holders of the voting trust certificates to remove a trustee or terminate the voting trust. In addition, the concentration of voting trust certificate ownership in a small group of holders, including these three trustees, gives this group the voting power to block stockholder action on matters for which the holders of the voting trust certificates are entitled to vote and direct the trustees under the voting trust agreement.

 

Our principal stockholders created the voting trust in part to ensure that we would continue to operate in a socially responsible manner while seeking the greatest long-term benefit for our stockholders, employees and other stakeholders and constituencies. As a result, we cannot assure that the voting trustees will cause us to be operated and managed in a manner that benefits our creditors or that the interests of the voting trustees or our principal equity holders will not diverge from our creditors.

 

 

Not applicable.

 

We conduct manufacturing, distribution and administrative activities in owned and leased facilities. We operate five manufacturing-related facilities abroad and 12 distribution-only centers around the world. We have renewal rights for most of our property leases. We anticipate that we will be able to extend these leases on terms satisfactory to us or, if necessary, locate substitute facilities on acceptable terms. We believe our facilities and equipment are in good condition and are suitable for our needs. Information about our key operating properties in use as of November 25, 2007, is summarized in the following table:

 

 

 

 

Our global headquarters and the headquarters of our North America region are both located in leased premises in San Francisco, California. Our Europe and Asia Pacific headquarters are located in leased premises in Brussels, Belgium and Singapore, respectively. As of November 25, 2007, we also leased or owned 104 administrative and sales offices in 40 countries, as well as leased a small number of warehouses in four countries. We own or lease several facilities that are no longer in operation that we are working to sell or sublease.

 

In addition, as of November 25, 2007, we had 200 company-operated retail and outlet stores in leased premises in 22 countries. We had 73 stores in the North America region, 71 stores in the Europe region and 56 stores in the Asia Pacific region. In 2007, we opened 67 company-operated stores and closed five stores.

 

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 against deferred tax assets. They also allege that, as a result of these and other tax-related transactions, our financial statements for several years violated generally accepted accounting principles in the United States and Securities and Exchange Commission (“SEC”) 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 independent registered public accounting firm and the Internal Revenue Service (“IRS”), that they refused to do so and, because of this refusal, they were wrongfully terminated. Plaintiffs seek a number of remedies, including compensatory and punitive damages, attorneys’ fees, restitution, injunctive relief and any other relief the court may find proper.

 

On March 12, 2004, plaintiffs filed a complaint in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. In this complaint, in addition to restating the allegations contained in the state complaint, plaintiffs assert that we violated Sections 1541A et seq. of the Sarbanes-Oxley Act by taking adverse employment actions against plaintiffs in retaliation for plaintiffs’ lawful acts of compliance with the administrative reporting provisions of the Sarbanes-Oxley Act. Plaintiffs seek a number of remedies, including compensatory damages, interest lost on all earnings and benefits, reinstatement, litigation costs, attorneys’ fees and any other relief that the court may find proper. The district court has now related this case to the securities class action (described below) styled In re: Levi Strauss & Co. Securities Litigation.

 

On December 7, 2004, plaintiffs requested and we agreed to, a stay of their state court action in order to first proceed with their action in the U.S. District Court for the Northern District of California, San Jose Division, Case No. C-04-01026. Trial of plaintiffs’ Sarbanes-Oxley Act claim, plaintiffs’ defamation claim and our counter-claims is currently set for May 27, 2008.

 

We are vigorously defending these cases and are pursuing our related cross-complaint against the plaintiffs in the state case. We do not expect this litigation to have a material impact on our financial condition, results of operations or cash flows.

 

Class actions securities litigation.  On March 29, 2004, the United States District Court for the Northern District of California, San Jose Division, issued an order consolidating two putative bondholder class-actions (styled Orens v. Levi Strauss & Co., et al. and General Retirement System of the City of Detroit, et al. v. Levi Strauss & Co., et al.) against us, a former chief executive officer, a former chief financial officer, a former corporate controller, our former and current directors and financial institutions alleged to have acted as our underwriters in connection with our April 6, 2001, and June 16, 2003, registered bond offerings. Additionally, the court appointed a lead plaintiff and approved the selection of lead counsel. The consolidated action is styled In re Levi Strauss & Co., Securities Litigation, Case No. C-03-05605 RMW (class action).

 

The action purports to be brought on behalf of purchasers of our bonds who made purchases pursuant or traceable to our prospectuses dated March 8, 2001, or April 28, 2003, or who purchased our bonds in the open market from January 10, 2001, to October 9, 2003. The action makes claims under the federal securities laws, including Sections 11 and 15 of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, relating to our SEC filings and other public statements. Specifically, the action alleges that certain of our financial statements and other public statements during this period materially overstated our net income and other financial results and were otherwise false and misleading, and that our public disclosures omitted to state that we made reserve adjustments that plaintiffs allege were improper. Plaintiffs contend that these statements and omissions caused the trading price of our bonds to be artificially inflated. Plaintiffs seek compensatory damages as well as other relief.

 

On May 26, 2004, the court related this action to the federal wrongful termination action discussed above, such that each action is pending before the same judge. On July 15, 2004, we filed a motion to dismiss this action. On

September 11, 2007, in the matter In re Levi Strauss & Co., Securities Litigation, Case No. C-03-05605 RMW, pending before the United States District Court for the Northern District of California, San Jose Division, the Court dismissed the Section 10(b) and 20(a) claims and dismissed the tax fraud aspects of the Section 11 and 15 claims. The Court also limited the plaintiff class on the Section 11 and 15 claims by eliminating from the class those bondholders who purchased the bonds in private offerings and then exchanged them for registered bonds in the subsequent exchange offer. Plaintiffs filed an amended complaint with respect to the tax-fraud claims January 14, 2008, and we stipulated with the plaintiffs that our response will be due on or before March 21, 2008, subject to court approval.

 

We are vigorously defending this case. We cannot currently predict the impact, if any, that this action may have on our financial condition, results of operations or cash flows.

 

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 of these pending legal proceedings that will have a material impact on our financial condition, results of operations or cash flows.

 

 

No matters were submitted to a vote of our security holders during the fourth quarter of the fiscal year ended November 25, 2007.

 

 

All outstanding shares of our common stock are deposited in a voting trust, a legal arrangement that transfers the voting power of the shares to a trustee or group of trustees. The four voting trustees are Miriam L. Haas, Peter E. Haas, Jr., Robert D. Haas and F. Warren Hellman, three of whom are also directors. The voting trustees have the exclusive ability to elect and remove directors, amend our by-laws and take certain other actions which would normally be within the power of stockholders of a Delaware corporation. Our equity holders, who, as a result of the voting trust, legally hold “voting trust certificates,” not stock, retain the right to direct the trustees on specified mergers and business combinations, liquidations, sales of substantially all of our assets and specified amendments to our certificate of incorporation.

 

The voting trust will last until April 2011, unless the trustees unanimously decide, or holders of at least two-thirds of the outstanding voting trust certificates decide, to terminate it earlier. If Robert D. Haas ceases to be a trustee for any reason, then the question of whether to continue the voting trust will be decided by the holders. The existing trustees will select the successors to the other trustees. The agreement among the stockholders and the trustees creating the voting trust contemplates that, in selecting successor trustees, the trustees will attempt to select individuals who share a common vision with the sponsors of the 1996 recapitalization transaction that gave rise to the voting trust, represent and reflect the financial and other interests of the equity holders and bring a balance of perspectives to the trustee group as a whole. A trustee may be removed if the other three trustees unanimously vote for removal or if holders of at least two-thirds of the outstanding voting trust certificates vote for removal.

 

Our common stock and the voting trust certificates are not publicly held or traded. All shares and the voting trust certificates are subject to a stockholders’ agreement. The agreement, which expires in April 2016, limits the transfer of shares and certificates to other holders, family members, specified charities and foundations and back to the Company. The agreement does not provide for registration rights or other contractual devices for forcing a public sale of shares or certificates, or other access to liquidity. The scheduled expiration date of the stockholders’ agreement is five years later than that of the voting trust agreement in order to permit an orderly transition from effective control by the voting trust trustees to direct control by the stockholders.

 

As of February 1, 2008, there were 177 record holders of voting trust certificates. Our shares are not registered on any national securities exchange, there is no established public trading market for our shares and none of our shares are convertible into shares of any other class of stock or other securities.

 

We have not declared or paid any cash dividends on our common stock since 1996. We may elect to declare and pay cash dividends in the future at the discretion of our board of directors and depending upon our financial condition and compliance with the terms of our debt agreements. Our senior secured revolving credit facility and the indentures governing our senior unsecured notes limit our ability to pay dividends. For more detailed information about these limitations, see Note 5 to our audited consolidated financial statements included in this report.

 

We did not repurchase any of our common stock during the fourth quarter of the fiscal year ended November 25, 2007.

 

The following table sets forth our selected historical consolidated financial data which are derived from our consolidated financial statements that have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, in 2007, and KPMG LLP, an independent registered public accounting firm, for 2006, 2005, 2004 and 2003. The financial data set forth below should be read in conjunction with, and are qualified by reference to, “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations”, our consolidated financial statements for 2007, 2006 and 2005 and the related notes to those consolidated financial statements, included elsewhere in this report.

 

 

 

 

Overview

 

Our Company

 

We design and market jeans, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s^®, Dockers^® and Signature by Levi Strauss & Co.^tm (“Signature”) brands in mature and emerging markets around the world. We also license our trademarks in many countries throughout the world for a wide array of products, including accessories, pants, tops, footwear, home and other products.

 

Our business is operated through three geographic regions: North America, Europe and Asia Pacific. Our products are sold in over 60,000 retail locations in more than 110 countries. We support our brands through a global infrastructure, as we both source and market our products around the world. We distribute our Levi’s^® and Dockers^® products primarily through chain retailers and department stores in the United States and primarily through department stores, specialty retailers and franchised stores abroad. We distribute products under the Signature by Levi Strauss & Co.^tm brand primarily through mass channel retailers in the United States and mass and other value-oriented retailers and franchised stores abroad. We also distribute our Levi’s^® and Dockers^® products through our online stores, and our Levi’s^®, Dockers^® and Signature products through 200 company-operated stores located in 22 countries, including the United States. These stores generated approximately 6% of our net revenues in 2007.

 

We derived nearly half of our net revenues and regional operating income from our European and Asia Pacific businesses in 2007. Sales of Levi’s^® brand products represented approximately 73% of our total net sales in 2007. Pants, including jeans, casual pants and dress pants, represented approximately 87% of our total units sold in 2007, and men’s products generated approximately 72% of our total net sales.

 

Trends Affecting our Business

 

We believe the key marketplace factors affecting us include the following:

 

 

These factors contribute to a market environment of intense competition, constant product innovation and continuing cost pressure throughout the supply chain from manufacturer to consumer. We believe we have the right strategies, capabilities and team in place to address both our challenges and our opportunities in the current competitive environment.

 

Our 2007 Results

 

Our 2007 results reflect continued growth, operating cash flow generation and debt reduction:

 

 

Our Objectives

 

Our key objectives are to strengthen our brands globally in order to sustain profitable growth, continue to generate strong cash flow and further reduce our debt. Critical strategies to achieve this include driving continued product and marketing innovation, driving sales growth through enhancing relationships with wholesale customers and expanding our dedicated store network, and enhancing productivity through systems improvements, optimizing the cost of our products without sacrificing quality, and continuing our disciplined working capital management. We are cautious in 2008 given the current economic environment.

 

Financial Information Presentation

 

Fiscal year.  Our fiscal year consists of 52 or 53 weeks, ending on the last Sunday of November in each year. The 2007, 2006 and 2005 fiscal years consisted of 52 weeks ending on November 25, 2007, November 26, 2006, and November 27, 2005, respectively. Each quarter of fiscal years 2007, 2006 and 2005 consisted of 13 weeks.

Segments.  Our business in 2007 was organized into three geographic regions: North America, Europe and Asia Pacific. As a result of establishing a new North America organization in late 2006, we changed our reporting segments in the first quarter of 2007 to align with the new operating structure; results for our U.S. Levi’s^®, Dockers^® and Signature brands, and our Canada and Mexico business, are included in our North America segment. In addition, we began including in the North America segment certain staff costs previously included in corporate expense. Segment disclosures contained in this Form 10-K conform to the new presentation for all reporting periods.

 

Effective as of the beginning of 2008, our reporting segments were revised as follows: our Latin America market moved to our North America region which is being renamed as the Americas region as a result of the change, and our Turkey, Middle East and North Africa markets moved to Europe; all of these markets were previously managed by our Asia Pacific region. Future financial reporting will reflect these and any subsequent segment changes.

 

Classification.  Our classification of certain significant revenues and expenses reflects the following:

 

 

Constant currency.  Constant currency comparisons are based on current period local currency amounts, translated at the same foreign exchange rates utilized in the corresponding period in the prior year. We routinely evaluate our constant currency financial performance in order to facilitate period-to-period comparisons without regard to the impact of changing foreign currency exchange rates.

Results of Operations

 

2007 compared to 2006

 

The following table summarizes, for the periods indicated, the consolidated statements of income, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

Consolidated net revenues

 

The following table presents net revenues by reporting segment for the periods indicated and the changes in net revenues by reporting segment on both reported and constant currency bases from period to period:

 

 

Consolidated net revenues increased on both reported and constant currency bases for the year ended November 25, 2007, as compared to the prior year. Reported amounts were affected favorably by changes in foreign currency exchange rates, particularly in Europe.

 

North America.  On both reported and constant currency bases, net revenues in North America were stable as compared to the prior year. Changes in foreign currency exchange rates did not affect net revenues significantly.

We faced a challenging retail environment in North America in 2007 as growth in the first half of the year was offset by declines in the second half. Net revenues increased for the U.S. Levi’s^® brand, our largest business, primarily driven by growth in the men’s category, particularly Red Tab^tm products, and increased sales in our retail network, primarily from new company-operated stores; these increases were partially offset by a decline in the women’s business. Net revenues for the U.S. Dockers^® brand grew slightly due to higher sales of women’s products driven by favorable customer response to our seasonal and fashion products; the men’s business was stable with growth in the first half of the year partially offset by declines in the second half due to market conditions, particularly the impact of retail consolidation and the loss of a customer early in the year. Increases in both U.S. Levi’s^® and U.S. Dockers^® brands were partially offset by higher sales allowances and discounts as compared to the prior-year to clear seasonal inventories and to support our customers, including promotional programs. We also had continued net revenue declines for the U.S. Signature brand.

 

Europe.  Net revenues in Europe increased on both reported and constant currency bases. Changes in foreign currency exchange rates affected net revenues favorably by approximately $84 million.

 

Net revenues increased on a constant currency basis in both our retail and wholesale channels, led by increased sales in the Levi’s^® brand, partially offset by the reduction in sales volume related to the withdrawal of Signature brand products in the second quarter of 2007. Increased sales in our dedicated store network, both from company-operated and franchised stores, and a higher proportion of premium-priced products, particularly Levi’s^® Red Tab^tm products, were key contributors to the net sales increase. We exited the Signature brand in Europe after the Spring 2007 season due to limited expansion opportunities in the value channel in Europe and to focus on our Levi’s^® and Dockers^® brands.

 

Asia Pacific.  Net revenues in Asia Pacific increased on both reported and constant currency bases. Changes in foreign currency exchange rates affected net revenues favorably by approximately $21 million.

 

Net revenues increased on a constant currency basis primarily due to growth in our Levi’s^® brand. Dedicated stores continued to drive growth in the region with the addition of company-operated and franchised stores. Net sales were strong in most markets, with growth particularly concentrated in our emerging markets. Certain of our mature markets continue to be challenging, primarily due to the persistence of high inventories held by our wholesale customers that reduced their demand for additional Levi’s^® products.

 

Gross profit

 

The following table shows consolidated gross profit and gross margin for the periods indicated and the changes in these items from period to period:

 

 

Our gross margin decreased slightly for the year ended November 25, 2007, as compared to the prior year. Gross margins declined in North America and Asia Pacific, and increased in Europe. In North America, gross margin was impacted primarily by higher sales allowances and discounts as described above. In Asia Pacific, gross margin was impacted primarily by higher inventory markdown activity and higher sales of closeout products due to high inventory at retail. In Europe, the increase in gross margin was primarily due to lower sourcing costs and the increase in net sales from company-operated stores. The increase in consolidated gross profit was primarily driven by changes in foreign currency exchange rates.

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 and occupancy costs associated with company-operated stores in cost of goods sold.

 

Selling, general and administrative expenses

 

The following table shows our selling, general and administrative expenses (“SG&A”) for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

Total SG&A expenses increased $37.9 million for the year ended November 25, 2007, as compared to the prior year. Changes in foreign currency exchange rates contributed approximately $44 million to the increase in SG&A expenses.

 

Selling.  Selling expenses increased across all business segments, primarily reflecting higher selling costs associated with additional company-operated stores and our business growth in Asia Pacific.

 

Advertising and promotion.  The decrease in advertising and promotion expenses primarily reflects a decrease in spending, primarily television media, in North America, particularly in the fourth quarter, in line with the region’s net revenue declines in the second half of the year. This decrease was partially offset by an increase in media campaign spending in Europe.

 

Administration.  Administration expenses include corporate expenses and other administrative charges. These expenses decreased as compared to prior year due to a reduction in accruals for our annual and long-term incentive compensation programs due to business performance below our internally-set objectives. Additionally, administrative expenses decreased due to the accrual in 2006 of severance and transition expenses related to changes in senior management. These decreases were partially offset by increases in other administrative expenses, primarily certain severance costs in Asia Pacific and Europe and higher costs associated with planning for our SAP implementation in the United States and our global sourcing organization in 2008.

 

Postretirement benefit plan curtailment gains.  During the third quarter of 2006 and first quarter of 2007, we recorded postretirement benefit plan curtailment gains of $29.0 million and $25.3 million, respectively, associated with the closure of our Little Rock, Arkansas, distribution facility. During the second half of 2007, we recorded a postretirement benefit plan curtailment gain of $27.5 million associated with the voluntary termination of certain distribution center employees in North America resulting from the new labor agreement we entered into with the union that represents many of our distribution-related employees in North America. For more information, see Note 11 to our audited consolidated financial statements included in this report.

 

Other.  Other SG&A costs include distribution, information resources, and marketing costs, gain or loss on sale of assets and other operating income. These costs increased as compared to prior year primarily reflecting higher distribution costs related to the separation and buyout costs of the voluntary termination of certain distribution center employees in North America and the growth in net revenues in the period. These costs also increased due to higher marketing expenses in support of revenue growth.

Restructuring charges, net

 

Restructuring charges, net, increased to $14.5 million for the year ended November 25, 2007, from $14.1 million for the prior year. The 2007 amount primarily consisted of asset impairment of $9.1 million and severance charges of $4.3 million recorded in association with the planned closure of our distribution center in Germany. The 2006 amount primarily consisted of severance charges associated with the closure of our Little Rock, Arkansas, distribution center, headcount reductions in Europe and additional lease costs associated with exited facilities in the United States.

 

Operating income

 

The following table shows operating income by reporting segment and the significant components of corporate expense for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

 

 

Regional operating income.  The following describes the changes in operating income by reporting segment for the year ended November 25, 2007, as compared to the prior year:

 

 

 

Corporate.  Corporate expense is comprised of restructuring charges, net, postretirement benefit plan curtailment gains, and other corporate expenses, including corporate staff costs.

 

Postretirement benefit plan curtailment gain in both periods relates to the closure of our Little Rock, Arkansas, distribution center, and with respect to the 2007 period, the voluntary termination of certain distribution center employees in North America. For more information, see Note 11 to our audited consolidated financial statements included in this report.

 

Other corporate staff costs and expenses decreased as compared to prior year primarily due to reductions in long-term incentive compensation expense and executive severance and transition costs. These decreases were partially offset by certain severance costs in Asia Pacific and Europe, the accrual of distribution expenses related to the separation and buyout costs of the voluntary termination of certain distribution center employees in North America, increases in other corporate staff costs primarily associated with increased investment in our information technology systems, and a reduction in our workers’ compensation liability reversals.

 

Corporate expenses in 2007 and 2006 include amortization of prior service benefit of $45.7 million and $55.1 million, respectively, related to postretirement benefit plan amendments in 2004 and 2003, and workers’ compensation reversals of $8.1 million and $13.8 million, respectively. We will continue to amortize the prior service benefit; however, we do not expect material workers’ compensation reversals in the future.

 

Interest expense

 

Interest expense decreased 13.9% to $215.7 million for the year ended November 25, 2007, from $250.6 million in the prior year. Lower debt levels and lower average borrowing rates in 2007, which resulted primarily from our refinancing and debt reduction activities in 2007 and 2006, caused the decrease.

 

The weighted-average interest rate on average borrowings outstanding for 2007 was 9.59% as compared to 10.23% for 2006. The weighted-average interest rate on average borrowings outstanding includes the amortization of capitalized bank fees and underwriting fees, and excludes interest on obligations to participants under deferred compensation plans.

 

Loss on early extinguishment of debt

 

For the year ended November 25, 2007, we recorded a loss of $63.8 million on early extinguishment of debt primarily as a result of our redemption of our floating rate senior notes due 2012 during the second quarter of 2007 and our repurchase of $506.2 million of the outstanding $525.0 million of our 12.25% senior notes due 2012 during the fourth quarter of 2007. The 2007 losses were comprised of prepayment premiums, tender offer consideration, applicable consent payments and other fees and expenses of approximately $46.7 million and the write-off of approximately $17.1 million of unamortized capitalized costs and debt discount.

 

For the year ended November 26, 2006, we recorded losses of $40.3 million on early extinguishment of debt primarily as a result of our prepayment in March 2006 of the remaining balance of our term loan of approximately $488.8 million, the amendment in May 2006 of our senior secured revolving credit facility and open market repurchases of $50.0 million of our 2012 senior unsecured notes in November 2006. The 2006 losses were comprised of prepayment premiums and other fees and expenses of approximately $23.0 million and the write-off of approximately $17.3 million of unamortized capitalized costs. For more information, see Note 5 to our audited consolidated financial statements included in this report.

 

Other income, net

 

Other income, net, primarily consists of foreign exchange management activities and transactions as well as interest income. For the year ended November 25, 2007, other income decreased to $14.1 million from $22.4 million

for the prior year. The decrease primarily reflects the impact of foreign currency fluctuation, primarily the weakening of the U.S. Dollar against major foreign currencies including the Euro, the Canadian Dollar and the Japanese Yen.

 

Income tax (benefit) expense

 

Income tax (benefit) expense was $(84.8) million for the year ended November 25, 2007, compared to $106.2 million for the prior year. The effective tax rate was (22.6)% for the year ended November 25, 2007, compared to 30.8% for the prior year. The decrease in the effective tax rate for 2007 as compared to 2006 was primarily driven by a reduction in tax expense of approximately $206.8 million due primarily to the non-recurring, non-cash reversal of valuation allowances of $215.3 million during the fourth quarter of 2007 against our deferred tax assets for foreign tax credit carryforwards. As a result of improvements in business performance and recent positive developments in an ongoing IRS examination, we believe that it is more likely than not that these credits will be utilized prior to their expiration. The income tax expense of $106.2 million in 2006 included a non-recurring, non-cash benefit of $31.5 million relating to a reduction in the overall residual U.S. tax expected to be imposed upon a repatriation of unremitted foreign earnings attributable to a change in the ownership structure of certain of our foreign affiliates.

 

Net income

 

Net income increased to $460.4 million for year ended November 25, 2007, from $239.0 million for the prior year primarily due to the $206.8 million net tax benefit recorded during 2007. Lower interest expense and the higher postretirement benefit plan curtailment gain as compared to the prior year also contributed to the increase.

2006 compared to 2005

 

The following table summarizes, for the periods indicated, the consolidated statements of income, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

Consolidated net revenues

 

The following table presents net revenues by reporting segment for the periods indicated and the changes in net revenues by reporting segment on both reported and constant currency bases from period to period:

 

 

Consolidated net revenues were stable on both reported and constant currency bases for the year ended November 26, 2006, as compared to the prior year. Reported amounts were affected unfavorably by changes in foreign currency exchange rates in Europe and Asia Pacific.

 

North America.  On both reported and constant currency bases, net revenues in North America were stable as compared to the prior year. Changes in foreign currency exchange rates did not affect net revenues significantly.

 

Net revenues for the U.S. Levi’s^® brand, our largest business, grew in 2006 despite the impact of retail consolidation. Net revenues in the men’s and women’s categories were stable in 2006, while the boys’ category grew as compared to prior year. New company-operated retail stores and a favorable wholesale sales mix reflecting

a lower proportion of discounted products in line with our pricing and product strategy, were the primary factors driving the increase. Higher sales allowances to support our retailers and their promotion of our products partly offset the gross sales increase. Net revenues for the U.S. Dockers^® brand increased from prior year, despite the impact of retail consolidation, due to growth in both our men’s and women’s categories. We successfully launched our wearing occasion strategy for men with products designed for work, weekend, dress and golf, introduced our Dockers^® Collection line and increased our seasonal/fashion mix in the women’s category through an overhaul of the women’s product range. Net revenues for the U.S. Signature brand decreased from prior year primarily due to a decrease in the women’s category resulting from Wal-Mart Stores, Inc.’s allocation of more retail space to its private-label programs.

 

Europe.  Net revenues in Europe decreased on both reported and constant currency bases. Changes in foreign currency exchange rates affected net revenues unfavorably by approximately $10 million.

 

The decrease in net revenues occurred across all brands, primarily driven by lower demand for our products, especially in the first half of 2006, and our exit from certain retailers in line with our strategy to strengthen the premium positioning of the Levi’s^® and Dockers^® brands in Europe. Increased sales in our dedicated store network, primarily from company-operated retail stores during the year, partially offset the decrease. Net sales in the second half of 2006 were stable as compared to prior year, helped by favorable currency fluctuation and an improved product offering.

 

Asia Pacific.  Net revenues in Asia Pacific increased on both reported and constant currency bases. Changes in foreign currency exchange rates affected net revenues unfavorably by approximately $15 million.

 

Net revenues increased on a constant currency basis in most countries across the Asia Pacific region. Increased sales of Levi’s^® brand products in both the men’s and women’s categories, the continued expansion of our dedicated store network, and an increase in licensing revenues drove the revenue increase. However, net revenues for Japan, the largest affiliate in the region, decreased due to a combination of a change in fashion trends, a weak advertising campaign and high inventory at our wholesale customers that primarily affected the second half of 2006. The decline in Japan was more than offset by growth in the rest of the region, including our emerging markets such as China and India, each of which nearly doubled its net sales over 2005.

 

Gross profit

 

The following table shows consolidated gross profit and gross margin for the periods indicated and the changes in these items from period to period:

 

 

Gross profit and gross margin were flat relative to prior year. Gross margin increases resulting primarily from an increase in licensing revenue were offset primarily by a shift in the regional revenue contribution away from Europe, which has the highest average gross margin of all our regions, to North America, which has a lower gross margin.

 

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 and occupancy costs associated with company-operated stores in cost of goods sold.

Selling, general and administrative expenses

 

The following table shows our selling, general and administrative expenses (“SG&A”) for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

Total SG&A expenses decreased $33.4 million and as a percentage of net revenues for the year ended November 26, 2006, as compared to prior year. Changes in foreign currency exchange rates did not affect SG&A expenses significantly.

 

Selling.  Selling expense increased as compared to 2005, primarily reflecting additional selling costs in North America associated with new company-operated stores and to support growth in our Dockers^® for women product line, and additional headcount in Asia Pacific to support our focus on emerging markets.

 

Advertising and promotion.  The decrease in advertising and promotion expenses primarily reflects lower media spending in Europe to bring the spend in line with our other business units. We continued to support our brands through a diverse mix of advertising and promotion initiatives; as a percentage of their net revenues, advertising and promotion expenses in our North America and Asia Pacific regions were consistent with prior year.

 

Administration.  Administration expenses include corporate expenses and other administrative charges. These expenses increased as compared to prior year primarily due to costs associated with the retirement of our former CEO, Mr. Philip A. Marineau, and the appointment of his successor, Mr. Anderson. These executive transition costs include $7.75 million in additional cash compensation and $5.4 million in non-cash pension curtailment loss in respect of our supplemental executive retirement plan resulting from the retirement of Mr. Marineau, and $3.8 million in additional cash compensation paid to Mr. Anderson upon his appointment as chief executive officer. A reduction in accruals for our annual incentive compensation program was offset by an increase in accruals for our long-term incentive compensation programs, for which performance is measured over multiple years.

 

Postretirement benefit plan curtailment gain.  In 2006 we recognized a $29.0 million gain related to the curtailment of the postretirement benefit plan associated with the closure of our Little Rock, Arkansas, distribution facility. For more information, see Note 11 to our audited consolidated financial statements included in this report.

 

Other.  Other SG&A costs include distribution, information resources, marketing costs, gain or loss on sale of assets and other operating income. These costs decreased primarily due to lower distribution costs in Europe as a result of lower sales volume and our prior restructuring actions, and a gain on the sale of our Nordic operations office in Europe, partially offset by an increase in information resources expense related to our implementation of SAP in our Asia Pacific region.

 

Restructuring charges, net

 

Restructuring charges, net, decreased to $14.1 million for the year ended November 26, 2006, from $16.6 million for the prior year. The 2006 amount primarily consisted of severance charges associated with the

closure of the Little Rock, Arkansas, distribution center, headcount reductions in Europe related to consolidation of Nordic operations and our decision to stop selling the Signature brand in Europe, and additional lease costs associated with closed facilities in the United States. The 2005 amount primarily consisted of charges for severance and employee benefits for U.S. and Europe organizational changes in 2004.

 

Operating income

 

The following table shows operating income by reporting segment and the significant components of corporate expense for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:

 

 

 

 

Regional operating income.  The following describes the changes in operating income by reporting segment for the year ended November 26, 2006, as compared to the prior year:

 

 

Corporate.  Corporate expense is comprised of restructuring charges, net, postretirement benefit plan curtailment gain, and other corporate expenses, including corporate staff costs.

 

Postretirement benefit plan curtailment gain relates to the closure of our Little Rock, Arkansas, distribution center. For more information, see Note 11 to our audited consolidated financial statements included in this report.

 

Other corporate staff costs and expenses increased as compared to prior year primarily due to incremental expenses incurred in connection with the retirement of Mr. Marineau and the appointment of Mr. Anderson as our chief executive officer. These costs also increased due to higher corporate information resources expense, reflecting a shift in spending from a regional to a global applications focus, and an increase in accruals for our long-term incentive compensation programs, for which performance is measured over multiple years. These increases were partially offset by an increase in periodic postretirement benefit plan income (resulting from the annual remeasurement of the plan at the beginning of the year) and lower expenses in our global sourcing organization.

 

Corporate expenses in 2006 and 2005 include amortization of prior service benefit of $55.1 million and $57.6 million, respectively, related to postretirement benefit plan amendments in 2004 and 2003, and workers’ compensation reversals of $13.8 million and $21.1 million, respectively. We will continue to amortize the prior service benefit; however, we do not expect material workers’ compensation reversals in the future.

 

Interest expense

 

Interest expense decreased to $250.6 million for the year ended November 26, 2006, from $263.6 million in the prior year. The decrease was attributable to lower average debt balances and lower average borrowing rates.

 

The weighted-average interest rate on average borrowings outstanding for 2006 was 10.23% as compared to 10.51% for 2005. The weighted-average interest rate on average borrowings outstanding includes the amortization of capitalized bank fees and underwriting fees, and excludes interest on obligations to participants under deferred compensation plans.

 

Loss on early extinguishment of debt

 

For the year ended November 26, 2006, we recorded losses of $40.3 million on early extinguishment of debt primarily as a result of our prepayment in March 2006 of the remaining balance of our term loan of approximately $488.8 million, the amendment in May 2006 of our senior secured revolving credit facility and open market repurchases of $50.0 million of our 2012 senior unsecured notes in November 2006. The 2006 losses were comprised of prepayment premiums and other fees and expenses of approximately $23.0 million and the write-off of approximately $17.3 million of unamortized capitalized costs.

 

For the year ended November 27, 2005, we recorded losses of $66.1 million on early extinguishment of debt primarily as a result of our repurchase of $372.1 million of our $450.0 million principal amount 2006 senior unsecured notes in January 2005, and repurchase and redemption of all of our outstanding $380.0 million and €125.0 million 2008 senior unsecured notes in March and April 2005. The 2005 losses were comprised of tender offer premiums and other fees and expenses of approximately $53.6 million and the write-off of approximately $12.5 million of unamortized capitalized costs and debt discount. For more information, see Note 5 to our audited consolidated financial statements included in this report.

 

Other income, net

 

Other income, net, primarily consists of foreign exchange management activities and transactions as well as interest income. For the year ended November 26, 2006, other income decreased to $22.4 million from $23.0 million for the prior year. The slight decrease primarily reflects the impact of foreign currency fluctuation, primarily the weakening of the U.S. Dollar against major currencies including the Euro and the Japanese Yen and an increase in interest income resulting from an increase in interest rates and higher average investment balances.

Income tax expense

 

Income tax expense was $106.2 million for the year ended November 26, 2006, compared to $126.7 million for the prior year. The effective tax rate was 30.8% for the year ended November 26, 2006, compared to 44.8% for the prior year. The decrease in the effective tax rate for 2006 as compared to 2005 was primarily driven by a modification of the ownership structure of certain of our foreign subsidiaries, which resulted in a reduction in the overall residual U.S. tax we expect to be imposed upon a repatriation of our unremitted foreign earnings. This change in ownership structure generated a non-recurring, non-cash reduction in tax expense of $31.5 million. The effective tax rate also decreased from 2005 as a result of our net reversal of valuation allowances totaling $28.7 million, which includes a $17.4 million benefit relating to state net operating loss carryforwards and a $13.8 million benefit relating primarily to net operating loss carryforwards and other foreign deferred tax assets in our European affiliates. Because of recent improvements in business performance and a more positive outlook, we believe it more likely than not that these deferred tax assets will be realized. The benefit of the reversal was partially offset by a $2.5 million increase in valuation allowance during the year relating to certain U.S. federal capital loss carryforwards.

 

Net income

 

Net income increased to $239.0 million for the year ended November 26, 2006, from $155.9 million for the prior year. The increase in 2006 was primarily due to the tax benefits related to the change in the ownership structure of certain foreign subsidiaries, the postretirement benefit plan curtailment gain, the reversal of deferred tax asset valuation allowances and lower losses on early extinguishment of debt. Lower interest expense also contributed to the increase.

Liquidity and Capital Resources

 

Liquidity outlook

 

We believe we will have adequate liquidity over the next twelve months to operate our business and to meet our cash requirements.

 

Cash sources

 

We are a privately-held corporation. We have historically relied primarily on cash flow from operations, borrowings under credit facilities, issuances of notes and other forms of debt financing. We regularly explore financing and debt reduction alternatives, including new credit agreements, unsecured and secured note issuances, equity financing, equipment and real estate financing, securitizations and asset sales. Key sources of cash include earnings from operations and borrowing availability under our revolving credit facility.

 

In 2007, we amended and restated our senior secured revolving credit facility; the maximum availability is now $750.0 million secured by certain of our domestic assets and certain U.S. trademarks associated with the Levi’s^® brand and other related intellectual property. The amended facility includes a $250.0 million term loan tranche. Upon repayment of this $250.0 million term loan tranche, the secured interest in the U.S. trademarks will be released. As of November 25, 2007, we had borrowings of $250.0 million under the trademark tranche and our total availability, based on other collateral levels as defined by the agreement, was approximately $447.2 million. We had no outstanding borrowings under the revolving tranche of the credit facility, but had utilization of other credit-related instruments such as documentary and standby letters of credit. As a result, unused availability was approximately $368.6 million as of November 25, 2007.

 

Under our senior secured revolving credit facility, we are required to meet a fixed charge coverage ratio of 1.0:1.0 when unused availability is less than $100.0 million. This covenant will be discontinued upon the repayment in full and termination of the trademark tranche described above and with the implementation of a liquidity reserve of $50 million, which implementation will reduce availability under our credit facility.

 

As of November 25, 2007, we had cash and cash equivalents totaling approximately $155.9 million, resulting in a net liquidity position (unused availability and cash and cash equivalents) of $524.5 million.

 

Cash uses

 

Our principal cash requirements include working capital, capital expenditures, payments of principal and interest on our debt, payments of taxes, contributions to our pension plans and payments for postretirement health benefit plans. In addition, we regularly explore debt reduction alternatives, including through tender offers, redemptions, repurchases or otherwise, and we regularly evaluate our ability to pay dividends or repurchase stock, all consistent with the terms of our debt agreements.

 

The following table presents selected cash uses in 2007 and the related projected cash requirements for these items in 2008:

 

 

 

 

 

The following table provides information about our significant cash contractual obligations and commitments as of November 25, 2007: