SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

For the fiscal year ended November 26, 2006

 

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 o     No þ

 

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 þ     No o

 

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” 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 8, 2007

 

Documents incorporated by reference: None

 

 

LEVI STRAUSS & CO.

 

TABLE OF CONTENTS TO FORM 10-K

 

FOR FISCAL YEAR ENDING NOVEMBER 26, 2006

 

 

Overview

 

We are one of the world’s leading branded apparel companies. We design and market jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s^®, Dockers^® and Levi Strauss Signature^® brands in 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.

 

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 our Levi Strauss Signature^® products primarily through mass channel retailers in the United States and mass and other value-oriented retailers and franchised stores abroad. We also distribute Levi’s^®, Dockers^® and Levi Strauss Signature^® products through 138 company-operated stores located in 18 countries including the United States.

 

We were incorporated in Delaware in 1973 and conduct our operations in the United States primarily through Levi Strauss & Co. and outside the United States through foreign subsidiaries owned directly or indirectly by Levi Strauss & Co. Our executive offices are located at Levi’s Plaza, 1155 Battery Street, San Francisco, California 94111. Our telephone number is (415) 501-6000. Our website is located at www.levistrauss.com. Our website and the information contained on our website are not part of this annual report and are not incorporated by reference into this annual report.

 

Our fiscal year consists of 52 or 53 weeks, ending on the last Sunday in November each year. Fiscal years 2006, 2005 and 2004 consisted of 52 weeks each and ended on November 26, 2006, November 27, 2005, and November 28, 2004.

 

Our History

 

Our history and longevity are unique in the apparel industry: Levi’s^® jeans are the original, authentic and definitive jeans. In 1853, during the California Gold Rush, our founder, Levi Strauss, opened a wholesale dry goods business in San Francisco. That business became known as “Levi Strauss & Co.” In 1873, Mr. Strauss and Jacob Davis, a tailor, saw a consumer need for work pants that could hold up under rough conditions. They worked together and received a U.S. patent to make “waist overalls” with metal rivets at points of strain on the pants — and in so doing created the first jean. Mr. Strauss commercialized the product and brought it to market that year, and, in 1890, first used the number “501” in the product line.

 

For nearly 100 years after our founding, we manufactured and distributed work pants and other products worn primarily by cowboys, miners and other working men in the western United States and also represented other manufacturers with an extensive line of dry goods. We introduced our first jeans for women in 1934. Our jeans rapidly grew in popularity after World War II and became a symbol of American culture by the 1960s. During these years, we exited the dry goods business to concentrate on manufacturing and marketing apparel under the Levi’s^® trademark, with export and international businesses opening in the 1950s and 1960s. In 1986, we introduced the Dockers^® brand of casual apparel, which was at the forefront of the business casual trend in the United States. In 2003, in response to the emergence and success of the mass channel, we launched our Levi Strauss Signature^® brand of jeans and casual apparel for consumers who shop in that channel. Our commitment to quality, innovation and corporate citizenship, manifested in many ways throughout our history, began with Mr. Strauss and continues today.

 

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

 

Our Global Reach

 

From our Gold Rush beginnings in San Francisco, we now operate around the world. Our business is organized into three geographic regions: North America, Europe and Asia Pacific. Our Asia Pacific region includes both

established markets such as Japan and Korea and emerging markets such as India and China, as well as our businesses in South America, the Middle East and Africa. Our global reach and presence are demonstrated by the following:

 

 

Our Business Strategies

 

Our strategies are designed to reflect marketplace dynamics and build on our competitive strengths. Our key strategies are:

 

 

Our Brands and Products

 

Overview

 

We market our products under the Levi’s^®, Dockers^® and Levi Strauss Signature^® brands and a number of sub-brands and product lines. We offer a broad range of products, including jeans and jeans-related pants, 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 fiscal years 2006 and 2005, and 85% in fiscal 2004. Men’s products generated approximately 72% of our total net sales in fiscal 2006 and 73% in fiscal years 2005 and 2004.

 

Our global product design, development and innovation capabilities are centered on the following key elements:

 

 

Levi’s^® Brand

 

In 1873, our founder Levi Strauss and tailor Jacob Davis created the first blue jean. Our jeans have been distinctive from the beginning. The double arc of stitching — known as the Arcuate Stitching Design — has adorned the back pockets of Levi’s^® jeans since their inception. We began using the lot number “501” in 1890 and the red Tab Device, a fabric tab stitched into the back right pocket, in 1936. Since those early days, the Levi’s^® brand, as the source of the original, authentic and definitive jean, has become one of the most widely recognized and distributed brands in the history of the apparel industry. Our merchandising and marketing reflect what we see as the brand’s core attributes: original, definitive and confident.

 

The original jean has evolved to include 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. Our Levi’s^® brand offerings extend from core jeans to premium-priced styles targeted to fashion leaders, reflecting what we believe is the broad consumer appeal of the brand across ages, genders and lifestyles. Our Levi’s^® brand businesses in Europe and Asia Pacific are positioned in the premium segments of the men’s and women’s markets. Our product architecture and strategy in the United States include an emphasis on growth in more premium segments while continuing to update and drive our core and trend Red Tab^tm jeans business in our chain and department store customers.

 

Our current product range includes:

 

 

We sell Levi’s^® brand products in more than 110 countries. Sales in the United States generated almost half of total Levi’s^® brand net sales in fiscal 2006, 2005 and 2004. Sales of Red Tab^tm products represented a majority of our Levi’s^® brand net sales in all three of our regions in fiscal 2006, 2005, and 2004. Sales of Levi’s^® brand products represented approximately 70%, 71% and 70% of our total net sales in fiscal 2006, 2005 and 2004, respectively.

 

  Dockers^® Brand

 

We launched the Dockers^® brand in 1986 to provide an alternative between jeans and dress pants for the baby boomer generation in the United States. The brand was at the forefront of the business casual trend in the United States. It has since grown to cover a wide range of wearing occasions for men and women with products that combine approachable style, relevant innovation, consistent fit and sustained quality. The brand remains a leader in developing and commercializing technical performance innovations into everyday apparel.

 

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

 

 

We sell Dockers^® brand products in more than 50 countries. Sales in the United States generated a substantial majority of total Dockers^® brand net sales in fiscal 2006, 2005 and 2004. Sales of Dockers^® brand products represented approximately 21%, 19% and 20% of our total net sales in fiscal 2006, 2005 and 2004, respectively.

 

  Levi Strauss Signature^® Brand

 

Our Levi Strauss Signature^® brand offers men’s, women’s and kids’ jeans and other products. Our merchandising and marketing reflects what we view as the core point of difference for the Levi Strauss Signature^® brand: bringing our company’s style, authenticity and quality to more value-seeking consumers.

 

The brand offers a wide range of products for men, young men, women, misses, juniors and kids. The product portfolio in the United States currently includes:

 

 

We sell Levi Strauss Signature^® brand products in seven countries in our North America and Asia Pacific regions. We are exiting the business in Europe after the spring 2007 season due to limited expansion opportunities in the European value channel. Sales in the United States represented a substantial majority of total Levi Strauss Signature^® brand net sales in fiscal 2006, 2005 and 2004. Sales of Levi Strauss Signature^® brand products represented approximately 9% of our total net sales in fiscal 2006 and 10% in fiscal years 2005 and 2004.

 

Licensing

 

The appeal of our brands across consumer groups and our global reach enable us to license our Levi’s^®, Dockers^® and Levi Strauss Signature^® 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 brands in each of our regions. 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, multibrand specialty stores, mass channel retailers and both company-operated and retailer websites. Our distribution strategy focuses on ensuring that our brands and products are available where consumers shop and that our product offerings and assortments are appropriately differentiated for the retailer. Sales to our top five and top 10 customers accounted for approximately 33% and 42% respectively, of our total net revenues in both 2006 and 2005.

 

North America

 

In North America, we distribute our Levi’s^® and Dockers^® products through national and regional chains, department stores, specialty stores, and franchise and company-operated stores dedicated to our brands. Top Levi’s^® and Dockers^® customers in North America include J.C. Penney, Kohl’s, Sears, Federated Department Stores and Mervyn’s in the United States, Hudson’s Bay Co. in Canada and Liverpool in Mexico. We target our premium products, such as Levi’s^® Capital E^tm products and Levi’s^® Vintage Clothing, to our dedicated stores and to independent, image-conscious specialty stores which cater to more fashion-forward, trend-initiating consumers, including Barneys, Fred Segal and Urban Outfitters in the United States. We distribute our Levi Strauss Signature^® brand through the mass merchant channel, including Wal-Mart, Target and Kmart stores in the United States.

 

Europe

 

Our European Levi’s^® and Dockers^® brand customers include large department stores, such as El Corte Inglés in Spain, Galeries Lafayette in France and Kaufhof in Germany; franchised Levi’s^® Stores and Dockers^® Stores; mail-order accounts; and a substantial number of independent retailers operating either a single or small group of jeans-focused stores or general clothing stores.

 

Asia Pacific

 

In Asia Pacific, we distribute our Levi’s^® and Dockers^® products through specialty stores, including multi-brand as well as dedicated Levi’s^® and Dockers^® Store retail shops, and department stores. Top customers include Right-On Stores and Eiko Shoji in Japan and Lotte Department Stores in Korea. We distribute the Levi Strauss Signature^® brand in general merchandise retailers such as Aeon stores in Japan and dedicated stores in India. Our Asia Pacific business is weighted toward Japan, which represented approximately 31% and 39% of our net revenues in the region in 2006 and 2005, respectively.

 

Dedicated Stores

 

Overview.  We believe retail stores dedicated to our brands are important for the growth, visibility, availability and commercial success of our brands. These stores include retail stores (both first quality and outlet)

operated by us and by independent franchisees and licensees. In international markets, dedicated shop-in-shops located within department stores are also an important component of our retail network.

 

Company-Operated Stores.  As of November 26, 2006, we had 138 company-operated retail stores that sell Levi’s^®, Dockers^® and Levi Strauss Signature^® products located in 18 countries across our three regions. We had 47 stores in North America, 60 stores in Europe and 31 stores in Asia Pacific. In 2006, we opened 72 company-operated stores and closed one store. Sales from company-operated stores generated approximately 4% of our net revenues in 2006.

 

Franchised Stores.  Over 1,100 franchised or other licensed stores sell Levi’s^®, Dockers^® and Levi Strauss Signature^® 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 in the United States and abroad. A majority of the outlet stores in the United States are operated by a third party under license.

 

Expansion.  Dedicated retail stores are an increasingly important part of our strategy for expanding distribution of our products in all three of our regions. In fiscal 2007 we expect approximately 200 new stores to open in our Asia Pacific region, 50 new stores in our Europe region and 40 new stores in our North America region, with the substantial majority of the new stores outside the United States to be franchised.

 

Internet

 

We sell products directly to consumers in the United States through the www.levisstore.com and www.dockersstore.com websites. In the United States, our products are also sold online through authorized third-party internet sites operated by our brick and mortar retail customers. In Canada and Europe, authorized dealers and mail order accounts which meet our standards may sell our products to consumers through their own internet sites. We also operate websites devoted to the Levi’s^®, Dockers^® and Levi Strauss Signature^® brands as marketing vehicles to enhance consumer understanding of our brands and help consumers find and buy our products.

 

Marketing and Promotion

 

We support our brands with a diverse mix of marketing initiatives to drive consumer demand. We incurred expenses of approximately $285.3 million, or 6.8% of total net revenues in 2006 on these activities, compared with expenses of approximately $338.6 million, or 8.0% of total net revenues, in 2005.

 

Marketing Vehicles.  We advertise around the world through a broad mix of media, including television, national publications, the internet, cinema, billboards and other outdoor vehicles. 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 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 pop-up stores near college campuses, street-level events and similar targeted “viral” marketing activities.

 

Levi’s^® Brand.  Our marketing programs for the Levi’s^® brand are designed to communicate the authenticity of Levi’s^® jeans, the original and definitive jeans brand. Our programs draw on the unique heritage and strength of the brand in contemporary, locally relevant ways by focusing on our innovative fits and new finishes and on what we believe is the unique connection that consumers have with their Levi’s^® jeans. We also work to increase the visibility of Levi’s^® brand products at retail, including refining product packaging and store displays, executing customer-specific marketing programs and continuing to open new dedicated stores in selected locations around the world.

 

Dockers^® Brand.  Our Dockers^® brand marketing focuses on communicating an integrated brand offering for men and women that covers a broad range of wearing occasions. 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. Our Dockers^® brand marketing programs also focus on updating of retail

floor presentations in order to improve the consumer’s shopping experience and drive increased visibility and consumption of the brand.

 

Levi Strauss Signature^® Brand.  We use a variety of marketing and publicity techniques to increase consumer awareness of the Levi Strauss Signature^® brand among value-conscious consumers. These initiatives focus on sponsorship programs, in-store presentation and online marketing. Sponsorship marketing in the United States centers on the brand’s involvement in NASCAR racing and our relationship with NASCAR 2006 NEXTEL Cup champion Jimmie Johnson.

 

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 approximately 95% of our products from independent contract manufacturers. We source the balance of our products from our company-operated manufacturing plants located in Hungary, the Philippines, Poland, South Africa and Turkey. See “Item 2 — Properties” for more information about those manufacturing facilities.

 

We source our products from contract manufacturers primarily through “package” or “ready to wear” arrangements in which the contractors produce or purchase fabric themselves and then sew, finish and ship the garments. We then purchase the finished goods. We typically conduct business with our garment manufacturing and finishing contractors on an order-by-order basis.

 

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 2006, we sourced products from contractors located in approximately 45 countries around the world. We sourced approximately 40% of our products in Asia, 40% in South and Central America (including Mexico and the Caribbean) and the balance in Europe, the Middle East and Africa. We expect to increase our sourcing from contractors located in Asia, the Middle East and Africa in future years. No single country accounted for more than 20% of our sourcing in 2006.

 

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 and 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, including third-party arrangements in the United States, Europe and Asia.

 

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 outside the United States.

 

Principal competitive factors include:

 

 

North America

 

We sell Levi’s^®, Dockers^® and Levi Strauss Signature^® products to retailers in diverse channels across a wide range of retail price points. As a result, we face a wide range of competitors, including:

 

 

Europe

 

Key aspects of the European competitive environment include the following:

 

 

 

Asia Pacific

 

Key aspects of the Asia Pacific competitive environment include the following:

 

 

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^®, Levi Strauss Signature^® 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 500 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.

 

Seasonality

 

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. In 2005, our net revenues in the first, second, third and fourth quarters represented 24%, 23%, 25% and 28%, respectively, of our total net revenues for the year.

 

Corporate Citizenship

 

We believe that great brands and businesses are built by consistently providing quality products and by earning the trust of consumers, investors, employees and society as a whole through responsible business practices. We believe, in short, that commercial success and corporate citizenship are closely linked. This principle of responsible commercial success is embedded in our 154-year experience. We believe it continues to anchor how we operate today.

 

For us, corporate citizenship includes a 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 believe our “profits through principles” business approach manifests itself in how we develop our business strategies and policies and make everyday decisions. Activities throughout our history reflect our approach to corporate citizenship:

 

 

 

Employees

 

As of November 26, 2006, we employed approximately 10,680 people, approximately 3,630 of whom were located in the United States, 3,540 in Europe, 3,190 in Asia Pacific, and 320 in Canada and Mexico. We added approximately 1,000 employees in 2006. Most of the new employees were associated with our company-operated stores. Approximately 3,870 of our employees were associated with manufacturing of our products and approximately 6,810 were non-production employees. Of the non-production employees, approximately 1,500 worked in distribution. Most of our distribution employees in the United States are covered by various collective bargaining agreements. Outside the United States, most of our production and distribution employees are covered by either industry-sponsored and/or state-sponsored collective bargaining mechanisms. We consider our relations with our employees to be good and have not recently experienced any material job actions or labor shortages.

 

Government Regulation

 

We are subject to federal, state, local and foreign laws and regulations affecting our business, including those related to labor, employment, worker health and safety, antitrust and competition, environmental protection, products liability, product labeling, consumer protection and anti-corruption. In the United States, these laws include the Occupational Safety and Health Act, the Flammable Fabrics Act, the Textile Fiber Products Identification Act, the Foreign Corrupt Practices Act and the rules and regulations of the Consumer Products Safety Commission and the Federal Trade Commission. We are also subject to import and export laws, including U.S. economic sanction and embargo regulations, U.S. homeland security laws and regulations and other laws such as the U.S. anti-boycott law and U.S. export controls regulations. We are also subject to comparable laws of the European Union, Japan and other foreign jurisdictions where we have a presence. We believe that we are in substantial compliance with the applicable federal, state, local and foreign laws and regulations governing our business.

 

All of our import operations are subject to tariffs and quotas set by governments through mutual agreements or bilateral actions. Our operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, the U.S.-Dominican Republic-Central America Free Trade

Agreement, the Egypt Qualified Industrial Zone program and the activities and regulations of the World Trade Organization.

 

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 customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and canceling orders. As a result, any substantial deterioration in general economic conditions, increases in energy costs or interest rates, acts of war, acts of nature or terrorist or political events that diminish consumer spending and confidence in any of the regions in which we compete could reduce our sales and adversely affect our business and financial condition. For example, the price of oil has fluctuated widely in the past. A 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 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 successfully with them. 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. 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, 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, ongoing emergence of new competitors with widely varying strategies and resources, and a continuing focus on apparel in the mass merchant channel of distribution in the United States. These factors contribute to ongoing pricing pressure throughout the supply chain. This pressure has had the effects below and may continue to:

 

 

 

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 used to produce them, primarily cotton. The price and availability of cotton may fluctuate substantially, depending on a variety of factors, including demand, crop yields, weather, supply conditions, transportation costs, government regulation, economic climates and other unpredictable factors. Increases in raw material costs, together with other factors, may 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, 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 for ten years, we have substantial debt and actions we have taken and may take to turn around 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 turn around 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 addition, recent efforts by mass channel retailers in the United States to expand their private label offerings may reduce floor space devoted to our Levi Strauss Signature^® products, which could have an adverse impact on our sales. For example, we experienced such impacts in 2006 as a result of actions taken by Wal-Mart to increase its private label women’s business.

 

In Europe, department stores and independent jeanswear retailers are our primary distribution channels. These channels have experienced challenges competing against vertically integrated specialty stores. Further success by vertically integrated specialty stores may adversely affect the sales of our products in Europe.

 

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 10 largest customers totaled approximately 42% of total net revenues in both 2006 and 2005. Our largest customer, J.C. Penney Company, Inc., accounted for approximately 9% and 8% of net revenues in 2006 and 2005, respectively. The retail industry in the United States has experienced substantial consolidation in recent years. For example, 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, merged in 2005. Consolidation in the retail industry has resulted 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.

 

A decision by a major customer, whether motivated by competitive considerations, strategic shifts, financial requirements or difficulties, economic conditions or otherwise, 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.

 

We must attract younger consumers and more female consumers to our brands.

 

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 target younger consumers. If we are not successful in attracting younger consumers and more female consumers to our brands, our results of operations and our ability to grow will be adversely affected.

 

Our inability to revitalize our European business could harm our financial results.

 

Our European net sales declined by approximately 8.5% and 8.0% on a constant currency basis in 2006 and 2005, respectively. The declines were attributable to a variety of factors, including loss of retail distribution, growth in the vertically integrated specialty store channel, declines in market share especially among 15-34 year-old consumers and the impact of organizational changes. In addition, in the third quarter of 2006, we announced that we would stop selling the Levi Strauss Signature^® brand in Europe (which represented less than 3% of our European net revenues in 2006) after the Spring 2007 season due to limited expansion opportunities in the value channel in Europe. Although we have taken product, marketing, distribution and organizational actions to reverse these sales declines, if our actions are not successful on a sustained basis, our results of operations and our ability to grow will be adversely affected.

 

Our Levi Strauss Signature^® business could erode our margins and our sales of our Levi’s^® products.

 

Our Levi Strauss Signature^® brand, which includes a broad line of jeans and casual apparel products, is available at mass channel retailers across the United States, including Wal-Mart, Target and Kmart, and in mass channel retailers and other value-oriented retailers outside of the United States. Although we believe that we have not experienced any substantial cannibalization of our Levi’s^® brand, it is possible that sales of Levi Strauss Signature^® products through the mass channel may result in reduced Levi’s^® brand sales. In addition, by offering a less expensive brand in the mass channel that carries the “Levi Strauss” name, it is possible that we may adversely affect the perception and appeal of our Levi’s^® brand by both our current retailers who sell our products and consumers who purchase our products. A decision by a retailer to stop carrying or reduce its support of the Levi’s^® brand or reduced purchases by consumers could result in an overall decrease in our sales.

 

During the past two 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.

 

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. The position of president of our European region, which we will fill in late February 2007, has been vacant since February 2006, and the region has been overseen by our chief executive officer during that period. Our senior human resources executive is leaving us in February 2007. In addition, in the last 20 months we also appointed a new president of our U.S. Dockers^® business, a new leader of our global sourcing organization and a new general counsel. Continuing changes in our senior management group could have an adverse effect on our ability to implement our strategies and on our results of operations.

 

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

 

We plan to expand the number of our company-operated retail stores dedicated to our brands. Although we currently operate 138 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. In addition, it may be difficult for us to identify and obtain retail space in locations and on terms we find acceptable. 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 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 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 in Asia, North America and our global sourcing organization, which we also plan to implement in Europe in the coming years. There are inherent costs and risks associated with replacing and changing these systems, including substantial capital expenditures, demands on management time and the risk of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. 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 and we depend on independent manufacturers to maintain adequate financial resources, to secure a sufficient supply of raw materials and to 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, the Middle East and Africa.

 

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. The failure 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 40% of our net revenues from our European and Asia Pacific businesses in 2006 and 2005. 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. Our consolidated net revenues in 2006 of $4.2 billion were stable as compared to 2005 on both a reported and constant currency basis. In addition, although we engage in hedging activities to manage our foreign currency exposures, our earnings may be subject to volatility since 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 China’s policies and actions regarding currency valuation could result in actions by the United States and other countries to offset the effects.

 

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

 

In the United States, most of our distribution employees are covered by various collective bargaining agreements, and outside the United States, 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 our distribution 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 imitation 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, which as of November 26, 2006, and November 27, 2005, totaled $729.9 million and $849.8 million, respectively. In addition, these plans and activities have and will generate substantial cash requirements for us. For example, for 2006, we made net cash payments of approximately $107 million relating to our pension and postretirement benefits plans and our restructuring activities. For 2007, we expect to make net cash payments of approximately $90 million relating to our deferred compensation, postretirement benefits and pension plans, and our restructuring activities.

 

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 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 be required to issue a report on their evaluation of the operating 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.

 

Risks Relating to Our Substantial Debt

 

We have substantial debt and interest payment requirements that may restrict our future operations.

 

As of November 26, 2006, we had approximately $2.2 billion of debt, of which substantially all was unsecured, and we had approximately $317.5 million of additional borrowing capacity under our senior secured revolving credit facility. Our substantial debt requires us to dedicate a substantial 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, any future borrowings under our senior secured revolving credit facility will be at variable rates of interest. Our floating rate senior unsecured notes due 2012 also bear 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 and our 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 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 our assets or use cash that we were planning to use elsewhere in our business.

 

We conduct our international operations through foreign subsidiaries, which accounted for approximately 45% of our net revenues during 2006 and 2005. As a result, 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 earnings 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 13 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 26, 2006, is summarized in the following table:

 

 

 

 

We also lease a manufacturing facility in Dongguan, China where a third-party operates production activities for us.

 

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 26, 2006, we also leased or owned 103 administrative and sales offices in 38 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 26, 2006, we had 138 company-operated retail and outlet stores in leased premises in 18 countries. We had 47 stores in the North America region, 60 stores in the Europe region and 31 stores in the Asia Pacific region. In 2006, we opened 72 company-operated stores and closed one store. In 2007, we expect to open approximately 40 new company-operated stores in our Asia Pacific region, eight new company-operated stores in our Europe region and 38 new company-operated stores in our North America region.

 

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 and 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 November 5, 2007, pending approval of the court.

 

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 or results of operations.

 

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. The

matter came before the court on October 15, 2004, and, after oral argument had concluded, the court took the matter under submission. The court has not yet issued a ruling.

 

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

 

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 or results of operations.

 

No matters were submitted to a vote of our security holders during our 2006 fiscal fourth quarter.

 

Our shares of common stock are held by members of the families of several descendants of our founder, Levi Strauss, and by several former members of our management. 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.

 

All 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. As of February 1, 2007, 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 to us. 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, 2007, there were 174 record holders of voting trust certificates.

 

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 26, 2006.

 

The equity compensation plan information required by this item is incorporated in “Item 11 — Executive Compensation” of this annual report.

 

The following table sets forth our selected historical consolidated financial data which are derived from our consolidated financial statements that have been audited by KPMG LLP, an independent registered public accounting firm. 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 2006, 2005 and 2004 and the related notes to those consolidated financial statements, included elsewhere in this report. Certain prior year amounts have been reclassified to conform to the 2006 presentation.

 

 

 

 

 

Overview

 

Our Company

 

We design and market jeans and jeans-related pants, casual and dress pants, tops, jackets and related accessories for men, women and children under our Levi’s^®, Dockers^® and Levi Strauss Signature^® brands in 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. In 2006, we derived approximately 40% of our net revenues and regional operating income from our European and Asia Pacific businesses. Pants, including jeans, casual pants and dress pants, represented approximately 87% of our total units sold in 2006. Men’s products generated approximately 72% of our total net sales in 2006. We source approximately 95% of our products from independent contract manufacturers.

 

Our products are sold through more than 55,000 retail locations in multiple channels of distribution worldwide. 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 dedicated franchised stores abroad. We distribute our Levi Strauss Signature^® products primarily through mass channel retailers in the United States and mass and other value-oriented retailers and franchised stores abroad. Sales to our ten largest customers represented approximately 42% of our net revenues in 2006. We also distribute our Levi’s^®, Dockers^® and Levi Strauss Signature^® products through our two company-operated online stores in the United States and 138 company-operated stores located in 18 countries including the United States. These stores generated approximately 4% of our net revenues in 2006.

 

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.

 

Our 2006 Results

 

Our 2006 results reflect our continued focus on generating strong cash flows and sustaining profitability while making investments we believe will drive future sales growth and productivity. Key results included:

 

 

 

We also reshaped our senior management team as we entered 2007. We appointed a new chief executive officer, R. John Anderson, upon the retirement of Philip A. Marineau, our former CEO, at the end of our 2006 fiscal year. We established a new North America structure and appointed the president of that organization, and named new presidents of our Europe and Asia Pacific businesses.

 

Our 2007 Objectives

 

Our key objectives for 2007 are to achieve profitable growth, continue to generate strong cash flow and reduce our debt. Critical actions to achieve this include:

 

 

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. In 2007 we expect to achieve, at minimum, net revenues that are stable with 2006 net revenues, and operating margins that are consistent with those in 2006. We intend to drive growth in our U.S. Levi’s^® and Dockers^® brand businesses, optimize our U.S. Levi Strauss Signature^® brand,

stabilize revenues in our Europe business, and achieve continued growth in our Asia Pacific region in part through focusing on emerging markets such as India and China.

 

Financial Information Presentation

 

Fiscal Year.  Our fiscal year consists of 52 or 53 weeks, ending on the last Sunday of November each year. The 2006, 2005 and 2004 fiscal years each consisted of 52 weeks, ending on November 26, 2006, November 27, 2005, and November 28, 2004, respectively. All references to years relate to fiscal years rather than calendar years.

 

Segments.  Our business is currently organized into six segments across three geographic regions: North America, Europe and Asia Pacific. Our North American region includes our U.S. Levi’s^®, Dockers^® and Levi Strauss Signature^® commercial business units. These commercial business units, together with our Canada and Mexico business and our Europe and Asia Pacific businesses, are our reporting segments for 2006. We are reviewing our reporting segments as a result of the establishment of a multi-brand North America organization in late 2006.

 

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

 

 

Changes in Presentation.  The audited consolidated financial statements for 2005 and 2004 included in this report have been reclassified to conform to the following changes in presentation made in 2006:

 

 

Correction of Net Revenues Presentation.  We determined in 2006 that in prior periods net sales relating to certain sales arrangements in our Asia Pacific business involving the use of a third-party were improperly presented net of costs incurred under these arrangements. We corrected the presentation for all prior periods reported within the consolidated statements of income. The effect of this correction increased both “Net sales” and “Selling, general and administrative expenses” in our consolidated statements of income by approximately $28 million, $26 million and $21 million for 2006, 2005 and 2004, respectively. The correction had no impact on our reported operating income, net income, consolidated balance sheets or consolidated statements of cash flows for any period, and an insignificant impact on gross profit and gross margin in all periods.

 

Results of Operations

 

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 segment for the respective periods:

 

 

Consolidated net revenues were stable on both a reported (0.8)% and constant currency basis (0.3)%. Increases in net revenues for the fiscal year in the U.S. Dockers^® brand, our Asia Pacific business and the U.S. Levi’s^® brand were offset by decreased net revenues in our Europe business and the U.S. Levi Strauss Signature^® brand and the unfavorable translation impact of foreign currencies.

 

U.S. Levi’s^® Brand.  The following table presents net sales and licensing revenue for our U.S. Levi’s^® brand for the respective periods:

 

 

Net revenues in 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. Our opening 21 additional company-operated retail stores during the year, 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. Our slim/straight fits and products with cleaner finishes and increased penetration in more premium distribution and price points, through products such as Levi’s Capital E^tm and other premium lines, also contributed to the growth. Higher sales allowances to support our retailers and their promotion of our products partly offset the gross sales increase.

 

U.S. Dockers^® Brand.  The following table presents net sales and licensing revenue for our U.S. Dockers^® brand for the respective periods:

 

Total net revenues in 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 targeted 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. Termination of a licensing agreement in the third quarter of 2005 resulted in the slight decrease in licensing revenues.

 

U.S. Levi Strauss Signature^® Brand.  The following table presents net sales and licensing revenue for our U.S. Levi Strauss Signature^® brand for the respective periods:

 

 

Net sales in the U.S. Levi Strauss 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. Modest sales decreases in the young men’s category were offset by increases in the kids’ category. The U.S. Levi Strauss Signature^® brand is a key component of our multi-channel distribution strategy and we are actively exploring ways to improve its net revenues performance.

 

Canada and Mexico.  The following table presents net sales and licensing revenue in our Canada and Mexico business for the respective periods:

 

 

Total net revenues in the Canada and Mexico business increased from prior year due primarily to changes in foreign currency exchange rates which affected net revenues favorably by approximately $7 million in 2006. On a constant currency basis, growth in our Mexico business, particularly in men’s Levi’s^® brand products, was offset by reduced sales of Levi’s^® brand products to certain retailers in Canada as we shifted our product offerings to better align with our brand strategies.

 

Europe.  The following table presents net sales and licensing revenue in our Europe region for the respective periods:

 

 

Total net revenues in Europe for 2006, as compared to 2005, decreased on both reported and on constant currency bases. Changes in foreign currency exchange rates impacted net revenues unfavorably by approximately $10 million in 2006.

 

The decrease in net sales on a constant currency basis 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. Net sales attributable to our opening 26 additional 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. On a constant currency basis, net sales for the second half of 2006 decreased 4% as compared to the same period in 2005, whereas net sales for the first half of 2006 decreased 12% as compared to the same period in 2005. We believe the improved second half sales results indicate that our strategies — driving the premium positioning of our products, leveraging our local market model and increasing our retail presence through additional dedicated stores — are working.

 

As previously disclosed, we will stop selling the Levi Strauss Signature^® brand in Europe after the Spring 2007 season due to currently limited expansion opportunities in the value channel in Europe and to allow for focus on our Levi’s^® and Dockers^® brands. Our Levi Strauss Signature^® brand in Europe represented less than 3% of our total European net revenues in 2006.

 

Asia Pacific.  The following table presents net sales and licensing revenue in our Asia Pacific region for the respective periods:

 

 

Total net revenues in the Asia Pacific region for 2006, as compared to 2005, increased on both reported and on constant currency bases. Changes in foreign currency exchange rates affected net revenues unfavorably by approximately $15 million in 2006.

 

Net revenues increased for 2006 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 retail presence, including the addition of more than 100 franchised stores, and an increase in licensing revenues drove the revenue increase. However, net revenues for Japan, the largest affiliate in the region, decreased on a reported basis in 2006 by 16% for the full year and 8% for the fourth quarter as compared to prior year, due to a combination of a change in fashion trends, a weak advertising campaign and high retailer inventory 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 China and India affiliates, each of which nearly doubled its net sales over 2005.

 

Gross profit

 

The following table shows consolidated gross profit and gross margin for the respective periods:

 

 

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 our U.S. businesses, which have lower gross margins.

 

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 respective periods:

 

 

Total SG&A expenses decreased $33.4 million and as a percentage of net revenues as compared to prior year.

 

Selling.  Selling expense increased as compared to 2005, primarily reflecting additional selling costs associated with new company-operated stores dedicated principally to the Levi’s^® brand, additional headcount in Asia Pacific to support our focus on emerging markets, and additional costs in our U.S. Dockers^® brand to support growth in our women’s product line.

 

Advertising and promotion.  Advertising and promotion expenses decreased as compared to prior year driven primarily by decreased advertising spending in Europe to bring the spend in line with our other business units. We continue 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 includes finance, human resources, legal, executive management and certain other administrative and employee benefit costs. Total administration expenses were affected favorably by a benefit plan curtailment gain offset by costs associated with the retirement of our former CEO and the appointment of his successor. In the third quarter of 2006 we recognized a $29.0 million gain related to the curtailment of the postretirement benefit plan associated with the closure of the Little Rock, Arkansas, distribution center. Our CEO 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 annual incentive compensation expense of $10.7 million in 2006 was offset by additional long-term incentive compensation expense totaling $7.2 million related to both our 2005 and 2006 Long-Term Incentive Plans and our Management Incentive Plan, for which performance is measured over multiple years. Excluding the curtailment gain and CEO transition costs, our administration expenses, including incentive compensation, decreased slightly as compared with 2005.

 

Other.  Other SG&A expenses include distribution, information resources, marketing, gain or loss on sale of assets, and other operating income. These costs decreased as compared to prior year 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

 

Restructuring charges, net of reversals, were $14.1 million and $16.6 million for 2006 and 2005, respectively. 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 Levi Strauss 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. For more information, see Note 10 to our audited consolidated financial statements included in this report.

 

Operating income

 

The following table shows operating income for our commercial business units in the United States, for Canada and Mexico, and in total for the North America, Europe and Asia Pacific regions, and the significant components of corporate expense for the respective periods:

 

 

 

 

Regional operating income.  The following describes the changes in operating income by geographic region:

 

 

 

Corporate expense.  Corporate expense is comprised of restructuring charges, net of reversals 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 decreased as compared to prior year primarily due to 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, partially offset by the incremental expenses incurred in connection with the retirement of Mr. Marineau and appointment of Mr. Anderson as our chief executive officer. A reduction in corporate annual incentive compensation expense of $9.0 million in 2006 was offset by additional long-term incentive compensation expense totaling $7.2 million related to both our 2005 and 2006 Long-Term Incentive Plans and our Management Incentive Plan, for which performance is measured over multiple years. 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 gross 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 2006 from $263.6 million in 2005. The decrease was attributable to lower average debt balances and lower average borrowing rates. The weighted average interest rate on average borrowings outstanding during 2006 and 2005 was 10.23% and 10.51%, respectively. The weighted average interest rate on average borrowings outstanding includes the amortization of capitalized bank fees, underwriting fees and interest rate swap cancellations, and excludes interest on obligations to participants under deferred compensation plans and other miscellaneous items.

 

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 debt refinancing activities. During the year ended November 27, 2005, we recorded losses of $66.1 million. 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. We incurred these costs in conjunction with 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. The 2005 loss was comprised of tender offer premiums and other fees and expenses approximating $53.6 million and the write-off of approximately $12.5 million of unamortized debt discount and capitalized costs. We incurred these costs in conjunction with our completion in January 2005 of a tender offer to repurchase $372.1 million of our $450.0 million principal amount 2006 senior unsecured notes, and completion in March and April 2005 of the tender offers and redemptions of all of our outstanding $380.0 million and €125.0 million 2008 senior unsecured notes. For more information, see Note 5 to our audited consolidated financial statements included in this report.

 

Other income, net

 

The following table summarizes significant components of other income, net:

 

 

 

 

Other income, net decreased to $22.4 million from $23.0 million in 2005. The slight decrease from prior year was primarily attributable to the net unfavorable impact of foreign currency fluctuation 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 2006 compared to $126.7 million for 2005. The effective tax rate was 30.8% for the year 2006 compared to 44.8% for 2005. The decrease in the effective tax rate from 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. The net $28.7 million benefit 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.

 

We expect the main driver in the effective tax rate for the foreseeable future to be the impact of changes to the valuation allowance against our deferred tax assets and our ability to credit, rather than deduct, foreign taxes on our U.S. federal income tax return.

 

Net income

 

Net income for 2006 was $239.0 million, as compared to $155.9 million for 2005. The increase in 2006 was primarily due to a postretirement benefit plan curtailment gain, lower losses on early extinguishment of debt, tax benefits related to a change in the ownership structure of certain foreign subsidiaries, a reversal of deferred tax asset valuation allowances and lower interest expense.

 

2005 compared to 2004

 

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