10-Q 1 a3q2018form10-q.htm 10-Q 2018 Q3 Document

 
 
 
 
 
 
 
 
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
Form 10-Q
(Mark One)
 þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended August 26, 2018
or
 ¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 002-90139
_________________
LEVI STRAUSS & CO.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE
  
94-0905160
(State or Other Jurisdiction of
Incorporation or Organization)
  
(I.R.S. Employer
Identification No.)
1155 Battery Street, San Francisco, California 94111
(Address of Principal Executive Offices) (Zip Code)
(415) 501-6000
(Registrant’s Telephone Number, Including Area Code)
None
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
_________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ¨  No  þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of "Large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
 
 
Accelerated filer ¨
Non-accelerated filer þ
(Do not check if a smaller reporting company)
Smaller reporting company ¨
Emerging growth company ¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  þ
The Company is privately held. Nearly all of its Common Stock is owned by descendants of the family of the Company’s founder, Levi Strauss, and their relatives. There is no trading in the Common Stock 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 — 37,602,316 shares outstanding on October 4, 2018
 
 
 
 
 
 
 
 
 
 



LEVI STRAUSS & CO. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018
 
 
 
 
Page
Number
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 



PART I — FINANCIAL INFORMATION

Item 1.
CONSOLIDATED FINANCIAL STATEMENTS
LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
(Unaudited)
 
 
 
August 26,
2018
 
November 26,
2017
 
(Dollars in thousands)
ASSETS
Current Assets:
 
 
 
Cash and cash equivalents
$
612,506


$
633,622

Trade receivables, net of allowance for doubtful accounts of $9,113 and $11,726
487,240


485,485

Inventories:
 


Raw materials
3,527


3,858

Work-in-process
2,883


3,008

Finished goods
931,843


752,530

Total inventories
938,253


759,396

Other current assets
157,982


118,724

Total current assets
2,195,981


1,997,227

Property, plant and equipment, net of accumulated depreciation of $967,765 and $951,249
420,008


424,463

Goodwill
236,492


237,327

Other intangible assets, net
42,850


42,893

Deferred tax assets, net
400,778


537,923

Other non-current assets
121,568


118,005

Total assets
$
3,417,677


$
3,357,838

 
 
 
 
LIABILITIES, TEMPORARY EQUITY AND STOCKHOLDERS’ EQUITY
Current Liabilities:
 
 
 
Short-term debt
$
35,790


$
38,451

Accounts payable
361,702


289,505

Accrued salaries, wages and employee benefits
249,889


227,251

Restructuring liabilities
463


786

Accrued interest payable
17,206


6,327

Accrued income taxes
36,473


16,020

Other accrued liabilities
340,498


300,730

Total current liabilities
1,042,021


879,070

Long-term debt
1,026,055


1,038,860

Long-term capital leases
15,762


16,524

Postretirement medical benefits
81,172


89,248

Pension liability
191,134


314,525

Long-term employee related benefits
97,038


90,998

Long-term income tax liabilities
8,048


20,457

Other long-term liabilities
77,183


78,733

Total liabilities
2,538,413


2,528,415

Commitments and contingencies





Temporary equity
225,090


127,035

 

 
 
Stockholders’ Equity:

 
 
Levi Strauss & Co. stockholders’ equity


 
 
Common stock — $.01 par value; 270,000,000 shares authorized; 37,615,303 shares and 37,521,447 shares issued and outstanding
376


375

Accumulated other comprehensive loss
(413,721
)

(404,381
)
Retained earnings
1,060,158


1,100,916

Total Levi Strauss & Co. stockholders’ equity
646,813


696,910

Noncontrolling interest
7,361


5,478

Total stockholders’ equity
654,174


702,388

Total liabilities, temporary equity and stockholders’ equity
$
3,417,677


$
3,357,838


The accompanying notes are an integral part of these consolidated financial statements.


3


LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017

(Dollars in thousands)
(Unaudited)
Net revenues
$
1,394,153


$
1,268,391

 
$
3,983,580

 
$
3,438,237

Cost of goods sold
652,591


611,762

 
1,833,017

 
1,658,663

Gross profit
741,562


656,629

 
2,150,563

 
1,779,574

Selling, general and administrative expenses
582,953


510,309

 
1,741,331

 
1,462,263

Operating income
158,609


146,320

 
409,232

 
317,311

Interest expense
(15,697
)

(14,476
)
 
(45,659
)
 
(52,305
)
Loss on early extinguishment of debt

 

 

 
(22,793
)
Other (expense) income, net
(3,032
)

(14,734
)
 
1,044

 
(32,413
)
Income before income taxes
139,880


117,110

 
364,617

 
209,800

Income tax expense
10,299


27,631

 
176,633

 
42,477

Net income
129,581

 
89,479

 
187,984

 
167,323

Net loss (income) attributable to noncontrolling interest
543


(1,487
)
 
(1,940
)
 
(1,672
)
Net income attributable to Levi Strauss & Co.
$
130,124


$
87,992

 
$
186,044

 
$
165,651
















The accompanying notes are an integral part of these consolidated financial statements.


4


LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
(Dollars in thousands)
(Unaudited)
Net income
$
129,581


$
89,479

 
$
187,984

 
$
167,323

Other comprehensive income (loss), before related income taxes:


 
 
 
 
 
Pension and postretirement benefits
3,347


3,693

 
9,864

 
11,153

Net investment hedge gains (losses)
8,645


(27,930
)
 
14,772

 
(57,570
)
Foreign currency translation (losses) gains
(15,483
)

18,051

 
(30,055
)
 
46,638

Unrealized gains on marketable securities
282

 
276

 
456

 
2,151

Total other comprehensive (loss) income, before related income taxes
(3,209
)
 
(5,910
)
 
(4,963
)
 
2,372

Income taxes (expense) benefit related to items of other comprehensive income
(2,050
)
 
9,287

 
(4,433
)
 
15,460

Comprehensive income, net of income taxes
124,322

 
92,856

 
178,588

 
185,155

Comprehensive loss (income) attributable to noncontrolling interest
700

 
(1,561
)
 
(1,883
)
 
(1,573
)
Comprehensive income attributable to Levi Strauss & Co.
$
125,022

 
$
91,295

 
$
176,705

 
$
183,582

































The accompanying notes are an integral part of these consolidated financial statements.


5


LEVI STRAUSS & CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended
 
August 26,
2018

August 27,
2017

(Dollars in thousands)
(Unaudited)
Cash Flows from Operating Activities:



Net income
$
187,984


$
167,323

Adjustments to reconcile net income to net cash provided by operating activities:




Depreciation and amortization
92,130


85,618

Unrealized foreign exchange (gains) losses
(13,827
)

36,717

Realized loss (gain) on settlement of forward foreign exchange contracts not designated for hedge accounting
20,446


(184
)
Employee benefit plans’ amortization from accumulated other comprehensive loss and settlement loss
9,865


11,153

Loss on early extinguishment of debt

 
22,793

Stock-based compensation
15,025


21,910

Other, net
3,678


4,146

Provision for (benefit from) deferred income taxes
127,626


(7,447
)
Change in operating assets and liabilities:




Trade receivables
(11,692
)

45,642

Inventories
(202,822
)

(77,758
)
Other current assets
(36,122
)

(4,947
)
Other non-current assets
(6,045
)

(3,747
)
Accounts payable and other accrued liabilities
111,164


23,022

Restructuring liabilities
(306
)

(3,559
)
Income tax liabilities
11,479


16,042

Accrued salaries, wages and employee benefits and long-term employee related benefits
(101,758
)

(42,599
)
Other long-term liabilities
(2,066
)

326

Net cash provided by operating activities
204,759


294,451

Cash Flows from Investing Activities:




Purchases of property, plant and equipment
(99,260
)

(75,793
)
(Payments) proceeds on settlement of forward foreign exchange contracts not designated for hedge accounting
(20,446
)

184

Net cash used for investing activities
(119,706
)

(75,609
)
Cash Flows from Financing Activities:




Proceeds from issuance of long-term debt


502,835

Repayments of long-term debt


(525,000
)
Proceeds from short-term credit facilities
27,737


23,898

Repayments of short-term credit facilities
(24,196
)

(20,382
)
Other short-term borrowings, net
49


(10,255
)
Payment of debt extinguishment costs

 
(21,902
)
Payment of debt issuance costs

 
(10,110
)
Repurchase of common stock, including shares surrendered for tax withholdings on equity award exercises
(53,773
)

(13,292
)
Dividend to stockholders
(45,000
)

(35,000
)
Other financing, net
(580
)

(3,196
)
Net cash used for financing activities
(95,763
)

(112,404
)
Effect of exchange rate changes on cash and cash equivalents
(10,406
)

9,288

Net (decrease) increase in cash and cash equivalents
(21,116
)

115,726

Beginning cash and cash equivalents
633,622


375,563

Ending cash and cash equivalents
$
612,506


$
491,289





Noncash Investing Activity:



Property, plant and equipment acquired and not yet paid at end of period
$
13,093


$
10,951

Property, plant and equipment additions due to build-to-suit lease transactions
2,750


4,459





Supplemental disclosure of cash flow information:



Cash paid for interest during the period
$
27,511


$
29,570

Cash paid for income taxes during the period, net of refunds
67,221


32,944




The accompanying notes are an integral part of these consolidated financial statements.


6


LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018
NOTE 1: SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Levi Strauss & Co. (the "Company") is one of the world’s largest brand-name apparel companies. The Company designs, markets and sells – directly or through third parties and licensees – products that include jeans, casual and dress pants, tops, shorts, skirts, jackets, footwear and related accessories for men, women and children around the world under the Levi’s®, Dockers®, Signature by Levi Strauss & Co.™ and Denizen® brands. The Company operates its business through three geographic regions: Americas, Europe and Asia.
Basis of Presentation and Principles of Consolidation
The unaudited consolidated financial statements of the Company and its wholly-owned and majority-owned foreign and domestic subsidiaries are prepared in conformity with generally accepted accounting principles in the United States ("U.S. GAAP") for interim financial information. In the opinion of management, all adjustments necessary for a fair statement of the financial position and the results of operations for the periods presented have been included. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended November 26, 2017, included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on February 7, 2018.
The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated. Management believes the disclosures are adequate to make the information presented herein not misleading. The results of operations for the three and nine months ended August 26, 2018 may not be indicative of the results to be expected for any other interim period or the year ending November 25, 2018.
The Company’s fiscal year ends on the last Sunday of November in each year, although the fiscal years of certain foreign subsidiaries end on November 30. Each quarter of both fiscal years 2018 and 2017 consists of 13 weeks. All references to years relate to fiscal years rather than calendar years.
Subsequent events have been evaluated through the issuance date of these financial statements.
Certain insignificant amounts on the Consolidated Balance Sheets and Consolidated Statements of Cash Flows have been conformed to the August 26, 2018 presentation.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the related notes to the consolidated financial statements. Estimates are based upon historical factors, current circumstances and the experience and judgment of the Company’s management. Management evaluates its estimates and assumptions on an ongoing basis and may employ outside experts to assist in its evaluations. Changes in such estimates, based on more accurate future information, or different assumptions or conditions, may affect amounts reported in future periods.









7



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

Recently Issued Accounting Standards
There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s consolidated financial statements and footnote disclosures, from those disclosed in the Company’s Annual Report on Form 10-K filed with the SEC on February 7, 2018, except for the following, which have been grouped by their effective dates for the Company:
First Quarter of 2019
In March 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2017-07, Compensation-Retirement Benefits (Topic 715) Improving the Presentation of Net Periodic Cost and Net Periodic Postretirement Benefit Cost. ASU 2017-07 changes the income statement presentation of net periodic benefit costs requiring separation between operating expense (service cost component) and non-operating expense (all other components, including interest cost, expected return on plan assets, amortization of prior service costs or credits, curtailments and settlements, actuarial gains and losses, etc). Accordingly, the Company determined this will impact the Company's Consolidated Statements of Income, as the service cost components of net periodic benefit costs will be reported within operating income and the other components of net periodic benefit costs will be reported in the Other Income (Expense), Net line item. The presentation change in the Consolidated Statements of Income requires application on a retrospective basis. A practical expedient is permitted under the guidance which allows the Company to use information previously disclosed in the pension and other postretirement benefit plans footnote as the basis to apply the retrospective presentation requirements. The Company continues to assess the impact that adopting this new accounting standard will have on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. Under the new standard and its related amendments (collectively known as Accounting Standards Codification 606 ("ASC 606")), an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. Enhanced disclosures will be required regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The Company has established an implementation team to assist with its assessment of the impact that the new standard will have on its processes and controls, consolidated financial statements and related disclosures. This includes a review of current accounting policies and practices to identify potential differences that would result from applying ASC 606.
The Company has identified its major revenue streams as sales of products to wholesale customers, including franchised stores, direct sales to consumers at the company-operated stores, including e-commerce, and company-operated shop-in-shops and performed an analysis of its contracts with customers to evaluate the impact ASC 606 will have on the timing and classification of revenue. The majority of the Company's revenue relates to product sales of which revenue is recognized when products are shipped or delivered to the customer or provided directly to consumers through retail locations. In addition, impacts associated with variable consideration received for items such as loyalty rewards, gift cards, discounts and retailer promotions are not expected to be material as the Company is currently accounting for this consideration consistent with the new standard.
The Company has identified certain changes in balance sheet classification under ASC 606. Allowances for estimated returns, discounts and retailer promotions and other similar incentives will be presented as other accrued liabilities rather than netted within accounts receivable and the estimated cost of inventory associated with allowances for estimated returns will be included as other current assets rather than inventories. The Company will be adopting the standard as of November 26, 2018 using the modified retrospective approach, and is still evaluating the practical expedient elections.


8



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

First Quarter of 2020
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) which requires the identification of arrangements that should be accounted for as leases by lessees. In general, for operating or financing lease arrangements exceeding a twelve month term, a right-of-use asset and a lease obligation will be recognized on the balance sheet of the lessee while the income statement will reflect lease expense for operating leases and amortization and interest expense for financing leases. The Company is in the process of gathering information to evaluate real estate, personal property, and other arrangements that may meet the definition of a lease. The FASB has subsequently issued updates to the standard to provide additional clarification on specific topics, including permitted transition methods. Given the significant number of leases, the Company anticipates the new guidance will have a material impact on the consolidated balance sheets.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815) Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 refines and expands hedge accounting for both financial and commodity risks. This ASU creates more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. In addition, this ASU makes certain targeted improvements to simplify the application of hedge accounting guidance. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). ASU 2018-02 addresses the effect of the change in the U.S. federal corporate tax rate due to the enactment of the December 22, 2017 Tax Cuts and Jobs Act (the "Tax Act") on items within accumulated other comprehensive income (loss). The guidance will be effective for the Company in the first quarter of fiscal 2020 with early adoption permitted. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements.
First Quarter of 2021
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The guidance provides criteria for determining which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The capitalized implementation costs are required to be expensed over the term of the hosting arrangement. The guidance also clarifies the presentation requirements for reporting such costs in the entity’s financial statements. Early adoption is permitted. The Company is currently evaluating the impact that adopting this new accounting standard will have on its consolidated financial statements and related disclosures.
First Quarter of 2022
In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20). ASU 2018-14 modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Early adoption is permitted. The Company is currently evaluating the impact that adopting this new accounting standard will have on its related disclosures.


9



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 2: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the Company’s financial instruments that are carried at fair value:
 
August 26, 2018
 
November 26, 2017
 
 
 
Fair Value Estimated
Using
 
 
 
Fair Value Estimated
Using
 
Fair Value
 
Level 1 Inputs(1)
 
Level 2 Inputs(2)
 
Fair Value
 
Level 1 Inputs(1)
 
Level 2 Inputs(2)
 
(Dollars in thousands)
Financial assets carried at fair value
 
 
 
 
 
 
 
 
 
 
 
Rabbi trust assets
$
32,330

 
$
32,330

 
$

 
$
31,139

 
$
31,139

 
$

Forward foreign exchange contracts(3)
16,450

 

 
16,450

 
6,296

 

 
6,296

Total
$
48,780

 
$
32,330

 
$
16,450

 
$
37,435

 
$
31,139

 
$
6,296

Financial liabilities carried at fair value
 
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(3)
$
10,619

 
$

 
$
10,619

 
$
23,799

 
$

 
$
23,799

_____________
 
(1)
Fair values estimated using Level 1 inputs are inputs which consist of quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Rabbi trust assets consist of a diversified portfolio of equity, fixed income and other securities.

(2)
Fair values estimated using Level 2 inputs are inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly, and include among other things, quoted prices for similar assets or liabilities in markets that are active or inactive as well as inputs other than quoted prices that are observable. For forward foreign exchange contracts, inputs include foreign currency exchange and interest rates and, where applicable, credit default swap prices.

(3)
The Company’s over-the-counter forward foreign exchange contracts are subject to International Swaps and Derivatives Association, Inc. master agreements. These agreements permit the net settlement of these contracts on a per-institution basis. Effective as of the first quarter of 2018, the Company recorded and presented the fair values of derivative over-the-counter forward foreign exchange contracts on a gross basis in its consolidated balance sheets, including those subject to master netting arrangements. The comparative period was revised to reflect the change from a net basis to a gross basis.
The following table presents the carrying value, including related accrued interest, and estimated fair value of the Company’s financial instruments that are carried at adjusted historical cost:
 
August 26, 2018
 
November 26, 2017
 
Carrying
Value
 
Estimated Fair Value
 
Carrying
Value
 
Estimated Fair Value
 
(Dollars in thousands)
Financial liabilities carried at adjusted historical cost
 
 
 
 
 
 
 
5.00% senior notes due 2025(1)
$
493,102

 
$
496,133

 
$
485,419

 
$
507,185

3.375% senior notes due 2027(1)
549,584

 
571,222

 
559,037

 
590,266

Short-term borrowings
36,148

 
36,148

 
38,727

 
38,727

Total
$
1,078,834

 
$
1,103,503

 
$
1,083,183

 
$
1,136,178

_____________
 
(1)
Fair values are estimated using Level 1 inputs and incorporate mid-market price quotes. Level 1 inputs are inputs which consist of quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.


10



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 3: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
As of August 26, 2018, the Company had forward foreign exchange contracts to buy $566.7 million and to sell $104.2 million against various foreign currencies. These contracts are at various exchange rates and expire at various dates through February 2020.
Effective as of the first quarter of 2018, the Company recorded and presented the fair value of its derivative assets and liabilities on a gross basis in the consolidated balance sheets based on contractual maturity dates, including those subject to master netting arrangements. The comparative period was revised to reflect the change from a net basis to a gross basis.
The table below provides data about the carrying values of derivative instruments and non-derivative instruments: 
 
August 26, 2018
 
November 26, 2017
 
Assets
 
(Liabilities)
 
Derivative Net Carrying Value
 
Assets
 
(Liabilities)
 
Derivative Net Carrying Value
 
Carrying
Value
 
Carrying
Value
 
 
Carrying
Value
 
Carrying
Value
 
 
(Dollars in thousands)
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Forward foreign exchange contracts(1)
$
16,450

 
$

 
$
16,450

 
$
6,296

 
$

 
$
6,296

Forward foreign exchange contracts(2)

 
(10,619
)
 
(10,619
)
 

 
(23,799
)
 
(23,799
)
Total
$
16,450

 
$
(10,619
)
 
 
 
$
6,296

 
$
(23,799
)
 
 
Non-derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Euro senior notes
$

 
$
(548,008
)
 
 
 
$

 
$
(562,780
)
 
 
_____________
 
(1)
Included in "Other current assets" or "Other non-current assets" on the Company’s consolidated balance sheets.
(2)
Included in "Other accrued liabilities" or "Other long-term liabilities" on the Company’s consolidated balance sheets.


11



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

The Company's over-the-counter forward foreign exchange contracts are subject to International Swaps and Derivatives Association, Inc. master agreements. These agreements permit the net settlement of these contracts on a per-institution basis; however, the Company records the fair value on a gross basis on its consolidated balance sheets based on maturity dates, including those subject to master netting arrangements. The table below presents the gross and net amounts of these contracts recognized on the Company's consolidated balance sheets by type of financial instrument:
 
August 26, 2018
 
November 26, 2017
 
Gross Amounts of Assets / (Liabilities) Presented in the Balance Sheet
 
Gross Amounts Not Offset in the Balance Sheet
 
Net Amounts of Assets / (Liabilities)
 
Gross Amounts of Assets / (Liabilities) Presented in the Balance Sheet
 
Gross Amounts Not Offset in the Balance Sheet
 
Net Amounts of Assets / (Liabilities)
 
 
 
 
 
 
(Dollars in thousands)
Over-the-counter forward foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
Financial assets
$
15,112

 
$
(3,745
)
 
$
11,367

 
$
3,218

 
$
(3,146
)
 
$
72

Financial liabilities
(4,177
)
 
3,745

 
(432
)
 
(20,876
)
 
3,146

 
(17,730
)
Total
 
 
 
 
$
10,935

 
 
 
 
 
$
(17,658
)
Embedded derivative contracts
 
 
 
 
 
 
 
 
 
 
 
Financial assets
$
1,338

 
$

 
$
1,338

 
$
3,078

 
$

 
$
3,078

Financial liabilities
(6,442
)
 

 
(6,442
)
 
(2,923
)
 

 
(2,923
)
Total
 
 
 
 
$
(5,104
)
 
 
 
 
 
$
155


The table below provides data about the amount of gains and losses related to derivative instruments and non-derivative instruments designated as net investment hedges included in "Accumulated other comprehensive loss" ("AOCI") on the Company’s consolidated balance sheets:
 
Gain or (Loss)
Recognized in AOCI
(Effective Portion)
 
As of
 
As of
August 26,
2018
November 26,
2017
 
(Dollars in thousands)
Forward foreign exchange contracts
$
4,637

 
$
4,637

Yen-denominated Eurobonds
(19,811
)
 
(19,811
)
Euro-denominated senior notes
(60,924
)
 
(75,697
)
Cumulative income taxes
31,339

 
35,253

Total
$
(44,759
)
 
$
(55,618
)


12



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

The table below provides data about the amount of gains and losses related to derivatives not designated as hedging instruments included in "Other income (expense), net" in the Company's consolidated statements of income:
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
(Dollars in thousands)
Forward foreign exchange contracts:
 
 
 
 
 
 
 
Realized (loss) gain
$
(2,298
)
 
$
(3,894
)
 
$
(20,446
)
 
$
184

Unrealized gain (loss)
6,835

 
(15,253
)
 
22,607

 
(44,705
)
Total
$
4,537

 
$
(19,147
)
 
$
2,161

 
$
(44,521
)
NOTE 4: DEBT 
The following table presents the Company's debt: 

 
August 26,
2018
 
November 26,
2017
 
(Dollars in thousands)
Long-term debt
 
 
 
5.00% senior notes due 2025
$
485,115

 
$
483,683

3.375% senior notes due 2027
540,940

 
555,177

Total long-term debt
$
1,026,055


$
1,038,860

Short-term debt
 
 
 
Short-term borrowings
$
35,790

 
$
38,451

Total debt
$
1,061,845

 
$
1,077,311

Senior Revolving Credit Facility
The Company's unused availability under its senior secured revolving credit facility was $669.1 million at August 26, 2018, as the Company's total availability of $713.6 million was reduced by $44.5 million of letters of credit and other credit usage allocated under the credit facility.
Interest Rates on Borrowings
The Company’s weighted-average interest rate on average borrowings outstanding during the three and nine months ended August 26, 2018 was 5.04% and 5.00%, respectively, as compared to 5.04% and 5.80%, respectively, in the same periods of 2017.


13



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 5: EMPLOYEE BENEFIT PLANS
The following table summarizes the total net periodic benefit cost for the Company's defined pension plans and postretirement benefit plans:
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
(Dollars in thousands)
Net periodic benefit cost:
 
 
 
 
 
 
 
Pension Benefits
$
819

 
$
2,990

 
$
2,434

 
$
8,952

Postretirement Benefits
925

 
1,148

 
2,777

 
3,443

Net periodic benefit cost
$
1,744

 
$
4,138

 
$
5,211

 
$
12,395

The Company increased the estimated contributions to its pension plans in 2018 from $94.7 million to $124.0 million.
NOTE 6: COMMITMENTS AND CONTINGENCIES
Forward Foreign Exchange Contracts
The Company uses over-the-counter derivative instruments to manage its exposure to foreign currencies. The Company is exposed to credit loss in the event of nonperformance by the counterparties to the forward foreign exchange contracts. However, the Company believes that its exposures are appropriately diversified across counterparties and that these counterparties are creditworthy financial institutions. See Note 3 for additional information.
Other Contingencies
Litigation.  In the ordinary course of business, the Company has various pending cases involving contractual matters, facility and employee-related matters, distribution matters, product liability claims, trademark infringement and other matters. The Company does not believe any of these pending legal proceedings will have a material impact on its financial condition, results of operations or cash flows.
Customs Duty Audits. The Company imports both raw materials and finished garments into all of its operating regions and as such, is subject to numerous countries complex customs laws and regulations with respect to its import and export activity. The Company is currently undergoing audit assessments and the related legal appeal processes with various customs authorities. While the Company is vigorously defending its position and does not believe any of the claims for customs duty and related charges have merit, the ultimate resolution of these assessments and legal proceedings are subject to risk and uncertainty.
NOTE 7: DIVIDEND
In the first quarter of 2018, the Company's Board of Directors declared a cash dividend of $90 million, payable in two $45 million installments. The Company paid the first installment in the first quarter of 2018. The second installment of $45 million is expected to be paid in the fourth quarter of 2018 based on the holders of record on October 5, 2018, and was recorded in "Other accrued liabilities" in the Company's consolidated balance sheets.
The Company does not have an established dividend policy. The Company will continue to review its ability to pay cash dividends at least annually, and dividends may be declared at the discretion of the Company's Board of Directors depending upon, among other factors, the Company's financial condition and compliance with the terms of the Company's debt agreements.


14



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 8: ACCUMULATED OTHER COMPREHENSIVE LOSS
The following is a summary of the components of "Accumulated other comprehensive loss," net of related income taxes: 
 
August 26,
2018
 
November 26,
2017
 
(Dollars in thousands)
Pension and postretirement benefits
$
(225,013
)
 
$
(232,181
)
Net investment hedge losses
(44,759
)
 
(55,618
)
Foreign currency translation losses
(138,850
)
 
(111,092
)
Unrealized gains on marketable securities
4,383

 
4,048

Accumulated other comprehensive loss
(404,239
)
 
(394,843
)
Accumulated other comprehensive income attributable to noncontrolling interest
9,482

 
9,538

Accumulated other comprehensive loss attributable to Levi Strauss & Co.
$
(413,721
)
 
$
(404,381
)

No material amounts were reclassified out of "Accumulated other comprehensive loss" into net income other than insignificant amounts that pertain to the Company's pension and postretirement benefit plans. These amounts are included in "Selling, general and administrative expenses" in the Company's consolidated statements of income.
NOTE 9: OTHER INCOME (EXPENSE), NET
The following table summarizes significant components of "Other income (expense), net": 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
(Dollars in thousands)
Foreign exchange management gains (losses)(1)
$
4,537

 
$
(19,147
)
 
$
2,161

 
$
(44,521
)
Foreign currency transaction (losses) gains(2)
(11,147
)
 
1,163

 
(10,528
)
 
7,216

Interest income
2,672

 
895

 
6,502

 
2,206

Investment income
306

 
287

 
734

 
629

Other, net
600

 
2,068

 
2,175

 
2,057

Total other income (expense), net
$
(3,032
)
 
$
(14,734
)
 
$
1,044

 
$
(32,413
)
_____________
 
(1)
Gains and losses on forward foreign exchange contracts primarily resulted from currency fluctuations relative to negotiated contract rates. Gains in the three-month period ended August 26, 2018 were primarily due to favorable currency fluctuations relative to negotiated contract rates on positions to sell the British Pound and Euro. Losses in the three-month and nine-month periods ended August 27, 2017 were primarily due to unfavorable currency fluctuations relative to negotiated contract rates on positions to sell the Mexican Peso, the Euro and the Canadian dollar.

(2)
Foreign currency transaction gains and losses reflect the impact of foreign currency fluctuation on the Company's foreign currency denominated balances. Losses in the three-month and nine-month periods ended August 26, 2018 were primarily due to the weakening of the Euro and Brazilian Real against the US dollar. Gains in the nine-month period ended August 27, 2017 were primarily due to the strengthening of the Mexican Peso and Euro against the US dollar.


15



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 10: INCOME TAXES
On December 22, 2017, the Tax Act was enacted in the U.S. The Tax Act introduced many changes, including lowering the U.S. corporate tax rate from 35% to 21%, changes in incentives, provisions to prevent U.S. base erosion and significant changes in the taxation of international income, and provisions which allow for the repatriation of foreign earnings without U.S. tax. By operation of tax law, the Company will apply a blended U.S. statutory federal income tax rate of 22.4% for fiscal year 2018 based on the pro rata number of days in the fiscal year before and after the effective date of the Tax Act. The enactment of the Tax Act resulted in a provisional charge of $129.6 million to tax expense for the nine-month period ended August 26, 2018. This charge was comprised of a $91.5 million re-measurement of the Company's deferred tax assets and liabilities based on the lower rates at which they are expected to reverse in the future as well as a $38.1 million one-time U.S. transition tax on undistributed foreign earnings. During the third quarter, the Company recorded a $7.1 million benefit mostly related to its provisional amount on re-measurement of deferred tax assets and liabilities due to the finalization of its U.S. tax return.
The provisions in the Tax Act are complex and broad. All components of the provisional charge of $129.6 million are based on the Company’s estimates as of August 26, 2018. Specifically, the transition tax and the re-measurement of deferred tax balances are provisional and have been calculated based on existing tax law and the best information available as of August 26, 2018. The final impact of U.S. tax reform may differ, possibly materially, due to factors such as changes in interpretations of the Tax Act, legislative action to address uncertainties that arise because of the Tax Act, changes to estimates the Company has utilized to calculate the provisional impacts, and additional guidance that may be issued by the U.S. government, among other items. As these various factors are finalized, any change will be recorded as an adjustment to the provision for income taxes in the period the amounts are determined during a measurement period granted by the SEC of up to one year after the enactment date of the Tax Act to finalize the accounting of the related income tax impacts.
In addition, the Company is still evaluating the Global Intangible Low Tax Income ("GILTI") provisions of the Tax Act and their impact, if any, on the consolidated financial statements beginning fiscal year 2019, including whether the Company adopts an accounting policy to treat such taxes as a current-period expense when incurred or whether such amounts should be factored into the Company's measurement of deferred taxes. As a result, the Company has not included an estimate of the tax expense related to this item as of August 26, 2018.
The effective income tax rate was 7.4% for the three months ended August 26, 2018, compared to 23.6% for the same prior-year period. The decrease in the effective tax rate in 2018 as compared to 2017 was driven by a 6.4% discrete tax benefit from U.S. tax return-to-provision reconciliation and a 5.1% discrete tax benefit mostly from the re-measurement of the Company's deferred tax assets and liabilities subject to the Tax Act rate reduction.
The effective income tax rate was 48.4% for the nine months ended August 26, 2018, compared to 20.2% for the same prior-year period. The increase in the effective tax rate in 2018 as compared to 2017 was driven by a 35.6% one-time tax charge related to the impact of the Tax Act described above, offset by a 3.6% discrete tax benefit from release of reserves for uncertain tax positions due to finalization of a foreign audit in the second quarter of 2018.
NOTE 11: RELATED PARTIES
Charles V. Bergh, President and Chief Executive Officer, Peter E. Haas Jr., a director of the Company, Kelly McGinnis, Senior Vice President of Corporate Affairs and Chief Communications Officer, and Elizabeth O'Neill, Executive Vice President and President of Product, Innovation and Supply Chain were board members of the Levi Strauss Foundation, which is not a consolidated entity of the Company. Seth R. Jaffe, Executive Vice President and General Counsel, is Vice President of the Levi Strauss Foundation. During the three-month and nine-month periods ended August 26, 2018, the Company donated $0.4 million and $7.3 million, respectively, to the Levi Strauss Foundation as compared to $0.2 million and $6.9 million for the same prior-year periods.


16



LEVI STRAUSS & CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
FOR THE QUARTERLY PERIOD ENDED AUGUST 26, 2018

NOTE 12: BUSINESS SEGMENT INFORMATION
The Company manages its business according to three regional segments: the Americas, Europe and Asia. The Company considers its chief executive officer to be the Company’s chief operating decision maker. The Company’s chief operating decision maker manages business operations, evaluates performance and allocates resources based on the regional segments’ net revenues and operating income.
Business segment information for the Company is as follows: 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
(Dollars in thousands)
Net revenues:
 
 
 
 
 
 
 
Americas
$
792,832

 
$
738,687

 
$
2,119,820

 
$
1,918,657

Europe
405,737

 
348,016

 
1,225,295

 
938,719

Asia
195,584

 
181,688

 
638,465

 
580,861

Total net revenues
$
1,394,153

 
$
1,268,391

 
$
3,983,580

 
$
3,438,237

Operating income:
 
 
 
 
 
 
 
Americas
$
162,469

 
$
155,652

 
$
370,926

 
$
347,873

Europe
76,848

 
61,536

 
245,307

 
160,778

Asia
14,720

 
11,246

 
71,839

 
56,655

Regional operating income
254,037

 
228,434

 
688,072

 
565,306

Corporate expenses(1)
95,428

 
82,114

 
278,840

 
247,995

Total operating income
158,609

 
146,320

 
409,232

 
317,311

Interest expense
(15,697
)
 
(14,476
)
 
(45,659
)
 
(52,305
)
Loss on early extinguishment of debt

 

 

 
(22,793
)
Other (expense) income, net
(3,032
)
 
(14,734
)
 
1,044

 
(32,413
)
Income before income taxes
$
139,880

 
$
117,110

 
$
364,617

 
$
209,800

_____________
 
(1) Included in Corporate expenses for the three and nine month periods ended August 27, 2017 is the recognition of approximately $9.5 million and $8.3 million stock-based compensation expense related to prior periods, for the correction of the periods used for the recognition of expense associated with employees eligible to vest awards after retirement.


17


Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Overview
We design, market and sell – directly to consumers or through third parties and licensees – products that include jeans, casual and dress pants, tops, shorts, skirts, jackets, footwear and related accessories for men, women and children around the world under our Levi’s®, Dockers®, Signature by Levi Strauss & Co.™ ("Signature") and Denizen® brands.
Our business is operated through three geographic regions: Americas, Europe and Asia. Our products are sold in approximately 50,000 retail locations in more than 110 countries. We support our brands through a global infrastructure, developing, sourcing and marketing our products around the world. We distribute our Levi’s® and Dockers® products in the United States primarily through chain retailers and department stores; and outside of the United States primarily through department stores, specialty retailers and approximately 2,100 franchised or other brand-dedicated stores and shop-in-shops. We also distribute our Levi’s® and Dockers® products through 798 company-operated retail stores located in 32 countries, including the United States, and through the e-commerce sites we operate. Our company-operated retail stores and e-commerce sites generated approximately 31% of our net revenues in the first nine months of 2018, as compared to 30% in the same period in 2017, with our e-commerce sites representing approximately 14% of this company-operated revenue in both periods. In addition, we distribute our Levi’s® and Dockers® products through e-commerce sites operated by certain of our key wholesale customers and other third parties.
Our Europe and Asia businesses, collectively, contributed approximately 47% of our net revenues and 46% of our regional operating income in the first nine months of 2018, as compared to 44% of our net revenues and 38% of our regional operating income in the same period in 2017. Sales of Levi’s® brand products represented approximately 86% of our total net sales in the first nine-month periods of both 2018 and 2017.
Trends Affecting Our Business
We believe the key business and marketplace factors that are impacting our business include the following:
Factors that impact consumer discretionary spending, which remains volatile globally, continue to create a complex and challenging retail environment for us and our customers, characterized by unpredictable traffic patterns and a general promotional environment. In developed economies, mixed real wage growth and shifting in consumer spending also continue to pressure global discretionary spending. Consumers continue to focus on value pricing and convenience with the off-price retail channel remaining strong and increased expectations for real-time delivery.
More competitors are seeking growth globally, thereby increasing the competition across regions. Some of these competitors are entering into markets where we already have a mature business such as the United States, Mexico, Western Europe and Japan, and may provide consumers discretionary purchase alternatives or lower-priced apparel offerings.
Wholesaler/retailer dynamics and wholesale channels remain challenged by mixed growth prospects due to increased competition from e-commerce shopping, pricing transparency enabled by the proliferation of online technologies, and vertically-integrated specialty stores. Retailers, including our top customers, have in the past and may in the future decide to consolidate, undergo restructurings or rationalize their stores, which could result in a reduction in the number of stores that carry our products.
Many apparel companies that have traditionally relied on wholesale distribution channels have invested in expanding their own retail store and e-commerce distribution and consumer-facing technologies, which has increased competition in the retail market.
Competition for, and price volatility of, resources throughout the supply chain have increased, causing us and other apparel manufacturers to continue to seek alternative sourcing channels and create new efficiencies in our global supply chain. Trends affecting the supply chain include the proliferation of lower-cost sourcing alternatives, resulting in reduced barriers to entry for new competitors, and the impact of fluctuating prices of labor and raw materials as well as the consolidation of suppliers. Trends such as these can bring additional pressure on us and other wholesalers and retailers to shorten lead-times, reduce costs and raise product prices.
Foreign currencies continue to be volatile. Significant fluctuations of the U.S. Dollar against various foreign currencies, including the Euro, British Pound and Mexican Peso, will impact our financial results, affecting translation, and revenue, operating margins and net income.
The current environment has introduced greater uncertainty with respect to potential tax and trade regulations. Most recently, the U.S. enacted new tax legislation, which is intended to stimulate economic growth and capital investments


18


in the U.S. by, amongst its other provisions, lowering tax rates for both corporations and individuals alike. In addition, the current domestic and international political environment, including potential changes to other U.S. policies related to global trade and tariffs, have also resulted in uncertainty surrounding the future state of the global economy. Such changes may require us to modify our current sourcing practices, which may impact our product costs, and, if not mitigated, could have a material adverse effect on our business and results of operations.
These factors contribute to a global market environment of intense competition, constant product innovation and continuing cost pressure, and combine with the continuing global economic conditions to create a challenging commercial and economic environment. We evaluate these factors as we develop and execute our strategies. For more information on the risk factors affecting our business, see Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q and Item 1A "Risk Factors" in our 2017 Annual Report on Form 10-K.
Our Third Quarter 2018 Results
 
Net revenues. Compared to the third quarter of 2017, consolidated net revenues increased 10% on a reported basis and 11% on a constant-currency basis driven by broad-based growth across all three regions, in every channel and product category.
Gross margin. Compared to the third quarter of 2017, consolidated gross margin percentage increased 1.4% primarily due to growth in our higher margin company-operated retail and international revenues.
Operating income. Compared to the third quarter of 2017, consolidated operating income increased by 8% and operating margin decreased to 11.4%, primarily reflecting higher net revenues and strong gross margin, partially offset by higher selling, general and administrative expenses ("SG&A") associated with the expansion of our company-operated retail network and higher advertising and promotion expense.
Financial Information Presentation
Fiscal year.    We use a 52- or 53- week year, with each fiscal year ending on the last Sunday of November in each year, although the fiscal years of certain foreign subsidiaries end on November 30. Each fiscal year generally consists of four 13-week quarters, with each quarter ending on the Sunday that is closest to the last day of the last month of that quarter, although in 53-week fiscal years, one quarter will have a 14-week quarter. Each quarter of fiscal years 2018 and 2017 consists of 13 weeks.
Segments.    We manage our business according to three regional segments: the Americas, Europe and Asia.
Classification.    Our classification of certain significant revenues and expenses reflects the following:
 
Net revenues comprises of net sales and licensing revenues. Net sales include sales of products to wholesale customers, including franchised stores, and direct sales to consumers at our company-operated e-commerce sites and stores and at our company-operated shop-in-shops located within department stores. Net revenues include discounts, allowances for estimated returns and incentives.
Cost of goods sold comprises of product costs, labor and related overhead, sourcing costs, inbound freight, internal transfers, and the cost of operating our remaining manufacturing facilities, including the related depreciation expense.
Selling expenses include, among other things, all occupancy costs and depreciation associated with our company-operated stores and commissions associated with our company-operated shop-in-shops, as well as costs associated with our e-commerce operations.
We reflect substantially all distribution costs in selling, general and administrative expenses, including costs related to receiving and inspection at distribution centers, warehousing, shipping to our customers, handling, and certain other activities associated with our distribution network.
Constant currency.    We report our operating results in accordance with U.S. generally accepted accounting principles, ("U.S. GAAP"), as well as on a constant-currency basis in order to facilitate period-to-period comparisons of our results without regard to the impact of fluctuating foreign currency exchange rates. The term foreign currency exchange rates refers to the exchange rates we use to translate our operating results for all countries where the functional currency is not the U.S. Dollar into U.S. Dollars. Because we are a global company, foreign currency exchange rates used for translation may have a significant effect on our reported results. In general, upon translation, our financial results are affected positively by a weaker U.S. Dollar and are affected negatively by a stronger U.S. Dollar as compared to the foreign currencies in which we conduct our business. References to our operating results on a constant-currency basis mean our operating results without the impact of foreign currency translation fluctuations.
We believe disclosure of constant-currency results is helpful to investors because it facilitates period-to-period comparisons of our results by increasing the transparency of our underlying performance by excluding the impact of fluctuating foreign currency


19


exchange rates. However, constant-currency results are non-U.S. GAAP financial measures and are not meant to be considered in isolation or as a substitute for comparable measures prepared in accordance with GAAP. Constant-currency results have no standardized meaning prescribed by U.S. GAAP, are not prepared under any comprehensive set of accounting rules or principles and should be read in conjunction with our consolidated financial statements prepared in accordance with U.S. GAAP. Constant-currency results have limitations in their usefulness to investors and may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies.
We calculate the effect of changes in foreign currency translation based on the difference between the prior-year period activity translated using the current period’s foreign currency exchange rates and the prior-year period’s foreign currency exchange rates, as reported.
The table below sets forth the calculation of net revenues for each of our regional operating segments on a constant-currency basis for comparison periods applicable to the three-month and nine-month periods ended August 26, 2018:
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
(Dollars in millions)
Net revenues:
 
 
 
 
 
 
 
 
 
 
 
Total revenues
 
 
 
 
 
 
 
 
 
 
 
As reported
$
1,394.2

 
$
1,268.4

 
9.9
%
 
$
3,983.6

 
$
3,438.3

 
15.9
%
Impact of foreign currency

 
(14.4
)
 
*

 

 
76.0

 
*

Constant-currency
$
1,394.2

 
$
1,254.0

 
11.2
%
 
$
3,983.6

 
$
3,514.3

 
13.4
%
 
 
 
 
 
 
 
 
 
 
 
 
Americas
 
 
 
 
 
 
 
 
 
 
 
As reported
$
792.9

 
$
738.6

 
7.4
%
 
$
2,119.8

 
$
1,918.7

 
10.5
%
Impact of foreign currency

 
(7.8
)
 
*

 

 
(0.5
)
 
*

Constant-currency
$
792.9

 
$
730.8

 
8.5
%
 
$
2,119.8

 
$
1,918.2

 
10.5
%
 
 
 
 
 
 
 
 
 
 
 
 
Europe
 
 
 
 
 
 
 
 
 
 
 
As reported
$
405.7

 
$
348.0

 
16.6
%
 
$
1,225.3

 
$
938.7

 
30.5
%
Impact of foreign currency

 
(2.5
)
 
*

 

 
64.2

 
*

Constant-currency
$
405.7

 
$
345.5

 
17.4
%
 
$
1,225.3

 
$
1,002.9

 
22.2
%
 
 
 
 
 
 
 
 
 
 
 
 
Asia
 
 
 
 
 
 
 
 
 
 
 
As reported
$
195.6

 
$
181.8

 
7.6
%
 
$
638.5

 
$
580.9

 
9.9
%
Impact of foreign currency

 
(4.1
)
 
*

 

 
12.3

 
*

Constant-currency
$
195.6

 
$
177.7

 
10.1
%
 
$
638.5

 
$
593.2

 
7.6
%
_____________
 
* Not meaningful


20


Results of Operations for Three and Nine Months Ended August 26, 2018, as Compared to Same Periods in 2017
The following table presents, 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:
 

 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
%
Increase
(Decrease)
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
%
Increase
(Decrease)
 
August 26,
2018
 
August 27,
2017
 
 
 
% of Net
Revenues
 
% of Net
Revenues
 
 
 
% of Net
Revenues
 
% of Net
Revenues
 
(Dollars in millions)
Net revenues
$
1,394.2

 
$
1,268.4

 
9.9
 %
 
100.0
 %
 
100.0
 %
 
$
3,983.6

 
$
3,438.3

 
15.9
 %
 
100.0
 %
 
100.0
 %
Cost of goods sold
652.6

 
611.7

 
6.7
 %
 
46.8
 %
 
48.2
 %
 
1,833.0

 
1,658.7

 
10.5
 %
 
46.0
 %
 
48.2
 %
Gross profit
741.6

 
656.7

 
12.9
 %
 
53.2
 %
 
51.8
 %
 
2,150.6

 
1,779.6

 
20.8
 %
 
54.0
 %
 
51.8
 %
Selling, general and administrative expenses
583.0

 
510.3

 
14.2
 %
 
41.8
 %
 
40.2
 %
 
1,741.4

 
1,462.3

 
19.1
 %
 
43.7
 %
 
42.5
 %
Operating income
158.6

 
146.4

 
8.3
 %
 
11.4
 %
 
11.5
 %
 
409.2

 
317.3

 
29.0
 %
 
10.3
 %
 
9.2
 %
Interest expense
(15.6
)
 
(14.5
)
 
7.6
 %
 
(1.1
)%
 
(1.1
)%
 
(45.6
)
 
(52.3
)
 
(12.8
)%
 
(1.1
)%
 
(1.5
)%
Loss on early extinguishment of debt

 

 

 

 

 

 
(22.8
)
 
(100.0
)%
 

 
(0.7
)%
Other (expense) income, net
(3.1
)
 
(14.7
)
 
(78.9
)%
 
(0.2
)%
 
(1.2
)%
 
1.0

 
(32.4
)
 
(103.1
)%
 

 
(0.9
)%
Income before income taxes
139.9

 
117.2

 
19.4
 %
 
10.0
 %
 
9.2
 %
 
364.6

 
209.8

 
73.8
 %
 
9.2
 %
 
6.1
 %
Income tax expense
10.3

 
27.7

 
(62.8
)%
 
0.7
 %
 
2.2
 %
 
176.6

 
42.5

 
*

 
4.4
 %
 
1.2
 %
Net income
129.6

 
89.5

 
44.8
 %
 
9.3
 %
 
7.1
 %
 
188.0

 
167.3

 
12.4
 %
 
4.7
 %
 
4.9
 %
Net loss (income) attributable to noncontrolling interest
0.5

 
(1.5
)
 
(133.3
)%
 

 
(0.1
)%
 
(2.0
)
 
(1.7
)
 
17.6
 %
 
(0.1
)%
 

Net income attributable to Levi Strauss & Co.
$
130.1

 
$
88.0

 
47.8
 %
 
9.3
 %
 
6.9
 %
 
$
186.0

 
$
165.6

 
12.3
 %
 
4.7
 %
 
4.8
 %
_____________
 
* Not meaningful



21


Net revenues
The following table presents net revenues by reporting segment for the periods indicated and the changes in net revenues by reporting segment on both reported and constant-currency bases from period to period.
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
 
% Increase
 
 
 
 
 
% Increase
 
August 26,
2018
 
August 27,
2017
 
As
Reported
 
Constant
Currency
 
August 26,
2018
 
August 27,
2017
 
As
Reported
 
Constant
Currency
 
(Dollars in millions)
Net revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas
$
792.9

 
$
738.6

 
7.4
%
 
8.5
%
 
$
2,119.8

 
$
1,918.7

 
10.5
%
 
10.5
%
Europe
405.7

 
348.0

 
16.6
%
 
17.4
%
 
1,225.3

 
938.7

 
30.5
%
 
22.2
%
Asia
195.6

 
181.8

 
7.6
%
 
10.1
%
 
638.5

 
580.9

 
9.9
%
 
7.6
%
Total net revenues
$
1,394.2

 
$
1,268.4

 
9.9
%
 
11.2
%
 
$
3,983.6

 
$
3,438.3

 
15.9
%
 
13.4
%
Total net revenues increased on both a reported and constant-currency basis for the three-month and nine-month periods ended August 26, 2018, as compared to the same prior-year periods.
Americas.    On both a reported basis and constant-currency basis, net revenues in our Americas region increased for the three-month and nine-month periods ended August 26, 2018. Currency translation had an unfavorable impact on net revenues of approximately $8 million for the three-month period and did not have a significant impact for the nine-month period ended August 26, 2018.
Excluding the effects of currency, the increase in net revenues for the three-month and nine-month periods ended August 26, 2018 was due to the strong performance within our company-operated retail network, primarily due to increased traffic and conversion, as well as 26 more stores in operation at the end of the third quarter of 2018 than the third quarter of 2017. Additionally, increases in Levi's® womens products and Signature products as well as growth in our Mexico business contributed to the wholesale growth in the region. Overall, the general continued improvement in the U.S. retail environment contributed to higher wholesale revenues.
Europe.    Net revenues in Europe increased on both a reported basis and constant-currency basis for the three-month and nine-month periods ended August 26, 2018, with currency translation affecting net revenues unfavorably by approximately $3 million and favorably by approximately $64 million, respectively.
Constant-currency net revenues increased for the three-month and nine-month periods ended August 26, 2018 as a result of strong performance in all channels including wholesale, company-operated retail and franchised stores. Growth in all channels reflects the strength of the brand and expanded product assortment across the customer base, mainly Levi's® tops and womens products. Additionally, growth in company-operated retail was a result of strong performance as well as 13 more stores in operation at the end of the third quarter of 2018 than the third quarter of 2017.
Asia.    Net revenues in Asia increased on both a reported and constant-currency basis for the three-month and nine-month periods ended August 26, 2018, with currency affecting net revenues unfavorably by approximately $4 million and favorably by approximately $12 million, respectively.
Excluding the effects of currency, the increase in net revenues for the three-month and nine-month periods ended August 26, 2018 was primarily due to the expansion and strong performance of our company-operated retail network, which included 26 more stores than the end of the third quarter of 2017. Wholesale revenues in the three-month and nine-month periods increased, particularly in Australia, New Zealand and India, and in the nine-month period were partially offset by lower franchised store revenues. Wholesale revenues in Japan also increased in the nine-month period.


22


Gross profit
The following table shows consolidated gross profit and gross margin for the periods indicated and the changes in these items from period to period: 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
(Dollars in millions)
Net revenues
$
1,394.2

 
$
1,268.4

 
9.9
%
 
$
3,983.6

 
$
3,438.3

 
15.9
%
Cost of goods sold
652.6

 
611.7

 
6.7
%
 
1,833.0

 
1,658.7

 
10.5
%
Gross profit
$
741.6

 
$
656.7

 
12.9
%
 
$
2,150.6

 
$
1,779.6

 
20.8
%
Gross margin
53.2
%
 
51.8
%
 
 
 
54.0
%
 
51.8
%
 
 
Currency translation unfavorably impacted gross profit by approximately $5 million and favorably by approximately $49 million for the three-month and nine-month periods ended August 26, 2018, respectively. For the three-month and nine-month periods, gross margin increased primarily due to growth in higher margin company-operated retail and international revenues, as well as favorable transactional currency impacts for the nine-month period.
Selling, general and administrative expenses
The following table shows SG&A for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:
 
 
Three Months Ended
 
Nine Months Ended
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
 
 
% of Net
Revenues
 
% of Net
Revenues
 
 
 
% of Net
Revenues
 
% of Net
Revenues
 
(Dollars in millions)
Selling
$
251.9

 
$
217.4

 
15.9
%
 
18.1
%
 
17.1
%
 
$
760.1

 
$
635.8

 
19.6
%
 
19.1
%
 
18.5
%
Advertising and promotion
78.6

 
65.4

 
20.2
%
 
5.6
%
 
5.2
%
 
251.7

 
194.5

 
29.4
%
 
6.3
%
 
5.7
%
Administration
122.9

 
109.0

 
12.8
%
 
8.8
%
 
8.6
%
 
345.6

 
291.0

 
18.8
%
 
8.7
%
 
8.5
%
Other
129.6

 
118.5

 
9.4
%
 
9.3
%
 
9.3
%
 
384.0

 
341.0

 
12.6
%
 
9.6
%
 
9.9
%
Total SG&A
$
583.0

 
$
510.3

 
14.2
%
 
41.8
%
 
40.2
%
 
$
1,741.4

 
$
1,462.3

 
19.1
%
 
43.7
%
 
42.5
%

Currency impacted SG&A favorably by approximately $3 million and unfavorably by approximately $31 million for the three-month and nine-month periods ended August 26, 2018, respectively.
Selling.  Currency impacted selling expenses favorably by approximately $2 million and unfavorably by approximately $18 million for the three-month and nine-month periods ended August 26, 2018, respectively. Higher selling expenses primarily reflected costs associated with the growth and expansion of our direct-to-consumer business, including increased investment in new and existing company-operated stores and e-commerce technology. We had 65 more company-operated stores at the end of the third quarter of 2018 than we did at the end of the third quarter of 2017.
Advertising and promotion.   Currency did not have a significant impact on advertising and promotion expenses for the three-month period and had an unfavorable impact of approximately $4 million for the nine-month period ended August 26, 2018. Advertising and promotion expenses increased due to incremental investments in advertising.
Administration.    Administration expenses include functional administrative and organization costs. Currency did not have a significant impact on administration expenses for the three-month period and had an unfavorable impact of approximately $4 million for the nine-month period ended August 26, 2018. As compared to the same nine-month prior-year period, administration expenses in 2018 reflect higher incentive compensation, including stock-based compensation, reflecting outperformance against our internally set objectives. The third quarter of 2017 included an adjustment of $9.5 million related to the correction of the periods used for the recognition of stock-based compensation expense associated with employees eligible to vest awards after retirement.


23


Other.   Other SG&A includes distribution, information resources and marketing organization costs. Currency did not have a significant impact on SG&A other costs for the three-month period and had an unfavorable impact of approximately $5 million for the nine-month period ended August 26, 2018. For the three-month period ended August 26, 2018 the increase in SG&A other costs was primarily due to a $7.9 million increase in distribution costs as a result of higher wholesale volume. For the nine-month period ended August 26, 2018, the increase in SG&A other costs was primarily due to a $23.5 million increase in distribution costs as a result of higher wholesale volume, and an $11.7 million increase in information technology expenses due to additional costs to support technology infrastructure.
Operating income
The following table shows operating income by reporting segment and corporate expenses for the periods indicated, the changes in these items from period to period and these items expressed as a percentage of net revenues:
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
August 26,
2018
 
August 27,
2017
 
%
Increase
 
August 26,
2018
 
August 27,
2017
 
 
% of Net
Revenues
 
% of Net
Revenues
% of Net
Revenues
 
% of Net
Revenues
 
(Dollars in millions)
Operating income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas
$
162.5

 
$
155.7

 
4.4
%
 
20.5
%
 
21.1
%
 
$
370.9

 
$
347.9

 
6.6
%
 
17.5
%
 
18.1
%
 
Europe
76.8

 
61.6

 
24.7
%
 
18.9
%
 
17.7
%
 
245.3

 
160.8

 
52.5
%
 
20.0
%
 
17.1
%
 
Asia
14.7

 
11.3

 
30.1
%
 
7.5
%
 
6.2
%
 
71.8

 
56.7

 
26.6
%
 
11.2
%
 
9.8
%
 
Total regional operating income
254.0

 
228.6

 
11.1
%
 
18.2
%
*
18.0
%
*
688.0

 
565.4

 
21.7
%
 
17.3
%
*
16.4
%
*
Corporate expenses
95.4

 
82.2

 
16.1
%
 
6.8
%
*
6.5
%
*
278.8

 
248.1

 
12.4
%
 
7.0
%
*
7.2
%
*
Total operating income
$
158.6

 
$
146.4

 
8.3
%
 
11.4
%
*
11.5
%
*
$
409.2

 
$
317.3

 
29.0
%
 
10.3
%
*
9.2
%
*
Operating margin
11.4
%
 
11.5
%
 
 
 
 
 
 
 
10.3
%
 
9.2
%
 
 
 
 
 
 
 
______________
 * Percentage of consolidated net revenues
Currency translation unfavorably affected total operating income by approximately $2 million and favorably by approximately $18 million for the three-month and nine-month periods ended August 26, 2018, respectively.
Regional operating income.    
Americas. Currency translation unfavorably affected operating income in the region by approximately $2 million for the three-month period and did not have a significant impact for the nine-month period ended August 26, 2018. The increase in operating income was primarily due to higher net revenues as a result of strong performance of our company-operated retail network and wholesale business. This was partially offset by higher SG&A expense as a result of an increase in occupancy costs and an increased investment in advertising.
Europe. Currency did not have a significant impact on operating income in the region for the three-month period and had a favorable impact of approximately $16 million for the nine-month period ended August 26, 2018. The increase in operating income was due to higher net revenues across all channels, partially offset by higher selling costs and increased investment in advertising.
Asia. Currency did not have a significant impact on operating income in the region for the three-month period ended August 26, 2018 and had a favorable impact of approximately $3 million for the nine-month period ended August 26, 2018. The increase in operating income was due to higher net revenues and gross margin, partially offset by higher SG&A expense to support retail expansion.