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Searching for a Cure: Ailing Levi Strauss & Co. Hires Corporate Doctor

Levi Strauss & Co. has hired the turnaround specialists Alvarez & Marsal - a sign of the serious issues the fabled jeans maker is facing.

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NEW YORK — Is Levi’s raising a red flag?

In a move seen as an acknowledgement that its continuing turnaround efforts are failing to pan out, Levi Strauss & Co. on Monday said it was hiring the consulting firm Alvarez & Marsal to help it find new ways of reducing debt and cutting costs.

Levi’s also turned to A&M for a key executive to replace chief financial officer Bill Chiasson, who stepped down Monday. Jim Fogarty, an eight-year veteran of A&M, whose last assignment was at Warnaco Group Inc., will fill that slot.

Alvarez & Marsal is best known as a company that has been involved in the bankruptcies of such major industry names as Warnaco and textile maker Galey & Lord.

But a Levi’s spokesman said the privately owned San Francisco company is not considering filing a petition.

“That is absolutely not the case here,” he said. “ We refinanced earlier this year and that gives us ample liquidity and financial flexibility to operate.”

Financial sources said that for the near future, Levi’s appears financially sound, though they said there are concerns among lenders that the jeansmaker might violate the terms of its debt next year.

“What people want to know is are they going to default or aren’t they,” said Catherine Guinee, vice president and senior credit officer at ratings agency Moody’s Investors Service. “They do have a [revolving credit line] that, as far as I know, is still available to them. So I don’t expect a cash crunch in the next month or so.”

Still, she said, the hiring of A&M is “certainly a confirmation of the great challenges they have, both operationally and financially….We’ll have to see what Alvarez & Marsal decide is the best option for them.”

Moody’s currently has a “Caa2” senior implied rating for Levi’s, with a “Ca” rating on the company’s bonds. The outlook for both of those is negative.

Guinee said that traditionally a “Caa2” rating is given to “bonds that are in poor standing,” that “present elements of danger,” while a “Ca” rating indicates that bonds are “speculative in the high degree.”

Another financial source, who spoke on condition of anonymity, said that while “liquidity is not going to be a problem” for Levi’s, there was concern within the financial community that the company could violate the covenants associated with its bonds next year.

Typically, when executives at a company know they are likely to violate debt covenants they seek to negotiate terms with their creditors to avoid defaulting on the loan, which can provoke a bankruptcy filing. Lenders can waive or amend terms — typically safeguard provisions that stipulate minimum financial performance targets — if they are convinced that the company is improving financially and will likely be able to keep up with its payment schedule.

Financial sources said the hiring of A&M, a firm they described as respected, could make lenders more likely to amend Levi’s debt covenants if they were convinced that the turnaround plans were sound.

Sources said Levi’s board members — primarily descendants of company founder Levi Strauss and relatives of current chairman Robert Haas — had pushed for the hiring of A&M.

In a statement, Haas said on behalf of the board, “We fully support [president and ceo Phil Marineau’s] decision to retain Alvarez & Marsal.”

Levi’s warning last month that its fourth-quarter sales lagged expectations suggested the company is on track to record its seventh consecutive year of sales declines. Last year, sales were $4.14 billion, well off the 1996 peak of $7.1 billion. Through the first nine months of this year, Levi’s sales inched up 0.4 percent and Levi’s reported an $11.2 million net loss, which was dragged down by special charges, and compared with a $19.5 million net loss a year earlier.

Last year, Levi’s reported net income of $25 million.

The privately owned company reports its financial results because of publicly traded bonds. When its third quarter ended Aug. 24, Levi’s total debt was $2.37 billion, compared with $1.85 billion as of Nov. 24, 2002, when its last fiscal year ended. The third quarter is typically a peak debt time for the company, as it builds inventory for the key fall and holiday selling seasons.

When the company obtained its new $650 million revolving credit facility and $500 million term loan this year, officials said the refinancing would give the company more financial flexibility.

Levi’s hired Marineau, a former Pepsi-Cola executive, in September 1999, charging him with turning around the company’s lagging sales. The company has rolled out several new initiatives on his watch, including radically redesigned jeans styles, which have generally lagged expectations. Most recently, the company has taken the radical step of rolling out a sub-brand called Levi Strauss Signature in Wal-Mart Stores Inc.’s more than 2,800 U.S. locations. That summer launch was expected to end the company’s sales slump, but Levi’s executives have acknowledged that the company’s core account base of chain and department stores have held off some orders out of concerns that the Wal-Mart line would cannibalize their business.

Levi’s officials have asserted that their studies show no such cannibalization has occurred.

Marineau said A&M would “advise me on additional strategies and actions to reduce debt and costs, while building brands and returning the company to profitable growth.”

Tony Alvarez, a cofounder of the turnaround firm said, “Jim [Fogarty] and I are enthusiastic about the opportunity to work with Phil and his management team to deleverage the company and to help restore the value inherent in their portfolio of world-class brands.”

Alvarez’s most prominent recent role in the apparel business was his 18-month stint as president and ceo of Warnaco, which began with the exit of Linda Wachner in November 2001, following the company’s bankruptcy petition.

Alvarez and his firm are described as very hands-on consultants who take an active role in any company with which they are involved. A&M also signed on in August to advise Galey & Lord, which last month filed its reorganization plan and expects to emerge from Chapter 11 protection early next year. Chairman and ceo Arthur C. Wiener remains at the helm of that company.

Isaac Lagnado, president of the consulting firm Tactical.org, called the A&M news, “very disturbing.”

“For a company like Levi’s to bring a turnaround firm in from outside really sends a shudder. You associate that with companies that are completely on the ropes,” he said. “Maybe things are much worse than we thought….The open question is really what does it do about Marineau?”

But the Levi’s spokesman asserted “They’re looking to work closely with Phil and our leadership team to consult on an interim basis on actions that will accelerate the company’s financial turnaround.”

A&M’s chief marketing officer, Rebecca Taylor, said the company’s practice is not limited to bankruptcies.

“Very much of the time, our out-of-court performance improvement or restructuring practice is not publicly disclosed,” she said. “That plays into the perception that when Alvarez & Marsal shows up, a filing is imminent.”

A&M has also been the subject of investor criticism in recent months. In October, Daniel Loeb of Third Point Management Co. LLC sent Warnaco a letter criticizing the firm’s high fees, and suggesting the firm regarded Warnaco as a “honey pot.”

Loeb claimed A&M was paid more than $12 million in cash and shares by Warnaco prior to May 27. Alvarez himself received $5.7 million in cash as well as subordinated notes and a percentage of the newly reorganized Warnaco’s stock.

Levi’s financial practices have also been under fire this year. In April, two former employees filed a wrongful termination suit alleging that they were fired because they refused to obey an improper policy regarding foreign taxes. Levi’s has said an internal audit of its procedures found them to be proper.

However, in a separate development, in October the company said it would have to delay a filing with the Securities & Exchange Commission and amend its report for fiscal 2001 because of mistakes. The company discovered it had double-booked a tax deduction.

Asked whether Chiasson’s exit was related to the lawsuit, the Levi’s spokesman said “no.” He declined to elaborate on the reasons for Chiasson’s exit, saying it was a personnel matter.

Chiasson, 53, joined Levi’s as cfo in August 1998, after working at Kraft Foods. His combined salary and bonuses last year came to $3,634,959.

The financial source who requested anonymity said that observers expected a further restructuring of the company’s financial staff to follow.

“The first order of business is to make sure the financials are in order and correct, to build up some confidence — because they have no faith in their financial statements,” the source said.

Sources speculated that the hiring of A&M might reflect an intent to reduce the company’s debt level to pave the way through an eventual sale of the company, most likely to investors through an initial public offering. Sources said company officials in recent months had met with investors about a possible sale, though company officials denied it.

Other observers suggested that any meetings might have been routine, and noted that this would likely not be an opportune time to try to sell the company due to its high debt levels and poor current sales performance.

Observers said a lot remains to be cleaned up inside Levi’s operations.

“Clearly, from an operational point of view, Alvarez & Marsal has to look at where the bleeding occurs, and maybe some of the bleeding is at the compensation level and at the organizational levels of who comes up with product,” said Andrew Jassin, a principal in the Jassin-O’Rourke Group.

He was referring to Marineau’s compensation package, which last year came to $25.1 million, a number that equalled Levi’s net profits for the year.

Levi’s has gone through many rounds of restructuring over the past decade, culminating this year with the closing of its final U.S. manufacturing plants.

Jassin said that, in the long-term, Levi’s needs to follow in the footsteps of industry giants like Liz Claiborne Inc. and VF Corp., amassing a broader portfolio of brands.

“Their responsibility is to be Levi’s brand management firm. They may have different trademarks they can manage into different channels that may not say ‘Levi’s’ on them,” he said. “The time has come to go beyond the old model of being dependent on Levi’s and Dockers exclusively for the future of the business.”

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