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Levi’s Outlook: Some Upside Potential Despite Retail Turmoil

Economic headwinds and a spate of retail bankruptcies in the U.S. could seem poised to worsen an already difficult situation for Levi Strauss & Co.

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ECONOMIC HEADWINDS AND A SPATE OF retail bankruptcies in the U.S. could seem poised to worsen an already difficult situation for Levi Strauss & Co. during the second half of the year.

But some analysts believe fresh products and a new marketing effort might yield gains for the San Francisco-based denim giant.

Levi’s is coming off a first half in which revenues for the Americas — the company’s largest segment, which includes the North, Central and South American markets — took a hit from the slowing U.S. economy. Revenues fell more than 10 percent to $1.06 billion from $1.18 billion. In the second quarter, revenues for the Americas plunged 19.3 percent to $477 million compared with $591 million last year.

The declines were sharper during the second quarter because of a combination of factors. A pullback in consumer spending gained momentum as energy prices soared and problems implementing a new management system eventually forced the company to stop making shipments for a full week. Robert Hanson, president of North America, said some retail customers struggling to make sales may have used the delays as a reason to cancel orders.

“Issues continued with respect to fulfilling customer orders in a timely manner and this did result in some customer cancellations,” Hanson said during a conference call with analysts.

As the quarter came to a close, Goody’s Family Clothing Inc. became the first in a series of retailers to file for bankruptcy protection. The situation among Levi’s retail customers in the U.S. has deteriorated since earnings were reported on July 8. Mervyns, which named Levi’s alum John Goodman as president and chief executive officer in March, filed for bankruptcy on July 29. A week later, Boscov’s did the same.

The collective impact of Mervyns, Goody’s and Boscov’s on Levi’s sales won’t be revealed until the company reports third-quarter earnings in October. However, bankruptcy filings indicate Levi’s was owed almost $23 million from the retailers.

According to Levi’s annual filing for 2007, the company had sales of about $144 million to Mervyns between 2006 and the first quarter of 2007. Mervyns bankruptcy filings revealed that Levi’s was its top unsecured creditor, with an owed claim of $12.8 million. Levi’s was also the top unsecured creditor for Goody’s, which owed some $9.1 million.

Carla Casella, managing director of high yield research at J.P. Morgan, said Levi’s, as a primary vendor, stands to recoup 50 percent to 80 percent of what it is owed. In addition, she said if Mervyns sells stores as part of its restructuring, a retailer like Kohl’s could pick up space and continue selling Levi’s products.

Casella also sees an upside for Levi’s in the third quarter. Consumers cutting back on spending may migrate to lower-cost Levi’s styles. A new skinny style for the Levi Strauss Signature brand is also slated to roll out during the quarter at Wal-Mart. The giant retailer has reported increased traffic as economic conditions have worsened. A new global marketing campaign for Levi’s 501 jeans should also spur sales.

“It gives the retailer a reason to want to carry it,” Casella said. “The load in for that will come this quarter, so they could see a stronger than trend quarter. I think brandwise and top-line-marketing productwise, they’re operating from a pretty stable and competitive position.”

She was surprised by Levi’s problems in implementing the resource management system, and believes the impact of the retail bankruptcies may ultimately cost the company only a few million dollars in sales.

“A lot of times these guys are willing to take this hit rather than cut [a retailer] off sooner if they think it’s going to be an ongoing business,” Casella said. “You don’t want to push the retailer into bankruptcy.”

A financial analyst who follows Levi’s and asked not to be identified said much of the impact of the bankruptcies depends on how many stores are closed. The analyst also was surprised by the resource management system breakdown, as well as how much Levi’s was owed by the bankrupt retailers.

“It does raise questions about what they’re up to and how well they’re watching the stores,” the analyst said.�

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