SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

For the fiscal year ended November 27, 2005

 

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 an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes o     No þ

 

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 9, 2006

 

Documents incorporated by reference: None

 

 

LEVI STRAUSS & CO.

 

TABLE OF CONTENTS TO FORM 10-K

 

FOR FISCAL YEAR ENDED NOVEMBER 27, 2005

 

 

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 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 also distribute Levi’s^® and Dockers^® products through company-operated stores located in the United States, Europe and Japan. We distribute our Levi Strauss Signature^® products through mass channel retailers in the United States and abroad.

 

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 ends on the last Sunday in November each year. Fiscal years 2003, 2004 and 2005 ended on November 30, 2003, November 28, 2004 and November 27, 2005, respectively. Fiscal year 2003 consisted of 53 weeks and fiscal years 2004 and 2005 consisted of 52 weeks each.

 

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 the 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 under those three brands. 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% and 85% of our total units sold in 2005 and 2004, respectively. Men’s products generated approximately 73% of our total net sales in 2005 and 2004.

 

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

 

 

Our go-to-market process is designed to ensure an integrated view of the marketplace — product, price, promotion and place — as we develop and execute our product offering, marketing and sourcing plans for each season across all of our brands in a manner consistent with each of our brands’ core attributes.

 

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 across the brand reflect what we see as the brand’s core attributes: originality, quality, individuality, integrity and youthfulness.

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 basic jeans to premium-priced styles targeted to fashion leaders, reflecting what we believe is the broad consumer appeal of the brand across ages, genders, nationalities 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 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 around the world. Sales of Levi’s^® brand products represented approximately 71% and 70% of our total net sales in 2005 and 2004, respectively. Sales of Red Tab^tm products represented a majority of our Levi’s^® brand net sales in all three of our regions in 2005 and 2004.

 

Dockers^® Brand

 

We launched the Dockers^® brand in 1986 to provide an alternative between jeans and suits for the baby boomer generation in the United States. The brand was at the forefront of the business casual trend in the United States. The Dockers^® brand is a leader in developing and commercializing technical performance innovations into everyday apparel, including pants, shirts and other products with the Stain Defender^® finish. Today, the Dockers^® brand covers a wide range of wearing occasions for men and women, from business and weekend casual to more dressy occasions, with products that combine style with performance and provide a “wardrobe solution” for consumers.

 

Our current Dockers^® product offerings include:

 

 

We market the Dockers^® brand in more than 50 countries. Sales in the United States generated a substantial majority of total Dockers^® brand sales in 2005. Sales of Dockers^® brand products represented approximately 19% and 20% of our total net sales in 2005 and 2004, respectively. Sales of Dockers^® Classic men’s products represented a large majority of our Dockers^® brand net sales in all three of our regions in 2005 and 2004.

 

Levi Strauss Signature^® Brand

 

Our Levi Strauss Signature^® brand offers trend-relevant men’s, women’s and kids’ styles interpreted for value consumers. The brand, which we introduced in North America and Asia in 2003 and in Europe in early 2004, offers a range of jeans and jeans-related products, and casual pants and tops. Our merchandising and marketing reflects what we view as the core objective of the Levi Strauss Signature^® brand: bringing our company’s quality and authenticity to everyday working consumers and their families who shop in the mass channel.

 

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:

 

 

Our Levi Strauss Signature^® brand is currently offered in the United States and eleven other countries, with net sales in the United States representing a substantial majority of total brand sales since its launch. Sales of Levi Strauss Signature^® brand products represented approximately 10% of our total net sales in 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. We license our trademarks for products complementary to our core bottoms and for accessory and other products. Our licensing strategy centers on extending our brands into product categories that are consistent with, draw on and enhance our core brand attributes, broaden the product range available to consumers and create compelling and distinctive brand looks. We also use licenses for products that we have removed from our own product lines through our ongoing product rationalization and profit improvement actions.

 

Our royalty income from licensees was approximately $68.3 million in 2005, a 31% percent increase from 2004. The growth reflects in part the fact that we have entered into a number of new licensing arrangements in recent years. We believe that licensing will continue as an attractive profit contributor in the future.

 

Our licensed products by brand, which vary across countries, include:

 

 

We have licensees for our three brands in each of our regions. In addition, we enter into agreements with third parties to produce, market and distribute our core products in several countries with smaller markets, including various Latin American and Middle Eastern countries.

We seek to work with leading firms in each product category we enter through licensing. 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 and submit the results of these inspections to us.

 

Royalty income from licensees located in our North America region represented approximately two-thirds of our total royalty income in 2005 and 2004, with licensees in the United States of the Dockers^® brand generating over half of those royalties for both years.

 

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 and mass channel retailers. 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 channel. Sales to our top five and top 10 customers accounted for approximately 34% and 43% respectively, of our total net sales in 2005. In 2004, sales to our top five and top 10 customers accounted for approximately 31% and 40%, respectively, of our total net sales.

 

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 (including its recently-acquired May Department Stores businesses) and Mervyn’s in the United States, Hudson’s Bay Co. in Canada and Liverpool in Mexico. We target our premium products like Levi’s^® Vintage Clothing to our dedicated stores and to independent, image-conscious specialty stores who cater to more fashion-forward, trend-initiating consumers, including Barney’s, 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. We have approximately 3,300 retail customers operating in more than 30,000 locations in the United States, Canada and Mexico.

 

Europe

 

Our European Levi’s^® and Dockers^® brand customers include large department stores, such as El Corte Ingles in Spain, Galeries Lafayette in France and Kaufhof in Germany; dedicated 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. Our Levi Strauss Signature^® customers in Europe include Carrefour in France, ASDA-Wal-Mart in the United Kingdom, Migros in Switzerland and Wal-Mart in Germany.

 

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 mass channel and general merchandise retailers such as Big W and Lowes stores in Australia and Aeon stores in Japan. Our Asia Pacific business is heavily weighted toward Japan, which represented approximately 41% and 45% of our net sales in the region in 2005 and 2004, 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, and that these stores are effective complements to our wholesale business. These stores include retail and outlet stores operated by us and by independent franchisees and licensees. As of November 27, 2005, there were a total of 107 retail and outlet stores in our North America region, 348 stores in

our Europe region and 492 stores in our Asia Pacific region. Sales from these stores represented approximately 11% of our total net sales in 2005 (company-operated stores generated 2.5% of our total net sales) and, in Asia Pacific, generated approximately one-third of regional net sales.

 

Company Stores.  As of November 27, 2005, we operated 44 retail stores dedicated to the Levi’s^® brand, including Levi’s^® Stores in the United States located in New York, Chicago, Costa Mesa, Santa Monica, Beverly Hills, San Francisco, San Diego, Miami, Portland, Seattle and Washington, D.C. and in Europe in London, Paris and Berlin. We also operate outlet stores, which include 16 Levi’s^®, three Dockers^® and four Levi’s^® and Dockers^® combined outlet stores. These stores are located in the United States, Belgium, Germany, Poland, Japan, South Africa and the United Kingdom.

 

Franchised Stores.  We have a network of approximately 880 franchised or other licensed stores selling Levi’s^® brand or Dockers^® brand products under the “Original Levi’s Store^®,” “Levi’s^® Store,” and “Dockers^® Store” names in Europe, Asia, Canada, Mexico and South America. The stores are an important distribution channel in newer and smaller markets in Eastern Europe, Asia and South America. These stores are owned and 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. We expect to open in fiscal 2006 approximately 150 new stores in our Asia Pacific region, 65 stores in our Europe region and 20 stores in our North America region, with the substantial majority of the stores outside the United States to be independently owned.

 

Internet

 

In September 2005, we began selling Levi’s^® products directly to consumers in the United States through the website www.levisstore.com. Our goal in operating the Levi’s^® online store is to provide a virtual shopping experience that mirrors the shopping experience in our brick and mortar Levi’s^® Store retail shops and showcases the breadth of our product offerings. 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. In the United States, our Levi’s^®, Dockers^® and Levi Strauss Signature^® products are also sold online through specifically authorized third-party internet sites that meet our standards relating to customer service, return policy, site content, trademark use and other matters. In Canada and Europe, authorized dealers and mail order accounts who meet our standards may sell our products to consumers through their own internet sites.

 

Marketing and Promotion

 

We support our brands with a diverse mix of marketing initiatives to drive consumer demand. In 2005, we increased our investment in marketing. We incurred expenses of approximately $332.9 million, or 8.1% of total net sales in 2005 on these activities, compared with expenses of approximately $302.6 million, or 7.4% of net sales, in 2004.

 

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 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 the Levi’s^® brand products at retail, including introducing new product packaging and new store display

programs, executing customer-specific marketing programs and continuing to open new Levi’s^® Stores in selected locations around the world.

 

Dockers^® Brand.  Our Dockers^® brand marketing is designed to position the brand as synonymous with “effortless style” for men and women. Products are featured in lifestyle settings that show complete outfits in real, everyday situations. The Dockers^® brand is marketed worldwide under a branding platform introduced in fall 2005, “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 continued 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 print advertising, sponsorship programs and in-store marketing efforts. Print advertising in the United States emphasizes the tagline “From Our Family to Yours” and is targeted primarily to drive awareness with women. Sponsorship marketing in the United States centers on the brand’s involvement in NASCAR racing and our relationship with NASCAR star Jimmie Johnson.

 

Sourcing and Logistics

 

Organization.  Our global sourcing and regional supply chain services 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 across brands and regions while maintaining our focus on local service levels and working capital management.

 

Product Procurement.  We source over 90% of our products from independent contract manufacturers. We source a small proportion of our products from our five owned or leased manufacturing plants located in Europe (2) and Asia Pacific (3). See “Item 2 — Properties” for more information on our owned or leased 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 also source a small proportion of our products through “cut-make-trim” arrangements in which we purchase the fabric and retain ownership of the raw materials and work-in-process throughout the contractor’s manufacturing process. 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 2005, we sourced products from contractors located in over 40 countries around the world, with no single country representing more than 20% of our production. Historically we have sourced more of our products from contractors in South and Central America (including Mexico and the Caribbean), although we are relying increasingly on contractors in Asia. Contractors in South and Central America (including Mexico and the Caribbean) produced approximately 43% of our products in 2005, compared with 59% in 2003.

 

Sourcing Practices.  Our sourcing practices include these elements:

 

 

 

Logistics.  We own and operate dedicated distribution centers in a number of countries and we also outsource distribution 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.

 

Competition

 

The worldwide apparel industry is highly competitive and fragmented. It is characterized by low barriers to entry, brands targeted at specific consumer microsegments 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

 

Brands such as VF Corporation’s Lee and Wrangler brands, Diesel and Pepe Jeans London have a pan-European presence. Strong local brands and retailers exist in certain markets and are expanding internationally, including G-Star in the Netherlands and Miss Sixty in Italy. Other competitors include vertically integrated specialty stores, such as Zara, Hennes & Mauritz, Next and Celio. Companies based in the United States, such as Gap, Inc., Polo Ralph Lauren and Tommy Hilfiger, also compete with us in Europe. The khaki and casual pant segment in Europe is fragmented and there is currently no significant pan-European branded competitor of our Dockers^® brand in Europe. Competitors in local markets include store private labels and, in Germany, Hugo Boss.

 

Asia Pacific

 

Asia Pacific is a fragmented market, with athletic wear companies such as Adidas and Nike, Inc. emerging as pan-regional competitors. Competitors in jeanswear consist of regional brands, such as Edwin, Something and Bobson in Japan, and U.S. companies such as Gap, Inc. and VF Corporation. We also face competition from vertically integrated specialty stores, such as UNIQLO and Giordano.

 

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. For example, 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 2005, our net sales in the first, second, third and fourth quarters represented 24%, 23%, 25% and 28%, respectively, of our total net sales for the year. In 2004, our net sales in the first, second, third and fourth quarters represented 24%, 24%, 24% and 28%, respectively, of our total net sales 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 153-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 27, 2005, we employed approximately 9,635 people, approximately 3,255 of whom were located in the United States. Of our 9,635 employees, approximately 3,730 were associated with manufacturing of our products and approximately 5,905 were non-production employees. Of the non-production employees, approximately 1,425 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 Consumer Product Safety Act, the Flammable Fabrics Act, the Textile Fiber Product 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 rules 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 Dominican-Republic Central American 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 sales 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, adverse economic conditions and a challenging retail environment throughout Europe in the last several years have contributed to our sales declines in the region, from $1.0 billion in 2004 to $981.1 million in 2005.

 

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 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 continuously 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.

 

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 an increasing 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 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 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. Any raw material price increases could increase our cost of goods and decrease 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 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 American 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 increased 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 and market share have declined since 1996, we have substantial debt and actions we have taken and may take to turn around our business may not be successful in the long term.

 

Our net sales have declined from a peak of $7.1 billion in 1996 to $4.1 billion in 2005. Our market shares in certain categories and geographies, including the men’s jeans market in the United States and Europe, have also declined in recent years. We currently face intense competition, customer consolidation, shifts by consumers to sales channels and price points where we traditionally have not had a strong presence, reliance on key customers who operate in sales channels facing considerable competitive pressures, 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 financial leverage. 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 of Levi’s^® and Dockers^® products 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 may depend on our ability to offer more premium, innovative, differentiated and exclusive products and to increase retailer profitability on our products, which could have an adverse impact on our margins.

 

In Europe, department stores and independent jeanswear retailers are our primary distribution channels. If some of these customers were to shift their strategies and seek to differentiate the brands they sell and reduce their purchases from us, our sales would decline. In addition, jeans with basic finishes historically have comprised a substantial portion of our sales to these channels. If we are not successful in selling to our customers a greater mix of products with more advanced finishes in order to meet changes in consumer preferences, our European sales could continue to decline. Finally, many of our European customers 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 sales. A significant adverse change in a customer relationship or in a customer’s performance or financial position could harm our business and financial condition.

 

Net sales to our ten largest customers totaled approximately 43% and 40% of total net sales in 2005 and 2004, respectively. Our largest customer, J.C. Penney Company, Inc., accounted for approximately 9% of net sales in 2005 and 2004. The retail industry in the United States has experienced substantial consolidation in recent years. For example, Sears Roebuck and Co. (a Levi’s^® brand and Dockers^® brand customer and one of our top ten customers) and Kmart Corporation (a Levi Strauss Signature^® brand customer) merged in 2005, as have Federated Department Stores, Inc. (a Levi’s^® brand and Dockers^® brand customer) and May Department Stores Co. (a Levi’s^® brand and Dockers^® brand customer and one of our top ten customers). 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 women consumers to our jeans brands.

 

In the United States, our Levi’s^® brand sales are heavily 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 entry into

the market of multiple brands that target younger consumers, including brands offered by vertically integrated specialty stores. We believe that 15-24 year-old consumers represent the highest growth segment of the U.S. men’s jeans market. In addition, we believe that over the last several years, the worldwide women’s jeans market has grown more quickly than the men’s jeans market and is now larger than the men’s jeans market. 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 Dockers^® business or our European business could harm our financial results.

 

Our Dockers^® business worldwide has suffered sales declines in recent years. In 2005, U.S. Dockers^® sales declined by approximately 0.4% compared with 2004, but declined by approximately 21% from 2003 to 2004. Our European business as a whole has also suffered recent sales declines. Our Europe net sales declined by approximately 8.0% and 5.7%, on a constant currency basis, in 2005 and 2004, respectively. The declines were attributable to a variety of factors, including weak market and retail conditions in Europe generally and poor customer service by us, including low order fulfillment rates.

 

Although we have taken actions to reverse these sales declines, if our actions are not successful, 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 denim 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 in Europe and Asia. Although our research to date indicates 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 sales of our Levi’s^® and Dockers^® brands. 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.

 

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 Levi’s^® brand. Although we currently operate over 50 retail stores, we are primarily a wholesaler and not a retailer, 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 appropriately manage greater inventory levels, install and operate effective retail systems, apply 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.

 

We rely on outsourced 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 currently source over 90% of our products from independent contract manufacturers who purchase fabric and other raw materials and may also provide us with design and development services. An increasing proportion of our outsourced supply consists of “package” or “ready to wear” arrangements, in which contractors produce or purchase fabric themselves and then sew, finish and ship the garments. As a result, we depend on independent contract 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.

 

This dependence 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 required 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.

 

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.

 

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

 

We generated approximately 45% of our net sales outside the United States in 2005 and 2004. 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 sales in 2005 were $4.1 billion, an increase of 1.3% compared to 2004 but flat on a 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.

During the past 24 months, we have experienced significant management turnover. The success of our business depends on our ability to attract and retain qualified employees.

 

We need talented and experienced personnel in a number of areas including our core business activities. An inability to retain and attract qualified personnel, especially our key executives, could harm our business. In the past 24 months, we have had several changes in our senior management, including three chief financial officers, a new general counsel and new leaders of our Europe business, our global sourcing organization and our U.S. Dockers^® business. Our European president, who joined us in February 2004, is leaving us at the end of February 2006, and we are conducting a search for his replacement. Turnover among our senior management could have a material adverse effect on our ability to implement our strategies and on our results of operations. Our ability to attract and retain qualified employees is adversely affected by the San Francisco location of our headquarters due to the high cost of living in the San Francisco area.

 

We have substantial liabilities and cash requirements associated with pension, post-retirement health benefit and deferred compensation plans, and with our restructuring activities.

 

Our restructuring activities, post-retirement health benefits plans and pension plans result in substantial liabilities on our balance sheet, which as of November 27, 2005 and November 28, 2004 totaled $754.0 million and $814.3 million, respectively. In addition, these plans and activities have and will generate substantial cash requirements for us. For example, for 2005, we made net cash payments of approximately $98 million relating to our restructuring activities, post-retirement health benefits plans and pension plans. For 2006, we expect to make net cash payments of approximately $17 million relating to restructuring activities, approximately $28 million under our post-retirement health benefits plan and approximately $47 million as contributions to our pension plans.

 

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.

 

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 name 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 intend to expand our trademark licensing programs. 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, distribution and sale of various products and intend to expand our licensing programs. While we enter into comprehensive licensing 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.

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 25, 2007, 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. This report must also include disclosure of any material weaknesses in internal control over financial reporting that we have identified. Additionally, our independent registered public accounting firm will be required to issue reports on management’s assessment of our internal control over financial reporting and 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 incurred approximately $8 million of third-party expenses in the year ended November 27, 2005 related to our activities regarding Section 404. 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 November 25, 2007. 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. In addition, our independent registered public accounting firm may not agree with our management’s assessment or conclude that our internal control over financial reporting is operating effectively.

 

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

 

We rely on various information technology systems to manage our operations and we regularly evaluate these systems against our current and expected requirements. 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 currently implementing an SAP enterprise resource planning system in Asia, which we also plan to implement in North America and Europe in the coming years. There are inherent costs and risks associated with replacing and changing these systems, including significant capital expenditures 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.

 

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 earthquake 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 owned or franchised stores, or the facilities of our suppliers or customers are affected by earthquakes, power shortages, floods, monsoons, terrorism or other events outside of our control, our business could suffer.

Risks Relating to Our Substantial Debt

 

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

 

As of November 27, 2005, we had approximately $2.3 billion of debt, of which $1.8 million was unsecured, and we had approximately $431.5 million of additional borrowing capacity under our senior secured revolving credit facility. Our substantial debt could 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 and a portion of our senior secured term loan also bear interest at a variable rate. As a result, increases in market interest rates may 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, our senior secured term loan 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 eurobond, our senior secured term loan and our senior secured revolving credit facility contain restrictions, including covenants limiting our ability to incur additional debt, grant liens, make acquisitions and other investments, prepay specified debt, consolidate, merge or acquire other businesses, sell assets, pay dividends and other distributions, repurchase stock, make capital expenditures, and enter into transactions with affiliates. We also are required to meet a leverage ratio under our senior secured term loan and, in certain circumstances, a fixed charge coverage ratio under our senior secured revolving credit facility. These restrictions may make it difficult for us to successfully execute our business strategy or to compete with companies not similarly restricted. In particular, these restrictions, in combination with our leveraged condition, could limit our ability to restructure our business or take other actions that require additional funds or that cause us to incur charges or costs that adversely affect our compliance with our leverage and fixed charge coverage ratio covenants.

 

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 foreign operations through foreign subsidiaries, which accounted for approximately 45% of our net sales during 2005 and 2004. 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 14 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 27, 2005 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 business 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 27, 2005, we also leased or owned 105 administrative and sales offices in 39 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 27, 2005, we had 67 company-operated retail and outlet stores in leased premises in 10 countries. We had 24 stores in the North America region, 34 stores in the Europe region and nine stores in the Asia Pacific region. In 2005, we opened 22 company-operated stores and closed six stores. In 2006, we expect to open approximately four new company-operated stores in our Asia Pacific region, eight new company-operated stores in Europe region and 20 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, 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. On February 7, 2005, the parties submitted the joint agreement to the court for approval. On June 17, 2005, the parties attended a case management conference where the court set a trial date of October 2, 2006 to try plaintiffs’ Sarbanes-Oxley Act claim, plaintiffs’ defamation claim and our counter-claims.

 

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 recently filed 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, our chief executive officer, a former chief financial officer, our corporate controller, our 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 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 2005 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, 2006, the four voting trustees are Miriam L. Haas, Peter E. Haas, Jr., Robert D. Haas and F. Warren Hellman, all of whom are directors. Under the voting trust agreement, Ms. Haas became a voting trustee upon the death of her husband, Peter E. Haas, Sr., on December 3, 2005. See “Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” 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, as noted, 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.

 

We may hold “annual stockholders’ meetings” to which all voting trust certificate holders are invited to attend. These meetings are not a “meeting of stockholders” in the traditional corporate law sense. Under the voting trust agreement, the trustees, not the voting trust certificate holders, elect the directors and vote the shares on most other corporate matters. In addition, the meetings are not official formal meetings, under the voting trust agreement, of the voting trust certificate holders. Instead, these annual gatherings are opportunities for the voting trust certificate holders to interact with the board of directors and management and to learn more about our business.

 

As of February 1, 2006, there were 172 record holders of voting trust certificates.

 

We have not declared or paid any cash dividends on our common stock since our recapitalization transaction in 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. We are currently precluded from declaring or paying cash dividends under covenants set forth in our senior secured revolving credit facility and our senior secured term loan. The indentures governing our senior unsecured notes also limit our ability to pay dividends. For more detailed information about these limitations, see Note 7 to our Consolidated Financial Statements.

 

We did not repurchase any of our common stock during the fourth quarter of 2005.

 

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 2005, 2004 and 2003 and the related notes to those financial statements, included elsewhere in this report. Certain prior year amounts have been reclassified to conform to the 2005 presentation.

 

 

 

 

Overview

 

Our Company

 

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. We also license our trademarks in various countries throughout the world for accessories, pants, tops, footwear, home and other products.

 

We derive approximately 45% of our net sales from operations outside the United States. Our products are available at over 55,000 retail locations worldwide. We market Levi’s^® brand products in over 110 countries, Dockers^® brand products in over 50 countries and Levi Strauss Signature^® brand products in the United States and eleven other countries.

 

We distribute our Levi’s^® and Dockers^® products primarily through chain retailers and department stores in the United States and primarily through department stores, specialty retailers and franchised stores abroad. We also distribute Levi’s^® and Dockers^® products through company-operated stores located in the United States, Europe and Japan. We distribute our Levi Strauss Signature^® products through mass channel retailers.

 

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 and continuing cost and pricing pressure throughout the value chain from supplier to consumer.

 

Our Business Transformation

 

We began several years ago executing an integrated set of strategic, operational and organizational initiatives designed to transform our business and address trends and dynamics in the global apparel marketplace. These actions include the following:

 

 

As a result of these and other initiatives, we have substantially improved our financial condition and profitability. Our net sales in 2005 increased as compared to 2004, ending an eight-year sales decline. Our operating margin improved from 8.9% in 2004 to 14.3% in 2005. Our operating income improved from $361.1 million in 2004 to $589.3 million in 2005. Our organizational streamlining and cost reductions enabled us to increase our investment in advertising and promotion activities in 2005 as part of our continuing effort to build our brands and strengthen our retail relationships. We also had lower restructuring expenses and we reached agreements with the Internal Revenue Service to close our open 1986 — 1999 tax years. In addition, we improved our financial condition by executing a series of actions, including our senior note financings in December 2004 and early 2005, that extended our senior note maturities on more favorable terms.

 

Our 2005 Results

 

Key financial results for 2005 were as follows:

 

 

Our 2006 Priorities

 

We remain focused on our key priorities of driving growth in the Levi’s^® and Levi Strauss Signature^® businesses, revitalizing our Dockers^® brand, including our Dockers^® women’s business, continuing the execution of our strategies for our Europe business, including positioning the Levi’s^® brand as a premium brand, and delivering solid and sustainable profitability. However, we are cautious about our outlook in 2006, particularly in the first half of the year, in view of:

 

 

We believe we have the right strategies in place to address these challenges throughout the year.

 

Results of Operations

 

2005 as compared to 2004

 

The following table summarizes, for the years indicated, items in our consolidated statements of operations, the changes in these items from 2004 to 2005 and these items expressed as a percentage of net sales.

 

 

Consolidated net sales

 

The following table shows our net sales for our North America, Europe and Asia Pacific businesses and the changes in these results from 2004 to 2005.

 

North America net sales

 

The following table presents our net sales in our North America region broken out for our U.S. brands and for Canada and Mexico, including changes in these results from 2004 to 2005.

 

 

The following discussion summarizes net sales performance during 2005 for our U.S. brands. In these sections, the tables showing net sales for the Levi’s^® and Dockers^® brands break out net sales between “Licensed Categories” and “Continuing Categories.”

 

 

We believe this presentation is useful to the reader as it shows the impact of product category licensing on our net sales. We present this data only for our U.S. Levi’s^® and Dockers^® brands because there has been no significant licensing of product categories that we have marketed and sold ourselves in our U.S. Levi Strauss Signature^® brand or in our Europe and Asia Pacific businesses.

 

Levi’s^® Brand.  The following table shows net sales of our U.S. Levi’s^® brand, including the changes in these results from 2004 to 2005.

 

 

Net sales in our U.S. Levi’s^® brand decreased by $5.1 million or 0.4% for 2005 as compared to 2004. This decrease was driven by our product rationalization actions and the related decisions to license certain product categories and discontinue underperforming categories. These actions were initiated in 2004 in line with our strategy to focus the brand on more category competitive products in our core channels of distribution and improve our profitability. Our decision to license certain products resulted in an approximately $40.7 million decrease in our net sales for 2005.

 

Net sales for our U.S. Levi’s^® brand’s continuing categories increased by $35.7 million or 2.9% for 2005 as compared to 2004. This increase was driven by higher sales volume across consumer segments in our core channels of distribution and proactive sale of excess and obsolete inventory to off-price channels. New products such as the

527 low rise boot cut, 569 loose straight and 514 slim straight in young men’s and the straight and skinny products in women’s, as well as long bottoms with premium finishing and destructed looks, contributed to the unit sales increase. In addition, in 2005 we did not experience the supply constraints that we had in the second half of 2004 that resulted in our missing orders and losing sales during that period.

 

During 2005, we continued to focus on driving consumer awareness and demand during the year through our marketing programs. This included a continuation of our “A Style for Every Story^tm” advertising campaign in print media and television and our continued investment in our retail floor presentations with our top retail customers.

 

We also expanded our retail store presence during 2005, opening four new stores including three stores in selected urban locations and an online store, www.levisstore.com. Net sales generated by our company-operated Levi’s^® retail and outlet stores increased by approximately $5.0 million for 2005 as compared to 2004. We now operate 25 stores (including the new online store) in the United States, and intend to continue to grow our network of stores.

 

Dockers^® Brand.  The following table shows net sales of our U.S. Dockers^® brand, including changes in these results from 2004 to 2005.

 

 

Net sales in our U.S. Dockers^® brand decreased $2.7 million or 0.4% for 2005 as compared to 2004. This decrease was driven by the product rationalization actions and the related decisions to license certain product categories and discontinue underperforming categories, including Slates^® pants, that we initiated in 2004. Our decision to license or discontinue certain products resulted in an approximately $10.0 million decrease in our total U.S. Dockers^® brand net sales for 2005.

 

Net sales for our U.S. Dockers^® brand continuing categories increased by $7.3 million or 1.1% in 2005 as compared to 2004. This increase was primarily driven by increased sales volume in our men’s premium pants business, led by our Never Iron^tm Cotton Khaki pant and our Essential Dress pant. We also had net sales growth in our shorts business due to improved product performance at retail. In addition, we experienced lower returns and allowances primarily driven by fewer sales at discounted prices. Our decision in 2004 to discontinue certain product lines resulted in substantial discounting in 2004. Also contributing to the decrease in returns and allowances was the reversal during the first quarter of 2005 of approximately $4.0 million in unclaimed deductions which had been previously accrued during 2004.

 

Partially offsetting the increase in net sales for our U.S. Dockers^® brand continuing categories were lower sales volume in our women’s business, which we attribute to a consumer shift away from basics like our women’s pants to more fashion products, and our decision to downsize our women’s shorts business.

 

During 2005 we launched our Dockers^® “Dress to Live” advertising campaign. These advertisements are part of a fully integrated marketing campaign that includes television and print advertising for our men’s and women’s products, a redesigned www.dockers.com Web site, Internet advertising, publicity and in-store campaign imagery to position the Dockers^® brand as a head-to-toe lifestyle brand for men and women.

Levi Strauss Signature^® Brand.  The following table presents our net sales in our U.S. Levi Strauss Signature^® brand, including the changes in these results from 2004 to 2005:

 

 

Net sales in our U.S. Levi Strauss Signature^® brand increased by $25.0 million, or 7.4%, for 2005 as compared to 2004. The increase was primarily driven by sales to accounts we launched during the second half of 2004, including Kmart, Meijer, Shopko and Pamida, and an increase in sales to Target. Our sales growth was also driven by new product introductions, product line extensions, including new fits and finishes and by the introduction of a new premium denim product line.

 

During 2005, we continued to focus on expanding our Levi Strauss Signature^® business through increased consumer awareness in the value channel. Our marketing efforts during 2005 included continuation of the “From Our Family to Yours” advertising campaign in print media, sponsorship of the All American Soapbox Derby in Akron, Ohio and the launch of the Levi Strauss Signature^® Brand Store on Walmart.com. In addition, we continued our public relations outreach activities and increased our brand exposure through our presence at events such as NASCAR races, state fairs and retailer locations.

 

Europe net sales

 

The following table presents our net sales in our Europe region, including the changes in these results from 2004 to 2005:

 

 

Net sales in our Europe region decreased $61.0 million or 5.9% and, on a constant currency basis, decreased 8.0%, for 2005 as compared to 2004. The net sales decrease was primarily driven by a decrease in unit sales volume for our Levi’s^® brand products, which represent approximately 90% of our business in the region, and increased sales discounts and allowances. Soft consumer demand throughout Europe unfavorably affected our replenishment business during the year. A reduction in Dockers^® brand sales due to soft consumer demand as well as the unfavorable impact of restructuring our Dockers^® business model in Europe, which we commenced in 2004, also contributed to the net sales decline. The decrease in net sales was partially offset by an increase in average selling price as a result of our ongoing repositioning of the Levi’s^® brand in Europe as a premium product.

 

During 2005 we continued the transformation of our business model in Europe, including focusing on lower cost sourcing, consolidating distribution, finalizing the relocation of our stand-alone Dockers^® operations in Amsterdam to our European headquarters in Brussels, rationalizing our product offerings and marketing efforts and improving our customer service levels. In 2006, we plan to continue the execution of our strategies for our Europe business, including promoting Levi’s^® as a premium brand, re-introducing our Dockers^® brand and expanding distribution of our Levi Strauss Signature^® brand.

Asia Pacific net sales

 

The following table presents our net sales in our Asia Pacific region including the changes in these results from 2004 to 2005:

 

 

Net sales in our Asia Pacific region increased $85.1 million or 14.1% and, on a constant currency basis, increased 11.1%, for 2005 as compared to 2004. The net sales increase was driven by a 12.5% increase in net sales on a constant currency basis for our Levi’s^® brand products, which represent approximately 95% of our business in the region. Net sales increased in most countries within our Asia Pacific region. Japan, which represented approximately 41% of regional net sales in 2005, generated a 4.1% increase in net sales on a constant currency basis.

 

Key drivers of our net sales results in our Asia Pacific region for 2005 were an improved sales mix, with increased sales of super premium and premium priced Levi’s^® brand products; the introduction of new fits and finishes for both our Levi’s^® men’s and women’s businesses and the continued strong performance of our Levi’s^® LadyStyle^tm products; and the continued expansion of our retail presence through additional store openings and upgrades of existing stores to more current retail formats.

 

Gross profit

 

Our gross profit increased $104.1 million or 5.8% for 2005 as compared to 2004. Our gross margin was 45.8% for the year, reflecting an increase of two percentage points. Factors that increased our gross profit for 2005 included:

 

 

The increase was partially offset by the impact of a lower gross margin on our Levi Strauss Signature^® products, due in part to an increased investment in product fits and finishes.

 

Our cost of goods sold is primarily comprised of cost of materials, labor and manufacturing overhead and also includes the cost of inbound freight, internal transfers, and receiving and inspection at manufacturing facilities as these costs vary with product volume. We include substantially all the costs related to receiving and inspection at distribution centers, warehousing and other activities associated with our distribution network in selling, general and administrative expenses. 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 in cost of goods sold.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses increased $27.9 million or 2.1% for 2005 as compared to 2004. On a constant currency basis, selling, general and administrative expenses were approximately $12.4 million higher

in 2005 as compared to 2004, primarily due to our increased investment in advertising and promotion. As a percentage of net sales, selling, general and administrative expenses were 32.2% for 2005 as compared to 31.9% for 2004.

 

Key factors driving the increase in selling, general and administrative expenses for 2005 were as follows:

 

 

These increases were partially offset by the following:

 

 

Long-term incentive compensation expense

 

Long-term incentive compensation expense was $31.1 million for 2005 as compared to $45.2 million for 2004. The decrease in our long-term incentive compensation expense relates primarily to the adoption in 2005 of new long-term incentive compensation plans for which the performance measurement periods are either two or three years, depending on the plan, as compared to eighteen months for our 2004 interim plan.

 

Other operating income

 

Other operating income increased 35.9% for 2005 as compared to 2004. Other operating income is comprised primarily of royalty income we generate through licensing our trademarks in connection with the manufacturing, advertising, distribution and sale of products by third-party licensees. During 2005, royalty income increased $16.2 million as compared to 2004. The increase was attributable primarily to recognizing in 2005 the full year benefit of product categories licensed during 2004 and our launch of Levi Strauss Signature^® brand licensing programs for several product categories. In addition, during 2005, we recognized approximately $1.7 million of royalty income related to the termination of a Dockers^® license agreement.

Restructuring charges

 

Restructuring charges, net of reversals, of $16.6 million for 2005 related primarily to current period activities associated with our 2004 U.S., Europe and Dockers^® Europe reorganization initiatives. Restructuring charges, net of reversals, of $133.6 million for the year ended November 28, 2004 primarily related to our 2004 reorganization initiatives in the U.S. and Europe. Those activities included plant closures, organizational changes and charges related to the indefinite suspension of an enterprise resource planning system installation. In addition, in 2004, we incurred restructuring charges related to organizational changes initiated in 2003.

 

Operating income

 

Operating income increased 63.2% in 2005 compared to 2004. Operating margin was 14.3% for 2005, reflecting an increase of 5.4 percentage points compared to 2004.

 

The following table shows our operating income by brand in the United States and in total for our North America, Europe and Asia Pacific regions, the changes in results from 2004 to 2005 and results presented as a percentage of net sales:

 

 

 

 

The increase in total operating income in 2005, as compared to 2004 was primarily attributable to lower restructuring charges, net of reversals, increased operating income in our Europe and Asia regions, lower other corporate expense and lower long-term incentive compensation expense.

Regional Summaries.  The following summarizes the changes in operating income by region:

 

 

Other corporate expense.  The following tables summarize significant components of other corporate expense:

 

 

We reflect annual incentive compensation plan costs for corporate employees and corporate staff costs, including workers’ compensation costs, in other corporate expense. The decrease of $26.5 million for 2005 was primarily attributable to our reorganization and cost reduction initiatives, changes made to our benefit plans that have resulted in lower net expense and workers’ compensation reversals realized during the year. Partially offsetting the decrease were increased third-party costs associated with our activities in respect of Section 404 of the Sarbanes-Oxley Act and higher annual incentive compensation plan expenses in 2005. The increase in our annual incentive compensation plan expenses in 2005 was primarily due to the implementation of an additional employee incentive plan and higher anticipated payments under our Annual Incentive Plan.

 

Interest expense

 

Interest expense increased 1.4% to $263.7 million for 2005, compared to $260.1 million for 2004. The increase was primarily attributable to higher average debt balances related to the time elapsed between our 2005 debt issuances and our use of the proceeds to tender and redeem a portion of our 2006 notes and all of our 2008 notes during the first half of 2005.

 

The weighted average interest rate on average borrowings outstanding during 2005 and 2004, including the amortization of capitalized bank fees, underwriting fees and interest rate swap cancellations, was 10.5% and 10.6%, respectively. The weighted average interest rate on average borrowings outstanding excludes interest payable to participants under deferred compensation plans and other miscellaneous items.

Loss on early extinguishment of debt

 

During 2005, we recorded a $66.1 million loss on early extinguishment of debt as a result of our debt refinancing activities during the year. The loss consisted of tender offer and redemption 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. These costs were incurred in conjunction with our completion in January 2005 of a repurchase of $372.1 million of our $450.0 million principal amount 2006 notes and in March and April 2005 of a repurchase and redemption of all of our 2008 notes.

 

Other (income) expense, net

 

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

 

 

 

 

Our foreign exchange risk management activities include the use of instruments such as forward, swap and option contracts, to manage foreign currency exposures. Outstanding derivative instruments are recorded at fair value and the changes in fair value are recorded in “Other (income) expense, net” in our consolidated statements of operations. At contract maturity, the realized gain or loss related to derivative instruments is also recorded in “Other (income) expense, net” in our consolidated statements of operations. The changes in foreign exchange management losses recorded for 2005 compared to 2004 were due to different conditions in foreign exchange markets and changes in the foreign currency exposures being managed. For more information, see “Item 7A — Quantitative and Qualitative Disclosures About Market Risk”.

 

Foreign currency transactions are transactions denominated in a currency other than the recording entity’s functional currency. At the date the foreign currency transaction is recognized, each asset, liability, revenue, expense, gain or loss arising from the transaction is measured and recorded in the functional currency of the recording entity using the exchange rate in effect at that date. At each balance sheet date for each entity, recorded balances denominated in a foreign currency are adjusted, or remeasured, to reflect the current exchange rate. The changes in the recorded balances caused by remeasurement at the exchange rate are recorded in “Other (income) expense, net” in our consolidated statements of operations. In addition, at the settlement date of foreign currency transactions, foreign currency (gains) losses are recorded in “Other (income) expense, net” in our consolidated statements of operations to reflect the difference between the spot rate effective at settlement date and the historical rate at which the transaction was originally recorded.

 

The increase in interest income for 2005 was primarily due to higher effective interest rates on our investments and a higher average investment balance during 2005 as compared to 2004.

Income tax expense

 

Income tax expense was $126.7 million for 2005 compared to $65.1 million for 2004. The $61.5 million increase was primarily driven by the $187.1 million increase in our income before taxes, partly offset by a decrease in our effective income tax rate, from 68.2% in 2004 to 44.8% in 2005. For more information, see “— Tax Matters”.

 

Net income

 

Net income was $155.9 million for 2005, compared to net income of $30.4 million for 2004. The increase was driven by higher operating income and lower foreign exchange management contract losses, partially offset by the loss on early extinguishment of debt, slightly higher interest expense and higher income tax expense.

 

2004 as compared to 2003

 

The following table summarizes, for the years indicated, items in our consolidated statements of operations, the changes in these items from 2003 to 2004 and these items expressed as a percentage of net sales.