At Levi Strauss,

Trouble Comes
From All Angles
By SALLY BEATTY
Staff Reporter of THE WALL STREET JOURNAL, 10-13-03

Back in the early 1980s, Levi Strauss & Co. got a big lift from a clever ad campaign
featuring its "501 Blues" original jeans. These days, the company is simply singing the
blues.

On Friday, the closely held apparel maker suffered yet another round of tax and
accounting embarrassments: It acknowledged taking the same tax deduction twice in
1998 and 1999 and said it will have to restate third-quarter 2003 and full-year 2001
financial results. Further, the company said it would delay its final third-quarter filing to
the Securities and Exchange Commission.

This follows a lawsuit filed by two former executives alleging fraud; a continuing dispute
with the IRS over aggressive tax positions and open tax years dating to 1986; and the
revelation last month that Levi had insufficient documentation to support six years of tax
reserves. It also said it will close its last U.S. factory and shed 21% of its workers.

Yet Levi's most significant problem is something else -- selling jeans. One of America's
most durable apparel brands is fighting for its life in the midst of tough environment for
apparel retailing, and its $2 billion debt load gives it little room for error. Although Levi
stock isn't sold publicly, more than half its debt is publicly traded.

The company's predicament reflects more brutal conditions than anyone in the business
can remember. "We are trying to turn around a company in a very difficult environment
with an enormous amount of debt," says Levi's chief executive officer, Phil Marineau. He
says the company appears to be on the right path.

Mr. Marineau, a former top PepsiCo Inc. executive who was paid more than $25 million
last year to rescue the San Francisco company, has a daring plan that he calls
segmentation: He wants to sell Levi's to everyone without alienating anyone, a delicate
fashion tactic in the best of economies. He is targeting various population segments --
fashionistas, trendy teens, aging men and budget shoppers -- with different jeans styles
placed in different stores, from Neiman Marcus at the high end to Wal-Mart Stores Inc. at
the low end, where the company sells its new Signature jeans that retail for $23.

Wal-Mart has publicly praised the line's sales. The goal is to reach the 160 million
consumers who shop in discount stores each week, and reduce Levi's exposure to
troubled department stores, which are losing share to mass merchants and specialty
stores. Levi badly needs the volume that only a big retailer like Wal-Mart can provide to
offset the decline in its main 501 jeans business.
The risk is that the down-market retailers will damage the brand's cachet. If this happens,
consumers now paying as much as $200 for a pair of Levi's high-end jeans may balk.
That's why Levi isn't advertising its Signature jeans: The company wants to avoid
damaging its status in fashion circles or irritating its full-price customers. Even Ralph
Lauren, who positions his brand as a luxury label but sells huge volumes of sheets and
polo shirts through his own discount outlets, has steered clear of mass merchants. Still,
Levi is a resilient brand that has long appealed to both workers and socialites, so it just
might pull this off.

Juggling these priorities requires a deft touch and has attracted some doubters. "It is
unclear whether the strategy can be effective," says Patrick Finnegan, a managing
director with Moody's Investors Service. Moody's in September slapped Levi with a
multiple-notch downgrade of its debt rating. On Friday, Standard & Poors lowered its
outlook on Levi debt to "negative" from "stable."

Levi enjoyed a resurgence in the second half of last year, but consumer demand fell off
generally in the first six months of this year, resulting in yet another sales decline. While
the apparel maker showed 4% growth in the third quarter, the gains came from the
Signature line -- otherwise, Levi revenue would have slipped again. Skeptics in the
financial community note that the recent launch of a high-fashion jeans line called Type
1, sold at department and specialty stores, proved too cutting edge for many shoppers.

Levi has little wiggle room, and not just because of its groaning debt. Even if the jeans
keeps selling, the company's reward could be minimal because mass-market margins tend
to be thinner than frayed denim. Wal-Mart is widely expected to ask Levi to lower prices
still further. (A Wal-Mart spokeswoman said she wouldn't speculate on future business
decisions.) Competitors, meanwhile, will also add pressure: VF Corp. sells its Wrangler
jeans in Wal-Mart for $15 to $18. And Wal-Mart sells its own line of private label jeans
for $9.99.

But for those manufacturers cagey enough to deliver the right product at low cost, doing
business with the mass merchants can be highly profitable. That's because retailers such
as Wal-Mart tend to sell their goods faster. They also don't often ask for "markdown
money" -- payments from suppliers to boost margins for department stores when goods
don't sell.

Levi's bet reflects the larger economic issues buffeting the apparel business, including
deflation resulting from an oversupply of goods. Five years ago, department stores sold
men's jeans at an average price of $40. Today, the jeans sell for an average of only $34.
At national chains like Sears, Roebuck & Co. or Kohl's Corp., the price is about $24.
When the World Trade Organization further relaxes trade barriers with China in 2005, the
U.S. market will be flooded with even more cheap clothing. All of this promises to put
greater pressure on Levi to lower its prices.

Levi executives are quick to cite some upbeat developments. Levi has improved its fit
and styling. It has shortened the time it takes to get a pair of jeans to market from 15
months when Mr. Marineau joined Levi in late 1999 to 10 to 11 months today. The goal
is to get to 7½ months by the middle of next year. Further, the company has cut its debt to
$2.37 billion from $2.7 billion in 1999.

In addition, consumers bought more Levi's and Dockers in the third quarter than a year
earlier, Levi says, based on reports from retailers. However, this was offset by lower
orders from traditional retailers; Levi attributes this to concerns about losing shoppers to
Wal-Mart.

Eager to quiet such fears, Levi surveyed 1,000 stores within 7½ miles of Wal-Mart to see
if Signature hurt their higher-priced Levi's sales. Surrounding retailers haven't suffered, it
says. Now the company is formulating plans to boost promotional activities with Wal-
Mart.