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Jean Therapy, $23 A Pop


As he pored over designs for a new line of jeans last year, Scott A. LaPorta, president of Levi Strauss & Co.'s new Signature jeans unit, decided the fabric his designers were specifying was simply unacceptable. The problem: "It felt a little more luxurious, a little more high-end than we wanted," recalls LaPorta. Huh? As head of Levi's new discount jeans business, LaPorta's job is to keep a tight lid on costs. A very tight lid. He figured the denim his designers wanted would have added at least a buck or two to the retail price. He sent them back to find something cheaper.

It's a new world for Levi Strauss. Once an iconic brand for youth worldwide, the struggling San Francisco-based company is seeking to reverse a long slide by going downmarket. Launched last July in Wal-Mart Stores Inc. (WMT), Levi's Signature line of jeans for men, women, and teens, is priced at only $21 to $23 a pair. That is as little as half the price of the familiar 505 and 501 pants that are part of Levi's core Red Tab line. Levi Strauss has since rolled out Signature in Target Corp.'s (TGT) 1,400 discount stores as well.

The stakes couldn't be higher for the 151-year-old company. Although Levi had operating earnings of $311 million in fiscal 2003, it posted a record $349 million net loss, largely reflecting non-cash charges for tax accounting changes. But revenues were only $4 billion, far below peak sales of $7.1 billion in 1996. Since then the company has laid off 26,600, or 71%, of its workers and moved all production to Latin America and Asia. Now it's looking to jettison its $1 billion Dockers casual-pants unit to help pay down its $2.2 billion debt load, and to refocus on the jeans business. And last year, it hired consultants Alvarez & Marsal Inc., known for assisting especially troubled companies.

All that gives Levi's almost no margin for error. If Signature stalls, the company that invented blue jeans could be pushed to the brink. "People at Wal-Mart shop on price, and that'll make it tough for Signature," says Alexis Gold, analyst at CIBC World Markets. On the other hand, even if Signature sells well, there is the danger it won't be profitable enough to help pare the company's debt. Levi's senior unsecured debt carries a CCC rating, meaning that the company is in danger of default. Indeed, a Signature failure could force privately held Levi to consider a sale of its brands, a sale of the company, or even a bankruptcy filing, says Thomas P. Razukas, a bond analyst at Fitch Ratings. LaPorta dismisses the possibility of Chapter 11: "Our liquidity is around $500 million, which is sufficient to operate the business. Analysts who follow the business closely have stated that bankruptcy is not an issue."

So far, Signature is making inroads. In stores for less than a year, the jeans racked up sales of $105.2 million, or 11% of Levi's $962 million in revenues for the fiscal first quarter ended Feb. 29. And since the world's largest retailer seems satisfied, LaPorta says he believes Signature sales can double in the next three to four years. Wal-Mart executives declined to be interviewed, but a spokeswoman called the Signature line a "significant business" for the retailer.

That's a big improvement for beleaguered Levi Strauss, which hasn't had cause to celebrate since 501s were hot 10 years ago. The company didn't just misread the shift away from department stores such as Kohl's (KSS) and J.C. Penney (JCP). It also missed trend after trend, often making jeans in out-of-favor colors or coming late to new looks like baggy hip-hop jeans.

RED TAB TROUBLES

Levi Strauss might have been in the discount game earlier if the company hadn't been in such bad shape. CEO Philip A. Marineau toyed with the idea of a Levi's discount jean after he arrived from PepsiCo Inc. (PEP) in 1999 to take over the company. After all, discount outlets sell about one-fifth of all jeans in the $12.4 billion U.S. market, according to research firm Mintel International Group Ltd. But the launch of a discount line had to be put off while the company cut costs, closed plants, put its finances in order, and wrestled with Red Tab's marketing and fashion problems -- which have yet to be resolved. In addition, Levi could not deal with a company the size of Wal-Mart until it had solved its logistics problems, which too often resulted in retailers getting wrong orders or late shipments. As a result, Marineau did not announce Signature until October, 2002, and the jeans didn't hit stores until last year. Marineau declined to speak with BusinessWeek.

The company has traditionally sold its goods in department stores, where prices range from $35 for the 501 jeans to $44 for 599 Giant Fit baggy jeans. Selling in the discount market takes a lot more discipline than Levi Strauss has shown in recent years. "We can't take chances and try to ship in anything that'll raise the price above $23 a pair," says LaPorta. That's the price the company agreed on with the notoriously hard-nosed Wal-Mart, which already sells a house brand called Faded Glory for about $16 a pair.

Levi Strauss won't disclose margins on the Signature line, except to acknowledge that they're thinner than in the Red Tab business. So squeezing out a profit means hammering down costs. To do that, Signature jeans roll out of the same factories that Red Tabs do, but with lower-quality fabric and cheaper dyes. LaPorta hired designers who had experience with discount-level brands, including Joe Boxer and Hanes. He also decided to make Signature jeans in only three fits (regular, relaxed, and classic) and three shades of blue (dark, medium, and light). Red Tab jeans, by contrast, come in hundreds of colors, fabric textures, and cuts. Finally, to control marketing costs, Signature won't use expensive print and television ads. Instead, the company is sticking with low-tech in-store posters and on-the-ground promotions, such as a marketing deal with NASCAR and top-ranked driver Jimmie Johnson.

As the Signature business grows, Levi runs the risk that it will cannibalize sales of the higher-priced Red Tab jeans. Although Signature jeans use lighter-weight fabrics than Red Tabs, they have similar stitching and both have a patch on the back of the waistband with the Levi Strauss name. "It's awfully close to Red Tab," says Michael C. Appel, managing director of Quest Turnaround Advisors LLC, a retail consultant. Levi's, however, maintains that the markets are predominantly separate and that Signature sales are climbing even as Red Tab sales begin to stabilize. "I wouldn't say [there's] zero cannibalization but very minimal cannibalization," noted Marineau during the first quarter conference call in April.

Signature may be Levi's last best shot at pulling itself out of the slump that has bedeviled it for years. Moving downscale will do little to reclaim the jean maker's standing as a trendsetter for youth. But it just might give Levi Strauss the chance it needs to survive and grow older.

By Louise Lee in San Francisco


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