What really happened at Levis?

by admin on July 22, 2008

in General

Mike Krigsman endeavours to dissect the impact of the SAP ERP implementation on Levi’s accounts quoting liberally from the company’s latest 10-Q quarterly filing. Other titles jump on the claim made by Levi’s that:

We ran into technical issues going through the implementation process, which interrupted shipping for about a week. We experienced shipping delays as we ramped the system back up, resulting in lost orders.

I find this curious but in order to unravel the issues, you have to go back to the revious 10-Q where it was revealed that:

Net revenues for the first quarter include approximately $18 million of shipments to certain wholesale customers in February 2008 in anticipation of our March 2008 conversion to SAP in the United States.

Hmm. The segment analysis for the second quarter show Q2 Americas revenues in 2007 of $591 compared to $477 million for the same period in 2008, a drop of $114 million. On that basis, a week’s deliveries (assuming parity with 2007 and a 13 week accounting period) amounts to $45 million. Mike suggests that:

Since the company presumably follows a standard methodology for all rollouts and has successfully deployed SAP in other regions, something different happened here. Although we can only guess, perhaps the differences relate to unexpected complexity in the financial environment at Levi’s company headquarters or in project management issues unique to the US rollout.

I suspect there is more to this than meets the eye. Levi anticipated ERP issues to the tune of $18 million so you can’t realistically count that because they took sales credit for those advanced shipments – at least that’s my reading of the Q1 10-Q filing. The company was anticipating a decline in revenues anyway from a variety of other factors, including a substantially weakened economy (in its opinion). Assuming the $45 million will be caught up to in Q3, the net revenue effect was more likely $27 million (45-18.) If however we take Q2 2008 as representative of constant sales then the effect is lower because we’re really looking at $40million (477/12×13). Taking $18 million out leaves $22 million impact. This is not an unreasonable assumption when you consider that stores usually prefer a constant and regular delivery call off schedule.

I have no doubt there were issues related to the ERP. But assigning so much emphasis when the company had already anticipated an issue is stretching credulity. If you look at JC Penney’s 10-Q for the comparable period, they too record a decline: 5%. Nowhere do they mention the impact of suspended deliveries as a contributing problem despite they are Levi’s largest customer at 9% of revenue.

Instead, I am drawn to the comments about the company’s system of internal control. Levi was replacing manual systems. These almost always throw up anomalies, especially around inventory. From Francine McKenna’s comments in Mike’s post:

The language suggests that fundamental internal control errors were discovered after the system went live. Apparently, auditors determined these problems could have resulted in a materially significant impact to Levi’s financial statements if not corrected. I can speculate that perhaps it was inventory related, because it’s the big balance sheet item for a company like this.

Also, given Levi’s previous errors and restatements, and with the recent change in auditors, new auditor PwC is probably taking a very strict approach to assessing Levi’s efforts to implement SAP with required controls.

That’s more like it. But of course it is always easier to blame the ERP implementation.

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