Levi Strauss & Co (LEVI) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Levi Strauss & Co. second-quarter 2006 earnings conference call. All parties will be in a listen-only mode until the question-and-answer session, at which time instructions will follow. This conference is being recorded and may not be reproduced in whole or in part without written permission from the Company. I would now like to turn the call over to Jeff Beckman, with Levi Strauss & Company's Worldwide Communications department.

Good morning and welcome to our conference call. I'm pleased to introduce Levi Strauss & Co. management team. With us here today are Phil Marineau, our President and CEO; Hans Ploos van Amstel, our Chief Financial Officer; Robert Hanson, President of the U.S. Levi's brand; John Goodman, President of the U.S. Dockers brand; Scott LaPorta, President of the U.S. Levi Strauss Signature Brand; and John Anderson, Chief Operating Officer and President of our Asia-Pacific business.

This call is being recorded and a telephone replay will be available through July 18, 2006 by calling 800-642-1687 in the United States or Canada, or from outside these countries, call 706-645-9291. For either number, please input the ID code of 234-0581 followed by the # sign.

This conference call also is being broadcast over the Internet and a replay of the webcast will be accessible for one month on our website at www.LeviStrauss.com.

Before we begin, let me briefly remind you of three items. Our CFO will speak to several slides posted in the financial news section on our website, LeviStrauss.com as he goes through the Company's results this morning. We encourage you to review them. Also available on the website is information about how we compile and use retail sell-through information, data that relates to our over-the-counter dollar sales of non-licensed products. You'll hear us talking this morning about sell-through results and trends. Finally, we filed our quarterly report on Form 10-Q with the SEC. You can link to our SEC filings from our website. Now, I'd like to turn the call over to Phil Marineau.

Thank you, Jeff. Good morning. Thanks for joining us today. Before we begin, I want to briefly comment on the announcement I made last week that I will retire at the end of the year. When I joined Levi Strauss & Co. nearly seven years ago, I told the board that being CEO is a seven to eight-year assignment. By the end of this year, I will have accomplished what I set out to do, which includes gaining control and strengthening the financial structure of the Company to improve profitability and cash flow, transforming the Company from a manufacturer to a global distributor, marketer and creator of apparel, stabilizing sales and beginning to grow again and creating a team-based performance-driven culture that will enable us to improve on a continuous basis. I am pleased with the transformation that we have achieved and the highly competitive position of the Company today. This gives me great confidence that the time is right to hand over the reins to the next generation of leaders at Levi Strauss & Co.

I know John Anderson will do a terrific job leading our operations globally as the Chief Operating Officer. He is a very strong, accomplished leader with 27 years of experience with the Company. He has managed virtually every facet of our operations in North America, Europe and Asia. Under his leadership, Asia has produced four consecutive years of double-digit growth.

John and the rest of the Levi Strauss & Co. senior management team are ready to lead the Company through its next phase of success and build on the turnaround that has been achieved. John is here today with us in San Francisco, where he is now based. John, is there anything you'd like to add to this?

Sure. I'm very excited about the opportunity to help drive the global execution of our strategies and ensure that we continue to build on the success we have achieved under Phil's leadership. I have worked closely with Phil on our business plans over the past few years and we're completely aligned on our strategic path. I'm looking forward to working with Phil over the next several months to ensure continuity and a seamless transition.

As Phil said, I'm now working in San Francisco but I will continue to manage the Asia-Pacific business until we identify a new leader for the region. I have no doubt that that transition also will be seamless as well.

Thanks, John. Now I want to add that until the end of the year, I will be fully engaged with John and our entire leadership team to deliver our 2006 plan and to continue to improve our business in Europe. I will also continue to lead the development of our strategic and annual plans for 2007 and beyond. Now, on to our quarter two results.

Our results for the second quarter show improved revenue trends and substantial net income gains since quarter one. Net revenues stabilized in quarter two and net income was up 50% versus a year ago.

The key challenges that we faced during the quarter were consistent with the issues that we discussed during the last conference call. They include -- number one, our softness in the European business, the impact of exiting certain retail doors in Europe as we upgrade our retail distribution network, Wal-Mart's increased emphasis on private-label products in the U.S. and the retail mergers and consolidations in the United States.

Since the beginning of the year, we have been aggressively addressing these issues. The results of our efforts are reflected in sales growth for the U.S. Levi's and Dockers businesses and improved net revenue trends for the U.S. Levi Strauss Signature business. Today I will talk about our Q2 performance within the context of our key priorities for 2006.

Priority number one is to sustain the profitability of the business to improve net income and to generate cash flow to pay down debt. As I said, our net income improved substantially this quarter. This was due in part to a tax benefit. We are generating now significant free cash flow and our net debt is down at the end of Q2 even as we invest in the business. Delivering strong cash flow in order to reduce debt remains the top focus for the Company.

Priority number two is to focus on Europe and fully execute our strategies market by market with the goal of sustaining profitability while improving our sales trends. Our net sales in Europe began to trend up during the second quarter with improvements led by our replenishment business and in our Levi's stores and branded shop in shops. I'm encouraged by these trends but we still have a lot of work to do to stabilize sales and strengthen the profitability of the business.

We have made significant progress in transforming the European business. I have spent much of the last five months personally overseeing this work. We have infused the business with new management, placing talented Levi Strauss & Co. veterans into key operational positions. We have overhauled our entire go-to-market process across the region, and we have decentralized decision-making to make us more market responsive, broadening our product assortments as we have done this and improving our support to our retail customers, including the new higher-end retailers who carry our premium products. These new products are now in stores across the region and we are seeing good sales trends as they get launched into these retailers.

Having witnessed the progress the European team has made, I'm optimistic the business will improve during the back half of the year. We have the right strategies. Now we're beginning to execute them fully and expect to produce success in Europe as we have everywhere else in the world.

Our third priority is to build on the Asia-Pacific division's growth momentum. Asia-Pacific continues to be a growth and profit engine for the Company, posting increases in revenue and operating profits for Q2. Asia-Pacific is now in its fifth year of sales growth while the rate of growth has predictably slowed after many quarters of double-digit increases. This is particularly true in Japan. We continue to invest in the region with new systems and new retail stores to support growth.

Priority four is to address the consolidating U.S. retail environment in ways that help maintain stable U.S. Levi's brand revenues. Despite the impact of initial U.S. retail door closures at a number of top customers, the U.S. Levi's brand net revenue grew this year. The men's business, the largest segment of the brand, is growing again, and our expanding Company operated retail store network is beginning to contribute to sales growth.

Priority number five is to grow the Dockers brand in the U.S. and the Levi Strauss Signature Brand worldwide. U.S. Dockers net revenue was up double digits in Q2 even with retail door closings. Theo growth is coming from both the men's and women's business. Dockers has turned around, posting growth for three consecutive quarters.

The U.S. Levi Strauss Signature Brand's net revenues were down this quarter. However, the brand's year-over-year performance was a significant improvement compared to Q1. This reflects the brand's strength and continued growth at other mass retailers while we are absorbing the impact of reduced women's fixtures at Wal-Mart. We continue to work closely with Wal-Mart to ensure that Levi Strauss Signature has a strong presence across all consumer segments as their premium jeans wear brand.

Our sixth priority is to continue to control costs tightly and seek opportunities for greater productivity improvements. Our SG&A expenses were up slightly for the quarter. These numbers include significant investments in new Company retail stores during the quarter. We continue to operate a lean organization model following the significant cost reduction initiatives we have implemented during the past three years. These lower organizational costs have allowed us to invest in building our retail network, which is contributing to the growth in the U.S. Levi's brand as well as in Asia and helping to improve our sales trends in Europe. Cost discipline remains a key priority and we will continue to focus on improving productivity and looking for cost savings opportunities in the future.

Now I'll turn the call over to Hans Ploos van Amstel, who will take you through the Q2 financial results.

Thanks, Phil, and good morning, everyone. I would like to remind you that the slide presentation that accompanies my comments is available on our corporate Website, LeviStrauss.com. Now, let's turn to the first slide.

Net revenues for the second quarter were stable with a 1% increase on a reported basis, including the impact of less favorable currencies. Year-to-date revenues are down 1%, or 3%, including the impact of less favorable currencies. Net income increased 50% in the second quarter or 40 million compared to 27 million in Q2 of last year. Net income was driven primarily by the impact of a tax benefit during the second quarter.

Working capital, which we define as Accounts Receivable, inventory and Accounts Payable improved again this quarter. This helps improve free cash flow. We continue to deliver our key priority of strong profitability and cash flow in order to reduce debt.

Turning to the second slide. Now let's have a look at the key elements of our operating results. As I mentioned, our consolidated net revenues were stable in the second quarter. Five percent growth in North America and 4% growth in Asia was offset by the sales decline in Europe. We are growing in all regions except Europe. As Phil said, we're working to revitalize the European business. We expect sales trends to improve in Europe during the balance of the year.

Now to earnings and margin performance. Q2 gross profit in dollars was down 4% mostly due to lower sales in Europe. Our gross margin was 46% in the second quarter. We continue to have a healthy gross margin within our target range of the mid 40s. Second-quarter operating income was 150 million or 21% below last year. This was mostly driven by lower sales in Europe, investment in retail and the benefit in 2005 to corporate expense due to the reversal of a litigation reserve.

Year-to-date operating margin remains strong at 15% of net revenue. SG&A expenses increased 3% in Q2. SG&A reflects our continued investment in new Company operated retail stores in Europe and the United States and continued expansion in Asia. The increase was partly offset by lower advertising and promotion expenses and lowering distribution costs. For the year-to-date, our SG&A expenses are 3% below the first half of last year. We continue to demonstrate cost discipline while investing in the business.

Turning to the third slide. Now let's have a look at the business units. In North America, second-quarter net revenue were up 5%. We posted a strong 11% year-over-year growth in the U.S. Dockers brand and 2% growth in the U.S. Levi's brand. This growth was partly offset by a 4% decrease in the U.S. Levi Strauss Signature Brand.

We are very encouraged by the growth momentum in the U.S. Dockers brand. The business grew (indiscernible) men's and women's this quarter, demonstrating the Dockers brand's revitalization strategies are working.

U.S. Levi's revenue grew modestly because of higher sales of men's products and the shift in timing of [short] shipments in Q2. Year-to-date U.S. Levi's revenues are stable.

The revenue decline in the U.S. Levi Strauss Signature business reflects the continued impact of Wal-Mart's decision to devote more women's fixtures to its private-label business. Operating income in North America was essentially even with Q2 of last year. The results were impacted by investments in retail while benefiting from cost control.

In our international business, Europe's margin remained strong at 18%. Operating income was lower because of lower sales partially offset by savings. Europe's net revenue declined as a result of weaker demand for core Levi's and seasonal products and the impact of ongoing changes in its retail network. We have begun opening new higher-end retail accounts across the region. As Phil mentioned, we have made significant operational improvements in Europe. We have rolled out new products across the region; we're optimistic that we will see improvements during the second half of this year.

Asia continues to be a steady source of growth and profit for the Company. The region's Q2 net revenues were up 4% this quarter and operating income was up 5%. The run rate for net revenue increases in Asia is down because of sales growth in Japan, the largest business in the region, has flattened out after many quarters of substantial growth.

Turning to cash flow on Slide 4. Compared to Q2 last year, we have a substantially stronger cash flow because working capital, interest, restructuring payments and taxes are all over this year. In Q2, we continued to reduce our inventory levels. This reflects our efforts to deliver strong service with lower inventories. I'm pleased to report that we continue to meet the on-time delivery targets in the second quarter while reducing inventory. Investing activities are up in Q2 versus 2005 as we increased our investment in IT systems and the Company operated retail store rollout.

Our refinancing transactions have helped further reduce our interest expenses in Q2. We expect the interest savings from repaying our secure term loan will be approximately $10 million annually. Amending our revolving credit facility also gives us additional financial flexibility.

Summarizing on Slide 5, our financial results show continued progress in line with our expectations given the challenges we faced during the quarter. We stabilized revenues, delivered improved net income and drove improved cash flow by reducing our working capital and lowering our interest expense. This gave us a lower net debt. We also lowered our effective tax rate. We face challenges for the remainder of the year, including Europe. The effect of higher gas prices and consumer spending and consumer confidence. However, we are cautiously optimistic that our business will produce solid performance for the second half of the year.

Now, I will turn the call over to Robert Hanson, who will discuss the results for the U.S. Levi's business.

Thanks, Hans. Good morning. The U.S. Levi's brand ended the second quarter with $252 million in net revenues. This is a 2% increase compared to the same period in 2005 and we delivered flat year-to-date revenue results compared to the prior year.

The year-to-date results were in line with our expectations and we feel good about our performance given the intense competitive environment we face and the ongoing impact of retail consolidation. The revenue increase for the quarter is primarily attributable to higher volume in our men's and young men's segments, the deferral of shorts and seasonal shipments from the first to the second quarter and increased net sales from our expanding Company-operated Levi's store network. These increases were partially offset by higher sales allowances, customer marketing activities, the impact of door closures at two of our top retailers, Mervyn's and Macy's.

Let me talk about our sell-through results at retail for the first six months of the year. Retail sell-through was up 2% for the first half of the year. Our total men's sell-through increased 1%. This is a continuation of Q1 results driven by our young men's less than 25-year-old segment, which increased 11% through new innovative fits with the focus on straight and skinny and also cleaner finishes.

In women's, retail sell-through was down 1%. Our junior's business is struggling, mostly offset by strength in special sizes and misses' long bottoms. In boys, we continued to deliver strong performance with a 34% sell-through increase year-to-date. Our leading innovative fits and finishes similar to our innovations in young men's continued to drive strong demand for our boy's products.

Looking at our Company operated stores, we continued to invest in our Levi's store retail network and have opened three new stores in the first six months of this year. The Las Vegas store opened in the first quarter and is meeting our sales expectations. Santa Barbara and Rancho Cucamonga stores recently opened and are building sales momentum.

We continue to leverage the success of our own stores to upgrade on-floor execution with our key customers. We are collaborating with Macy's and JC Penney to implement an upgraded on-floor execution in the back half of this year. Additionally, our online store, which you can visit and hopefully purchase from at LevisStores.com has been a great success, driving revenues that are double our expectations. We launched the latest edition of our style for every story marketing campaign on July 5.

The new television ads feature our flagship 501 jean, the 559 Relaxed Straight and an ad with both men and women that supports our slim, straight jeans. Print and digital marketing efforts support our category leading range of fits for all segments.

We expect the retail environment to remain challenging over the remainder of the year as we work to balance the impact of additional door closures during the second half of the year. We are working with all of our customers to ensure that they have the right assortments and sufficient inventories to handle the demand for Levi's products as we enter the heavier back-to-school fall selling period and beyond.

Now let me turn it over to John Goodman, President of the Dockers brand.

Thanks, Robert. Good morning. Q2 was another strong quarter for the U.S. Dockers business. Net revenues, including licensing income, increased by 11% versus 2005. The increase was driven by growth in both the men's and women's businesses. The women's business delivered outstanding results in Q2. Net sales increased by 50% versus last year. As you may remember, when we explored selling the brand, our women's business was most impacted. Retailers lost confidence in our women's products. Last year, we began overhauling our entire women's line. These efforts have restored retailers' confidence and we have great women's offerings and are being responsive to their needs with our significantly improved speed to market process. Their renewed confidence is reflected in our results.

The women's growth in Q2 was driven largely by the success of seasonal capris and shorts that proved to be market right. Core pants also continued to perform strongly led by the metro pant. Based on the recent success in our women's business, we believe there's significant potential for future growth.

The men's business also delivered strong results in the second quarter the third consecutive quarter of year-over-year growth. Sales of men's pants increased by 10% versus prior year despite the impact of retailer consolidation. The growth was driven by solid performance in core pants in both classic and premium segments and the rollout of our two new trend core products, the iconic khaki and the iron-free programs.

Men's top sales increased by 36% compared to Q2 2005, driven by additional fixtures and the success of our golf line. Our growth has been achieved under our Dockers San Francisco brand positioning, which celebrates the spirit of West Coast casual style. This positioning has been successful and we will continue to leverage it going forward. For fall, the men's business will include a wearing occasion strategy under the Dockers San Francisco platform. In the past, we have trained our men's consumers to wear one product, a basic khaki for all occasions. This new initiative will communicate to consumers that we have a range of products that are right for a variety of occasions -- work, weekend, dress and golf. This will reinforce Dockers as a lifestyle brand that will help consumers to dress appropriately from head to tow for any occasion. This strategy will be used in the fall '06 advertising campaign and in-store marketing. The iconic khaki and the iron free pant, successfully rolled out in Q2, will be two of the cornerstones of this plan, which we believe will have a strong impact on the consumer.

The Dockers brand's three strategic priorities remain unchanged. They are strengthen our position in the men's business, evolve and grow the women's business and develop the brand relationship with consumers. We believe these priorities are key to driving future performance, including profitable growth.

In conclusion, Q2 2006 saw substantial improvement in revenue and profit performance of the U.S. Dockers brand. The brand is growing again and we continue to focus on developing and growing our women's business and continuing the positive momentum of the past nine months in our larger men's business. Now I'd like to turn the call over to Scott LaPorta, President of the Levi Strauss Signature Brand.

Good morning. During the second quarter, the Levi Strauss Signature Brand doubled last year's operating income on a 4% decline in revenue. The increase in earnings was primarily driven by higher first quality margins achieved through efficient product development and lower SG&A spending. The financial performance highlights are as follows. Q2 revenue was $74 million compared to 77 million in the second quarter of 2005. While our revenues were down 4% versus Q2 of 2005, this is a strong turnaround from Q1 when we posted a 20% decline. Strength across the rest of our business offset Wal-Mart's continued reduction in our women's business.

From a profit standpoint, the Signature Brand generated $7 million in operating income during the quarter versus 3 million in last year's second quarter. We have driven this profit improvement by bringing more premium product to market combined with efficient product development [counting] margin expansion. Additionally, we have reduced our organization costs. Benefits from both of these initiatives have increased the bottom-line performance of the Signature Brand.

For the first half of 2006, we generated revenue of $144 million, down 13% versus last year. Despite the revenue decline, our first half operating income reflects a 20% increase over last year's earnings and a 2 percentage point improvement in operating margin. We believe our core strategies of number one, expanding the fit portfolio in each segment; two, offering category leading fabrics, finishes and styles; three, efficient product development; number four, partnering with our retail customers to improve the in-store experience; and number five, driving brand awareness will continue to drive improved earnings as we move forward.

From a marketing standpoint, our initiatives in the second quarter included continued communication through fashion editorial, Internet advertising, and NASCAR-focused print advertising to keep the brand top of mind with value-seeking consumers.

In conclusion, the Levi Strauss Signature business performance recovered well from Q1 and we are cautiously optimistic about the balance of the year as our back-to-school programs begin rolling out. Starting this month, we begin selling new programs at all three of our major retailers across all consumer segments, while updating the finish and styling on all of our opening price point core replenishment programs. As a result, consumers will see newness and fresh category leading fit and finish jeanswear for back-to-school. And now over to Phil for Europe.

This is Phil Marineau again. I'm going to talk about the European business. As I mentioned for the last five months, I've taken direct responsibility for managing the European business until we appoint a new European president. This is the key priority for the Company and our goal is to focus on improving our revenue trends through the end of this year with the goal of stabilizing the business at the top-line by the beginning of next year while sustaining the profitability improvements that we have achieved in Europe over the last two years.

The key here is to turn around the European Levi's business. Our second-quarter financial results continue to be down substantially versus 2005, which I mentioned earlier. But this is in line, given the pre-book nature of this business, the preorder nature of this business with our expectations -- the results that we have achieved are right where we expected to be at this particular point in time. We are though beginning to see some initial improvements in sales trends that are encouraging and indicative of an improvement in consumer demand. Our overall replenishment business is up in the second quarter over last year after several quarters of year-on-year decline. Importantly, our comparable store sales and our control distribution, which includes Levi's stores and shop in shops at department stores have improved over the course of the whole six months of 2006, with stronger improvement in the second quarter versus the first. These comp store sales are up slightly in total for the first half of the year. So this really indicates that the assortments that we're putting out there and our efforts to improve our distribution base are starting to take hold and driving an improvement in overall demand for the brand. We will continue to improve and broaden our product assortments across the region.

We have introduced some new girl's fits this year that have generated strong consumer demand and have really helped drive that replenishment business that I spoke about. What this does is having a much stronger girls business allows us to drive incremental sales above and beyond our core 501 business. Again, we will continue to expand this assortment and have continued to improve the retail distribution network that we have both in terms of retailers that we do business with but as well our own controlled store distribution. We have opened 15 new Levi's stores in Q2 and that includes Company-owned stores, franchise stores, as well as factory outlets. And in total, we have opened 22 stores during the first half of the fiscal year. So the key is to improve that Levi's brand. The initial trends on consumer demand or the current trends on consumer demand are encouraging and we expect to continue to improve these sales trends as we go through the back half of the year.

The Dockers brand is delivering solid and predictable performance in Europe, driven by strong sales in the new fit that we introduced into the market this year. Our Dockers business was down in Q2 but we expected that because we closed out Dockers in a number of European countries last year. We intentionally shrank or European Dockers business so that we could make the business more profitable, which it was last year and continues to be this year. And the revenue results reflect these efforts that we took to make the business more profitable. So over time, we believe we will grow the business using the Dockers San Francisco branding platform. It's now delivering strong results as John talked to you about in the U.S. and beginning to take hold in APD. It's a platform that seems to work worldwide. And we see encouraging results in the European business in the countries where Dockers remains, particularly Spain and France.

Our Levi Strauss Signature revenues in Europe were down during this quarter, even though our sell-through trends are good. The challenge that we face is the same that we face in the United States, which is to hold and build new distribution for Levi Strauss Signature, even as value retailers increase their emphasis on private-label and exclusive brands. It's the same story in Europe as in the United States.

We have much work to do through the balance of the year but we have definitely made progress during the first half. Our sharp focus on executing our strategies is beginning to improve the European trends and I do expect positive momentum as we continue into the second half of the year. Let me turn it over to John for Asia-Pacific.

The results for the Asia-Pacific division at midyear reflect steady growth continuing from the first quarter. The region delivered 5% profit growth for the second quarter. The Q2 net sales were up 4% on a reported basis over prior year and 6% on a constant currency basis. Year-to-date, net sales are up 6% on a reported basis over prior year and 9% on a constant currency basis. The best performing businesses were India, China, South Africa, Turkey, and the Latin America region. Although Japan's second-quarter results were up 3% over prior year on a constant currency basis, consistently weaker yen exchange rates resulted in a 5% decrease versus prior year on a reported basis. Heavy allocation of resources to manage the SAP implementation, which we successfully rolled out on June the 8th, and weaker than expected results of our 501 Stay True advertising campaign that ran during Q2, also adversely affected our Japan business during the period. We're implementing plans to restore the growth rate of Japan.

I will review our performance against our four key strategies for the division. The number one strategy is grow the Levi's brand equity and drive category demand. We launched a very strong Levi's 501 Stay True campaign in Q2, which worked effectively in Korea, India, Pakistan, greater China and the Southeast Asian markets to drive both existing and new consumers to our stores. And increasing Asia-Pacific division's overall 501 revenue and equity. As I previously mentioned, it was not as successful in Japan. We also launched a new campaign for our Levi's Ladies Style collection, building on the strong momentum from last year with our super-premium ladies business in Asia. This collection continues to have strong appeal among Asian consumers.

These initiatives, coupled with the success of Levi's engineered jeans in Q1, generated a 6% increase in the Levi's brand year-to-date net sales over the first half of the prior year.

Our second strategy is to rigorously pursue profitable growth opportunities. Our Dockers business grew by double digits for the first six months of the year due to a well executed new brand positioning and retail plan aligned to the Dockers San Francisco global brand platform. It's still a small business but we're encouraged by the improvements. Our Levi Strauss Signature Brand remains a small part of the Asia-Pacific business at this time although we are optimistic about its potential. We're aggressively marketing the brand in India, Japan and Taiwan and we recently launched in Korea. Our third strategy is to drive the retail business. Driving retail excellence has become a major strategic initiative for our division as we continue our evolution from wholesaling to controlled retailing. We now have approximately 1200 franchise stores and store in stores across the region, including seven flagship stores.

During Q2, we opened flagship stores in Pakistan and India, which garnered significant media attention. We also opened a further 55 stores across the region. We have developed a strategic vision and blueprint for obtaining retail operational and service excellence. In the coming months, we will be strengthening retail systems through the rollout of new point-of-sale technology, as well as rigorous operational managing and ongoing service training for our retail staff.

Our fourth strategic initiative is install and enterprise resource planning system. We have now successfully brought three countries online with the SAP system with no interruptions. We successfully went live with SAP in Japan on June the 8th. Although SAP installations have a reputation for causing operational disruption, our implementation in Japan has not impacted our operations. As I noted earlier, the resources required to successfully launch Japan did cause some management disruptions that impacted our sales results but now their attention has returned to executing our business plan and once again driving growth.

We're now working to bring SAP up in Hong Kong, China and Korea. The implementation of SAP also is in progress for our global sourcing organization. This will help improve service levels and increase our sourcing responsiveness and efficiency around the world. This rollout should be completed by the midyear of 2007.

In summary, our Asia-Pacific division continues to grow and contribute to the Company's profitability. All three brands continue to contribute to our growth and our key strategies are proving to be relevant and effective. Now I'll pass it back to Phil.

Thank you, John. So in summary, our results were good, in line with our expectation for the first six months of '06 and we're particularly pleased with the continuous improvement in profitability and cash flow in allowing us to drive down our debt. As we go into the back half of the year, we understand that we face two key challenges. That's the impact of the U.S. retail consolidation and our continued challenges to rebuild our top line in Europe. We do remain optimistic about our second-half prospects, because we have outstanding products and marketing programs, which are in the process of being launched as we enter the critical fall and holiday seasons. We will be happy to take any of your questions as we go forward now.

(OPERATOR INSTRUCTIONS). Carla Casella, JPMorgan.

Hi, I have one question about Europe. You mentioned that the comps were up both at your stores as well as the places where you have a store within a store. If the (indiscernible) overall sales were down significantly, can you give us an idea of how much of that was related to just exiting retailers or existing retailers that are carrying less of your product?

Well, I can't break it out for you, Carla, buy percentages but it is due to three things. First of all, a substantial portion of our business in Europe is done on a pre-booking basis, a preordering basis. And it becomes somewhat of a self fulfilling prophecy. So a substantial amount of the decline is due just to the fact that on a pre-book basis, people ordered substantially less than a year ago.

The second part is that we have discontinued distribution in some retailers, which we don't think support the brand strategy. And the third thing is that we continue to monitor our Levi's retail network so that goods that are particularly 501's don't slip into the gray market, meaning that we don't find them in unauthorized retailers at very low prices. So that we protect our retail network and the distribution strategy that we have there. We have been very vigilant in that and that has some impact in the short term on top-line results. I know it is working because I see now 501's in the European gray market. The price used to be about EUR35; it's now about EUR60 in the gray market because we've gotten the supply down to such a small amount and the average out the door price should be about EUR80. So we're beginning to really make progress in that gray market. So it's a combination of those three things.

Okay, and then can I clarify the pre-book orders being less than a year ago, does that imply that the same-store sales in the coming couple of quarters would be weaker at even your store within a store partners?

No, store within a store concept and our own stores, we set the assortment ourselves. So we have a full assortment of the product that we have going into the marketplace and it is controlled by us and that is the good sign. When you get the right assortment of products out there and the full range of product we have, we see consumer demand being strong for the brand. So what we need to do is first of all, go back and get that right assortment in the other retailers that we are in, show them the evidence that Levi's is coming back and then the next time we go through a pre-booking period, we expect to see pre-book strengthening. So it takes once you sort of fall down, it takes two to three selling seasons to get back up and run again. And that's part of the problem here.

Okay and how many seasons would you say you are into this? Is it two seasons into it at this point?

We're into two seasons of really terrible pre-booking and as we go into the back half of the year, we have seen the pre-booking trends improve, but it takes probably one or two more pre-booking seasons for people to really have regained the confidence in the brand and get the kind of orders. But as I said, we've also gone through a big transformation while I've been over there.

We have a much greater sales capability and the ability to what's the right word, when you're unhappy with the pre-book, go back and sell it again. So we have made some changes to be much more agile and responsive than we were prior to this.

Okay. And then your advertising overall was less than we had expected it to be. And I'm wondering is this now a good run rate in advertising or are you still advertising below a normal run rate?

We don't give guidance. Remember, the advertising is really skewed to the back half of the year, given the seasonality of the business, particularly in Europe and the United States. That said, we have reduced our advertising in Europe and we will keep -- because we didn't think it was being effective, given the other issues that we have here, we have gone to a much greater digital and print approach in Europe than broadcast advertising and we've reduced it and it will probably not go back to the previous level.

[Finality] is now of in the back half as well.

Yes.

Okay. And then, I will ask one more question and then I'll let someone else have the floor. But the corporate staff costs were up significantly. Can you explain what are the factors driving that?

The corporate staff costs have not gone up from -- we haven't staffed up in a headcount point of view. We have some onetime benefits in nature last year, which included the reversal of that [Comexca] reserve on the litigation and while we're not disclosing the individual amounts in that, those were not insignificant. So if you take away those onetime things, our staffing costs at corporate have not increased.

Okay, great. Thanks a lot.

Alexis Gold, UBS.

Hi, good morning. Just a few questions. You ended the quarter with a lot of cash on your balance sheet. I know it's early to talk about, but any thoughts on what your plans are for the cash? You definitely talked about deleveraging and we know the 12.25's and the floaters are callable next year. Can you maybe give us a little bit of insight as to what your plans are?

We indeed delivered strong cash flow and we continue to focus on driving key cash flow as we already said, and that's now sitting on the balance sheet. There's one thing which we have disclosed in the Q is that we need to pay the remainder $78 million on those 2006 notes, so that's one cash outlay in the second half of the year, which will reduce our debt. And then going forward, we are obviously constantly looking at our refinancing but we're not ready to discuss anything at this stage. But the key thing you need to know is that we're going to have that 78 million in the second half on the remainder of the 2006 bonds.

On your recent credit facility amendment, I guess one of the changes gave you the ability to make restricted payments. I know that your restricted by your bond indentures, but could you just tell us or remind us what's available on your restricted payments [as] under the senior secured indentures?

We're not disclosing that. But we continue to -- I mean if you take a step back, we continue to deliver solid cash flow. We have a solid balance sheet so we will continue to deliver that cash flow. So I don't think it's that important.

What the changes have allowed us, which is good, is to [talk] that we refinanced to get some flexibility, which enabled us to make some changes in the European tax structure, which enabled us that tax benefit in this year, which helped our P&L by $32 million. But that was a key driver also to refinance.

Right. I think we were just trying to get a sense if there were any thoughts at some point in the future to potentially take any -- pay any dividends out to shareholders?

We have no plans at this particular time to pay dividends. Our focus is on reducing debt through improved cash flow.

Just, you know, to go back to the inventory a little bit, you talked about new fits at men's and straight and skinny jeans. I'm just trying to get a sense for the quality of your inventory today. Does your inventory reflect these changes in styles or do you expect to see any markdowns on older styles as we look out for the next couple of quarters?

I think if you see our working capital improvements, you can see that we have continued to make substantial progress in working capital and this is both on inventory and receivables as well. And we have a high degree of confidence in the quality of the inventory and we have in hand. And we don't believe that there are any unusual adjustments that will be made or closeouts. We have very tight control of our inventory.

Great, and just on women's Dockers, it sounds like there were some pretty significant improvements. Did you actually see and view customers or was it did you regain floor space or shelf space that was older customers and do you think that you end the year I guess net shelf space positive in women's Dockers?

We actually just the existing customers we had, we grew again and that was really important to build a base with our existing customers that we have and we continue to see that growth, which is very positive. So it was additional fixtures within our existing retailers that drove the growth.

[Kelly Sakki], Eaton Vance.

Thanks for taking my question. I was just wondering, it seems you might be accelerating the openings of Company-owned and franchised stores and I was just wondering what the longer-term goals of that are by region?

Well, one of our strategies for sure is controlled -- what we would call controlled distribution. And that can be owned and operated stores, franchised stores, outlet stores and what we would describe as shop in shops, where we control the assortment and often the salespeople on the floor are employees of Levi Strauss. We believe in many countries around the world, this is the key to growth because it makes the brand available where the consumers that we're trying to target shop and where the opportunity to intercept people exists. And sometimes, in some of these countries, it's the only way to be able to reach these people because existing retail distribution is too sparse.

In general, we would prefer as we go forward and the majority of our efforts are on franchise stores outside the United States because that is a model that's been very successful for us. In the United States, it is an owned and operated model because a franchise model is inappropriate in the United States.

We're not giving specific guidance in terms of how many stores but we will continue to open new retail doors in the United States, on the Levi's brand. Today, we can have Robert tell you how many we have and how many we expect by the end of the year. And we will continue to open doors in Europe. We have about 400 points of controlled distribution and outside Europe, as John said, we have over 1200. That will be continued focus as a way of making sure that we have an opportunity to profitably grow the business going forward. Robert, do you want to say how many we have today and how many we will have by the end of the year?

Sure, we have currently opened 15 first-quality stores and four outlets in the United States and we're planning on opening a total of 20 stores, which is a mix of both first=quality and outlet stores through the balance of this year, including the three that we have already got opened to date.

Okay, so that's 17 additional stores in the second half?

It's 20 additional stores in the U.S., including both first-quality and outlet stores. But for this year, it's three that we have opened plus 17 additional stores.

Okay, appreciate that. My other question was, it looks like you know Dockers was very, very strong this quarter and I'm curious who you believe you're taking share from? Is it other branded products or is it private labels?

As we have got our -- this is John Goodman. As we've got our market data back, we are taking it from other competitors as well as private-label. So we've gained market share in the category in both men's and women's this past quarter.

Okay. And then on the Levi brand, it was mentioned briefly that junior's is struggling and I'm just wondering what is going on with that if there is an overhaul in progress or there's a deemphasis on it?

The situation with the junior's business is pretty straightforward. We had a terrific run of about 2.5 years of pretty significant sales growth in our five pocket jeans business, which were essentially super-low boot cut and flare jeans. The market for basic five-pocket jeans slowed quite considerably over the past couple of quarters and really shifted to a fast fashion merchandise demand. What we found is that our targeting of our merchandise development in fashion was probably skewing just a little bit older than the targeted consumer range of a 13 to 17-year-old girl. So what we've done is gone back and really looked at that target consumer, what her demand requirements are, a little bit of the competitive landscape and worked with our top customers to reposition that business moving forward.

It would be too early to call when we will have it repositioned effectively but we're working quite aggressively with all of our top customers to engage in a strategy to get that business back on track.

Okay, that's helpful. I appreciate it. And then just finally, I was wondering if you could comment on what's your read on the consumer at this point with higher gasoline prices, if you're noticing any pullback, particularly as it's segmented from the Levi's Signature Brand up to the premium level?

You're asking me the question that everybody in the sort of how do you solve world hunger. And everybody in the world wants the answer to that question. We would see that the business ebbs and flows almost as you see. Retail in June across the board wasn't particularly strong. The good news is though people that are doing well are some of our top customers, like JC Penney and Kohl's and so we see relatively good, strong sell-through there. We have a tendency to follow the ebb and flow of their traffic and how well they do rather than what I would say trying to ascribe the effective gas prices on consumer demand. I just can't tell you that one. It's more how well they do in terms of consumer traffic has a tendency to affect our business.

Karen Miller, Bear Stearns.

Hi, good morning. I'm wondering if you have any plans to replace the CEO. I know you appointed John Anderson, the COO, but there are any further plans for management at this time?

Not that we are prepared to announce. The Board of Directors has had a CEO succession plan in place for some time as any good Board of Directors should. And they're working on that and I'm sure they will be prepared to announce their plans at a time that is appropriate for the Company.

Okay thanks. And just circling back, talking about the retail stores, as they become more significant, would you be reporting on them as a separate segment or at least give us some color as to perhaps comp store sales and their performance. And then secondly, when you open a store, do you find that it might cannibalize existing sales?

I will go to the first one. So far, we have not seen significant cannibalization through opening our own stores. In the United States, we have found in many ways that it enhances sales in current distribution because it exposes the consumer to the full range of Levi's products and the story Levi's story. So, so far it has been additive to our strategies.

To be honest, we are not in the position, given the franchise network that we have to be able to give you comp store growth to any great degree when you operate a franchise operation. So we said we are installing an SAP system in Asia and we hope to move that across the world. When we get better information systems, we might be able to tie them into our franchisees and consider doing this. But at this point, we would be leading you down the primrose path.

Okay and then one last question regarding your retail plans. You, I believe, used to have outlet stores and you closed them. Can you talk about your strategy for now having outlet stores?

Where? Are we talking about around the world?

Just in the U.S. or in general?

Well, why don't you, Robert, talk about our situation with most and then we'll talk about the ones that we own and the ones that we license.

Just to clarify, we actually have been continuously operating four outlet stores on the Levi's brand and three outlet stores on the Dockers brand that are owned and operated and continue to run those stores as owned and operated stores. But the majority of our outlet business, as Phil mentioned, in the United States is under a licensing agreement with most, which is a part of Sun Capital and they run the majority of our outlets. It's approximately 88 stores right now that is in that network. And we continue to engage in running the outlook business primarily through that licensing arrangement that we have with most.

In Europe, I think the issue that we face in Europe is as we really closed down the gray market on 501's and other Levi's products. It is some jobbers that we used to sell product to we no longer sell product to. And they were often the outlet for our closeout products. So having more outlet stores is absolutely essential in our European business to make sure that we can close out our inventories, either product that didn't work right or that we have too much of on a timely basis. So we are opening outlets aggressively in Europe in order to be able to avoid that product getting into the gray market and can control the closeout volume on our own.

We would ideally prefer most of those outlets to be owned and operated because they can be highly profitable but we also, with certain key franchisees, run a combination of first quality doors as well as outlet doors to give them the mix of product that they need in order to be profitable. So our strategy in Europe is to aggressively open outlet doors there to deal with our closeout issues and keep the gray market clean.

Similar strategy for Asia-Pacific. Outlet stores are being an integral part of our distribution strategy. We link them to our franchised owners. So where there's a group of first-quality stores, they tend to have an outlet store as well. So we will continue to grow outlet stores as our business grows because that's where we flush our product through. It means we can control the product all the way through to the consumer buying the product. So it's an integral part for us and we will continue to grow outlet stores between O&O and franchise.

The outlet stores, is it mostly closeouts or do you manufacture anything specifically?

In Asia, it's predominantly closeouts.

In the United States, it's a combination of predominantly closeouts to second-quality merchandise but we do actually have some made-for outlet products because we're trying to keep the outlets stocked with a good size range, especially of five pocket jeans and pants on the Dockers side of the business, because the consumer has an expectation coming into a Levi's or Dockers outlet that they will be able to find their favorite pair of jeans or khakis. So we do do a limited amount of made-for products for the outlet.

And then one last question before I give up the floor. Where then do these franchise revenues show up? Is it in licensing revenue? Is it lumped into net sales?

We have -- well it flows in (indiscernible). Obviously the owned and operated ones flow through the P&L through net revenue cost of goods. Then the franchisee agreements are within the royalties and then we have some licensing from -- so it's royalty income from the licensee agreements.

Okay, thank you, that's helpful.

Jessie Colby, Citigroup.

Good morning. I wanted to delve a little deeper into Europe. Can you just talk a little bit about what are some of the specific operating issues that you are seeing in the UK and Germany and how they differ from some of the smaller countries? And you know, basically what your specific actions are in the UK and Germany.

Well first of all in Europe, one of the things that we have done over the last six months is move to what I would describe as a full affiliate model, which means putting P&L responsibility back at the general manager level in each country. This is a model that we have successfully used in the United States and Asia to really improve business performance because it puts end to end accountability of the four p's with a team of people as close to the customer and the consumer as you possibly can get. So we've been going through that process.

In some of the countries, like Spain, France, where we have an experienced team of people that has had an immediate and positive impact on the business and you see Spain and France, to some degree the Netherlands, Eastern Europe really starting to perform and improve their results both in terms of sell-through and sell in.

We have had problems in the UK that were driven by really just a huge exodus of people, some intentional, some unintentional and we still had gaps in the management ranks there that we are rapidly trying to fill. And that has contributed to some of our business performance problems in Europe to as well as a weak UK market.

And then the third thing is last year we had a large franchisee go bankrupt and rather than lose the doors or the stores, we bought those and we have become a much larger owned and operated retailer in the UK than we were previously and we are going through the growing pains associated with operating those stores and we're making comparisons against a period of time on those doors, where the guy who owned them was basically having a fire sale on everything. So we had high revenues and not very much profitability and so we are comparing against those revenues last year. It's probably more than you need to know.

And on Germany, the issue first of all starts with a weak German retail market and some of our major customers, [Harhoff & Karshdedt] struggling themselves and they represent a huge percent of our business in Germany.

The issue there is the same as we have is to the get the right assortment by door, to strengthen the assortments in those large department store customers while expanding the network for the premium jeans in what we would call retail professional and trend diffuser retailers, which are not as well developed in our German business as they are let's say in a Spanish or a French business.

The third thing is that we don't have many of our own retail doors with the Levi's name on it, either on a franchise or owned and operated basis in Germany, which gets in the way again of having the right distribution and the right full range of product in the German market. And the problem there is both finding franchisees and or owned and operated, where you can run the economics, where the retail economics are strong enough to open the door, because the cost of real estate in Germany at the retail level is extraordinarily high right now. So those are the two issues in the UK and Germany and we are focusing quite extensively on dealing with these issues and those are the ones that are lagging the success that we are enjoying in the France and the Spains and the Netherlands and the Scandinavian countries right now.

Okay. I think you mentioned this earlier but you're looking at sort of first half of '07 for some improved numbers and what was that?

Well we expect to see our trends in Europe improve quarter to quarter as we move forward. We're not making any -- we're not giving any more forward guidance than that because as soon as I give you a number and given the complexity of that business, I just couldn't -- we wouldn't give any more than that except we expect to see the trends improve quarter by quarter here.

And that is just based on comps or just improvements in the operating (multiple speakers)?

All of the above.

Okay. And then finally when would you expect to announce a hiring of a new European president?

Well we have been working quite diligently in finding the right person to run our European business. I have been very -- I'm trying to think of the right word -- very demanding in terms of who that person is and making sure that he or she has the right skills for that business. But to be honest, also giving me the opportunity to be more hands-on in terms of operating that business and turning it over to somebody with the right strategies and the right operational and organizational structure that will enhance their ability to succeed. That said, I would expect by the end of the year to have a new European president in place.

John Sullivan, [Cosmic]

Yes, good morning. A couple of questions. You made a comment regarding potential cost savings or operational improvements in the business. Could you sort of discuss, I mean given you have made such strong strides forward already in that regard, really, what is left or do you have a sense of quantum or percentage of sales that might be available and what sort of initiatives might they include?

We're continuing to work savings and productivity going forward. As Phil mentioned indeed and as you concluded, we made a significant improvement over the last three years and we'll continue to drive costs out of the system going forward. We have a set of initiatives over the productivity umbrella. One is to drive and leverage the SAP investment. The second one we're looking constantly and you have seen us closing -- the announcement of closing Little Rock is getting at our distribution costs. We have done the same in Europe with closing the Northern facility, which is the second one and now we have an [end of] supply chain obviously, while we outsourced our supply chain from a manufacturing base, we continue to look at taking costs out. So we will have to continue the initiatives going forward.

Can you sort of make any comments on the quantum or what this might represent as sales or even some range indication?

We have obviously specific goals and targets for our strategic business planning horizon, which covers three years but we're not disclosing forward-looking statements on our profitability or our net sales. So we can't do that, I don't think.

Can you talk -- I mean you have also been able to achieve demonstrable successes with working capital improvements. How would you recommend that we analyze your working capital requirements from here. Can we sort of take a view that's -- and I know that you have these other initiatives, which are all designed to improve supply chain logistics and reduce distribution costs, etc., etc. So we will see some benefit coming through our working capital. But can you give us some sense of how we might analyze working capital if we will see some moderate growth back on the top line?

On working capital, you have seen us very consistent as you [feel] the dealings and the accounts receivable with a type (indiscernible). On the payables, you have seen that we have had some changes with the new model of (indiscernible) ready to wear. Those will be relatively stable.

And then on inventory, you will see us, we have optimized a lot. We will continue to run lean on inventory but you need to be careful given the seasonality of this business and how that flows over the quarters. It's hard to do that; you need to be careful on the dollar predictions on that. I think the key prediction we can give you without giving specific numbers is that we will deliver free cash flow with an optimized working capital this year. We have been at a cash use last year and we will be delivering free cash flow into this year.

And that's, so you will be expecting some structural working capital improvements? I think that's what you are saying?

Yes.

Right. Okay, so I understand. I presume, okay fine, I won't get anything else out of you. We all do try, as you know. Regarding the succession plan, would it be too bold to ask would that person be coming from internal or external?

I really think -- I don't think I know. This is a board announcement as opposed to something that we can make over an investor conference call.

So you can't even tell us whether it would be, it's an internally driven succession plan or whether it is designed to capture external talents as well?

No, I can't.

Right, okay. The final thing was the Levi Strauss Signature, we have seen sort of a strong bounce-back there but still continued pressure from as a result of Wal-Mart moving towards the private-label. Can you give us some sense of, is this the type of declines that we anticipate based on Wal-Mart's strategy? Or do we ever LSS coming back with some growth due to Wal-Mart? Or do we just anticipate some sort of moderate decline from here?

First of all, our goal is that we believe Levi Strauss Signature remains a tremendous opportunity in not only the United States but outside the United States to service the value consumer. The issue that we face on Levi Strauss Signature in many ways is the same issue that we face on the Levi's brand. Many of our retailers would prefer or certainly have a key strategy to sell their private-label and exclusive brand and attempt to emphasize those brands sometimes at the expense of national brands. And this has a tendency to ebb and flow in the marketplaces and we are in one of those ebbs with Levi Strauss Signature right now, particularly at the Wal-Mart.

We believe we remain -- we will by the virtue of the quality of the product that we will offer and how we will work with our customers to market that brand that the premium nature of this product will remain relevant within that channel of distribution and our goal is to work with them to strike the right balance between our brand and their exclusive or private-label brands. And we expect Levi Strauss Signature as we go forward to continue to be an opportunity for growth for the Company.

This is Scott. What I would add there is being part of Levi Strauss & Co. enables us to bring category leading fits, finishes and styles that may not be otherwise available to them from their other national brands or from their private-label. So we do have the ability to drive category growth and have displayed that ability to do so. So we will keep, as Phil mentioned in Europe about sequential growth, or improvement, we intend to keep driving for sequential improvement in the Signature Brand in the U.S. as well.

When do you expect an announcement regarding a new CEO? Will that be in the next quarter or by year-end?

Certainly by year-end.

Okay, within the next quarter?

You know, I'm not the Board of Directors.

Okay, thank you very much.

[Jeff Coblar], Stone Harbor.

Good morning. Hans, I was curious about the working capital improvement you have had so far year to date. Can you say that you will -- do you think you will be able to maintain this working capital you've generated so far or will you have to give back some due to the timing of payments or receipts?

I think from a percent of sales investment, we will sustain the improvements we're making because we're making sustainable improvements in our working capital management across the three pillars, and that has continued to drive the planning process. The dollars will always fluctuate because of the seasonality of our business and our sales projections on the business. And because we're not giving any forward-looking guidance on our sales projections, it's hard for me obviously to give you some dollars. But from days or percent of sales, we'll sustain this improvement.

And you should understand that our annual incentive program, which starts at the top of the organization and works pretty deep down into the organization, rewards people for a combination of revenues, profitability and working capital targets that they have to it. So we have a key focus throughout our organization on working capital because, again, our number one objective is to improve the cash flow to pay down debt.

Right, okay. Robert, you mentioned that I believe you said that your U.S. Levi's sell-through was up 2.5%. Was that right?

Up 2% for the quarter, yes.

Oh, for the quarter.

And flat for the first six months.

Okay.

Which is in line with the sales performance because U.S. Levi's is flat year to date based on what was growth in the sellout.

Okay, and so the retail consolidation that has occurred in the U.S. -- what was -- is most of that impact do you think behind you now? Or is there some more to come?

We face the store closures at two customers primarily in the U.S. for Levi's and Dockers, Mervyn's, the majority of the store closures occurred in the first quarter. That was about 17% of their total business and we were able to improve our expectations versus plan against the store closures primarily by kind of converting sales from the closed doors to the doors that remained open.

As far as May Company, Macy's is concerned with the closure of either both Macy's and May Company doors, we expect the door closures to continue for the balance of the year. It would be difficult for us to predict precisely on the impact that that will have on the business, but it's certainly one of the issues that has us remaining cautious for the balance of the year.

And I think the other thing is, on those store closures, we need to see when they take The May Company name, whatever that name was and switch to Macy's, what impact that has on their business. And we're not trying to predict; we're just saying that's an uncertainty that we're going to have to deal with.

About the -- in Europe, Phil, just curious about this -- and the UK -- this franchisee that you acquired. Can you say when you acquired that large franchisee?

We acquired him in what, the fourth quarter of last year and maybe slipping over to the first month of this fiscal year.

Okay. So another six months or so to annualize what he was up to.

Right.

And in Germany, to get the right product in the stores, do you select a higher management team to do that or is that --?

We have a full complement of people in Germany. We don't have some of the gaps in the management team in Germany that we have experienced in the UK. So the fundamental issue more in Germany is more about again the retail market, our dependence on these large department stores that are struggling themselves and our ability to enhance the retail distribution of Levi's either through other retailers or our own doors.

CapEx, you increased the budget by 20 million. Is that more so for new stores or is it for SAP?

The key thing we're doing, we're delivering strong free cash flow this year so we're working to [aspirate] the retail a little bit and there is some extra we're looking into SAP. So those two are driving that extra 20 million versus the last quarter.

Okay. Just lastly, just curious about with the lower advertising expenditures, it's down 20% in the first half of this year and what are your thoughts about just how this might impact the power of your brand and any general comments you can make about second-half advertising expenditures?

The primary reason for that is what I mentioned, is the reduction in European A&P spending. Done very intentionally. We believe that you need to do the basic blocking and tackling that I talked about in Europe before you spend at the rate we were spending a year ago. As I said, it's unlikely that we will ever get back to that. The spending rates for the rest of the brands around the world are either equal to or will be over the course of the year equal to or higher than they were a year ago.

Carla Casella, JPMorgan.

Just one follow-up. You were talking about the doors that have closed and I'm wondering for back-to-school, do you have a total number or percentage of how many fewer doors you will be in for back-to-school period and if you are able to make up that decline with sales in your existing retailers?

As I mentioned and I'll just use the Mervyn's example as the example. In the first quarter this year, Mervyn's closed about 17% of their doors by revenue. And our plans were to obviously address those door closures in terms of more cautious business plans with Mervyn's but to convert as many sales as we could to the doors that remained open and we were successful in implementing that strategy.

As we look at the Macy's issues, both the door closures as well as the name change that Phil mentioned for the back half of this year, we're deploying the same strategy. So we don't -- we're not providing specific guidance in terms of what our plans are. What I could say though is that the Macy's business in total represents a relatively small amount of the total Company's revenues, around 5%, and the U.S. business is around 10%. Given that they're closing a small percentage of their doors, it's material in terms of the Levi's and Dockers business plans for the balance of the year but wouldn't have a material impact on the total Company performance.

Okay. And then in some of your bigger retailers like JC Penney or Wal-Mart. would you say you are generally getting more space or less space during the back-to-school season? They both seem to be focusing on private label?

I will speak for the Levi's brand in the U.S. and we can ask John and Scott to reference Dockers and Levi Strauss Signature.

We are very much focused on expanding our fixture points in space on the Levi's brand in all of our department store and national chain customers. We have in fact been able to secure new programs across the majority of our consumer segments, particularly young men's, boys and misses. Our traditional men's business, we have the same real estate and we're just trying to turn that business faster because most of our customers have a focus on gross margin return investment and are expecting higher inventory turns out of our core business. And in junior's, we have been facing a business downturn there so it's a matter of holding onto the real estate and turning that business around. But our goals certainly in the Levi's brand is to really focus on expanded fixture point presentation. Clearly, our customers see Levi's as the category leader. We are the share leader in the category and our goal is to win with our customers by being able to be complementary in their growth strategies alongside their private-label businesses.

And with regards to Dockers, we continue to grow fixture points and continue -- our product continues to perform so we keep adding fixtures as we perform. So those retailers you listed are very important for us and we will continue to grow with them.

In Signature, to have Wal-Mart, we are increasing our fixtures in men's and kids and decreasing our floor space in women's and we are increasing our women's business in our other retailers.

Okay, great.

I would say, Carla, in the time that I have been at Levi's, our relationship with our U.S. customers are at the strongest that I have seen them and certainly from what I have heard before I came, probably the strongest in the last 10 years, both in terms of their willingness to get behind your brand, use our assortment to complement their private-label and exclusive brands and work with us to drive their overall business. So I'm very positive about the relationships we've built with our retail customers at this point.

Okay, that's great. And then on the Signature side, I'm trying to [go over] how much of your revenue last year in the back half was from sell-in versus replenishment. Do we still have some difficult comparisons to any sell-in last year or are you on a pure replenishment cycle with Signature?

Pretty close to a pure replenishment cycle. There may have been a few new fixtures that we have got to anniversary but from as far as opening up new accounts, there's no big new account openings in the second half of last year.

Okay, so the target rollout was completed before then?

That's correct.

Okay. And then on the retail side of the business, I would assume that we're going to see more volatility quarterly because of the higher fixed costs that you're carrying for retail. Is that true and should second quarter be your weakest margin quarter because of the retail fixed cost and yet the low kind of selling season?

I wouldn't -- there are more things happening into the quarter than that. But we'll comment to that. Because Q2, the results are impacted still by the lower sales in Europe and we had some onetime items in the second quarter benefiting last year, including a reserve reversal on the litigation on Comexca. So this year, Q2 is not having that benefit.

If you look, we will have a higher fixed cost to our retail network but if you look at our total SG&A expenses year-to-date, they are down versus last year. So we are continuing to work on the [mobile] where we're investing in retail. We will continue to work on cost and productivity so that the total fixed cost of the Company stayed the same while we're impacting at retail.

And the total number of owned and operated stores that we have are still a small percentage of our total revenue and our total cost structure. Our main goal with the stores on controlled retail is franchise and franchise is a variable cost structure rather than a fixed cost structure.

Okay great, that's helpful. And then on the short-term incentive, are you still paying any or accruing for any short-term incentive or was there any of that in your MG&A costs?

Yes.

You just don't break it out any longer?

No.

Okay, and then one last question. CapEx, your forecast for '06 CapEx is higher than it was last quarter. Is that just the additional retail stores or is there something else behind that?

It is both retail investment and SAP.

On SAP, as John said, we have now rolled out successfully to Australia and New Zealand, South Africa and now Japan, which was quite a success story given the streets strewn with unsuccessful SAP installations in Japan. We have other countries that John mentioned that we are going to follow and then we're doing our global supply chain organization.

We are in the process of formulating a plan to do our corporate financial systems in our U.S. basically selling systems as the next phase and then Europe after that. We don't have a rollout plan determined yet but we eventually over the course of the next three or four years have to have SAP fully installed across the whole Company.

And then your Asia growth which has been so strong, would you say you're maxing out the number of new locations you could add in Asia and we'll start to see more run rate type growth from that business?

I think we're just seeing a mix in where our business is growing in Asia. We're seeing India and China as our two growth engines. Clearly, Japan, which represents about 40% of our business. We probably are seeing the run rate slow down a little bit there. We still think it will grow but we're just seeing a change in mix of the businesses. Some of the new developing countries come on stronger. Because they are off a lower base, we are not feeling the true impact of that yet.

And we believe we have an opportunity as we go forward to the Dockers San Francisco positioning seems to be quite relevant and turn Dockers into a brand that can grow both in Europe and APD as we go forward.

Okay, great, and then one last question, I promise. Gross margin in the U.S., you mentioned was weaker. Is any of that mix shift or change in markdown allowances for retailers?

The U.S. total gross margin is slightly down and we had some mix change because of the shorts moving into the second quarter. You don't see any things in the markdown allowances; it is mainly a mix shift.

And marketing support with our retailers. We have run some very strong promotions lately with some of our retailers and it's investing in that to drive the top line. But whatever margin change exists in the U.S. is not a result of any kind of product problem or close-out problem.

Alexis Gold, UBS.

Yes, just a quick follow-up on Carla's question. I just wanted to confirm. I thought that last year you actually sold in during the [third] quarter to about 800 Kmart stores. So should we expect you to anniversary that and see maybe Signature sales decline as a result in the third quarter this year?

Kmart expanded to almost all doors for the back-to-school period last year. Some of those shipments were in May and some of those shipments were in June. But given that Kmart is less than 10% of our business, it is not a big driver.

Christina [Boney], Credit Suisse.

Yes, good morning. Given all the questions, I only have one. Just wanted to get a sense if your view at all is changed from the first quarter. You sounded a bit more optimistic than you were at the end of the first quarter, where you didn't want to say that the second half would be stronger than the first half. Is that a function of looking at your pre-bookings into Europe? Is there something else y you are seeing that would potentially make you a bit more optimistic or maybe I am just reading into that incorrectly?

Beginning at the end of last year, we tried to say that we thought the first half of this year was going to be difficult for the two reasons that we talked about. One, the uncertainty associated with these retail door closures in the U.S. and the trends that we had experienced in our European business for six months. And we tried to be very cautionary in our guidance here, whatever guidance we give, in terms of the business given these issues. I think what we have seen is what we said is that we are seeing the kind of progress that we hoped to make in the European business and that's why we talk about, on the replenishment business and on controlled retail distribution, which provides some encouragement relative to where we want to be in the second half of the year. And then secondly, as Robert says, we dealt with these retail door closures on a so far so good basis and you can see it in the trends of the U.S. Levi's and the U.S. Dockers business, again, which gives us some -- a greater degree of both visibility into what we can realistically expect in the second half and gives us a little more optimism than we expressed to you the last two conference calls.

Fair enough (indiscernible). I guess does that infer that the second half should be in turn then stronger than the first half? Can we infer that?

Our business overall has been stable for the last almost three years now if you look at it. And those trends, you can I think can feel relatively confident about is that we have a stable top line. Obviously, we would love to have the opportunity to grow but we're not giving that kind of guidance at this point.

Fair enough. Just wanted to clarify. Thanks so much.

At this time, I'd like to turn the floor back over to the presenters for any closing remarks.

Thank you for joining us today. We are cautiously optimistic as we move forward and are progressing in achieving our goals and we look forward to talking to you at the next conference call for the third-quarter results, where we will certainly have a good sense of what back-to-school and the fall season looks like. Thanks.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.