Levi Strauss & Co (LEVI) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co.'s third-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 & Co.'s worldwide communications department.

Good morning and welcome to our conference call. I am pleased to introduce the 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 October 17, 2006, by calling 800-642-1687 in the United States or Canada. From outside these countries call 706-645-9291. For either number please input the ID code of 7557595 followed by the pound 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 a few 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 our website is information about how we compile and use retail sell-through information, data that relates to our retail over-the-counter dollar sales of nonlicensed products, and about net debt. You'll here us talking this morning about sell-through results and trends and net debt.

Finally we will file our quarterly report on Form 10-Q with the SEC. You can link to our SEC filings from our website. Now I would like to turn the call over to Phil Marineau.

Thank you, Jeff. Good morning. Thanks for joining us today. We improved our profits and cash flow this last quarter, which is our number-one objective for the year. Net revenues remained relatively stable on a reported basis. Our net income was up 29% versus a year ago.

We are where we expected to be at this point of the year, given the numerous challenges that we face that have put pressure on our revenue performance. These include Wal-Mart's increased emphasis on private-label products in the U.S., retail mergers and consolidation in the United States, and the need to strengthen our European retail network.

In the face of these challenges I am pleased with our third-quarter performance. Here is how we performed against each of our 2006 key priorities during quarter three.

Our 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 noted earlier, our net income did improve this quarter. Our operating income remains healthy. This improved profitability has allowed us to lower our net debt this year, even as we invest in both retail and other initiatives to build our business.

Our second priority is to focus in Europe and execute our strategies market by market with the goal of sustaining our profitability while improving our sales trends. Our sales trends did improve in quarter three in Europe. We had a double-digit decline in the first half of the year; and we were down 5% in constant currency for quarter three.

This improvement reflects our efforts to expand and upgrade our productlines across Europe and strengthen that retail network. Our retail sell-through continues to improve across the region. Like for like sell-through for the year to date is up modestly versus last year. I expect our sales trends in Europe to continue to improve. We believe our European business is heading back in the right direction.

Priority number three is to continue to build on Asia-Pacific's growth momentum. In Japan we saw an inventory backup at retail that had a significant impact in our sell-in during Q3 in Japan. We are adjusting for this in the third and the fourth quarters; but we believe it is a temporary issue.

Excluding Japan, which is the largest business in the division, our Asia-Pacific region continues to grow.

Priority number five is to address the consolidating U.S. retail environment in ways that help maintain a stable U.S. Levi's brand revenue position in the United States. Even with the impact of door closures of the two top U.S. customers, the U.S. Levi's brand has maintained stable revenues for the first nine months of the year. Our very important young men's business is growing, and our new Company-operated retail stores are contributing incremental net sales to the business.

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 grew again this quarter. The growth is driven by both the men's and the women's businesses, and our new fall assortments, which have performed very well at retail.

U.S. Levi Strauss Signature brand's net revenues were down this quarter due to the continued impact of Wal-Mart's decision to reduce our women's fixtures. The brand does continue to perform well at other mass retailers, and we are working with Wal-Mart to maximize our presence across all consumer segments.

As you probably know, last month we announced our intention to stop selling the Levi Strauss Signature brand in Europe after the spring 2007 season. The brand has sold well where it is distributed in Europe; however the European value retail channel currently does not provide us with sufficient expansion opportunities. Now as the market evolves, we will continue to evaluate the commercial opportunities there for Levi Strauss Signature.

This decision does only affect our European region. We have no plans to stop selling the Levi Strauss Signature brand in Asia-Pacific or North America, where we do believe the business opportunities are substantially greater. In Asia the brand continues to grow. We have expanded into new countries such as India and Korea, where the consumers' reaction to the offering has been strong.

Our sixth priority is to continue to control costs tightly and seek opportunities for greater productivity improvements. We remain focused on cost discipline. Our efforts to improve our productivity is reflected in our strong operating margins.

Before I hand it over to Hans, I want to say that John Anderson and I have been working very closely on the Company's strategic business plans for the next three years and the leadership transition that we will go through at the end of November. I have no doubt that that transition will be seamless.

Now Hans Ploos van Amstel will discuss the details of our Q3 financial results.

Thanks, Phil, and good morning, everyone. I would like to reminder that the slide presentation that accompanies my comments is available on our website, LeviStrauss.com.

Net revenues for the third quarter were down 1% on a reported basis and 2% excluding the impact of more favorable currencies. The change was due mostly to lower U.S. Levi Strauss Signature and Japan revenues, partly offset by increased U.S. Dockers revenues. Excluding a revenue decrease in Japan this quarter, we saw double-digit growth in the balance of our Asia-Pacific business. Year-to-date revenues were down 3%, or 2% including currency impact.

Net income was $49 million compared to $38 million in Q3 of last year, a 29% increase. Net income was driven by the impact of higher operating income, helped by a benefit plan gain related to the planned closure of a U.S. distribution center.

Working capital, which we define as Accounts Receivable, inventories, and Accounts Payable, improved once again this quarter. Our focus on improved working capital management has strengthened our cash flow this year and reduced our net debt.

Let's look at the key elements of our operating results on the second slide. As I mentioned, our consolidated net revenues were down slightly in Q3. Europe showed a significant net revenue improvement, with the trend moving from a double-digit decline to down 5% in constant currency or about stable with the help of currency. I believe the region's performance indicates that the turnaround initiatives that we have been implementing since the beginning of this year are beginning to work.

Now to earnings and margin. Third-quarter operating income was $158 million or 14% better than last year. This was driven by a $21 million or 6% decrease in SG&A expenses, mostly driven by the favorable impact of the $29 million U.S. distribution center benefit plan gain, partially offset by the $13 million total cost of the CEO transition.

Looking beyond these items, operating income would still be up modestly, indicating that lower net revenue was more than offset by our cost savings even while investing in new retail stores.

Operating margins for the quarter and the year-to-date remained strong at 15% of net revenue. Our gross margin was stable at 46% in the third quarter. This is consistent with the gross margin rate for Q3 of last year, confirming that we continue to deliver healthy margins.

Let's look at the business unit performance on the next slide. In North America, Q3 net revenues were essentially stable. The 1% decrease was mostly due to the decline in the U.S. Levi Strauss Signature business as a result of Wal-Mart's earlier decision to devote more women's fixtures to its private-label business. The U.S. Levi's brand was down 1%, reflecting the relative stability of that business even in the face of retail consolidation.

We are very pleased by the continued growth of the U.S. Dockers brand. The business grew across both men's and women's again this quarter, demonstrating that the Dockers' strategies are turning around the business.

Operating income in North America was down 4% versus Q3 of last year, reflecting our investments in retail expansion.

In our international businesses, Europe's revenue show an improving trend since last quarter. Operating income was up 14%. About half of this was the result of exchange rates and the rest due to cost savings.

Asia-Pacific's net revenues declined 3% this quarter due to a slowdown in Japan, which represents a significant proportion of the region's net revenue. During Q2 this year, retailers' inventory in Japan was too high, and this has had a significant impact on our sell-in during Q3 as our customers worked to rebalance their inventories. We expect retailers to work through their inventory backlog by the end of this year. Excluding Japan, the region continues to deliver strong revenue and profit growth.

Turning to cash flow on slide 4, compared to the first nine months of 2005, we have a substantially stronger cash flow from operating activities because working capital, interest, and restructuring payments are all lower. We have continued to maintain lower inventory levels.

Investing activities increased this year compared to 2005 as we continue to invest in IT systems and new Company-operated retell stores.

To summarize, our Q3 financial results show solid profit, continued healthy margins, and strong cash flow while investing in retail and SAP. Our working capital management, and lower interest expense are also contributing to our lower net debt this year.

We will continue to address several challenges during the remainder of the year including the issues in Japan, improving our U.S. Levi Strauss Signature business, and continuing the positive sales trend in Europe. We are optimistic that we will continue to deliver healthy margins and strong cash flow. As we end the year, our goal is to hold net revenues stable in the fourth quarter.

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

Thanks, Hans. Good morning. The U.S. Levi's brand ended the third quarter with $345 million in net revenue. This is a 1% sales decrease. We delivered $874 million in year-to-date net revenue, which is stable with 2005. This is solid performance, particularly when considering the mixed performance of our retail channels and competitors.

We have continued to experience strength in our young men's business, our boys, misses, plus, and petite businesses, and we have experienced stability in our men's business overall. The new Company-operated Levi's stores have also contributed incremental sales.

These increases were offset by weaknesses in our juniors business as well as the impact of our customers' inventory strategies and higher sales allowances.

Our stable sell-through results for the first nine months of the year reinforced that we are on track to deliver our goals. Total men's sell-through is stable year-to-date. We continue to experience growth in the young men's under-25-year-old segment, which is driven by a balanced fit portfolio; and this is coupled with new, innovative fits such as our straight and skinny fits as well as cleaner finishes.

In women's, sell-through was down. This was driven mostly by our performance in the juniors business. Sell-through in all other segments of our women's business is up year-to-date.

Boys continues to deliver substantial sell-through increases year-to-date. Our innovative fits and finishes, which are similar to those we have in the young men's segment, continue to drive strong consumer demand for our products.

Our Company-operated stores delivered comp store sales increases through the back-to-school season. This is a trend we are pleased with heading into the fall and holiday period.

We continued to expand our retail presence in the third quarter and are on track to open the 20 new stores that we've spoken about by the end of the year.

We launched the latest edition of our Style for Every Story marketing campaign at the beginning of the third quarter with new television ads featuring our flagship 501 jean, the 559 relaxed straight jean, and an ad that supports the slim straight jeans for both our men's and our women's segments.

We also kicked off a program targeted at college students, including the chance to be featured in the college edition of our advertising campaign, as well as to purchase product in temporary stores on or near college campuses.

All in, we had a solid performance reinforced by stable year-over-year sell-through trends. Now over to John Goodman, President of the Dockers brand.

Thanks, Robert. Good morning. The U.S. Dockers business delivered another strong performance in Q3. Net revenues increased by 3% versus 2005, driven by growth in both the men's and women's businesses.

The women's business continued its strong performance in Q3. Net sales increased by 15% versus LY. The growth was driven largely by the continued success of our seasonal capris and shorts that proved to be market-right. Core pants also continue to perform well, led by the Metro pant.

We've seen outstanding results in the women's business in 2006. We believe that this performance is based on our ability to be agile and responsive to customers through substantially improved speed to market. We also believe that we will continue to deliver strong performance in our women's business if we continue to execute the strategies we've been following for the past year.

The men's business also delivered solid results in the third quarter and now has grown consistently for the past year. This growth was driven by a solid performance in core pants, particularly in the premium and collection segment. Our new trend core product, the iconic khaki, and iron-free programs have also performed well. Men's top sales increased by 7% compared to Q3 2005, driven by additional fixtures and the success of our golf line.

Year-to-date net revenue increased by 6%, driven by growth in both the men's and women's businesses. The women's business has grown year-to-date by 21%, driven by core long bottoms and seasonal fashions. Our much larger men's business grew by about 3.5%, driven by growth in both the premium and collection pants and tops.

Retail sell-through for the quarter was also very strong for both the men's and women's businesses. We believe that this is an indicator that the Dockers business is positioned to continue its positive momentum.

In September the men's business launched a wearing occasions advertising campaign that we are excited about. TV ads air on primetime and major sporting events. The campaign, which shows product by occasion -- work, weekend, dress, and golf -- reinforces Dockers as a lifestyle brand that will help consumers to dress appropriately from head to toe for any occasion. In addition to television and print, the campaign will include out-of-home and in-store marketing.

In conclusion, for Q3 2006 U.S. Dockers business delivered year-over-year growth. As the brand continues to grow, we will maintain our focus on developing and growing our women's business and continuing the positive momentum of the past year in our larger men's business.

Now I'd like to turn over the call to Scott LaPorta, President of the Levi Strauss Signature brands.

Thanks, John. Good morning. In the United States Levi Strauss Signature business we continue to focus on delivering increased profits, while we work towards stabilizing revenues. During Q3, revenue was $93 million compared to $104 million in the third quarter of 2005, an 11% decrease. This decrease was driven entirely by a $13 million decline in women's sales to Wal-Mart during the period as a result of their decision to allocate more space to their private-label program.

Despite [their] drag on revenues, our operating income for the third quarter was $12 million, 9% ahead of last year's earnings of $11 million. Our operating margin also increased by 2 percentage points from the third quarter of 2005, as a result of offering a more premium product assortment, sourcing savings, and reduced SG&A cost.

For the first nine months in the year, we generated net revenues of $237 million, a 12% decline versus last year's revenues of $259 million. Despite that revenue decline, year-to-date earnings of $22 million grew 14% over last year's earnings of $20 million.

Beyond the decline in our women's business at Wal-Mart, the brand is performing well across the other consumer segments in the channel. Our product highlights during the third quarter included strong capri and shorts selling, the expanded distribution of our men's straight fit into all Target doors, and it is now offered in both denim and corduroy. This has helped grow our business at Target.

Third, the expansion of our fit portfolio (inaudible) men's, boys, and girls has proved successful, with new market-right fits such as men's loose relaxed, the boys' boot cut, and the girls' easy flare.

In conclusion, the Levi Strauss Signature business continues to deliver incremental revenues and profits for the Company by offering premium products in the channel to value-seeking consumers. Now over to Phil for Europe.

Thank you, Scott. In Europe we continue to focus on improving our revenue trends as we go through the end of this year. We've made progress towards this goal in the third quarter, and we are continuing to sustain the relatively high profit margins of this business.

The key to turning around the European business is to turn around the Levi's business first and foremost, because it is 90% of the business there, while really fully capitalizing on the opportunity to grow the Dockers brand in Europe.

Our third-quarter net revenue was almost flat on a reported basis and down 5% in constant currency compared to the same quarter in 2005. We are beginning to see improvements in sales trends that are very encouraging.

Our operating income improved 14% in the quarter. Again, we are focused on running the European business efficiently so that we can sustain those high profit margins.

We are improving and broadening our product assortments across the region. The girls' fits that we launched last year continued to grow and to generate strong demand. We will continue to expand and improve our assortment while we add new premium retail accounts and open more Levi's stores.

Early indications are that the fall '06 product line has been received by retailers and consumers across all these retail segments. Sell-through of our new products in our Levi's stores are really off to a very good start. We opened 12 new Levi's stores in Q3, including Company-owned and franchised stores. We are on track to hit our goals in terms of store openings for the year.

The Dockers brand continues to exceed our expectations, driven by strong sales of new slimmer core fits which we have introduced over the last two seasons. Brand revenues are still down on a year-to-year basis as a result of the more focused business model that we put in place last year. But the brand is now contributing positively to the overall profitability of the region.

We opened the first shop-in-shop store with Dockers San Francisco branding in Copenhagen this summer. Initial impressions from the retailer and consumers have been very positive. We believe there are opportunities to grow the business in Europe using this Dockers San Francisco branding platform.

The Levi Strauss Signature revenues in Europe were down versus last year. As I mentioned earlier, in September we decided stop selling the Levi Strauss Signature brand in Europe due to the limited expansion and profit opportunities.

We made good progress through the first nine months of the year overall in Europe. Our sharp focus on executing our strategy is showing improvement. We expect to see continued improvement in our revenue trends as we end the year. Now over to John Anderson for our Asia-Pacific Division.

The Asia-Pacific Division in the third quarter, we experienced a number of challenges related to our largest business, Japan, resulting in third-quarter net sales being down by 1% on a constant currency basis and 3% on a reported basis versus prior year. Profit was also down on prior year.

The negative impact of Japan on the total APD business was cushioned by the growth of most other affiliates, with the strong sales and profit performance being Turkey, Malaysia, Hong Kong, India, and China. Excluding Japan, we experienced double-digit growth across the division.

The key reasons for our performance in Japan are -- weaker than experience results from a Levi's brand advertising campaign; and a faster than anticipated change in core denim trends towards skinny fits and cleaner finishes. Combined, these factors contributed to high inventory at retail carried over from the previous quarter that restricted sell-in during the period.

We have a recovery plan in progress for Japan, with a number of specific initiatives identified that we believe will restore momentum to the business and also position it for longer-term growth. While Japan will continue to be a key contributor to the Asia-Pacific business, future growth will be driven by emerging markets, including India and China.

Year-to-date the Asia Pacific Division has delivered growth. Year-to-date net revenues are up by 6% over prior year on a constant currency basis and nearly 4% on a reported basis.

Now, let me review our performance against our four key strategies. Our first strategy is grow the Levi's brand equity and drive category demand. During the third quarter the Levi's brand equity and demand were driven by strong local marketing campaigns and consumer promotions outside of Japan that effectively drove purchase in stores.

In the fourth quarter we're rolling out an integrated campaign across the region to support the latest Lady Levi's product collection. We have also just begun selling the Levi's RedWire jean across the region, a Levi's jeans for the iPod.

Our second strategy is to rigorously pursue profitable growth opportunities. Our Dockers' business scored another quarter of strong double-digit growth thanks to the well-executed new brand positioning and retail plan aligned to the Dockers San Francisco global brand platform.

Our Levi Strauss Signature brand is showing steady growth where the brand is currently available, which includes Japan, Taiwan, India, and Korea. We are very committed to the brand in the Asia-Pacific region.

Our third strategy is to drive the retail business. This is a major strategic initiative for the Asia-Pacific region, as we place more emphasis on developing controlled retail environments. We opened two more flagship Levi's stores in Taiwan and India in the third quarter. We now have nine flagship Levi's stores in India, Pakistan, Taiwan, and Hong Kong.

We also opened the first Dockers San Francisco flagship store in Bangalore, India, in August. We are on track to open approximately 150 stores in the region this year as we indicated in our 2005 10-K.

Our final initiative is to install an enterprise resource planning system. On June 8, LS Japan went live with the SAP implementation four days ahead of plan. We are on track with the next big SAP rollout, which includes Hong Kong, China, in November 2006; and Taiwan and Malaysia in January 2007.

In summary, we are quickly addressing the challenges in Japan, and we expect to have them behind us by year-end. Our remaining markets continue to grow, giving us confidence that the division will return to being a source of consistent growth for the Company. Back to Phil.

Thank you, John. So, to recap our results overall were on track relative to where we expected to be. They were good, and they have been consistent with the performance trends that we have experienced so far this year.

We are very optimistic that we will continue to deliver strong cash flow and profitability through the balance of the year. We are confident about the products that we have in the marketplace. We are supporting them with very strong advertising and marketing programs. We are looking forward positively as we go into the fourth quarter and next year. Now we will take questions.

(OPERATOR INSTRUCTIONS) Alexis Gold, UBS.

I just wanted to focus a little bit on the retail stores. I know that it's something you've spoken about for the last couple quarters. I just want to get a sense for what your targets are there, in terms of Company-owned versus franchise; and what the cost is for -- what the average cost is in terms of investment; and what kind of return on those you're looking at.

As we said, we will continue to work to expand our retail around the world. We're doing that through franchising models mostly in the international business; and it is an owned and operated retail model in the U.S.

We are not breaking out the financials of retail versus wholesale. We obviously have an economic model store by store which we have benchmarked versus the industry, which gives us good returns on that investment. We are tracking that on a monthly basis while we are investing.

I think it is good to know, if you look at where our overall numbers are, while we are investing in retail we are holding onto a very solid level of profitability. We continue to deliver very strong cash flow while we make that investment.

So in the 10-K last year we did provide guidance about how many stores we would expect to have around the world, both franchised and owned and operated. I would tell you, relative to that guidance we are on track to achieve that in 2006.

Because most of our stores or the vast majority are still franchised, we do not have a large number of owned and operated. When we hit a significant number of owned and operated and it represents a large portion -- or not a large portion, but a reasonable portion of our business, we will start providing more information on our retail sales.

But they're not significant enough at this point to be reporting them. We would also tell you that, from an economic model standpoint, we are achieving our objectives as we open those.

That is helpful. Just as we look at Europe, you talked a little bit about the new stores and adding some new accounts. Can you tell us where you have seen the greatest opportunities, and maybe give us a sense for where there might be additional opportunities?

We believe that continuing to expand our own retail network on a franchised basis in Europe for first-quality stores is an important part of our strategy, as the more traditional retailers who we've sold to in the past have a tendency to be going out of business in the face of the specialty retail competition that exists out there.

So we continue to expand our own first-quality doors. We also continue to expand our owned and operated outlet doors in Europe, because that is the way that -- we need that to be able to deal with our closeouts and excess inventory, and not let those closeouts and excess inventory escape into the gray market, which is what has happened in the past. It has a tendency to corrupt the distribution system as well as the pricing system in Europe.

So we're focusing on those two things. The third thing then is continue to strengthen our different assortments. Sort of a good, better, best assortment strategy that allows us to put in -- strengthen our business in the traditional retailers that continue to exist in the marketplace, while expanding to the more fashionable or higher-end retailers that we call retail professionals and trend-diffusers, which would not mean anything to you, but turn out to be relatively small specialty stores.

We have created a broader assortment of product in Europe that allows us to expand distribution in those higher-tier retailers. So we have been able over the course of last nine months to win back some traditional retailers and begin to expand our distribution into the higher tiers. That will be the key as we go forward into the fourth quarter and next year, to stabilize the business and to begin to grow again.

Just looking at the U.S. for a minute, advertising was essentially flat as a percentage of sales. I know you have had your new skinny jeans campaign out there. I guess I'm just looking at juniors' sales looked like they were down during the quarter.

Can you give us a sense if you've seen pickup just in terms of back-to-school, in terms of new trends? I am assuming that you've seen that more kind of the lower end. Just give us a sense for how those new trends are performing. I think we have heard pretty mixed results from retailers recently.

I will let Robert give you the detailed answer to that. I would only provide the color commentary that we are the largest women's jeans purveyor in the United States, in the channels of distribution and in total. And that the misses business is substantially much larger and more profitable; and that business has performed well.

The juniors business we would like to be competitive in, but it would not be a top priority within the segments that existed in the market. That said, let me turn it over to Robert.

Just to reinforce a couple of points that Phil said, we are growing our share in the misses side of the business. Interestingly, though we talk about the skinny and the straight businesses primarily when we discussed juniors, they actually have been quite successful in our misses as well as our men's segments, more so than in our juniors' segments.

I think in juniors we, like the majority of our competitors out there, have had a tougher quarter. The juniors business seems to have hit a bit of a malaise across the category.

In discussing the business with the majority of our customers across most categories of business, not just limited to denim jeans, the juniors business has been a bit slower.

We were surprised and disappointed to the slower uptake in the skinny fit within the juniors segment. Sell-through results have tripled since we introduced the business. They started in the low single digits, and they're actually hitting a nice run rate, which would be similar to an average run rate that we would expect for this time of the year.

So that is particularly true on the coast, though we have started to see some business improvement in the middle of the country.

Additionally we worked pretty hard to balance our fit portfolio across juniors. I think the market expected a more rapid movement away from mid to low-rise boot cuts and into the slim and straight trends.

So we have rebalanced our inventory investments going into the fourth quarter. It is balanced across mid to low-rise boots, flares, and then the appropriate level of investment in boy fits and skinny and slim fits. And feel better about the sell-through trends that we have started to see most recently.

But the juniors business is a tougher business out there. We will pay attention to it, to get it back on track.

The final point on women's is we did face a challenge in our business with the consolidation at Macy's and May Company. Macy's had made the decision initially to discontinue our women's business. But we have since worked with them and we are back in most divisions. That had an impact on our performance in the quarter.

Great. Thanks very much. I will pass it along and get back in queue.

[Reed Kim], Merrill Lynch.

Hans, I was wondering; the Q says that the SAP rollout is going to unfold over the, quote, coming years. I was wondering if you could -- it is good that the transition worked well in Asia, I guess. But could you provide us a little bit more specificity on when you think that is going to be complete in other regions?

Yes. We are started in Asia with SAP and our objective is to rollout SAP around the world; and that means in also the U.S. and Europe.

We are phasing that rollout over the next two to three years. Because as you know, when you invest in SAP and that changes management from legacy systems, it's something you want to do in a controlled and phased way. Because you also need to run the business.

So that is balanced over the next year. That is also reflected when you go into the cash and capital section, which we disclosed. That you see an increase going forward in our CapEx, because obviously the U.S. rollout is more costly than a Japan rollout. But we are phasing it over the next two to three years.

So in terms of sequence, when does the U.S. occur, in terms of timing? Will that be next year?

We're looking at the moment when to best do that. We would not envision that that would be in early '07. So that would be an end of '07, '08 type of schedule. That is what we're thinking of at the moment.

Okay. The increased CapEx spend that you expect to lay out there, that is because you have -- as you go into the details and you find out what you need to do, the costs just rise? Or could you provide a little bit more detail on that?

If you look at our total CapEx, which we disclose -- and that is indeed going up a little in 2007 -- you see two things. Our CapEx as we say splits 1/3, 1/3, 1/3 roughly between normal maintenance CapEx, SAP, and retail expansion.

So we'll continue to focus on that retail expansion which is one pillar of that capital spending. The other one is SAP. As we get into a rollout in the U.S., that obviously has more cost than rolling it out in Japan.

Okay. Just another, a brand question. I was curious on the Capital E brand. I've been seeing a lot of advertising for that. I was wondering; maybe Phil, you could talk about this -- what you see that business contributing over time; what the target is there in terms of financial contribution.

I will let Robert; that is in Robert's arena, Capital E. It is part of the Levi's assortment here.

Just briefly, we don't disclose the contributions of individual brand segments. What I can say is the Levi's Capital E subbrand is the subbrand that we use to compete in the super premium jeans segment within the United States. It is doing very well for us. We are pleased.

It was named as the number-one new premium jeans brand launch by DNR this year, as I think we discussed last time around. We have gone from being, I would say, a competitor to being within the top two to three brands within several of our major retailers in a very short period of time.

Have put the core fits on a replenishment business, and have been receiving nice healthy reorders as we moved through the quarter and through the back-to-school selling period. We have to remind ourselves, though, that for as much as the premium jean segment gets a tremendous amount of press in the United States, it is still extremely small, about 2% of the revenue of the total category. So it is not going to be a significant contributor to either revenue or profit against our total business performance.

It is particularly critical, though, as an equity builder. I should say, though, that we do make a substantial margin on that business as we have gotten the business model right, and we are able to run it competitively against the other players in the category.

Is a brand getting accepted by retailers where your core Levi's products are no longer sold?

We have never sold the Levi's Capital E range to the retailers that have typically carried our Levi's Red Tab range. We have a pretty sophisticated segmentation model I think we have discussed in the past quarters.

We are developed Levi's Capital E to be sold into the premium and luxury departments in specialty store channel in the United States. So you see retailers such as Barneys, such as Bloomingdale's, carrying this brand. We have not typically sold Levi's Red Tab jeans into those customers, because they do not carry the price point that we sell the core Levi's Red Tab range at in the United States.

I would only add to that -- is just to remind people that we have a $1.3 billion Levi's jeans business here in the United States, 90-some-odd-% of it is sold to chains and department stores.

The average out the door price for a pair of Levi's is around $30 in terms of retail. So Capital E is approaching the $200 price point.

What we have learned is that we can operate at all price segments with the right products and the right assortment. That is what is different about us than in the past. Capital E will play a key role in our own retail stores as well, in terms of an assortment that runs to a premium price point rather than that $30 average out the door price.

We're not trying to sell many $30 jeans in our own retail stores. Having an assortment with Capital E at the top strengthens that assortment for those retail doors as well. But again when you're talking about $1.3 billion as the baseline, that is not -- that strengthening, that holding on, and making sure that the profitability of that $1.3 billion wholesale business is very, very strong.

Jeff Kobylarz, Stone Harbor.

Just curious if you could comment about any industry data you have about U.S. men's Levi and boys' Levi; and also at the Dockers. If you have any industry data, just to see how your sales compare to the industry.

Yes, this is Robert. I will talk about Levi's first and then I will throw it over to John on Dockers. We have seen the category, the men's and boys -- which you've asked about -- categories continue to sell above the prior year. So we're continuing to see some momentum in the category.

It has slowed somewhat over the past several quarters but is continuing to grow. Happily we have seen our ability to maintain share on the men's side of the business. That is particularly driven by robust sell-through increases in the young men's segments. We have really seen a pretty significant increase in sell-through in the products that are targeted to guys under the age of 25 in particular. That has helped to stabilize our share overall.

We have gained about 4 share points on the boys' side of the business. We're having a particularly strong run on the boys' business right now. Our sell-through results are great there.

We've been running the business essentially off of the same platform that we are running our young men's business, rather than treating it as a little boys' business. It is paying nice dividends.

In Dockers I would say that the casual pant category is declining. It is still declining, albeit a smaller decline. We are outperforming the category significantly in men's at this point in time in casual bottoms.

In women's we are stable with the category. We are doing better than the category; but the category is growing a little bit.

Do you have any general outlook for what you think the industry will do in the fourth quarter?

We typically do not provide guidance moving forward in terms of what we think the category performance is going to be. But if you look at the current trends, as we said, on the denim side of the business the sell-through for the category has been still growing, but slowing down considerably, particularly on women's side of the business. I think John has covered the comments for the Dockers brand.

We are encouraged by the trends that we see in September in the marketplace and our performance within the context of that.

We are on track too, on a Company basis, on the goal we disclosed, as to have our net revenue stable in the fourth quarter.

Hans, in your bullet points there, where you said fourth-quarter outlook revenue stability; and then you said strong profitability and free cash flow. So your strong profitability, that kind implies it is going to be up in the fourth quarter. Would you agree?

I agree to that on the fourth quarter.

Okay. That is even though your advertising is down $34 million year-over-year in the first nine months.

The reason -- the advertising is down only because we have changed the model in Europe. You have seen the business improving in Europe while we changed the advertising model. So in percent of net revenue we're spending less in Europe; that is the key change. And we have a little less on Signature. The key change is Europe.

On the balance of our business, we continue to invest in advertising. It is just that change in Europe.

For the fourth quarter you'll see versus year ago we will spend a little less probably as well. But you always have a higher seasonality of spending in the fourth quarter to support fall and holiday.

The key difference is Europe where we have gone to a much more digital marketing approach in Europe than our traditional broadcast advertising approach, and have taken our A&Ps to sales ratios down closer to the Company average.

And the business has improved while we did that.

Yes, it is working.

Okay, thanks very much.

John Sullivan, Cognis Capital.

Just four quick questions here, if you can bear with me. Levi Strauss Signatures next year in Europe, where we will be taking them off-line. Can you give us a sense based on the recent trends in Europe whether we would actually see Europe in total come back to revenue growth for 2007? Is that a realistic assumption?

We do not provide guidance by line of business. But our goal as we move forward is to have a stable European business. We feel reasonably confident in our ability to deliver that.

Okay. What is the impact potential on sales in Europe of removal of excess [LSF] off the shelf?

We will have a spring/summer '07 season, but it is a relatively small business in Europe. That won't affect that comment that I just made.

Okay, I understand. Fantastic. Japan, we have now sort of gone through the September month-end. Is it a fair comment to make that we have now seen the sell-through or the inventory at the retailers, -- has that now been cleared? Are we expecting to see either a decline -- or sorry, a reduction in the sales decline for the last quarter? Or can we expect essentially comparable sales for last year? Just get a sense of what you feel Japan will do in that last quarter.

The inventory reduction in quarter three had a big impact on Japan. But the retailers in the fourth quarter will still be working through that inventory reduction. So to a lesser extent you'll see that happening in the fourth quarter for Japan.

As I said, we are on track for our overall goal as a Company to keep the net revenue stable.

Right, okay. Very good. Thank you. The other question was just regarding one of your core objectives. I think the last time I was on the call we spoke about a policy or an approach towards deleveraging the business over the foreseeable future.

We're still, I suppose, running over sort of $2 billion of debt. Based on our numbers, in order to sort of deleverage down to the targets that you are expecting, we are running about 3, 3.5 turns of leverage at the moment, non lease-adjusted. You guys are saying you're comfortable for the closer to the 2 times.

Can you just give us a sense of how we might get there? Because that sort of represents about $900 million of surplus cash flow generation in the business. The way I figure it is that is quite a few years in order to achieve that objective. Or am I missing something here?

The first thing I would say is that we would remind people that we now very strong financial performance, with good net income generation and cash flow generation. Our EBIT margins are in the top decile of all apparel companies. Our asset turns are moving into the top quartile. We are stabilizing the top-line revenue. We are generating $100 million in cash flow while still investing in the initiatives to improve the top line as we move forward.

So we feel quite comfortable with our control of the business and the financial performance of the business. We have got the debt under $2 billion now. (multiple speakers) free cash flow it gives us the opportunity in future years to -- albeit slowly but surely -- whittle down that debt.

But we do not think the debt is standing in the way of making the investments we need to continue to strengthen the business.

That said, we are just keeping our powder dry and focusing in on the business. We have no -- of course we consider all possibilities of how we can lower our debt and improve the financial performance. But we have nothing to say about it, other than what I just said at this particular point in time.

I suppose that -- that point, I raised the point because there is a lot of talk. We are over on this side of the pond, and we are all mindful of what is going on with the consumer in the U.S. at the moment.

We are just thinking -- when is the right time to position your capital structure for any softness in that particular market? I am just wondering, are you saying that you're comfortable with just sort of progressively deleveraging this from organic cash flows for the next three to four years? Because that is probably what it looks like it might take.

Or else do you think you might need to get there a little bit sooner, to give you the flexibility in a softer environment? It's just really a sense; are we talking about a four or five-year exercise, or you think you might need to do it a bit sooner than that?

I have nothing else to add, other than we are quite comfortable with where we are at, at this point in time. when we have new news, we will certainly be providing it to people.

Final question. Discussions with the rating agencies, when did you last take those? When do expect that you might have another discussion with them? Given that you are now generating -- as we had all expected, and stuck with you to see -- the much stronger cash flow generation.

Can you give us a sense of maybe what they might be looking for to consider a positive revision to where your ratings are?

Yes. First, we meet the rating agencies on a quarterly basis. We have a dialogue on our business. We are very connected and aligned where our business is.

If you would ask rating agency, I think what is important for this Company is that we deliver strong free cash flow, which we're doing now; and that we continue to deliver that. As Phil said, we feel comfortable that we will deliver that $100 million this year, and we continue to work against driving that free cash flow.

Another thing which is important is we are investing in SAP so that we get solid systems, which is also important.

I think with our net revenue getting less volatile, because Europe is doing better, we have growth in Dockers; we have stability in the fourth quarter. I would envision that that will have a positive impact on the rating. But that obviously comes always a little later, the way that process works.

But all our key measures are moving in the right direction from a rating agency point of view. The business volatility, the free cash flow, and our investments in SAP, which they find very important.

So you get to meet with them in the next few weeks, is that right?

I am going there early November. We always combine it with some bank visits. We go once a quarter to New York to meet the rating agencies.

Very good. Good luck and thank you.

Zubin Kapadia, JPMorgan.

It is actually Carla Casella from JPMorgan. Back on the question of the fourth quarter, the Signature for women's, how much would that have been in last year's fourth quarter? The amount at Wal-Mart. This quarter it was down $13 million.

I don't want to really make a forecast of it, but it would probably be a comparable amount as we had in the third quarter.

Okay, great. Then any -- on the Pacific Sunwear rollout of additional Levi's to their stores, how much would the sell-in be for that? Or has that already been done?

We don't typically report customer by customer results. What I can say is that Pacific Sunwear acknowledged themselves on their own earnings call they had really strong sell-through in the men's business in the initial pilot. They have agreed to a full-store rollout on our men's businesses with a nice portfolio of fits.

They have also come back over the past several months and engaged in discussions with us on our women's business. We are in the process of implementing a similar rollout strategy on women's. But that is all we would disclose by customer at this point.

Okay, but the rollout for the men's, that would have been this quarter? Or will that be in the coming quarter? Or can't you say?

It is going to be on a rolling basis. We did have a solid assortment in for the third quarter; and we will continue to expand the assortment as we move forward, as well as to respond to consumer takeout.

Okay, great. Then on the retail stores, have you given an estimated time to breakeven? It has been a drag on operating profit in the U.S. I am wondering how long that should continue.

We're don't give -- we are not giving -- I would say we are not very unprofitable. This is not a big money loser for us.

Five years ago when we started on this we were losing a lot of money. Before we ever got to the point of expanding our retail presence, we eliminated that unprofitability and started out at pretty close to breakeven. So we are not underwriting this to a large extent. It is pretty close to a pay-as-you-go basis.

As we get to some critical mass and number of stores, we will get to the breakeven pretty quickly. But we're not giving any time frame for that or any more specifics on that, other than in general. But don't view this as a huge profit drain on us.

Plus the new stores are sometimes in an invest mode. (indiscernible) what Phil said, we are on track on our individual stores. We have a solid economic model. We have market-competitive rate of returns and net present values. We are measuring that monthly, and we are on track on our profitability on the retail.

Okay, that's great. One last question the balance sheet. You generated more cash than we had expected over the beginning of this year. I am wondering if that means that the fourth quarter we will see less of a cash inflow from your working capital than we normally do.

That is a good question. We took around $70 million of working capital out year-to-date. If you saw what we had, we had more of a valley last year. It is more now every quarter we have that working capital [down].

If you go at the year-end, we expect to land at about where we landed last year. So you don't see a major dip going, when we close the books this year. About flat working capital.

With last year's fourth quarter?

Which fiscal-year average gives you a little benefit in cash flow. Because we're better throughout the year in managing working capital, which gave us throughout the year around $70 million extra free cash flow. But balance sheet to balance sheet, year end we will close about the same of last year.

Okay, great. Thanks a lot.

Jessie Colby, Citigroup.

I am just wondering in Europe about the improvement. Was it more a function of the increase in new doors? Or would you say it was more of a function of improvements in your relationships with your retailers? What was the mix there?

It was more of an improvement, as the new doors are not significant enough to improve the overall trend. This is an improvement in what we would describe as our once wholesale business, the sell-through at retail in our traditional retail customers. That sell-through continues to improve.

As I said in the last conference call, half the business is pretty booked. When you lose confidence in the retailers you're prebookings go down. They were really down in the spring. They will continue to be down in the fall, but less so.

We have been able to close that revenue trend gap by a much stronger performance on that at-once business, which means sell-through to the consumer as we went to the (technical difficulty) quarter.

Is that, would you say there is an element of just an improving European market there? Or is it, would you say, largely just due to your internal efforts?

I would like to take all the credit personally. I would say the market has not changed much, to be perfectly honest. I would say it is really just about a better product assortment out there, tops and bottoms, than we had a year ago particularly.

It has improved in the spring, but particularly in the fall. We have had a very successful fall season. Most of our seasonal goods have already sold through. We have very few closeouts. So we just improved the product range tremendously here, particularly on the women's side of the business.

Okay, great. Then just looking forward, I know you don't give guidance. But could you give us an indication of whether you think sort of over the next year or so we will continue to see sort of a change in mix between, as we saw this quarter, into a similar sort of proportion -- the mix between Europe as a percentage of total sales and Asia-Pac as a percentage of total sales?

We believe going forward that the Asia-Pacific Division is the great growth opportunity for the Company. We have a footprint in developing markets with our own management team, whether it is South Africa, Turkey, India, China, Malaysia, that few if any other apparel companies have. That will represent strong growth going forward, as it has for the last five years.

We can't imagine the European market or the U.S. market having the kind of growth rates as those markets have. So they will over time represent a larger percentage of our business.

The Asia-Pacific, you said?

Asia-Pacific for us, it's a -- we made sure John traveled a lot here. It's [50] countries from Brazil to Mongolia. So it is everything but Europe and North America.

But when we talk developing countries, it is the ones that I talk about which are really showing strong growth. Turkey, South Africa, Malaysia, India, China, just huge growth opportunities against a small base, but over time could be a substantial business.

Just terms of the mix we saw, the mix shift towards Europe this quarter, do you anticipate that going forward? Or is it --?

We saw Japan, which is 40% of the business, have a tough quarter, right? So. Then the European business was only down 5%. Asia-Pacific was -- what? -- down, off the top of my head, 2%.

Yes, 2%. So what you'd --

I would say that was an abnormal quarter, right? We don't expect Asia-Pacific to have a quarter that looks like that as we go forward. But on the other hand we also expect the European business to continue to improve.

We expect more of the mix over time to come out of that Asia-Pacific Division as you look at the Company over time.

Okay, great. Finally, your comment about profitability, I missed that. Was that in -- did pertain to Europe in the fourth quarter?

Miss, could you repeat the question, please?

Maybe I can't really hear very well, but it sounded like you said profitability would be up in the fourth quarter. I was just wondering what that was in reference to. Or did you not say that?

We said -- the question was raised, would we expect profitability to be up for the fourth quarter? We said yes for the total Company. (multiple speakers) seen the profitability in Europe already improving in the third quarter by that general improvement in the business in Europe.

Okay, thanks. That's it.

Andrew Berg, Post Advisory Group.

Just going back to the SAP implementation, do you have the same team working on the implementation of SAP throughout the world? Or regionally are there different teams working on it in each region?

We have different teams working on it; but it is coordinated on a global basis. So we are taking the learnings we have leveraged out of Asia-Pacific as we push up through our global sourcing organization; and we will also be using those learnings and some of the subject matter experts working on the future rollouts as well.

So part will be in Asia-Pacific, getting it right, then leveraging those learnings across the rest of our rollouts.

Okay, thank you.

Amil Shiaffino, BMO Capital Markets.

I was wondering, given Wal-Mart's recent weakness, especially as they attribute it to apparel sales, do you see any opening to reverse the trend with women?

I think there is an opportunity there for us, for sure. It is just a matter of what their corporate strategies are on a go-forward basis.

Our women's business has performed well at other places in the channel. As a matter-of-fact we expanded our juniors business significantly at one of the other retailers, and have done quite well there. We have also expanded our misses fit portfolio throughout the channel.

So I think we're demonstrating the ability to drive category growth. We hope to partner with them and see if we can help turn their category around as well.

So do you have discussions with regards to that with them?

They are ongoing, and we have quarterly business meetings with them all the time and continue to do so.

Conversely do you feel any vulnerability to the other parts of the Signature business with them, with men and boys?

I think that our business is pretty stable in the other consumer segments. We have had a decent second half of the year with them, a decent first half of the year. We continue to perform in those segments, if you look at our results.

As we said if you backed out the reduction in our fixtures and the resulting decline in the revenue of women's revenues at Wal-Mart, you don't see a declining story for Signature. So that tells you that the brand performs well with the consumer. So as long as that national brand fits in with their corporate strategies, I don't see the risk.

Okay. Just on a different note, is there any progress to report, anything at all to report, on new leadership for Europe?

I continue to run the European business personally. I think frankly it has to some degree been a choice that we have made, so that we make sure that we are absolutely rock solid in where we want to be and where we expect to be in the European business.

I would expect that we will have a successor to announce in the first quarter of 2007 after I depart the Company.

Okay. Thank you very much.

Alexis Gold, UBS.

Just a couple quick follow-ups. You have talked a lot about Asia-Pacific. I think one of the areas you have spoken about potential expansion is in China. I know it is something you haven't spoken about in a while. But can you give us a sense for what you're seeing in the gray market over there, and how that might impact your sales?

There is a gray market in China. [That being] a couple of areas, it is either counterfeit or product coming in from outside China. But it is not having any impact on our sales at all. It is not significant enough yet to cause us any concern on the growth in that market.

I would only add that our strategy in those markets is to make sure that we are relentlessly protecting our retail distribution channels from gray market products. So that if you walked into a department store or shopping center in China, we have policed that, so that the gray market product is not there.

If you walk into a flea market, that is another story. But we're time to make sure that we police those channels. So that when people are looking for the real deal, they know they are getting the real deal.

Okay, just back to the retail stores for a minute. I know you had called out the numbers in the 10-K, but just -- I think -- is it possible to get a sense from what your overall longer-term targets?

When we are looking at a bunch of years back, you guys had actually closed a lot of your retail stores. So this is certainly a new effort and another focus in the story. If you could just give a sense, as we look out longer-term, what your targets might be with the retail efforts, that would be helpful.

We're reluctant to provide any further guidance on this. This is a small portion of our business that we think is an important strategy for enhancing brand equity and serving consumers who shop in specialty retail. But as a percentage of our business it remains a small percentage here in the United States.

When we believe we have proven to ourselves that the economic model is working now, is really scalable, and we're going to do it, we will let you know. But we do not want to provide any guidance, because as soon as we do, then if we change our mind we're going to have to come back and go through all that on something that is still a relatively small portion of our business.

Just lastly, you definitely alluded to working through the Federated/May consolidation. I know we have spoken about that for a while. But now that they have launched their combined advertising campaign, can you give us a sense as if you're seeing any pickup or opportunities on that side of the business?

I can speak on the Levi's brand; and then if you want, John can speak on Dockers. We have had a good year to date on our men's and our boys' businesses. Federated did make the decision to expand into all Macy's doors on our men's and boys' businesses.

We worked with them since late last year and all throughout this year to get the assortments right by door, with the appropriate on-floor execution, and to be a part of their overall advertising approach.

We are experiencing solid performance. It is performance which is slightly below our expectations; and it has primarily to do with startup issues. But we feel that the performance has been solid and contributing to the performance that we have spoken about throughout the year.

We did, as I mentioned earlier, face a situation where they had made the decision initially to discontinue our women's business. That is one of the reasons that you see our women's business down overall. Since then we've been engaging in discussions with Macy's.

Not all, but the majority of the divisions has come back into engage, particularly on our misses and special sizes business segments. Where we have placement we're seeing pretty solid performance.

So we expect to just continue to focus on division by division execution, moving forward. We think that the majority of the impact of the consolidation is now behind us. We have had some small hiccups related to the integrations of their systems in the quarter, but we believe those are behind us as well.

With regard to Dockers, we launched a collection this fall with Macy's both in men's and women's. It has been off to a very strong start. We're very pleased with the performance. I think Macy's is pleased with the performance. Men's is selling very well, as well as women's. We continue to look to grow our business with Macy's in the future.

Great. Thank you.

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

Thanks for joining us today. We look forward to reporting our results in Q4, for both -- not only for the quarter but our annual results for the year. We will see you in February.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time.