Levi Strauss & Co (LEVI) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co. third-quarter 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. A telephone replay will be available through October 18, 2011 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 conference ID number of 15016647, followed by the pound key.

This conference call is being broadcast over the Internet, and a replay of the webcast will be accessible for one month on the Company's website, levistrauss.com. I would now like to turn the call over to Kris Marubio, Director of Corporate Affairs at Levi Strauss & Co.

Good afternoon, and welcome to our conference call. I am pleased to introduce members of the Levi Strauss & Co. Management team. With us here today are Chip Bergh, our President and CEO, and Blake Jorgensen, our Chief Financial Officer. Before we begin, let me briefly remind you of a few items. Our discussion today may include forward-looking statements that are based on our current assumptions, expectations, and projections about future events.

Although these statements reflect the best judgment of our senior Management, they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the statements, as more fully described in our annual report on Form 10-K, our registration statements, and other filings with the Securities and Exchange Commission. Other unknown or unpredictable factors also could have material adverse effects on our future results, performance, or achievements. We provide information on our website about how we compile various measures used to describe our business performance. Finally, today we filed our quarterly report on Form 10-Q with the SEC. You can link to our SEC filings from our website. And now, I would like to turn the call over to Chip Bergh.

Good afternoon, and thanks for joining us. I'm happy to be with you on my first earnings call at Levi Strauss & Co. Before we discuss our results, I want to talk about how we are changing the format of our quarterly conference calls. Going forward, Blake and I will lead these calls, consistent with the practice of many companies. Today, I will provide an overview of our business, and then Blake will provide more detail on the regional and total Company financial results. But before I dive into the results, I'd like to share a little bit about myself, and tell you how I have been spending my time since I came on board September 1.

My top priority is getting to know the Company first-hand. I've been out in the markets, meeting employees, customers, and consumers. I've held town hall meetings in each of the regions, reaching thousands of employees. I started in San Francisco, went on to Brussels, Amsterdam, and Hong Kong. I've begun meeting with key customers, and I've shopped our stores, our customers' stores, and competitors' stores to learn more about how consumers are connecting with brands in the apparel industry. Most recently, I was in Hong Kong in China, and I shopped with consumers in both markets.

I've also started digging into our business and performance, and I am furthering my understanding of the key issues and opportunities. I joined Levi Strauss & Co. for three main reasons -- first, we have tremendous brands, and I would argue one of the most iconic brands in any industry. Second, this is a Company with rich history, in part due to its enduring values. And third, I think this Company has significant upside and unrealized potential.

After spending my first month immersed in the business, I believe this Company has what it takes to be great. I'm passionate about building strong, enduring brands, deeply rooted in consumer understanding. Over the past three decades, I've launched and led powerhouse brands in consumer goods. I am a global guy; I've spent one-third of my career living and working in Europe and Asia. I think I have a good idea of what it takes to build strong, global brands and execute well in markets around the world. I believe in balancing the scale with agility and responsiveness. Levi Strauss & Co. has these strengths, which I will continue to build upon as the CEO.

Now, let's turn to the details of the quarter. Total Company third-quarter net revenues were up 9% on a reported basis. Net income increased to $32 million, up 14% from 2010. Despite a tough economic environment, we delivered a solid quarter. The top-line improvement was primarily due to the Levi's brand, and through the performance and expansion of our global retail network. On a reported basis, revenues were up in all three geographic regions. In particular, we saw strong revenue growth in the Asia-Pacific region, driven by the expansion of the Levi's dedicated retail networks in China and India, as well as the ongoing expansion of the Denizen brand.

Along with the industry, we began to see some negative consumer response to price increases, which we extended across additional product lines this fall. During the quarter, consumers purchased items on a wear-now basis, and August back-to-school shopping was muted. Not surprisingly, consumers in the value segments of the markets were more careful with their spending. As a result, in some of our wholesale customers, price increases were offset by a related decline in the volume of units they ordered. While their sentiment was cautious, we found that consumers were willing to purchase compelling products, reinforcing the importance of innovation and differentiation.

In the Levi's brand, female consumers continued to respond well to our fall Curve ID collection, which has a variety of finishes and features, as well as two rises -- classic and modern. In men's, we offer a range of silhouettes, from slim and skinny to straight and tapered. The slimmer fits continue to be particularly popular. Turning to Dockers, while business outside the United States continued to grow, Dockers revenues in the United States declined, due to the effects of pricing and competitive issues in our core channels. In response, we are designing khakis at compelling price points for our more price-sensitive consumers, while continuing to offer khakis with slimmer fits and modern washes, such as our newly launched Alpha Khaki.

The global rollout of the Denizen brand continues. The brand is gaining consumers' attention in Asia with its great fitting, affordable jeans. In the United States, Denizen launched at more than 1,700 Target stores this summer, demonstrating our commitment to offering high-quality jeanswear to value shoppers. We supported the launch with a social media campaign; and although it's still early days, we have been encouraged by the initial response.

In addition, Walmart expanded its Signature offerings by adding men's and juniors to the women's line, and we were pleased with the early results. We're cautious about the remainder of the year. Like our customers, we face an economic environment that continues to be uncertain and challenging, particularly for consumers shopping for value. We're concentrating on what we can control, continuing to put consumers at the center of our thinking, and offering them compelling, innovative product and brand experiences. Now, I'd like to hand it over to Blake Jorgensen, our CFO, to take you through the financials before we open it up for questions.

Thanks, Chip. I would like to welcome Chip to the Company, and say that it has been very exciting working together. As a reminder, in our remarks today, our performance comparisons are on a year-over-year basis, unless I indicate otherwise. Total consolidated net revenues for the third quarter of 2011 were $1.2 billion, up 9% on a reported basis and 4% on a constant currency basis. Net revenues for each of our regions increased on a reported basis.

Higher net revenues were mainly driven by the performance and expansion of our global store network, inclusive of the price increase that we've taken in many of our products during the year, in response to the rising cotton costs. During the quarter, we saw volume declines in some of our wholesale customers -- notably, in the moderate and value segments of the market, due to these price increases, as well as due to the continued economic pressures in the United States and Europe. We believe these conditions will continue for the remainder of the year and into 2012.

Third-quarter consolidated gross profit was $569 million, up $25 million from prior year. Our higher net revenues and favorable effects of currency were partially offset by a lower gross margin. Margin declined to 47%, as compared to 49% last year, reflecting the higher costs of cotton and our efforts to manage inventory levels, which have resulted in increased sales discounts. We expect these trends to continue as we move through the remainder of 2011 and into 2012. Due to our sourcing lead times, the lower cotton prices we have seen this summer won't show up in our product cost until the back half of fiscal 2012.

Third-quarter SG&A expense was $489 million, up 7%, in line with our revenue growth. Higher expenses reflected our additional Company-operated stores, as well as the costs related to the retirement of our former CEO. Operating income for the quarter was $81 million, down from $86 million last year. Our operating margin was 7%, a decline from 8% last year, due to our lower gross margins. Below operating income, interest expense was consistent with prior year, and we returned to a more normalized tax rate yielding net income of $32 million for the third quarter, up 14% from last year.

Now, I'll share more detail on the regional revenue results. For the Americas region, third-quarter net revenues were up 7% on a reported basis, and up 6% on a constant currency basis. Revenue growth was primarily driven by the Levi's brand, due to higher volume of sales and price increases in our retail stores, and a launch of Denizen in Target. In Europe, net revenues were up 6% on a reported basis, but declined 4% on a constant currency basis. Our retail stores improved, and our Levi's Curve ID collection continued to perform well in the market. However, these gains were offset by declines in our wholesale channel, due to lower shipping volumes as we rolled out our SAP platform in Europe.

As we announced on our last call, we implemented SAP in Europe in July. As with any major implementation, there is a stabilization period, and our wholesale performance in Europe was impacted by our inability to fully satisfy some customer orders during the quarter, as well as slowing our cash collection cycle. Our SAP effort includes a core system for ordering, shipping and invoicing, and replaces a 20-year-old legacy system. Our new core system is now fully up and running, and we are working through the normal customer-related issues that exist in any large-scale implementation. In addition, we are building an SAP supply and demand planning module, and this work will continue throughout the remainder of the year.

In our Asia Pacific region, net revenues increased 20% on a reported basis and 11% on a constant currency basis. The region's performance continued to be led by the Levi's brand through the expansion of our brand-dedicated retail network in China and India. Denizen products continued to perform well, and we're pleased with the ongoing expansion of the brand. Now, before I go into details on cash flow and balance sheet, I want to take a moment to highlight our announcement last month that we successfully refinanced our asset-backed credit facility, subsequent to quarter end. The new $850 million facility, which matures in 2016, will be used for general corporate needs and will provide us with significant liquidity for years to come.

For the first nine months of 2011, operating cash flow was $17 million -- a decline of $79 million as compared to last year, reflecting higher inventory. We are focused on inventory management. The substantial majority of the increase in our inventory balance is due to the higher cost of cotton, and we have had some unit growth, as well. Year-to-date expenditures of $106 million reflect our ongoing retail expansion and our investment in SAP. We entered the quarter -- we ended the quarter with total cash of $231 million, and we had $337 million available under our credit facility. Net debt rose to $1.75 billion.

To summarize, we had a solid quarter despite the impact of cotton prices and a difficult economic environment. While we're pleased with our performance during 2011, we continue to face uncertain demand, due to consumer price trade-offs and the recent softening of the economy as we enter the holiday season. With that, we will now take your questions.

Operator, we'll take questions now.

Thank you. The floor is now open for questions. (Operator Instructions) Carla Casella, JPMorgan.

One question on the cash flow and balance sheet, how you look at -- in the past, you said that you expect free cash flow to be relatively thin this year, because you're spending on new initiatives. Do you -- would you change that, or do you expect to continue to still operate under that view? Or, given the weakness in the environment, would you use more of your cash flow to pay down debt?

This is Blake. We -- as you, I think -- no, the bulk of our CapEx is primarily into two buckets -- one bucket is the rollout of retail stores internationally, and the second is to support the buildout of our SAP platform, primarily in Europe. We have not yet set our CapEx budget for next year, but you should be assured that we will be watching closely in what the level of that CapEx will be and how much we can spend on programs like SAP or on retail buildout. At the same time, we are being -- we want to continue to be aggressive in building out our retail platform. And in many places around the globe, we are finding exciting opportunities to deploy that capital, at very good rates of return. So, I don't see that that number drops dramatically, but we will certainly be watching it. And as normal, we will provide some guidance on CapEx to everyone during the first quarter of 2012.

I do want to say, though, on top of that, that part of use of cash during the quarter has primarily been driven by the dollar increase in inventory, and the support of the overall growth of the business with inventory to support that. We are highly conscious of the fact that the inventory values are up. We're being very careful trying to maintain the appropriate balance; but at the end of the day, we're seeing that as part of the challenge in our cash-collection cycle, along with just a slower cash-collection cycle in Europe due to SAP. And we are focused on, and we think we will get back to normalized levels, as we roll into next year.

Okay. On that retail front, how -- right now, at 18% of sales, how high could that go? Could it be 30%, 40%, or could retail be the majority of your business at some point?

I don't want to speculate. But I think, as you know, wholesale is always going to be a very important part of our distribution. We sell product at all levels of the economic chain. And so, key wholesale customers in the value channels, as well as our own retail stores, or especially retail stores at the high end of the product mix, will always be in play. So, I wouldn't want to speculate, but wholesale will still maintain our -- be our -- wholesale and franchise will still be our dominant distribution platform, I think, for many years to come. And as a reminder, while we have substantial amount of retail stores globally, a large portion of those in Europe and in Asia are franchise dominated. And so, I think we will continue to use the franchise system aggressively to help grow the business.

Okay. And then, just one more on the cash side, as well. The pension contribution, was it -- what was the amount in the quarter? It looks like it was over $70 million? And do you have any more planned for the back half of the year?

Yes, so, that's the year-to-date number, Carla. And almost all of that came in the first and second quarter. So, relatively little in the third quarter. And we are fairly [trued] up for the year, and so won't have substantial amount in the last half of the year.

Okay, great. Thank you.

William Warner, Bank of America.

It sounds like there were some challenges with some of your wholesale customers at some lower price points. I'm wondering whether you guys feel that you lost any shelf space, or whether some of those wholesale channels are just stocking at lower levels?

Bill, it's Chip. I think what we are seeing -- I mean, you open up the newspaper and you see that the consumer, particularly in the lower tier, is pressed. And that's playing through to retail. We haven't really seen any dramatic loss of floor space or shelf space. I think what we are really seeing is the consumer pulling back; and as I said earlier, really spending to wear. We're seeing the opposite in department stores -- the more premium parts of our business have remained fairly robust through this upper period. So, it's really the consumer who is struggling with the $5 a gallon gasoline and food inflation and everything else, who's just trying to make ends meet every month.

Okay, that's useful. And then, in terms of some of the challenges in Europe with ERP, I'm wondering whether you feel like you guys have gotten past most of those challenges -- I think you guys mentioned that it went into effect in July -- or whether you are still working through them? Are there still going to be challenges ahead?

I think, Bill, we have gotten through most of the challenges, as you can appreciate -- you've seen us, I think, with some of your other companies. It takes a good two to four months to get everything fully up and running. We have electronic connections with all of our major customers there, so you have to make sure all those work -- billing addresses, product mix, so forth. You're just working through those issues. I think the biggest challenge was the go-live stage in the first 6 to 8 weeks, when you are slowly turning the system on, to make sure you don't have any issues. And what that does is, it slows the cash-collection cycle down.

We're very confident that we won't miss the cash-collection cycle; it's just a question of that slowing down, as well getting the same level of volume that you might have if you weren't doing a system implementation. We should be fully caught up, clearly by year end, and we're running virtually at full capacity now. So, it's not much of an issue, it's just working through all the bugs. But we're very pleased with how it's rolled out, and excited about having our European business on a system that actually is -- a software code that was written in this century.

[Laughter] Okay, and then one last one -- can you talk about when the most recent cotton-price increases you guys pushed through, when those went into effect? And whether those would have helped your third-quarter margins at all? Or whether those would have been done after the quarter would have ended, so that maybe they'll just help the fourth quarter?

Yes, so, we put price increases in starting as early as the first quarter. As you know, we do it by product, and by men's and women's split. And some of those increases or additional increases went into effect and certainly benefited for the third-quarter revenue. So, clearly, you are seeing a revenue boost from both price increases and volume. On the other hand, the impact on gross margin is really coming through, trying to keep our inventories as clean as possible.

The challenge we have is, we are trying to balance supply and demand; and as you know, much of the supply was put in place last year. And so, we had product coming in long before we knew what the trade-offs would be on a price-elasticity basis for the consumer. And in some places we underestimated, and in some places we overestimated. And so, we are trying to make sure we are balancing that and liquidating product that needs to be liquidated, to keep our inventories as clean as possible. And that clearly impacted gross margins in the quarter, and we'd probably see some of that same trend going forward, as cotton prices still filter through at a high level for the next couple of quarters.

Okay, that's all for me. Thanks, guys.

Grant Jordan, Wells Fargo.

My first question -- you talked a little bit about inventory being up due to cost and a bit higher volume. The pace of increase was down from the previous quarter. When do you expect that will be more to a normalized level?

Yes, Grant, we think, as we've said, that cotton will impact us really through the first half of 2012. In other words, we won't start to see lower-priced cotton into the products until the -- late summer next year, into the fall, winter time frame -- or fall holiday time frame. So, that will continue to impact, we think, customer volumes; people may not be willing to pay as high a prices. And it will continue to impact our management of inventory. As we get through the year, we will start to align better what we think is the appropriate supply, versus what's coming down the pike today.

And so, I would say by the tail end of the first quarter, into the second quarter, you will start to see better control of some of that. But I don't want to speculate or provide guidance on that yet. I just think you are going to see this across the industry, where anyone who works with a long supply chain is going to have to deal with some of the inventory challenges and matching of the demand and supply level.

Okay, that's helpful. As you've talked to your wholesale customers about the upcoming holiday season, have you seen any of the customers starting to get more nervous about potential consumer spending trends? And trying to pull back in orders?

I think nervous is probably a little bit of an overstatement. I think our retail customers, just like us, are looking at the economic headwinds that we have. One of the things that they didn't do, they didn't adjust their open to buy budgets to reflect higher costs. So -- and I think they are going to be managing their inventories pretty tightly going into the holidays, and trying to keep it pretty tight.

You would say that's pretty much in line with the same kind of thoughts you had a month ago?

Yes, I would probably say so. I think -- I think the economy, if we were to go back to the springtime, I think most of us probably would have thought the economy would see some upturn. And we just haven't seen any movement, particularly on unemployment figures. And so, I'd say that there has been a fairly dour mood by consumers in the summer and early fall time frame, that I don't think is going to -- I think will continue on for some time, until we really see true economic uptick in the US and in Europe.

Okay. My last question -- you guys have expanded, mainly through your retail network, recently. If the right M&A deal came along, in terms of adding another brand, is that something you are open to? Or are you primarily focused on the brands are currently have?

Well, as you guys know, in our world, cash is our focus. And so, if the right brand came along for $10, I might consider it. But right now, we are not really in a position where we would want to increase a lot of leverage or use a lot of our cash. We're really focused on the growth potential of what we are seeing with the Levi's brand and the Dockers brand and in our -- obviously, our new brand, Denizen. We're benefiting today from the great acquisition we did in the outlet space of our partner. It's a business we knew well, because we were essentially working with that partner; and when they ran into financial issues, we were able to buy that business. Those are great deals for us, but I don't think many of those deals come along very often.

So, we're going to keep our heads down and focused on the business we've seen and the amazing reception to some of the product innovations that we've put in place -- Water<Less, Curve ID, some new brands like Denizen, as well as exciting fits and finishes in Dockers. We feel like we have a lot more work to do, and a lot more opportunity. So, that's where we are going to stay focused.

I'll just pile on there, Grant, because I've been asked that question as I've traveled around the world by a lot of our employees. And the message I've sent is a pretty strong one, very similar to what Blake said -- we have plenty to do with the brands in our portfolio today, lots of growth opportunity on those brands that are going to require some investment. And doing a deal right now would be a distraction. Even if we could afford it, it would be a distraction versus the job at hand. And as Blake said, we have some great innovation, some great programs coming down the pipe that warrant continued investment behind them; and that's where we are going to put our energy -- really focusing on the core, short-term.

Great, thank you very much.

Emily Shanks, Barclays Capital.

Just a couple of follow-up questions. The first one is -- can you give us what the unit growth is, embedded in the inventory increase year over year?

Yes, we don't break out our inventory between units and value, but you should assume that value was the majority increase versus unit. There is some unit growth there, but value is the real driver. In other words, the dollar value of that inventory going up, because of cotton price going up.

Okay. Is there any way you can -- can I make an assumption that unit growth is less than 5%? Or any way you could characterize it for us?

It was probably more than that, but that's about as much as I'll give you.

Okay, okay.

So, I think the key to think about is -- we are going to see some unit growth because we continue to roll out retail stores, which require more units. We've also entered into some new businesses over the last 12 months; Denizen is a new business, so we've built units for that -- that Company, as well as our Signature business is expanded in Walmart. We're now selling women's, men's, and boys; and so, that's required some unit growth. And we've continued to build units to help fuel the growth that we are seeing at the top line and have been seeing over time.

I think the pricing issue, because of cotton, is a unique issue to this time frame we're in, and we'll tend to see more cotton cost value increases in the inventory that way. But we also -- I want to be very careful not to miss sales out there in the marketplace, and so we've tried to build some units. But at the end of the day, if you look back historically during periods of growth, say this time last year or even this time the year before, you would not see inventory increases along the level that you're seeing today. And that delta, much of that delta can be driven towards the dollar-cost increase of all that inventory.

The other dynamic that I'll just add on here, as I've gotten educated to the apparel business, is there is a seasonal dynamic here. And we do tend to build inventories in the third quarter, as we head into the important holiday period. So, on top of all of the other dynamics, which Blake mentioned, we are building some inventory for the holidays coming up.

Great, thank you for those details. And a follow-up -- you had called out the Denizen rollout. Can you give us a sense of how much that contributed to the Americas sales growth year over year?

Yes. It's still very small, so we won't break the sales out. But we only started the rollout in Target in early July, so it took us most of the month of July just to get rolled out in all of the 1,700 or more stores that we are in now. And it's a new brand, so the consumers are getting used to it. It's still early days. We're also trying to best fit what the regional aspects or store fits are for each different store, so it'll take some time. And similar, even in our Asian businesses where we've rolled out a lot of stores, in India, the Denizen business replaced the Signature business, and so those sales are now fairly similar to what Signature was. And then, in China, it's new business for us, coming forward. So, early days, and it'll probably be some time before we even have metrics that we can start to talk about, relative to the brand.

Okay, great. And then, my last question is just around the European wholesale execution, with the delays related to SAP rollout. Were customers able to cancel or refine their orders down during that period? Or did you just simply fill those existing orders after quarter end?

Yes. So, our bigger problem was the opposite, which was we couldn't fill all the customer orders that we wanted to. We preshipped as much as we could during the month of June before we go live -- we went live, which is pretty typical in an implementation like this. In the month of July, we weren't able to ship full amounts, because we were turning the system up; and then, by late August, we were back up to full speed. So, potentially, you try to balance pre-shipments and shipments. And to the extent that there were additional orders required during that month, we weren't able to fill all those orders.

And while the economy is bad, the business has remained fairly robust. So, we saw some imbalance there during the quarter. We'll make up some of that during the fourth quarter, but in a replenishment -- core replenishment business, it's hard to make up a lot of that. It just kind of rolls forward, quarter to quarter. And so, I don't think you are going to see a big fourth quarter, if that's what you were looking for relative to that. I think it will be more dampened, just with the slow turn on, as well as some of the economic issues that continue to seem to get worse over there.

Okay, that's helpful. And then, my last one, if I could squeeze one more in -- just around the $11.5 million charge, around severance, CEO pay, et cetera. Can you give us a breakout of cash versus non-cash?

I can't, but just assume that most of it was cash.

Okay, thanks.

Colleen Burns, Oppenheimer.

I guess, first, on the gross margin decline -- was that mostly in the US?

We saw it globally, because the pricing issue is global. But I would say it was most dominated in the US, because of the value -- the value segment in the market is the most defined here in the US. So, the customer who is typically buying our product on a replenishment basis, wearing it daily for work, they like the quality and the value they get for it. That customer has been the most impacted, as Chip said a minute ago, by all of the inflation that's gone on during the last six months -- food, gas, housing, whatever it might be.

And so, that customer is probably buying less in the store of all products; and thus, we are trying to be the most careful there and maintaining the appropriate levels of inventory. That was also the customer we had the least visibility on, in terms of price elasticity. I think I've said this before, but we went through 15 years of no inflation in raw material costs like cotton. So, this is the first time in 15 years we've really had to assess how much elasticity would exist in the customer, relative to price increases. And then, when you layer on top of that, I think, an economic malaise that hit during the summer, you just had a lot of customers that resisted stepping in and buying. And so, we saw more of that impact in the US in the value chain -- the value segments. But I think some of that existed in Europe as well, and probably even in some parts of Asia.

Okay. And then, it looks like advertising was down about 15% year over year in the third quarter. Was some of that pushed into the fourth quarter? Or how should we think about advertising in the fourth quarter?

So, I would think about our advertising levels for the year as fairly consistent, year over year. But as you know, we go through swings and campaigns; and so, we tended to do more advertising earlier in the year. We will have some in the back quarter of the year, as well. And then, remember, our advertising, that's really A&P dollars; so that -- advertising and promotion dollars -- so that includes on-floor investments in either advertising or fixtures.

So, it's hard to predict quarter to quarter how that's going to swing; and in fact, we don't -- we book our campaigns and a lot of our investment plans long-term, and so, it's hard to even control that on a quarter to quarter basis. So, you should assume that on a year-over-year basis, we'll be fairly consistent, but even see some minor swings year to year.

Okay. But it's not that you held any of it back to be pushed into the fourth quarter.

No. Unfortunately, you can't control ad spending quite that while. And particularly since ad spending itself is a small part of that overall number.

Okay. And then, just lastly, on Europe -- it sounds like most of the constant currency sales decrease you saw in Europe was really related to SAP. Have you seen any weakness there from the European consumer?

Yes, so, let me be careful on my comments. Part of the decline was SAP-related to our wholesale customer base. I would say the overall decline is continued softness in the wholesale customer base, no different than we've seen here in the US. The higher -- the department stores, at the upper end of the economic strata have done fairly well, and our own retail stores have done fairly well in Europe. The lower end, more value-oriented department store chains have had some pressure. And we're seeing that similar trend that you have in the US, you're seeing that in Europe as well.

So, it was overall weakness in the wholesale channel, and that channel was also the channel that was most impacted by our inability to fill short orders through SAP. So, if they had a great July because the weather was up and they needed replenishment, we couldn't have filled some of those orders during the quarter.

Did you see any -- did you see trends deteriorate throughout the quarter in Europe, or were they fairly consistent?

I think pretty consistent. It's hard to really see because we work ahead, but I think it's fairly consistent.

Okay, great. Thanks for the color.

Todd Harkrider, UBS.

Todd, I know you're going to ask Chip a really tough question.

[Laughter] I'm going to let him off easy. He just started. But congratulations, Chip. It seems like Levi's a great global brand, as you're definitely aware of. I guess, to continue on the wholesale theme, it seems like half of your sales growth this year has been from the retail channel, despite it only being like 18% of your consolidated sales. Can you give us a little bit more color on the wholesale side, in regards to what you are seeing in units today versus during the recession?

And if the price elasticity is kind of what you expected, especially on the value format? It kind of sounds like it doesn't [stick] as much as you wanted it to. Thanks. And just a follow-up, just on A&P real quickly, just like in the -- when you [meant] consistent with last year, I assume you're talking about on a dollar basis, as opposed to the percentage basis?

Yes, a dollar basis on the A&P question. You know, wholesale, let me start, and then Chip may want to add to this, because he's met with some of our wholesale customers and might have some views there. I think, in general, we are seeing in the economy this dichotomy that's continuing to evolve, in which the top end of the marketplace doesn't seem to be impacted. And in many of our core wholesale customers of the top end, our brand has only gotten stronger and our volumes have grown. It's at the lower end of the value chain -- not pure value, but the more mass-market and value-oriented wholesale customers, where the consumer has just been more cautious. And difficult-to-handle price increases.

So, the average back-to-school shopper who went in to buy two pairs of pants for their kid saw a pair of pants that, for any brand, that may have been up anywhere between 10% and 25% in price. That two pair of pants turned into one pair of pants. And we hope it was Levi's, but it's clearly a tough environment for consumers right now. And so, that's really the constraint that we have seen. And I think while it felt a little better in the first and second quarter, I think the -- without follow-through in employment and without growth in the economy, I just think the consumer has probably gone back into the cellar for a little while.

And that's why, I think, Chip said we are very -- and I said we are very cautious about the back half of the year. And I'm cautious going into next year as well, because I just don't see a lot of signs that the economy is going to reemerge. But I am starting to sound like an economist, so I'll avoid going much further than that. But I just think that's the major driver in that part of the market.

I would just add a couple of other thoughts here. At the top end, with the more premium department stores and even in our own mainline stores, what we're seeing is -- our products, which are well-differentiated, that bring a lot of innovation, we can command a premium price. We're getting it. And the higher end of our business is doing just fine. It's the real price-sensitive price shopper today who is really feeling the squeeze. And that is most evident in our mass retail business, with products that are maybe a little bit less differentiated, we don't have the same innovation, opening price points have been a challenge for us on a couple of businesses.

Dockers was hit particularly hard with a price increase. And that's where we're seeing it most. So, I think what you are really seeing is kind of a -- almost a bipolar situation, where the top end will continue to do well. We're going to continue to drive that with innovation and strong differentiation, products like Curve ID for women, Water<Less jeans, across the line, and that's working. It's the real price-sensitive shopper that's the challenge for us right now.

But I would add to that, that that's where we see some of the biggest opportunity for ourselves to continue. We have a great -- exceptional market share in those channels, we have great partners in our wholesale customer base, and we are working very closely with them to try to make sure we are building product that best fits their consumer and leverages the strength of Levi's and the quality that we have been able to bring to the table. That's been the core of our business for a long time, and we are going to continue to make sure it's the core going forward. And I think we are very excited about it, but that's where we are seeing the biggest economic challenge.

I appreciate it, that's helpful. And then, quickly, can you give us an early read on what you expect pension contribution to be next year?

Not yet. We true up the plan every June, so we're just coming out of that process. Well, let me -- I'll say the -- answer the question different. If you can tell me what the stock market is going to do by June of next year, I'll tell you what the pension contribution is going to look like. So, no, it's just too early. We'll try to give some guidance next year at the start of the year, like we've done in the past.

And with all the volatility in the markets, I think if we -- any of us had that answer, we would be retired by now.

Yes, you got it.

Appreciate it. Thanks for taking my question.

Kevin Coyne, Goldman Sachs.

I may have missed it, but I know, regarding gross margins, you've stated a range in the past of high 40%s to low 50%s, and obviously the 47% margin this quarter kind of comes in at the low end. Is that a safe low end to kind of use going forward? Or with the higher cotton coming through, should we be thinking a little lower than that number? I was just wondering if you could comment.

I'm still comparable with the high 40%s, low 50%s. Obviously, cotton challenges that, and trying to maintain inventories challenge it. So, I think you're going to have to -- the best thing to do is look at the seasonality of our gross margins and how that trended in the year to try to forecast where we're going to come in for the rest of the year. We'll give you some guidance at the end of -- or the start of next year, like we did last year.

But I think we're going to be obviously challenged like we were this quarter, relative to this time last year. And we'll probably see a similar trend going through next year, through the end of next year -- or through the end of this year, as well. But it's really, for us, it's less of trying to plan relative to pricing, because we just have this unknown around some of the supply and inventory. And we're trying our best to balance the margin with balanced clean inventories and keep the cash level strong by trying to make sure we liquidate inventories when required.

Okay, that's fair. And then, just turning to Europe -- obviously, over there some countries are getting headlines as being more challenged than others. And we could all probably list which countries those are. Are you seeing those countries underperforming over there? Or is it just more or less a broad-based weakness across the whole continent over there? I was wondering if you could give any color?

I think your read of it is right, which is that the countries that are making the headlines are where the consumer is feeling the most pressure, and that's where we are seeing it in our business. So, it tends to be more southern Europe than northern Europe. You can go down the list, but you pretty much nailed it.

Okay, thank you.

Jeff Kobylarz, Stone Harbor Investment.

Chip, you mentioned, I think, in your comments that you said for back-to-school, the consumer is buying closer to the need. So, were you talking about your wholesale customers? Are you talking about your -- the end buyer, the consumer? And are sales being delayed now into the fourth quarter from your third quarter?

I was really talking about the consumer kind of buying it to wear. But I -- as I said in one of the questions, our retail customers are also trying to manage their inventory pretty tightly. They didn't change their open to buy, so as the prices to them have gone up, they've been managing their inventory a little bit tighter. So, it's really both.

Yes, and Jeff, we're -- our quarter's at the end of August, and to the extent that some of the August back-to-school shopping was muted, we can't give you a comment on what's gone on in September. But I think most retailers have said that August was not as robust in the back-to-school, and we clearly saw that in the data that we see on our own business.

Right, okay. And then, your gross margin being down 170 basis points -- you mentioned some inventory markdowns and not being able to pass through the cost increase of cotton. Is there any way to break out the 170 basis points, how much of that is more of the inventory markdowns versus gross margin squeeze?

No, I can't do that. But I would just say that clearly, inventory had a major impact in that, to try to maintain the margin and the cash balance and the forward inventory levels.

Right, okay. And then, your AP to inventory ratio, it's down 33%. It's down 1,000 basis points. What's your incentive to pay down the trade, more so than last year? Are you getting a discount by doing that?

Yes, most of our payables are for product, and we work very closely with our supplier base. And so, we tend to try to drive payables to be pretty consistent. We might see non-product-related payables change a bit; but the core component of that is really trying to work with suppliers, and to some extent we've tried to be more supportive to suppliers during the tough time that we've seen over the last nine months, to make sure that they didn't go out of business.

These would be typically cut-sew manufacturers or denim manufacturers that are responding to cut-sew manufacturers' orders from us. So, we've just tried to be as supportive as we possibly can, by either extending our payables to them or being careful. We just don't have that much degrees of freedom around those supply base.

Sure. Okay. All right, thank you.

Okay. Well, I appreciate everyone's questions. I think -- Chip?

Well, thank you all. To close, the Company drove top-line growth, despite a challenging fall season. We'll continue to face headwinds in the fourth quarter, as consumers remain cautious about their spending and we continue to work through the impact of cotton pricing. We're focusing on navigating through this difficult environment by operating more efficiently and offering consumers the craftsmanship and value they expect from our iconic brands. So, thank you for your time this afternoon, and I look forward to speaking with you further next quarter.

Thank you. This concludes today's conference call. Please disconnect your lines at this time.