…ladies and gentlemen, and welcome to Levi Strauss & Company Third Quarter Earnings Conference Call for the period ending August 25, 2019. [Operator Instructions]. 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 two hours after the completion of this call through October 14, 2019. Please use conference ID 6988596. This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for 1 quarter on the company's website: levistrauss.com. I would now like to turn the call over to Aida Orphan, Senior Director Investor Relations and Risk Management at Levi Strauss & Co.

Good afternoon, and welcome to our quarterly conference call. I'm pleased to introduce members of the Levi Strauss President and CEO; and Harmit Singh, Executive Vice President and CFO. Before we begin, let me briefly remind you of a few items. Our discussion today may include forward-looking statements, including statements regarding our strategies and expected financial and operating performance. 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 these statements, as more fully described in our annual report on Form 10-K, our registration statement, today's earnings press release, and our other filings with the SEC, all of which are available on our website at levistrauss.com. We disclaim any responsibility to update our forward-looking statements. Other unknown or unpredictable factors also could have material adverse effect 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. Participants on today's call may discuss non-GAAP financial measures. Reconciliations and descriptions of our non-GAAP financial measures are available in the investor section of our website as well as in today's earnings press release. Finally, today we filed our quarterly financial report on Form 10-Q with the SEC, which is now available on our website. Now I'll turn over the call over to Chip Bergh.

Thank you, Aida, and good afternoon, and thanks to everyone for joining us here today. We delivered strong third quarter results and remain on track to achieve our full year expectations. Revenues of $1.45 billion in the third quarter were up 4% on a reported basis and 5% on a constant currency basis. This brings year-to-date revenue growth to 8% in constant currency. Our strategies to strength the Levi’s brand and diversify the business beyond U.S. Wholesale and men’s bottoms to faster growing markets in categories have helped us deliver these results and offset the challenging U.S. wholesale dynamics. Our strategies are working and we are confident in the future. I’ll briefly touch on some key highlights from our third quarter, all in constant currency and versus prior year. Our international results were again very strong. Europe grew 18% on top of 17% a year ago, and Asia grew 12% on top of 10% a year ago. The global direct-to-consumer business was up 12% and has now grown double-digits for 15 consecutive quarters, and within that our e-commerce business grew 21% with increased e-commerce traffic in all three regions. Our total women’s business grew 12% which was the 17th consecutive quarter of growth in women’s with each of the last 11 quarters being double-digit growth. And our total tops business was up 17%, a 15th consecutive quarter of double-digit growth in tops. The Levi’s brand continued its momentum delivering 8% revenue growth in the quarter on top of 12% growth a year ago. Levi’s brands strength is driven by our ability to bring the brand to life for our fans to reading product and marketing. With a history of nearly 150 years for Levi’s brand is both iconic and relevant as we continuously re-invent the brand and lead the industry…

Thank you, Chip. And welcome to everyone joining our call. My comments today with reference third quarter comparisons on a year-over-year basis in U.S. dollars unless I indicate otherwise. Third quarter revenue of $1.45 billion grew 4% on a reported basis, and 5% in constant currency. The contributions by region, channel and category of the five points of constant currency growth were as follows; by region 5 points of growth from Europe and two points from the Asia, were partially offset by lower sales in the Americas. By Channel, three points came from our company operated stores, one point from e-commerce and one point from global wholesale. And by category, 6 points of growth generated by a diversification into Levi's, women's and tops was partially offset by a decline in Dockers. Levi's men's bottoms were flat for the quarter. Third quarter gross profit of $767 million represents an increase of $25 million despite $11 million of unfavorable currency translation. Gross margin of 53% declined 20 basis points on a reported basis due to currency headwinds, from a stronger U.S. dollar. Excluding all currency effects, both translation and transaction, gross margin expanded by 40 basis points driven by the margin benefits of our direct-to-consumer and international growth. We are also starting to see benefits of the price increases, we have taken globally, was substantially mitigated, the product investments we have made. Third quarter SG&A expense of $596 was up 2% or prior year. SG&A as a percentage of revenues improved by 60 basis points. High investments in direct-to-consumer expansion, technology and distribution capacity were more than offset by higher incentive expense -- compensation expense last year, reflecting performance significantly ahead of internal expectations in 2018, and a lower impact from previously cash settled stock-based compensation awards. Additionally, we drove leverage on…

Thank you. The floor is now open for questions. [Operator Instructions]. Your first question comes from Matthew Boss with JPMorgan. Go ahead with your question.

Thanks for all the color, guys. Maybe just on U.S. wholesale revenues as we think about the 4% adjusted underlying decline in the third quarter that you laid out ex some of those items. I guess what's the magnitude of improvement that you're expecting as we think about the fourth quarter? Maybe help us to think about underlying U.S. wholesale run rate as we think about next year? And just larger picture as we kind of parse through this' with the department store softness does this impact your ability to drive mid-single digit underlying revenues as we think about next year and beyond?

So, I'll answer your last question first and then come back and talk about U.S. wholesale specifically. In short, I think our growth algorithm remains completely intact. Our ability to grow LSA in the 2% to 4% range remains unchanged. And it's fundamentally driven by the underlying strength of the Levi's brand across the whole region, which is best evidenced by the strength of our DTC business. On wholesale, excluding those one-time dynamics that we talked about, which was worth six points, the balance of the underlying trend of negative four as we said in the prepared remarks, we do expect that this is going to be the toughest comp for the quarter -- for the year, toughest comp quarter for the full year. I think it's fair to assume over the long haul that we are going to be able to manage our U.S. wholesale business to be about flattish. That's what we been saying all along. We've really been focused on structurally evolving our U.S. wholesale business to be sound than it was as we enter the year. So things like exiting as much as possible the off-price business which comes at a really low gross margin and is not healthy for the brand as we do that that strengthens our business structurally. And things like testing the brand in Target, which still is continuing to do really, really well at a very good price point by the way. So, I'm confident that we're going to be able to maintain that business in the flattish in terms of total dollars and as a percentage of our total business it will continue to decline as we grow our faster growing businesses of DTC and international.

Hey, Matt, as I'd mentioned, on adjusted basis you can take the three factors out. Our U.S. wholesale business is fattish on a year to-date basis and we expect the same for the year. In terms of anniversary [ph], Dockers reset is going to be fairly minor in quarter four, and we're resetting off-price, we expect to reset off-price by Q1 of 2020. So we anniversary most of these one-time factors over the next quarter or so

Great. And then just one follow-up. On the gross margin maybe, Harmit, could you just walk us through the drivers of gross margin expansion in the fourth quarter, and then just as we think multi-year just maybe the puts and takes on the gross margin line? Thanks.

Sure. So I think if you think of the quarter, our gross margin ex currency was up 40 basis points. I would say the expansion of direct-to-consumer and international helps gross margins 40 to 50 basis points. We have taken price increases globally in the U.S., Europe and Asia, and those price increases are offsetting our product investments. And then there is just saving from sourcing and the like. So that's really what's driving us in quarter four because we're upping the top end of our gross margin range, ex currency to 40 – from 40 to 50 to 40 to 60. That's largely driven by the fact that we expect lower off-price sales in quarter four. And as Chip mentioned, those sales come at lower, much, much lower margin. So that really benefits us. And currency I think in quarter four will be a much lower impact as you've seen in quarter three. It's kind of progressively come down over the last couple of quarters. Does that help you, Matt?

We'll take that as a yes. Next question.

Your next question comes from Paul Lejuez with Citigroup.

Hey, thanks guys. Can you talk a little bit about Europe business? I'm curious on the wholesale side that revenue growth -- how much of that is being driven by new doors this quarter versus same-store sales. And same question for DTC, the percent driven by new store openings versus comp growth in that region. And then I guess just one follow-up on the U.S. wholesale channel. Can you maybe break out for us how growth in the channel, contraction in the channel looks by department stores versus the mass channel versus specialty? Thank you.

So, first question was about Europe, right?

Yes, sir.

So, if you think about a business in Europe, our business in Europe was up 14% on top of mid-teens growth. Last year it was across all channels. So wholesale was up 18. I think. Direct-to-consumer was up 18. The channels are fairly -- really work together fairly harmonious from that perspective. In terms of is it more doors or is it comp sales? I would say, our comp sales performance in Europe is probably the strongest around the world. We've had generally positive traffic in quarter three in Europe and in Asia. In the U.S., traffic in the outlets is slightly down, but more than offset through better conversion, and conversion and increased unit per transaction leading to positive comp. So I think it's a combination of both new doors as well as comp sales. The fun fact in Europe is between franchise and company doors. We're opening one new door a week on a gross basis, okay?

Okay. And just same on the wholesale side, is it mostly the new accounts? Or is it same accounts, same chains that you're just selling more to?

It's largely same chains we're selling more to, but we're selling more of lifestyle, as women's business and our tops business continues to grow to build more of a lifestyle. So we are selling more products and obviously taking more floor space given the strength of the brand.

Got you. Thanks from me.

The question, Paul, just to answer your question on U.S. Wholesale, Chip talked about incremental penetration in premium retailer. So our premium business in U.S. wholesale is up 8% for the quarter, 16% year-to-date. We're also growing our digital footprint in the U.S. and that's across pure players as well as wholesale.com and that business in quarter three was up 20%. So again, our strategies are to grow premium and to continue to grow digital, and that's offsetting some of the traffic declines in traditional department stores.

Got you. Thank you. Good luck guys.

Thanks.

Your next question comes from Bob Drbul with Guggenheim Securities.

Hi. Good afternoon. Just a couple of questions from me. The first one is, can you just elaborate a little more on the Target test. And I guess specifically, are you seeing any cannibalization with other retailers or do you think it's purely additive with the Red Tab? And I would also just be curious to know within Target do you think that it's impacting the Denizen brand at all?

Okay. So, Hi, Bob. So, the Target test just to take everybody back. We started with the 20-door test early in the calendar year. They actually came to us. They had consumer research with their guest that indicated that the brand that they most wanted to buy in Target but couldn't buy was Levi's, the most searched item on target.com that people couldn't buy was Levi's. And so, we started with a 20-door test just on men's and in those 20 doors, we pulled Denizen. And so, Levi's was purely incremental at really good price point. So it was Levi's men's. It was bottoms, tops and some trucker jackets. The bottoms, we included some of our latest, most contemporary fits like the 502, which was priced around $50. We quickly learned that their guests loved finding Levi's in their stores. We work with Target to have great in-store presentation. The merchandising is really well done. And the test in short it worked. We look very, very carefully at the impact of cannibalization because this was purely a left pocket right pocket, we're just shifting Levi's from one customer to another and not gaining incremental share from this. We weren't interested in pursuing it. And we -- so we drew a five mile radius around every test store, and we'd look at the incrementality of the test, and it was incremental. So we have now -- since now expanded to 50 doors on men's and we have started a 20-door test on women's, which is also off to a very good start. May recall last quarter I said, at full potential, this is we're really focused on the urban doors and the college town doors. And one of the things we're learning is we're converting a younger target consumer who isn't shopping at the malls and they're discovering Levi's at their Target, and we're converting them on some of our premium wholesale product. So feels really, really good. And it does appear to be truly incremental. So, full potential, this is probably somewhere in the range of a couple hundred doors, 200 doors or so, but we're continuing to work with the Target team, but feel really good about the progress that we've made. And this is part of as I said in those prepared remarks. This is part of evolving the structural nature of our U.S. wholesale business and this one seems to be a good one for us.

Got it. Great. And just the second question is on the marketing side, can you just talk about the plans for the fourth quarter and sort of how you're managing the marketing budget even as you look in the next few quarters into the next year?

Yes. From a financial standpoint, what we've guided is that we expect advertising to be about flattish for the full year around 7% of revenues and that implies that it's a little bit heavier in the fourth quarter, which is normal given the seasonality, and so we are going into the holiday season, loaded and ready to bear. As I said, we've got a number of really strong collaborations connecting with consumers digitally around the world is really, really important. I talked about the collaboration that we've got with QQ Dance in China, which really is awesome and we're connecting with the young consumer through that, and really marrying the virtual world, the digital world and the physical world with product that consumers can put on their avatar in the game and buy for themselves. So we've got a lot of exciting things but just continue to put the brand at the center of attention. And we will continue to double down on our marketing every time we do it, it appears to be working. So we feel really confident as we go into the holiday that we've got a really strong program lined up for the fourth quarter and through the holiday season.

Great. Thank you very much. Good luck guys.

Thanks Bob.

Your next question comes from Alexandra Walvis with Goldman Sachs.

Hey guys. Thanks so much for taking the question. I wonder if you could dig a little bit more into the strategy with respect to off-price. So could you remind us when the decline in sales to that channel started, perhaps your views on how long that will continue? Any color on how big off-price is a percentage of the American business today would be would be helpful. Where do you see that going over time?

Okay. So, hi Alex. So first of all, just to back up, we don't make the full off-price. There are a lot of apparel manufacturers that see that as an ongoing channel. They build products, specifically to hit those price points and they're kind of in there on an ongoing basis. We do not do that. We treat off-price purely as a channel for selling distressed inventory. We sold a lot last year because part of the Dockers reset as a matter of fact we had to get rid of a lot of inventory. So, we have a lot of it in the base period. We kind of -- our inventory position really started to get very clean as we were coming into Q2 of this year. So there will be some hangover on off-price going through Q1 of next fiscal year. But our objective as we continue to manage our inventories pretty aggressively is to avoid using off-price. We will only go to off-price when we are trying to get rid of distressed inventory. It's not healthy from a brand management standpoint, it's not, certainly not attractive financially, but finding Levi's in one of these off-price customers at $14.99 [ph], just makes it really, really hard to sell Levi's at full-priced in this market. So that's how we're trying to manage it. The off-price cycle will end in Q1 of 2020 from a lapping standpoint. Is that answer your question?

It does indeed. Thanks so much. That's very helpful. And one more if you wouldn't mind me sneaking in and follow-up to some of the earlier questions. Could you give us any color on how fast your Signature grew this quarter and then perhaps also Denizen given some of the measures that you're taking in Target?

Yes. So both of those brands we didn't even talk about it in the prepared remarks. Both brands were essentially flat for the quarter. One of the things in Target, I did say that as we tested Levi's Red Tab in Target, we pulled Denizen. We have had a conversation with Target about going back in testing Denizen, because it plays in a very different price point and Target is a very different consumer. So going back into some of those original test stores and seeing what happens when we put Denizen back in incrementally.

And Alex the flat for the quarter was on the back of a 15% growth in quarter three of last year.

Awesome. Thanks guys for all the color.

Thank you.

Your next question comes from Kimberly Greenberger with Morgan Stanley.

Thank you so much. I'm wondering if you could just talk about the accounting impact when you acquire a distributor. Is there a sort of subsequent benefit in future quarters to revenue to EBIT dollars? If you can just sort of walk us through how to think about the impact? And then understanding that you're not giving 2020 guidance today, I'm just wondering if you have a view of how we should on a preliminary basis think about FX impacts going into next year? And then lastly, China, you indicated grew modestly in the quarter. I'm wondering if that sort of meeting your expectations. And what are sort of puts or takes in China as separate from Hong Kong? Thank you.

Okay, Kim. Let me answer one and two and then Chip can answer China. So let's take the first one which is the acquisition. Our distributor model is very similar to the wholesale model which is it's a sell-in model. So we sell into the distributor, they mark up and book the consumer revenue at their end. As we -- when we announced the transaction and the transaction is very consistent with capital, our philosophy to deploy capital to growth as business and actually growth in markets where we think we can drive the business faster than in some of our partners. So, the reason we stopped selling in quarter three and quarter four was largely to avoid the accounting issues that you're talking about, plus the distributor had enough inventory. And so in terms of the change in the business model what will happen is post the acquisition, the business model will move from wholesale business model that we were recognizing the revenues based on sell-in to a consumer business model where we recognized revenues based on sell-out. So that's the change. We will give a perspective on the impact of the acquisition in 2020 when we talk about 2020 guidance in early 2020, when you report quarter full earnings. We're in the process of taking a hard look on what is the impact of the business conversion, plus importantly what are the dollars and cents we have to invest, whether its in advertising, whether it's in organization. But intrinsically, we believe that this transaction is accretive to EPS over the long term and does accelerate growth in that market. So that's the question on the acquisition. To your question about FX, if I could predict FX, I'd be probably doing something very different. But what I would say right now is -- it's probably best to use today's rates as the best proxy. When we close out the year and talk about 2020 at that point, we'll indicate the impact on 2020. But I think the best indicator is probably current spot rates. And the last question I think was on China.

Okay. So on China, I think just backing way up since we're new to a lot of you. China is still a huge opportunity for us. It represents about 3% of our total business overall. As we said in the prepared remarks, it grew 2% in the quarter primarily driven by the strength of our business in company-operated doors. We've been evolving our China business over the last couple of years. Go back two fiscal years, we declined in China. Last fiscal year we were flat. We took a number of steps in China last year to set ourselves up for success long term in China. So we took back a number of franchise stores in Beijing and Shanghai where we own and operate our own doors. We stopped heavily discounting in Tmall and now we're basically selling predominantly full-priced products, and we are now moving to premiumize and super premiumize that marketplace, because that's what's working there if you look at other, particularly look at other brands. So I talked a little bit about this new store that we opened in Wuhan. It's 7,000 square feet. It's over three levels. That store features expansive sections for all of our premium collections including Levi's Made and Crafted, Levi's Authorized Vintage and Levi's Vintage Clothing. It's also got a massive tailor shop. So we're putting kind of customization and personalization right at the forefront of everything and we're going to continue to focus on strengthening and premiumizing the way that Levi's brand shows up in that marketplace. We've got a brand new team on the ground and that's been -- that's led by Amy Yang who we hired about a year ago. She's Chinese. And we're very, very optimistic that we've turned the corner and we expect kind of much stronger results over the next couple of years as it represents one of the biggest opportunities we've got.

Terrific. Thank you.

Thanks Kim.

Your next question comes from Omar Saad with Evercore ISI.

Thanks for taking my question. I guess I'll ask -- I wanted to ask about tops. Looks like it accelerated to the mid -- from mid-teens to high-teens. It's an area in your business where maybe there's been some skepticism about the sustainability, in the fashion quotient there. But the Graphic Tees piece, I think you said was only plus six. So maybe help us deconstruct what's really working in that business; men's, women's, international. Is it all trucker jackets? And help us to think about some of the strategies going forward for that category? And clearly you're being able to sustain the level of growth at a high rate, you know maybe perhaps higher than somewhat expected? Thanks.

Thanks Omar. Clearly an under penetrated opportunity for us, the acceleration quarter-over-quarter from that perspective is largely driven. If you think about our tops business, think about a third being Tees, made up the bulk of it Graphic Tees. A third truckers and sweatshirts and a third, woven and other stuff that we don't sell a lot of and there's a huge opportunity. I think polo T-shirts from that perspective. The acceleration in quarter threes relative to quarter two was driven by truckers and sweatshirts really growing at a much faster clip than the average that we indicated of 17%. And as you think about our longer term opportunity and just get a preview of what's coming down the pike for H1 and H2 of 2020, I think is really focusing on the other opportunities we have. I think is what makes us confident that we can continue to grow this for a long, long time.

There is time for one more question.

Your next question comes from Dana Telsey with Telsey Advisory Group.

Good afternoon everyone. As you think about the wholesale -- if you think about the wholesale business and the shift that's going on whether to more premium or to Target, how do you see department store penetration changing? Will we see a shift in the account base of wholesale? And just lastly on price increases that you mentioned, which began to be initiated. Is that globally? And how does it range by category? Thank you.

Yes. I guess I'll take the wholesale footprint piece. I mean, as we've said before the channel, especially department stores and the large chain stores, which is the bulk of our legacy wholesale business, its facing structural headwinds and challenges. And one customer has gone bankrupt, that customer used to be our biggest single wholesale customer not even 10 years ago. And they are almost gone. And so there's going to continue to be door closures. We're going to continue to see these customers that are over store cutting from the bottom up. To-date, fiscal year to-date we've faced over 700 doors that have closed where we were in distribution and that is going to continue for the foreseeable future. And so, our commitment has been to continue to run this business, to try to manage the revenue which is profitable revenue in this channel to be about flat over time. I think it's inevitable that we will see a shift in what that footprint looks like as some of these bigger legacy customers close doors that they need to close, and we are mapping the market and trying to preserve our wholesale business by being in the right place at the right time. And I can't crystal ball exactly what it's going to look like in three years or five years, but our commitment is to -- and what's built into the growth algorithm is that we will be able to maintain this business about flattish over time. And if you look at our track record, that's what we've been able to do despite all the headwinds over the last three plus years. So I'm confident in our ability to be able to continue to do that. And then quickly to answer your question about pricing, we had more during the road show as well as when we had met with all of you last couple of weeks we had said pricing is an opportunity for us. The brand has pricing power. We have taken several pricing actions globally, for example in the U.S. we raised prices on some of our fits, the 502, the 514, the 527 by $10 and it's largely sticking. We've taken several actions in Europe and Asia. In Europe in different markets we have taken pricing between 3% and 5%, similar in Asia. That's generally speaking, we're seeing an increase in AURs and that's indicative, plus, just the performance if you look at what's happening in Europe and Asia there's this indicator of the fact that the brands how [ph] can we able to take pricing. So as we think about pricing strategies longer term, it’s all about pricing for inflation and trying to offset currency as one bucket. It's about reducing markdowns where we can. And thirdly, it's about pricing for innovation. We did price in the second half for our Levi's engineer jeans in Asia, and for example that's also helping.

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

I was just about to go there. So with that, I suspect we will probably be the first earnings call to wrap by wishing you all a happy holiday because we won't be back with you all until after the holidays when we report our fourth quarter. So I wish you all very happy holiday. We'll talk to you again in the new calendar year. Thank you all for dialing in today.

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