Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co's Second Quarter Earnings Conference Call for the period ending May 28, 2023. All parties will be in a listen-only mode until the question-and-answer session, at which time instructions will follow. This conference call is being recorded and may not be reproduced in whole or in part without written permission from the company. This conference call is being broadcast over the Internet, and a replay of the webcast will be accessible for one quarter on the company's website, levistrauss.com. I would now like to turn the call over to Aida Orphan, Vice President of Investor Relations at Levi Strauss & Co.

Thank you for joining us on the call today to discuss the results for our second fiscal quarter of 2023. Joining me on today's call are Chip Bergh, President and CEO of Levi Strauss; and Harmit Singh, our Chief Financial and Growth Officer. We have posted complete Q2 financial results in our earnings release on the IR section of our website, investors.levistrauss.com. The link to the webcast of today's conference call can also be found on our site. We'd like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular, the Risk Factors section of our Form 10-K and the information included in our quarterly report on Form 10-Q that we filed today for the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today, and we assume no obligation to update any of these statements. During this call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for our GAAP results. Reconciliations of our non-GAAP measures to their most comparable GAAP measures are included in today's press release. Finally, the call in its entirety is being webcast on our IR website, and a replay of this call will be available on the website shortly. Please note, for the balance of the remarks, Chip and Harmit will reference year-over-year revenue growth in constant currency. Today's call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And now, I'd like to turn the call over to Chip.

Thank you, and welcome everyone to today's call. We delivered a solid quarter in line with our expectations. Our results reflect two very different dynamics in our business, on one hand, strong DTC and International and on the other continued softness in U.S. wholesale, which I will address in a moment. Revenues for the quarter were down 9%. However, this was mostly attributable to the $100 million shift in revenue from Q2 into Q1, primarily due to the ERP implementation in the U.S. which we discussed on our last call. Excluding this shift, Q2 was down 2% versus prior year and first half revenue was flat against a difficult plus 23% comparison versus year ago. Our strategic growth priorities are performing at or above our plan. Our DTC business, the most premium expression of the Levi's brand globally continues to perform very well, up 14% in Q2 with broad based positive comp growth and AURs up mid-single digits. The continued strength of our DTC first strategy, which grew to a record 44% of total sales in the first half underscores our confidence in unlocking Levi's tremendous brand value. Our international business also remained strong growing 8% or 10% excluding Russia, led by continued momentum in Asia and Latin America. International has been the fastest growing part of our business over the last few years and it represents one of our largest opportunities going forward. However, this strength in International and DTC has been more than offset by a soft U.S. wholesale business. Today, U.S. wholesale represents less than 30% of our total revenues, down from 40% a decade ago as our strategic focus has been to grow DTC and International. And while first half U.S. wholesale revenue was down from last year on difficult comparisons, U.S. wholesale revenues are still…

Thanks. In the second quarter we delivered on our objectives for revenue, profitability and inventory, while continuing to advance our strategic initiatives in a challenging environment. We delivered strong results in our global direct-to-consumer channel and are seeing positive momentum in our international business. These businesses today make-up the majority of our total revenue and are the primary drivers of our long-term growth and margin objectives. We also made progress in several other key areas of our business. In the quarter we meaningfully reduced our inventory position and our U.S. service levels improved as we exited the quarter, giving us confidence to now say we will end the year with inventories below prior year levels, ahead of our initial plan. Also, highlighting our commitment to long term investment, we accomplished a major milestone with our U.S. ERP upgrade, a cloud solution allowing us to leverage data more productively. That is also the foundation to growing our DTC and digital businesses. Related revenue impacts are also now behind us. While we are lowering our outlook for the back-half of the year, given the dynamics impacting U.S. wholesale, we have several initiatives Chip mentioned to drive stronger results in this business in the second half and the longer term. In the second half revenues, gross margins, EBIT margin and EPS are all expected to be up to prior year. To put this into perspective, second half sales are expected the same run-rate as the first-half. The back-half will also benefit from incremental sales drivers and margin tailwinds from lower product costs and freight, laying a solid foundation for next year. And we will end the year with a structurally stronger business with a higher growth and gross margin accretive DTC and international businesses, representing a greater share of the company. I will…

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Matthew Boss of JPMorgan. Your question please, Matthew.

Great. Thanks. So Chip, could you elaborate on current demand trends that you're seeing in the U.S. relative to Europe today? Could you provide an update on the denim category and market share trends? And then Harmit, what is your level of expense flexibility if macro trends worsened globally in the back half?

Hi, Matt. Thanks for the question. I'll kind of take this -- I'll start with the category, then I'll dig in a little bit deeper and talk market share and the contrast between U.S. and Europe. So first of all, on the category, you may remember that we only get quarterly data here in the U.S. So outside of the U.S. internationally, we don't get -- we don't really get any market share data or market data. So all we've got is U.S. data. And as you know, since the pandemic, there have been wild swings within the category, extreme downs, extreme peaks, extreme downs, lots of volatility. But if we take a look on a past 12 month basis through May, we are up against the biggest spike in category growth. So the May 2022 past 12 months versus May of 2021 past 12 months was a 20-plus percent spike in the category. That's the base that we're up against right now. And if you look at it on a past 12 month basis, we were down modestly versus that peak. The key point, though, when we take a look at the denim category overall in the U.S. is the category today on a past 12-month basis is 12% bigger than it was in 2019, 12% bigger than the pre-pandemic period of time, and that's on a dollar value basis. I'll talk about market share here in a minute. In the U.S., as we talked in the script, in the prepared remarks, it really is a story of two different channels, U.S. wholesale being very soft, paradoxically U.S. DTC much stronger. And I say paradoxically, because we're very strong in our U.S. mainline business, which is the most premium expression of the brand. But digging into U.S. wholesale, there…

Yes. So let me talk the levers that we could push further. But let me just talk a little bit about what we're doing. So overall, Matt and everybody on the call, you're familiar that as things tighten, we can really tighten expenses. COVID was a good example and readjust our expense base to whatever new revenue base there is. What we've been doing so far this year because, it's not only a tale of two halves is also a tale of two worlds, and it's a tale of two channels. The channel -- international is working. Direct to consumer is working. So we're putting -- we're reallocating resources to fuel those businesses, and we're tightening costs related to U.S. wholesale. The other thing we have done overall is, we're really focused on discretionary costs, and I'll give you some examples. We have tightened travel. We've tightened new hires and the like. So for example, on travel, because we've been this business for the long term, we're still ensuring that people travel to meet customers, meet consumers, while most of the other travel is kind of on hold. If things get worse, we will look at what's still open. Hires, we're not hiring new heads. We're hiring critical heads. If things tighten, we'll tighten that and take a hard look at fixed costs from that perspective like we did during COVID. So again, realigning our cost base to drive the prospective revenues, I think, is an important principle. And we have tightened quite a bit the few other options available, but we run this business for the long term. But the important point to think about Matt is, and I think I said it in my prepared remarks, there are some critical pieces that are becoming tailwinds. COGS, for example, commodity costs and [indiscernible], which was a headwind in H1, it's going to be a tailwind, especially as we start thinking exiting the year and thinking about 2024 and ensuring that our costs are maintained, so that we drive profitability and get to that magic EBIT margin number that we laid out at Investor Day is critical for us.

It’s great color. Best of luck.

Thank you, Matt.

Thank you. Our next question comes from the line of Bob Drbul of Guggenheim. Your question please, Bob.

Yes. Thank you. I guess just my question probably for Harmit. When you think about the decline, the outlook that you've lowered in the second half of the year, can you just give us a little more color on the cadence expectations, you gave from gross margin, but between Q3 and Q4 and some more of the quarterly trends that you're expecting in the back half? Thanks.

Sure, Bob. First, as I mentioned in the prepared remarks, three factors driving the reduction in guidance. And that's despite H2 is still growing. Gross margin in H2 largely flat, but substantially up to 2019, and EBIT margins substantially better. The factors really are a slight reduction in revenue outlook, gross margin lower than what we anticipated largely because of the targeted pricing actions that Chip talked about in his prepared remarks and the last piece is really tax rates slightly higher. In terms of the color on Q3 and Q4, comparisons, as you know, sequentially ease for both sales and gross margins into Q3 and Q4. Growth improves. Our view is low single digit up in Q3 and high single digits up in Q4. The benefit of lower product costs, which is largely driven by cotton doesn't fully materialize until Q4. We still have inventory that we bought when cotton was high, we're going to -- we're working that through in Q3. And the new inventory is at the lower prices and is substantially different. In fact, I think COGS improvement in the new price is about 200 basis points. And so that's something that will not only -- we'll see in Q4, but we can see a substantial of it piece in 2024. SG&A is expected to be up mid-single digits in H2, weighted towards Q3 and EPS, we expect about double the EPS in Q4 versus Q3 just because of the revenue growth and the gross margin expectation. The only other thing that I would probably note for all of you are, what I call, recent trends. Our results are as of May. But recent trends -- we've seen positive trends in wholesale sell-through, especially as Chip mentioned, we are filling orders and making sure there is stock. We're seeing similar trends in DTC and outlets. And so, I think as we fill and ensure the stock situation is addressed, we will see progress. And then once the prices for the targeted fit that we talked about reduced sometime in the next 30-odd days. I think that's where we feel that we can address this price-sensitive consumer and continue to accelerate consumer demand as we continue to grow share.

Thank you.

Welcome, Bob.

Thank you. Our next question comes from the line of Jay Sole of UBS. Your line is open, Jay.

Great. Thank you so much. So my question, hoping we can talk a little bit more about this divergence in performance between the U.S. DTC channel versus the wholesale DTC channel. Maybe Chip, can you tell us how much is sort of just the performance of the channel? It sounds like that the lower income consumer, that middle income consumer is sort of reason for the divergence. But how much is it just those channels themselves are not performing that well. How much is the supply chain issue? How much sort of is the brand where maybe is the brand not resonating as much in those channels? If you can sort of unpack that a little bit, that would be helpful. Thank you.

Sure. And it's really good question, because it is kind of the big paradox as we take a look at the results, our U.S. DTC business, including e-commerce and especially including mainline, are performing really, really well. And that's -- I would say that's -- why that's a strategic focus of ours globally is, we're in control with the brand, we're in control of the consumer experience, we're in control of what we focus on in our stores, we're in control of the assortment in the stores and the consumer comes into the store wanting to buy Levi's. And we're seeing really good success there, as you heard from the results. I think the wholesale dynamic, some of it is clearly the consumer, okay? So as we said, our value brands are down double digits. U.S. wholesale is down double digits. Some of it is definitely a channel dynamic, I think that moderate to lower income consumer is definitely under pressure. And I suspect we're all reading the same newspapers, feeling the trade-offs of needing to pay for a summer vacation versus a new pair of jeans. And I think that's some of it. But we're competing now for other dollars that are being spent out of the consumer's wallet, and that moderate income consumer is having to make some tough choices now. So I think -- I suspect that that is part of it. But there's also the dynamic, as I said earlier, that's within our control. This customer fill rate issue that we've had because of our loaded inventory, as I'll say it that bluntly in prior quarters that as our inventory levels start to trend towards something that's more normal, or the congestion that we were experiencing in our distribution centers has abated and our fill rates…

Got it. That’s very helpful. Thank you so much.

Thank you. Our next question comes from the line of Ike Boruchow of Wells Fargo. Your question please, Ike.

Hi. Thanks for taking the question. Harmit, two follow-ups on the margin guidance to reach. Just the -- I understand the big gross margin downtick in 3Q because of these pricing actions. Maybe I'm not understanding clearly, but why does that then flip in the fourth quarter and become much more favorable, whether it's year-over-year versus 2019? Like why are the gross margins improving once we get out of Q3 due to these pricing initiatives? And then just can you clarify that the SG&A up mid-single digits year-over-year in the back half? Is that what you said? Because that seems a little heavy to kind of get to the guidance that you're giving. So I just wanted to make sure I'm understanding that. Thanks.

Yes. The -- on the gross margin and why should it flip in Q4, because Q4, we will see the full impact of the lower COGS. That's the big switch. In Q3, we still have inventory that we're going to carry over into Q3. What we really did to manage inventory, because our inventory is largely core, Ike, we didn't have to dramatically mark it down. We just cut future receipts to match demand. And that's why in Q3, we still have some of the whole inventory that we're selling in and then the new inventory and new prices in Q4 that is behind us. And so, it's largely -- and that's why you see the big delta in pricing. From that perspective, the pricing is largely similar. It started -- we take pricing about a month from now, about 30 days. So you'll see a little bit of impact in Q3 and a little more in Q4, but it's largely the COGS piece that is making the difference. Our second half gross margins, I think, are going to be north of 56%. We'll end the year [with another] (ph) 56%. And relative to 2019 is still 300 basis points in H2 better. And I think we were asked this question in 2021 by some of you, because we were seeing margins improve 400 basis points relative to 2019, and I’ve estimated that point of time was probably two-thirds stakes longer term. One third, it probably goes over time because we were not promoting inventories, they are very clean, et cetera. And that's bearing out in this fashion. At that time, it's difficult to predict commodity prices. That was a huge headwind in the first half is becoming a tailwind in the second half and cotton futures, at least at this point of time, look at similar levels for 2024. So that stays then, that's a bit of a tailwind in 2024.

And the SG&A in the back half?

The SG&A for the -- for quarter three, we think mid-single digit, quarter four low single digit, H2, low to mid-single digit, on a full year mid-single digit. That's how we're thinking about it at this stage. We still are opening stores, Ike. I mean that's really driving a big chunk of it. I think we opened on a net basis 20-odd stores in the first half, in the second half, it's 50, 60 stores. So that's really driving most of the SG&A, which is really setting up DTC for the long term. But as I mentioned earlier, discretionary costs, et cetera, et cetera, are fairly tight at this stage.

Great. Thank you.

Thank you.

Thank you. Our next question comes from the line of Jim Duffy of Stifel. Your question please, Jim.

Thank you for taking my questions. More from me on the U.S. consumer environment, but a little more focus on perspective from your stores and DTC. How would you characterize your current promotional backdrop? And Harmit, what's assumed in the outlook for the second half with respect to promotions? And I'm also curious if you could speak to consumer activity in your U.S. stores in DTC. Are you seeing slowing trends and price resistance from this consumer as well? Are they buying full price? Or is volume driven by promotion? Thank you.

Yes. So what's assumed in promotions, if you recall, Jim, last year quarter four was fairly promotional. Quarter three, we began to see some promotion, but quarter four was fairly promotional. So our view is, quarter three is probably promotional, probably slightly less promotional than quarter two because inventories are getting better, trade inventories are getting better, our inventory is getting better. And quarter four, it's kind of slightly better than a year ago, and we end H2 probably slightly better than last year H2. That's what we're thinking on promotion at this time. Plus, by taking some pricing actions, in the absence of pricing actions, there were probably deeper promotion on the same fits because people wanted to set by taking pricing actions that will help offset the deeper promotions to an extent. So that's kind of kind of factored in. To your question about our own DTC business and our DTC business in the U.S. is outlets, as well as our mainline stores. Our mainline, we're seeing the consumer and largely consumers earning $100,000 plus less price sensitive. I mean, we do promote on days where it's important, like Father's Day, for example, et cetera, et cetera. Black Friday will happen, but it's very targeted. And the same cadence we have for our outlets, too. And some of the pricing, some of the Tier 3 products that Chip talked about are also sold in our outlets. So that should adjust for the outlook. But overall, we are seeing less promotions in our own stores than probably in wholesale.

I guess I would just add one other thing, Jim, is the other thing that is clearly working in our DTC channel is newness and we're right now at end of season. So if you go look online or shop around, you're going to see a lot of sales us and everybody else because everybody is trying to get ready for the next season. That product will begin hitting the floors later this month, setting us up for back-to-school. And we're really excited because we're excited about the next season and the product that we've got coming in and some of the collaborations and -- but newness definitely works. And we have no product, no problem selling through product at full price when new products [indiscernible] when it's resonating.

Thank you.

Thanks, Jim.

Thank you. Our next question comes from the line Dana Telsey with Telsey Advisory Group. Your question please, Dana.

Hi. Good afternoon. As you think about the mass channel, which I think was down 13% in the prior quarter, how did the mass wholesale channel differ from the other wholesale businesses? And then with marketing, given the birthday of the 501, how is marketing being planned in the back half compared to last year? And then CapEx, is that still expected to be the same number, around $280 million? Or what are you looking for there? Thank you.

So I'll answer the CapEx question, and I'll give the value channel to Chip. But on the CapEx question, I think we had indicated $290-odd million. Our expectation for CapEx is between $290 million and $300 million, something like that. So in and around what we talked about and is largely oriented towards the new doors, Dana, that I talked about and investments to -- on technology really to accelerate our e-commerce business. Those are the two broad areas. And then we've had some infrastructure CapEx. We opened a digital DTC, we just upgraded our ERP and we're building the DC, which will be an omnichannel DC in Europe. So that's why we're looking at some infrastructure investments really to propel and service the growth in our growth algorithm.

Yes. And I may be forgetting the second of the three part question, but the mass channel is soft. And I think softer in general and the balance of wholesale -- balance of wholesale also includes Amazon, which is pretty strong right now. But our value brands, and I would say, in general, the mass consumer overall is under pretty tough economically challenged, I guess, and you saw that in their last results, their last quarter. So -- but that is an in signature, which sell in that channel, respectively, is down double digits. We do have Levi's of target. And I would say Levi's of Target is performing roughly in line with how Levi's is performing elsewhere in the wholesale channel. And that's, I think, collectively, our focus with Target is how do we continue to expand on the success that we've had over the last several years with the Levi's of Target. And I think over time, we're going to the trading out floor space for Denison for more floor space for Levi's. Did you have one other question?

And Dana, your question was, I think, on marketing?

Exactly.

Yes. So in the first half, we spent more than a year ago because of the 501 campaign that fell in H1, in the second half it will be a little less and then we are adjusting our marketing expenses depending on which part of the world is working on hard. And so, overall, our marketing expenses as a percentage of revenue is slightly lower than a year ago.

Yes. And just, I mean, to be blunt, in the U.S., where U.S. wholesale is down, below our plan, we've had to cut advertising expenses in the second half. We did have the 501 campaign globally. Our spending was front loaded this year. And so, we have had to scale back a little bit in the second half just to kind of balance the books and keep our spending as a percentage of revenue, roughly in line with what we guided originally. But in total dollars, the spending is coming down in the second half, reflecting the softer outlook that we have on the top line.

Thank you.

Thank you. Our next question comes from the line of Laurent Vasilescu of BNP Paribas.

Good afternoon. Thank you very much for taking my question. Harmit, Chip, could you hear me?

Yes, we can.

Fantastic. Thank you very much for taking my question. Just two questions, two follow-ups, One on Ike’s question. Harmit, last quarter you gave us a very helpful bridge around the gross margin, noting product cost was a 20 bps headwind. Promotionality was about 300 bps. Maybe you can you just -- for the audience, can you maybe parse that out for the second quarter? And how much are you expecting in terms of promotions for the second half of the year? And then a separate question, great to hear on China that is back to pre-COVID level. Maybe Harmit, could you give a little bit of color on just what you're seeing in China? Are seeing sequential improvement every month in that marketplace?

Yes. So I'll quickly help answer both. So H2, in my prepared remarks, I mentioned gross margin versus last year flat to slightly up. The -- relative to a year ago. So I'd say pricing 70 basis points to 80 basis points, adversely impacting. So a year ago, COGS second half really offsetting that. So that's largely flat. I mean, that's broadly -- there's a little bit of airfreight, which is a tailwind. But broadly, that's what's really driving between the two factors, pricing and the COGS benefit. And the COGS benefit is less in Q3, more in Q4. So we exit the year with a higher COGS benefit that obviously rolls into 2024. To your question in China. Michelle, Chip and I, along with our teams were recently in China. Quarter two was a great quarter for them. The business was up big time, businesses is higher than 2019. As we think over the rest of the year, our Asia guidance, which is higher than last quarter, Asia, I think we think in the high teens from a double digit growth reflects a slight bounce back in China as along with the rest of Asia. We are going to watch and see what happens and how the business stabilizes in China before we think about China's expectations for 2024. But the team that was there pre-COVID is still there they're long in China and the Chinese market is a little different in some markets in Asia, the premium-oriented markets. We're really focused on premiumizing our product offers there, and that seems to be working.

Very helpful. Thank you very much.

Thank you

I think we're going to wrap it there [indiscernible]. Okay. We're at time, and I just want to thank everybody for dialing in and for your very thoughtful and penetrating questions, and we look forward to speaking with you again next quarter.

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