Good day, ladies and gentlemen, and welcome to Levi Strauss & Co.'s First Quarter Earnings Conference Call for the period ending February 28, 2021. 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 2 hours after the completion of this call through April 15, 2021. Please use conference ID 5889497. This conference call is also 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, Senior Director, Shareholder Relations at Levi Strauss & Co.

Thank you for joining us on the call today to discuss the results for our first fiscal quarter of 2021. Joining me on today's call are Chip Bergh, President and CEO of Levi Strauss; and Harmit Singh, CFO. We have posted complete Q1 financial results in our earnings release on our 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 would 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 the 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 non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in today's earnings release on our IR website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our IR website, and a replay of this call will be available on the website shortly. Today's call is scheduled for 1 hour, so please limit yourself to 1 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.

Good afternoon, everyone, and thanks for joining us today. I'm very pleased with the pace of recovery in our business and our strong financial performance this quarter, particularly in light of a very strong pre-pandemic year-ago base. The actions we've taken during the pandemic are having a positive impact on our results. We exceeded our expectations across the board despite one third of our stores in Europe being closed. Our strategies of leading with our brands, acting with a direct-to-consumer-first mindset, and continuing to diversify our business are working. These strategies are driving record gross margins and significant EBIT margin expansion even as we continue to invest for growth, resulting in a healthier, structurally stronger business. Wholesale is bouncing back faster than expected and faster than the overall results of our brick-and-mortar doors, reflecting the concentration of our store fleet in tourist locations as well as Europe's lockdowns. My confidence in the business is even higher than it was just a month ago for several reasons. We're seeing consumer demand increase given continued recovery in the U.S. and Asia, and demand signals for our wholesale business in Europe are even higher than they were in 2019. We're encouraged by the positive news of the progress of the vaccine rollout in many parts of the world. Consumer excitement and optimism is returning in ways it hasn't since well before the pandemic, and we're seeing a denim resurgence as more people are going out. Consumers are eager to shop the brands they trust and love while sticking to the more conscious consumption they embraced during the pandemic. These trends play to our strengths and are reflected in our strategies. Our strong first quarter performance combined with the strength of the brand around the globe, the improving consumer sentiment, and the momentum of our business as we head into the second quarter all fuel my conviction that we are emerging from the pandemic a stronger company. Let me share a few highlights from the quarter. Consumer engagement with our brands remains strong all over the world, demonstrating our ability to identify and provide assortments they want and capitalize on the ongoing trend towards casualization. Our men's bottoms business has strengthened significantly and was the best-performing segment in the first quarter. We are leading denim trends industry-wide and bringing innovative new products to market. Consumers are embracing the looser fit and wider silhouette trends that we launched during the pandemic and which are now being followed by the competition. These new silhouettes give consumers a reason to buy Levi's as we emerge from the pandemic. We introduced exciting products like our women's 501 crop and extended sizes, earning GLAMOUR UK's endorsement as one of the best plus-sized jeans in the market. We launched new fashion fits focused on Gen Z for both men and women, commanding higher AURs in Asia and Europe as we continue to premiumize the brand. And relaxed fits for men like the 550, 559, and our comfortable non-denim XX chino line were up more than 20% over the prior year. Finally, I'm excited to announce our upcoming global marketing campaign focused on sustainability and the quality and timeless style of Levi's, which encourages our fans to wear what they love and live with it longer. We're calling it buy better, wear longer, and it will be supported holistically through media, in-store, and online around the globe, launching in late April and early May. In our direct-to-consumer channel, we've continued to accelerate our omnichannel capabilities to ensure that our consumers can get products wherever and whenever it works for them. Our own e-commerce business grew 25% in the first quarter and increased to 10% of total company revenues. An increasing share of consumer demand continues to be fulfilled by omni capabilities we’ve rolled out in the last year. These include shift from store, associate ordering, BOPIS, and 2-day shipping. We initially launched these in the U.S. and are now expanding them globally. We recently saw our largest week of sales from associate ordering, a capability that helps ensure we don't miss a sale and caters to how younger consumers are shopping, behaviors we expect will stick beyond the pandemic. We're just scratching the surface. As these omni-capabilities scale, they are becoming increasingly more meaningful. Our NextGen store rollout continues around the globe. We've opened our first NextGen store in the Middle East, an ultra-premium store in the Dubai Mall, one of the largest malls in the world, shopped by 80 million people annually. We're leveraging AI to continue to accelerate our digital transformation within direct-to-consumer. A new product recommendation engine on levi.com now personalizes the individual experience online based on consumer profiles and browsing and purchase patterns showing increases in revenue and conversion. Loyalty program membership increased by 35% in the last quarter to more than 5 million members globally, and revenue contribution from our mobile app is exceeding expectations and continues to grow month-over-month. We are reaching a younger consumer who is engaging with us more times per month and longer per visit. We're using the app as a seamless connector for the online to offline experience and are piloting new convenience-oriented, in-store features like contactless returns and self-checkout. We continue to diversify the business. On the international front, our developing markets of China, India, and Russia all had great first quarters and represent significant growth opportunities. Despite the lockdowns, first quarter sales of women's bottoms in Europe exceeded Q1 2019 in net revenues. In our top 10 wholesale accounts, revenues from our women's business grew double digits as compared to a year ago. Our wholesale channel continues to transform and become healthier with a higher share of business in digital, mass, premium, and with financially healthy retailers. Our total digital ecosystem grew 36% and comprised 26% of total company first quarter revenues, up from 16% a year ago. The opportunity in digital remains huge, and we aspire to grow this over time to a third of our business. All these efforts are driving higher AURs resulting from premiumization, product mix, and pricing. We have additional pricing opportunities going forward on the back of the brand's strength. Finally, before I turn it over to Harmit, I'd like to take a moment to share some of the things we're doing on the ESG front. We continue to make progress on our goals for climate and water and in becoming a more environmentally resilient company. We recently rolled out new greenhouse gas emission targets to all our key suppliers, and three quarters of our products are now made with our industry-leading waterless techniques, which have cumulatively saved over 4 billion liters of water and recycled an additional nearly 10 billion liters. On diversity, equity, and inclusion, we published our most recent representation numbers in February. We still have work to do, and we're putting our money where our mouth is. We've added DEI targets as a component of long-term compensation for executive leaders in the company. We've expanded our sustainable fabric collection with the successful launch of Eco Ease, bringing our stretch platform and organic cotton together and also driving premium AURs. You can find more details on how we're making progress against our sustainability goals in our recently issued 2020 annual report. Let me now turn it over to Harmit.

Thanks, Chip. Good afternoon, everyone. I hope all of you, your families, and loved ones are safe and healthy. We had a very strong quarter, beating our expectations despite store closures, mainly in Europe. The structural economics of our business continue to improve with ongoing and outsized digital growth, record gross margins, and a reduction in base operating costs, while reallocating dollars to strategic choices that will accelerate growth. The first quarter was again profitable and generated positive operating cash flow despite the double-digit revenue decline versus the prior year. While we continue to manage our business prudently as we operate through ongoing uncertainty, particularly in Europe, I remain convinced we will emerge from this crisis a significantly more profitable and cash-generative company with ROIC in the mid-teens and adjusted EBIT margin of at least 12%, much higher than our prepandemic margin of 10.6%. As I walk you through additional detail of our first quarter results, my comments will reference constant currency comparisons on a year-over-year basis in U.S. dollars, unless I indicate otherwise. We published the details of our results in today's press release, so I will not repeat all of those here. First quarter net revenues of $1.3 billion declined 16%, and adjusted diluted earnings per share was $0.34, both beating our guidance. Black Friday week falling in the first quarter of the prior year hurt year-over-year revenue comparison by 3 percentage points. Taking into consideration the adverse Black Friday impact and the fact that stores in Europe were closed for 3 months in Q1 as compared to 1 month in Q4, our estimated Q1 revenue decline was more like high single digits, a sequential improvement from last quarter's double-digit decline. Consumer spending continued to shift towards online shopping due to the changing retail landscape. As Chip mentioned, total digital growth was strong, especially in Europe. Within digital, growth of our own e-commerce business was approximately 27% when adjusted for the Black Friday calendar shift. During the quarter, our e-commerce growth accelerated, reaching 55% for the month of February. And it was again profitable on a fully allocated basis. Our first quarter adjusted EBIT was $174 million, and adjusted EBIT margin was 13.3%, driven by the acceleration in gross margin while holding SG&A at 2019 levels. We were pleased to deliver adjusted EBIT margin in the low teens, while keeping in mind it benefited a couple of points from advertising at only 5% of revenue, below our expected annual 7% target. Let me now give you some color on the details. Adjusted gross margin expanded 200 basis points to 57.7%, the highest adjusted gross margin we have ever posted. FX contributed about 70 basis points of the favorability, reflecting a weaker U.S. dollar against international currency. The remaining 130 basis points was driven by the improving structural economics of our business. Levi's AURs rose in all global channels, demonstrating the intrinsic health of our brand. Price increases and a higher share of business from our own e-commerce channel contributed to the expansion. We've also reduced promotions, both in depth and breadth on the strength of the brand and our healthy inventory position. Gross margins were particularly strong in wholesale, reflecting a strong customer mix including from growth in digital and healthy retailers as well as a favorable shift in product mix towards higher-margin products. Adjusted SG&A was down $85 million from the prior year, a 13% decline. At $579 million, this represents a return to 2019 levels. Notwithstanding a substantial increase over the past couple of years behind the areas driving our growth, namely direct-to-consumer and technology, we're able to deliver adjusted SG&A at 2019 levels because of the structural cost reduction initiatives we have taken. Now I'll share a few highlights from our 3 regions. First quarter revenues in the Americas declined 13%, better than the overall company. Our focus on building a healthier wholesale business in the U.S. is gaining traction as wholesale revenues grew slightly and delivered higher gross margins compared to last year. The full digital ecosystem in the region grew 16%, and nearly a quarter of the region's sales was digitally driven. Our own e-commerce growth rates in the U.S. accelerated through the quarter to 29% for the month of February. Our NextGen store rollout in the U.S. remains on track, and these stores continue to outperform. For example, our new Scottsdale store is a top-performing store in our fleet. Finally, the region's operating income grew 6% despite the revenue decline on the back of stronger gross margins and cost control. Europe's revenue declined 22%. Impressive results, given that one third of the region's business footprint was closed in the quarter, showing the brand strength and our agility to execute a playbook developed over the last year as conditions changed. We are recapturing sales in our own e-commerce channel, which grew 40% in the quarter adjusted for Black Friday and where growth rates accelerated in the quarter to nearly 70% in February. While tourist doors are under pressure, local doors are faring well on higher conversion despite lower traffic with growth in the markets that were open, including France. Our wholesale channel in the region grew compared to the prior year, and we are seeing a strong forward demand signal at wholesale, giving us confidence in a speedy recovery when lockdowns lift. An operating margin of 26% for the region was in line with last year despite the sales decline because of higher gross margin, lower variable expenses, and cost discipline. Asia as a region declined 8%. The full digital ecosystem in the region grew over 60% in the quarter. EMEA's performance was slightly ahead of the region. Importantly, this market grew compared to Q1 of 2019, driven by the acceleration of the digital ecosystem and the ongoing transformation of our store fleet and franchise network. China posted strong growth as expected versus Q1 2020, and our direct-to-consumer channels in the market posted growth compared to Q1 2019. We continue to transform our business in China and move towards more company-operated stores. Productivity is up on higher capture rates and a higher share of more premium products. Our best-selling jeans are from Made in Japan, Made & Crafted, and Levi's Vintage Clothing line. Our beacon store in Wuhan is emerging strongest, back to prepandemic revenue levels and is selling more tops than bottoms. We are elevating our fleet and opened 4 new NextGen doors in China in the quarter. The franchisee reset in the market continues as we clean up unprofitable doors. Our business in China is being transformed and is headed towards a mix of 70% direct-to-consumer and 30% franchise about a year from now. Three years ago, it was the inverse of this mix. We continue to be pleased with our progress in this key market, which had only 3% of total company revenues, and remains one of our biggest long-term opportunities. Turning to balance sheet and cash flows. Inventories at the end of the quarter, net of reserves, were 2% below the prior year and 9% below the prior year in the Americas, reflecting our ongoing disciplined inventory management. Inventory composition remains healthy with more than two-thirds able to carry over into future seasons. Cash and liquidity remain strong, and at the end of the quarter, net debt was negative. Adjusted free cash flow in the first quarter was negative $9 million, only a $6 million decline over the prior year despite much lower revenues and adjusted EBIT. We refinanced $0.5 billion of our 5% U.S. dollar note, obtaining a substantially lower coupon of 3.5%. In March, we paid down most of our 5% note. The lower coupon in debt reduction will save us $20 million annually in interest expense. We expect to pay down the remaining $200 million of 5% notes in the second half of this year. With business trends improving, we expect substantial improvement in our leverage ratio as we move through the remainder of the year. We continue to return cash to our shareholders. Last quarter, we reinstated our quarterly dividend payments at $0.04 per share. Based on our strong first quarter performance, I'm pleased to announce that we are increasing the second quarter dividend to $0.06 per share. As business trends continue to improve, we'll consider increasing dividends further. Before sharing our Q2 outlook, let me take a moment to provide an update on our sales performance through March. As a reminder, the economic impact of the pandemic really started to hit us in March of last year, right after the end of our first fiscal quarter. For the 3-month period of January through March, revenues were slightly up compared to the same 3-month period of 2020. Now turning to our Q2 outlook. Based on our first quarter outperformance and my confidence in the stronger trends we are seeing headed into Q2, we are banking our Q1 revenue and EPS beat and we are raising our outlook for the second quarter. We now expect reported revenues for the first half of 2021 will grow 24% to 25% versus the prior year, significantly higher than the 18% to 20% growth estimate we shared last quarter. Our higher first half outlook includes our second quarter reported growth estimate of around 140%, a substantial increase from the 120% implied by our prior guide. We expect to deliver another $0.07 to $0.08 of adjusted EPS in the second quarter, bringing first half adjusted EPS to $0.41 to $0.42. Our outlook is on a reported basis and incorporates the expectation that currency will again benefit revenue and adjusted EPS comparisons to the prior year. Our perspective balances our confidence and watch within our control with the uncertainty in the marketplace related to the virus variant, vaccine rollout, and the consequent impact to markets and our distribution footprint, particularly in Europe, where we have assumed current store closures will persist through mid-May. This equates to a weighted estimate of around 35% to 40% of our stores in Europe. A few colored comments on our key second quarter assumptions beyond revenue. We expect gross margin to remain substantially higher than the prior year. Due to seasonality, we expect second quarter gross margin to dip below first quarter gross margin by at least 200 basis points, a similar trend to what we have usually seen in the years prior to the pandemic. SG&A continues to track around 2019 levels. As we did in 2019, second quarter SG&A will increase notably compared to Q1 due to the timing of our advertising campaign. Interest expense will be lower than Q1, reflecting our recent refinancing and debt paydown. On taxes, the exercise of stock appreciation rights will benefit our tax rate in the second quarter. Based on recent and potential additional exercises, we expect a tax rate of less than 0, and could see it in the negative double digits in Q2. This benefit will also help our annual tax rate, which we now expect will land in the low teens. Finally, as we shared on our last call, due to the uncertainty introduced by the impacts of COVID, we are planning our current fiscal year in two halves and expect to guide the second half in our July earnings call after our planning process is complete. Although we have not yet completed our planning process, the encouraging trends we are seeing suggest that we may see a return to pre-COVID revenues a month or two sooner than our previous thinking, primarily driven by the strength of the U.S. consumer and key markets in our Asia region. Accordingly, we are now confident that fourth quarter revenues will be slightly above 2019 levels, with some of our individual markets getting there sooner. We continue on the path of emerging a stronger company than we entered the pandemic a year ago, with a sustainable annual adjusted EBIT margin of 12%-plus once we return to pre-COVID revenue. With that, we'll now open it up and take your questions.

Your first question comes from Matthew Boss of JPMorgan.

Congrats on a really nice quarter, guys. So Chip, could you elaborate on the denim resurgence? I think that was the commentary that you said that you're seeing. Is this industry-wide, Levi's-specific, or maybe both? And then just any additional color that you could provide around, I think, the comment that you made, was demand signals in Europe today are higher than pre-pandemic levels that you were seeing in 2019. Just any additional color around that.

Certainly. First, regarding the resurgence of denim, I believe this trend is occurring both for us and across the industry, driven by a few factors. The primary one is the ongoing shift towards casual attire, which has become evident recently. As more consumers get vaccinated and begin to venture out again, they're looking for outfits that suit social occasions, leading them to purchase denim from brands they know and trust, including ours. Additionally, as I mentioned in the prepared remarks, new fits and styles are contributing to this trend. We introduced a high-rise, loose fit in early 2020, coinciding with the onset of the pandemic. Initially, it was a smaller collection, but it quickly gained popularity, prompting us to expand it. This style has now been adopted by our main competitors, highlighting its significance as a leading trend. As consumers prepare to socialize, this shift towards high-rise, loose fit jeans—true for both men and women—encourages them to refresh their wardrobes. A relevant anecdote: our relaxed men's fits, the 550 and the 559, which we considered discontinuing a couple of years ago due to their outdated style, have seen a 50% growth compared to the previous year in our most recent quarter. This could indicate that we are entering a new cycle for denim. The last cycle was initiated by skinny jeans over a decade ago, long before my time here. Lastly, regarding the denim resurgence, it’s important to remember that while we lead in denim, we also see significant opportunities in non-denim products, which we are eager to pursue. Concerning stronger demand signals in Europe, our brand is thriving there despite pandemic challenges. This is reflected in our business results, where a third of our stores were closed, yet our direct-to-consumer business accounted for half our European sales, with decent performance reported. Their e-commerce sales rose by 40% this quarter when adjusted for Black Friday, highlighting a 70% increase in February. Consumers are actively seeking Levi's, indicating a strong pent-up demand that wholesale customers are also recognizing as they prepare to reopen. Ultimately, this can be traced back to the overall strength of our brand.

Our next question comes from Paul Lejuez with Citi.

I think you referenced a better mix within wholesale as a driver of gross margin improvement. I'm just curious if you could talk a little bit more about how the geographical mix, product mix, or specific retailer mix was really the driver of that. And also, sorry if I missed it, but did you mention how women's and tops performed during the quarter?

Sure, Paul. Regarding the U.S. wholesale mix, as we entered the pandemic, we indicated that post-pandemic, we would have a healthier wholesale mix. This means a lower percentage from traditional retailers and a stronger contribution from other channels. This shift includes a higher volume of premium products and increased average unit retails due to better inventory management and brand strength, which has allowed us to reduce dilution across the board. We've also implemented price increases, with a successful pricing adjustment in U.S. wholesale women's last year that began with a 2% to 3% increase. Our ongoing partnership with Target is also proving beneficial. As we emerge from the pandemic, we are concentrating on top-tier retailers, building a lifestyle brand identity, and our women's business is performing well, having grown in the third and fourth quarters of last year. In terms of overall sales, tops remain about 20% of our business, but we are witnessing growth in tops in Europe and other regions, which presents further opportunities for us. We still sell four bottoms for every top, and we aim to achieve a 1:1 ratio in the future, which aligns with our plans for growth in non-denim categories.

Our next question comes from Jay Sole with UBS.

Great. Harmit, you mentioned the impact on revenue from the store closures and the calendar shift. Can you just talk about what kind of impact those factors had on margins in the quarter?

Yes. I would say it was a challenge primarily because the average gross margins in Europe are higher than the overall company average, and the gross margins from stores are also higher. We didn't recover all of the lost sales due to store closures in Europe. So, it was a challenge, but overall, considering our strong gross margins, we achieved significant growth, reaching record levels. Other factors, like the pricing strategies we've implemented, the ongoing increase in average unit retail prices, and improvements in channel and geographic mix have been beneficial. We were also supported by foreign exchange impacts during the quarter, although we don't anticipate these FX benefits will persist. However, we believe other favorable factors will carry through the year. I would also note that, as I mentioned earlier, the record gross margins shouldn't be expected to stay on a full-year basis, as they will adjust in the second quarter due to normal seasonality. Typically, gross margins in the second quarter are about 200 basis points lower than in the first quarter, which is consistent with our historical pattern. Nevertheless, we do anticipate ending the year with stronger gross margins compared to '19 and '20.

Got it. And then maybe if I can ask one more. There's just been a lot of talk about port congestion and the Suez Canal issue. Are you seeing that impact your ability to flow inventory in a timely fashion? And is it impacting your margins this year? And would it show up more in gross margin or SG&A?

We are closely monitoring potential supply chain bottlenecks. While we've faced delays, the geographic diversity of our portfolio and the strength of our brand have allowed us to mitigate the impacts of these delays in both the first and second quarters. Regarding costs, as I mentioned last quarter, our capacity negotiations are helping us manage some of the cost increases we are experiencing. We've had to increase our air freight, but our strong gross margins are helping offset that in the short term. In the long run, we are encountering inflationary pressures, but we remain optimistic about 2021 because our product prices and overall fulfillment costs are secured. Looking ahead to 2022 and beyond, considering the price increases we've implemented, we believe we have the pricing power to manage inflation, supported by our brand strength and market leadership. Overall, we are confident in managing our performance in 2021 and addressing any inflation we encounter in 2022 with our pricing strategies.

Our next question comes from Omar Saad with Evercore.

Chip, I wanted to follow up on one of your opening comments. It sounded like you said you're seeing a more engaged and active consumer, not just before the pandemic, but a period that goes back even farther. I wanted to see if you could clarify and elaborate there. And then on the inventory, do you have the supply chain and inventory coming through the chain to meet that kind of exuberant demand as we continue to reopen globally?

Yes. So from a consumer demand standpoint and just the comment about it being even stronger than what we had seen immediately before the prepandemic, I think what we're seeing is a combination of a lot of pent-up demand from people being stuck at home and hunkered down and not really doing a lot of shopping, combined with an exuberance from the economic stimulus here in the U.S., vaccination rates, and people feeling more comfortable about going out and these new denim trends that we have established. I think it's really a combination of all of those things, Omar. As I said in the prepared remarks, I feel much more confident today than I did even a month ago about our ability to come through this pandemic in a much stronger position and really seeing lift-off. Your question about inventory, it is probably, and I'm sure you'll hear this from others as you talk around the horn during earnings season, I think it's the biggest challenge we're all facing is what we're seeing here recently sustainable for the next 6 or 12 months, or is it a pop in the arm, and it goes back to something that looks more like the immediate prepandemic period. And so we're trying to be very balanced. I think that was the word Harmit used as we provide our outlook and as we forecast the second half of the year. On the one hand, there is good reason to believe that demand is going to be very, very strong; and as we said, we think our fourth quarter will be ahead of 2019. But on the other hand, a week ago, the director of the CDC was saying be careful folks because there could be another wave. So, we're trying to take all of this into consideration and be as balanced as we can as we think about our second quarter and then the second half of the year, and that's what's reflected in our guidance. If it turns out to be much stronger, we'll put a ton of pressure on our supply chain to be able to chase. I think we're well positioned to do that because many of the products that we're selling are core replenishment products where we always have the fabric on hand, and we can fire that engine up pretty quickly and the more seasonal things. We've got flexibility of F.L.X. and other things like that to address unexpected higher demand beyond what we've built in the forecast.

Our next question comes from Bob Drbul with Guggenheim.

Just a couple of questions for me. Just the first one is, can you talk a little bit more about China in terms of how you feel you're performing? It sounded pretty good. And I'm just curious if you could maybe give us a little bit of thought around your cotton sourcing strategies, particularly in China. That's my first question.

Sure. Go ahead, Chip.

Yes. Let me take that, Harmit. So first of all, let me talk to the commercial aspects of our business in China. This remains a huge opportunity for us, as you all know. It's only 2% to 3% of our total global revenue. Our story in China is one of a turnaround. But we're very encouraged with the recent trends. China posted strong growth, as we expected, versus Q1 2020, where they were impacted by the pandemic. We're seeing great results with fewer doors versus a year ago. So we're continuing to transform our business in China. We are moving more and more towards a company-operated footprint. As we said in the prepared remarks, our beacon store, which we opened in Wuhan just a couple of months before the pandemic started, is emerging really strong. It's back to prepandemic revenue levels, and we're really excited about that. So we think we're making good progress there. We've got a great team and now some continuity on that team and see nothing but upside. Over time, we believe that this business mix is going to shift to about 70% DTC and 30% franchise. On the Xinjiang cotton situation, I guess I would say a couple of things. First, it is an extremely complicated situation, and we are watching it very, very closely. We do not source any products in Xinjiang, nor do we have any relationship with fabric mills in Xinjiang. It's in good part because we have, for 30 years, have what we call our terms of engagement, where we prohibit forced labor anywhere in our supply chain. We also insist with our suppliers the ability to audit our suppliers on an unannounced basis. Neither one of those things have any supplier in Xinjiang ever agreed to. So for more than a decade, we have not been doing any business in Xinjiang. We have not been materially impacted by the boycotts. As I said, from a commercial standpoint, China is a big opportunity for us, and we're going to continue to operate there, consistent with our values.

Great. And just as a follow-up, on the Target relationship, I know you guys did the home offering this most recent quarter. Just any update on the Target relationship? What you've learned so far? And really what you've learned from the home capsule that you guys did both online and in the stores? That would be very helpful.

Sure. Well, first, I'll talk about the home collaboration that we did with them, which is what they call a limited time offer. It's a onetime drop that they have done historically now for over 20 years, primarily with high-end fashion brands. So, Lilly Pulitzer, Missoni, they've done this, as I said, for 20 years. We've been really pleased, and I think they would say the same thing about this collaboration. We did it primarily as a brand energy center of culture kind of moment, and it definitely did that. Hopefully, you got an opportunity to go into a Target and see what it looked like in-store. It definitely drove a lot of brand excitement. I think it introduced the Target consumer to the Levi's brand in a way that they had never expected before. So we've been very pleased with it. But beyond that, we're really happy with our overall relationship with Target. You'll remember, we entered initially with just a 20-store test on men's. We were at 140 doors. We're now at 300 doors across men's and women's. On our way to 500 doors, which we've committed to together. We'll be in 500 doors by back-to-school. The brand continues to do really, really well there. Importantly, the Denizen brand continues to do well in Target as well. So we feel really good about the portfolio that we've got in their store, the way they're executing from an in-store merchandising standpoint. We think it's been really, really good for the brand. They're selling product out the door at higher than U.S. wholesale average pricing and onwards. We're really happy with that relationship.

Our next question comes from Lorraine Hutchinson of Bank of America.

Chip, it sounds like you view the recent AUR gains as durable. I just wanted to get your view on the opportunity for AUR gains going forward. You said there are continued opportunities. Is that all pricing? Or are there any other strategies that you're looking to drive that metric?

We believe there is still potential for growth in our average unit retail pricing. With inflation on the horizon, it's advantageous to be in a position where price adjustments are manageable. There are various ways to achieve this, and even at the store level, mixing up our business at our mainline locations presents a significant opportunity. We've been successful in reducing promotions over the last few quarters, moving away entirely from the off-price channel as we've managed our inventory effectively. Our focus remains on increasing average unit retail prices, and we believe there are more opportunities to do so. In the last two quarters, we implemented a $10 price increase on women's products, which has proven effective. Our pricing remains stable, and looking at our assortments, particularly with T-shirts, there’s potential to introduce more tiered pricing. We are actively exploring this, and given the strength of our global brand, we see continued opportunities for growth.

Our next question comes from Kimberly Greenberger with Morgan Stanley.

Really nice results here today. I wanted to ask about the 12% margin target. And Harmit, if I heard you correctly, I think you indicated that you expected to get back to 2019 levels beginning in the fourth quarter this year. I assume that would continue, I guess, through the first three quarters of 2022. So that 12% margin target, it sounds like it would be on track for 2022. I want to make sure, first, that I've understood you correctly on that. And then when you think about that 12% margin, are you thinking that sort of where margins are going to normalize kind of medium to longer term? Or are there other levers that you've got to raise margin beyond 2020 to something above that 12% number?

Thanks, Kimberly. I was wondering when somebody would ask that, so I appreciate it. As you know, quarter one, our EBIT margins were higher than the 12%, and it's a combination of gross margins tracking at 57. SG&A going back to '19 levels, but revenue is still down 16%. If you adjust for things sequentially, organic revenues down high single digits. So as we think about the path to get to the 12%-plus, and the reason we are confident about it is the three real drivers. One, revenues returning to '19 levels. We think Q4 of '21 is the first quarter where we, as a company, holistically will have revenues higher than Q4 of '19. There are countries and there are markets that are already there, and some will get there earlier. But that's the first driver. The second is SG&A to '19 levels. We're already there. I think our latest perspective on the first half really talks about '19 levels of revenue even in quarter two. I think it's an important point because by the end of '21, we'll have 250 more doors that we are operating than at the end of '19. As you know, brick-and-mortar does add SG&A. We've been successful as a team and as a company reallocating dollars between the other forms of overhead and towards things that will really accelerate growth, things like digital, technology, AI, et cetera. The third is gross margin acceleration. What we have said in the past is to think of a 56 handle on a full year basis. Obviously, we can't replicate the gross margins in Q1 for a whole bunch of reasons, including FX, but I think, over time, all the actions we have taken, including the AUR question we just talked about, plus the channel mix, plus the pricing part on the brand, have improved that. Going to your question about sustainability of the 12%-plus and what's the growth algorithm, I think we can sustain the 12%-plus. In terms of what the growth algorithm is, let’s put the pandemic behind us. Let's have a moment or two of what I call sustainable results, and then we'll come back and talk about what our sustainable growth algorithm is. What I would remind everybody is even pre the pandemic, when we went public, we talked about growing our adjusted EBIT margins by 20 to 30 basis points driven on the back of growth in gross margin as well as slower growth on SG&A costs. About the future, '22 and beyond, we’ll get back to you, but we feel good about the path to get to 12%-plus.

Our next question comes from Laurent Vasilescu with Exane BNP Paribas.

Following on Kimberly's question, Harmit, I think on recent calls, you've noted you would execute about $200 million structural cost savings, of which I think half would be reinvested. Is that still the right way to think about it? And then on the $78 million decline in SG&A for the first quarter, can you maybe parse out how much was driven by cost savings? And how do we think about the cost savings over the next three quarters?

Yes. I think, Laurent, I think to your first question, the $200 million, less $100 million is broadly correct. When we started 2020 pre-pandemic, our run rate on SG&A was higher than '19. What we did during the pandemic is we took out some structural costs, and we're reinvesting in areas that will accelerate growth, omnichannel technology, AI, new doors, et cetera. The best way to think about SG&A is that there will be puts and takes on a quarterly basis, but think of us closing the year at '19 levels of SG&A. In quarter two, we will accelerate our investment in advertising and promotion because of the campaign that we talked about. On a full year basis, we think advertising and promotion costs are about 7% of revenue, and I think that's the basis of our thinking. There is probably inflation. We are doing our best to offset inflation through productivity and cost efforts; our indirect procurement and sourcing teams are doing a phenomenal job taking costs out. Those are the things that give us confidence that we can keep costs in check.

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

Congratulations on such nice improving results. In the past, as you've talked about the direct-to-consumer channel and the split between e-commerce and stores, what's the update on the store formats, NextGen, and how you're thinking about the omnichannel initiatives there, or the ship-from-store, any of the other activations?

Yes. So I think, Dana, what we have said about direct-to-consumer, I mean we think about last year, direct-to-consumer broadly was about 40% of our business. As we have made the strategic pivot to the three areas that Chip talked about, with direct-to-consumer being one of the three. We have said that we could grow direct-to-consumer to around 60% of our total revenue over a period of time, so we feel good about it. As that grows, we think our own e-commerce business doubles in size. Once our e-commerce business doubles in size, we think our own e-commerce business gets to the 12% EBIT margins that we're talking about. This quarter, because of the fact that our doors were closed largely in Europe, and Europe, as you know, has a large direct-to-consumer business, our direct-to-consumer business was down, I think, in the mid-20s, where wholesale was down much less. Structurally, longer term, we feel good about growing our direct-to-consumer business because we're making efforts on expanding omnichannel. We've done a ton in the U.S. on omnichannel, BOPIS, I think you've talked about, think about loyalty, think about the app that we have launched, et cetera. We're in the process of scaling that now across Europe. Ship from store is what we launched during the pandemic. It's across the U.S. and now markets in Europe are deploying it. For example, in the next month, Belgium, Netherlands, Spain, France, will all have ship-from-store. We’re really focused on expanding omnichannel globally. That’s going to take some technology dollars. We’ve got that in our capital forecast. Where it really makes a big difference is direct engagement with our consumer, especially younger consumers, and we think that really bodes well for the brand longer term.

Great. Chip, to follow up on Target and the new home collection, you've had successful collaborations. What should we expect in the coming quarters regarding brand activations? Are there any collaborations or new products we should be keeping an eye on?

We have several collaborations in the pipeline. In the last quarter alone, we initiated over 10 regional and global partnerships. One standout was the Pokémon launch in February, which became one of our most successful collaborations, accounting for 20% of our app revenue that month. While these collaborations generate considerable buzz and interest, many are modest in terms of volume and revenue. However, they significantly enhance excitement around our brand. One collaboration to highlight for the upcoming quarter is our second partnership with Valentino. We are releasing 517 units of Levi's Valentino Vintage 517, along with 5,107 units of a reedition of the 517, which replicates the original vintage orange tab 517 jeans, both featuring co-branded patches and interiors by Valentino. The reedition 517 is currently available for preorder online. As we aim to elevate our brand, this unisex jean will be offered at Saks, Neiman Marcus, Bergdorf, and Luisaviaroma. Saks has already sold out of this collaboration at a preorder price of $990 per pair. While the number of units may be limited, the excitement it generates will be substantial, contributing to our ongoing efforts to enhance the brand's premium positioning. With that, we’ll conclude here as it's around 3:00 PM on the West Coast. Thank you for joining us, and we look forward to our Q2 earnings call in a couple of months. Thank you, everyone.

Thank you. Stay safe and healthy.

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