Levi Strauss & Co (LEVI) Q2 2022 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company Second Quarter Earnings Conference Call for the period ending May 29, 2022. All participants will be in a listen-only mode until the question-and-answer session, at which point instructions will be provided. The 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 available 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 & Company.

Thanks for joining us on the call today to discuss the results for our second fiscal quarter of 2022. Joining me on today's call are Chip Bergh, President and CEO of Levi Strauss, and Harmit Singh, our CFO. We posted complete Q2 financial results and 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, 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. In addition, 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. 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 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.

Good afternoon, and thanks for joining us today. It's been just over a month since I saw many of you at our Investor Day in New York, where we laid out our plans to accelerate profitable growth over the next five years. The team is off to a strong start in executing the strategic initiatives that will deliver those plans, and you can see that clearly in the results we reported today. Revenue in the second quarter grew 20% on a constant currency basis and 15% on a reported basis to $1.5 billion, reflecting strong consumer demand across our business and around the world. We also increased profitability, expanding adjusted EBIT margin 90 basis points to a record 9.9% for the second quarter, which drove adjusted EBIT growth of 27% and adjusted diluted earnings per share growth of 26%. Combined with our strong brands, our relentless focus on our strategic priorities being brand-led, DTC-first, and diversifying the portfolio has delivered strong results, even with continued macro-economic uncertainty and persistent inflationary pressures. The momentum we are driving today reinforces my conviction in the potential of our strategy and the execution abilities of our team, leaving us firmly on track to deliver on our long-term commitments. There are several notable dynamics that underscore our performance this quarter, for which my and Harmit's comments will reference revenue, constant currency comparisons to 2021, unless we indicate otherwise. Let me start with our first priority, being brand-led. The Levi's brand is stronger than it has ever been, and the demand is stronger than it has been in my career here at LS&Co. Levi's is the number one jeans brand in the world and has strengthened its standing over the past year, driving most share growth amongst the world's top jeans brands, with brand awareness remaining well above the competition across most markets. We've been moving with agility to capitalize on global casualization trends, fueling strong growth for Levi's, while also driving strong underlying category growth that continues to outpace apparel. This performance was supported by our focused efforts to leverage our leadership position with a strong pipeline of innovation. This past quarter, we dug into our archives, releasing the Levi's Fresh collection, which was inspired by our product collection from the 1970s, featuring a range of sustainably dyed pieces for men and women, including 501 jeans, sweats, accessories, and more at premium price points. The innovative collection saw particular success with women's and tops, in addition to younger consumers with whom we are gaining share and seeing record engagement on our industry-leading TikTok. Overall, the Levi's brand grew 20%, with our top five markets collectively growing at an even faster rate. Levi's bottoms revenue was up double digits across both men's and women's versus last year and pre-pandemic Q2 2019 levels. Nearly all Levi's fits across genders contributed to growth globally, led by strength in looser fits. The 501 family of products also continued to show strong growth, up 40% across men's and women's, highlighting the momentum of the most iconic fit in our line. Turning to our second strategic priority, DTC-first. Our direct-to-consumer business continues to thrive, allowing us to deepen our connection with consumers while showcasing the fullest expression of our brands. This quarter, total DTC net revenue increased 22%, with growth driven by our company-operated stores. Strength in our global brick-and-mortar business was driven by both mainline and outlet stores across geographic segments as a result of increased foot traffic and store expansion, as well as higher unit volumes and average unit retail. During the quarter, we also benefited from a return of tourist traffic in many of our downtown locations, propelling growth on our flagship stores in key cities, including San Francisco, New York, Paris, and London. Our latest generation of new stores continued to perform against our expectations, reflecting the market potential that we have yet to unlock. The success of these newer stores reinforces our conviction of reaching more than 1,500 company-operated stores by 2027. Our e-commerce business remains healthy, with revenue continuing to far exceed pre-pandemic levels. We did see a moderation in online traffic as consumers return to shopping in our stores in large numbers. E-commerce remains an important driver of our growth algorithm, and we are committed to tripling its size over the next five years after successfully growing e-commerce into nearly a $0.5 billion business over the last decade. To achieve this ambitious goal, we are building the capabilities and the organizational structure to both scale e-commerce and accelerate our broader digital transformation. As part of that, we are establishing a new Chief Digital Officer role that will report to me. This role will bring together our data, AI, engineering, and digital product management efforts under one leader who will spearhead our digital efforts for both e-commerce and our digital go-to-market. We see tremendous potential in e-commerce, and with the leadership to drive its success, we will move more quickly to realize it. We also continue to leverage our data capabilities to deepen our direct personalized relationships with our consumers through our Levi's app and loyalty programs. The app continued to see strong engagement, with monthly active users up double digits. It also expanded into India and is now available in 10 countries total, with plans to further rollout to eight more countries across Europe this year. These initiatives helped expand our loyalty member base by over 50% year-over-year, with gains in key member productivity metrics, including average order value. And while our direct-to-consumer business continues to generate consistently strong growth, our global wholesale business also continues its strong performance in Q2, growing 18% with improved profitability. In terms of diversifying our portfolio, our third priority, we are focused on significant market opportunities in underpenetrated high gross margin parts of our business that can drive strong growth even in these times of macro uncertainty. The opportunities here are tremendous, with untapped potential across women's, tops, international, and our Other Brands, Dockers and Beyond Yoga. This quarter, we made progress across each of these areas of focus. Following 11 consecutive quarters of pre-pandemic double-digit revenue growth, our total women's business grew 23%, the fifth consecutive quarter of double-digit growth since exiting the most challenging parts with the pandemic. While women's saw broad-based growth across geographic segments, growth was especially strong in the Americas, where the Levi's women's business was up 30%. In our top 10 wholesale accounts globally, Levi's women's were up 50%. One of the biggest long-term opportunities we have ahead of us is to extend into true head-to-toe expressions of our brands. We're making solid progress. For the total company, tops were up 23%, with strength broad-based globally across categories. We saw particularly strong growth in the Americas, up 26%, with traction in polos in the U.S., which were up more than 10-fold on levi.com. Overall, women saw continued strength in wovens and dresses, in addition to double-digit growth in non-graphic tees. Our non-denim bottoms business also performed well, up nearly 20% for Levi's men's, with continued success with our XX Chino and more. Our international business was up 19%, with all geographies delivering strong double-digit revenue growth. Our top markets in Europe, France, Germany, and the UK were collectively up strong double digits. Excluding China and Hong Kong, where lockdowns have persisted, growth in Asia was over 40%, with every market contributing to that growth. Our Other Brands also performed well in the quarter. Dockers continue to build momentum, delivering 27% growth in Q2, as it beat internal plans on both the top and bottom line. This was supported by strong international and DTC growth, as well as some notable wins with women's. Reflecting the progress we've made in refreshing the brand, Dockers women's launched on Amazon in the U.S. this quarter and at Zalando and El Corte Ingles in Europe. While it's early days, so far the product is performing well. Beyond Yoga also made solid progress in the quarter, with success in dresses, pop colors, and prints, and its Mommy & Me Collection, most of which sold out in the first week. On June 25th, the brand also opened its first pop-up store at The Grove in Los Angeles, and the initial response from consumers has been terrific. Beyond Yoga remains on track to open its first permanent store in Q4 of 2022. Across the board, this was a strong quarter marked by consistent execution of our strategic priorities. I want to recognize the hard work and dedication of our teams across the organization. We delivered solid results in a uniquely challenging operating environment. I'll now turn it over to Harmit to cover the financial results in more detail.

Thank you, Chip, and good afternoon, everyone. At our Investor Day in June, we laid out a clear long-term strategy designed to deliver faster growth, stronger margins, and increased cash returns to our shareholders on our path to drive annual shareholder returns of 10% to 12% over the next five years. Our plan, which calls for annual revenue growth of 6% to 8%, adjusted EBIT margin expansion to 15%, and our commitment to return 55% to 65% of our free cash flow to our shareholders over that time frame is bold, yet achievable. In our second quarter, our team delivered on each of the three drivers of our long-term TSR algorithm, accelerated sales growth, margin expansion, and cash return. We generated strong growth. Total net revenue grew 20% to $1.5 billion, driven by 21% revenue growth in the US and strong performance across our diverse global portfolio. Supply chain-related issues limited further revenue opportunity by approximately 2%, primarily in the US where strong demand continues to outpace supply. Adjusted EBIT grew even faster, up 27% reported and 37% in constant currency as adjusted EBIT margin expanded 90 basis points to a record second quarter level of 9.9%. The strong EBIT growth was the principal factor driving adjusted diluted EPS up 26% to $0.29. We achieved these strong results even as we invested in our brand and navigated the impact of rising inflation, continued COVID-related challenges, geopolitical turmoil, and foreign exchange headwinds. We also returned $80 million of capital to our shareholders through a combination of higher dividends and the repurchase of 2 million shares. Given the continued strong performance of our diversified business, we reaffirm our financial outlook for the year. Second quarter net revenue growth of 20% was primarily driven by higher volume as well as an increase in average unit retail, demonstrating again the strength of our brand and our leadership in the denim category as we price to offset inflation. Direct-to-consumer channel net revenue increased 22%, driven by increased traffic, store expansion, and continued gains in average unit retail, which were up high single digits. As Chip referenced, with consumer shopping behavior shifting from online to in-person shopping, our e-commerce business was down 2% in quarter two, yet remains over 60% higher versus 2019 with its operating margin on a fully allocated basis in the mid-single digits. Growth through all digital channels was up 8% year-over-year, remaining elevated versus 2019 levels and comprising approximately 20% of total second quarter net revenue. Adjusted gross margin was maintained in reported dollars as a second quarter record of 58.2%, primarily due to improved structural elements, including mix shifts to higher gross margin DTC, international, women's as well as a sustainable improvement within wholesale. Combined with price increases, these factors offset higher product costs, including 80 basis points of higher air freight costs to support delivery of seasonal merchandise, as well as a 30 basis points negative impact due to declines of high gross margin in markets, China and Russia. Moving to SG&A, adjusted SG&A expenses in the quarter were $711 million or 48.3% of net revenue, leveraging 90 basis points despite advertising and promotion being higher by 10 basis points. Our gross margin, coupled with our disciplined SG&A management and operating leverage, generated an adjusted EBIT margin expansion of 90 basis points to 9.9%, while adjusted EBIT dollars were up 37% in constant currency, even as we continue to strategically invest in our long-term growth initiative. As a result of Russia's invasion of Ukraine, we suspended the majority of our commercial activity in Russia, including the closure of the majority of our stores and the suspension of shipments to our wholesale and licensing customer. Given the high level of uncertainty surrounding our business in Russia, we fully instituted the related long-term assets, including store assets and goodwill. The total charges related to the Russia-Ukraine crisis recorded during the quarter were $60 million, impacting diluted earnings per share by $0.15. Our effective tax rate was approximately 36%, which is higher due to a 16-percentage-point tax rate increase resulting from non-tax deductible charges related to the Russia-Ukraine crisis. Adjusted net income of $117 million was up from $93 million in quarter two of '21 due to the increase in adjusted EBIT and lower interest expense, partially offset by higher taxes, as just referenced. I'll now take you through key highlights by segment. Recall, the regional segments include our Levi's brand, Levi's Signature, and Denizen, while the other brand segment includes Dockers and Beyond Yoga. In the Americas, revenues grew 17%, driven primarily by higher unit volume as well as higher average unit retail across channels. Overall, momentum in our largest market, the US, continued delivering growth of 16%. Canada saw strong growth, up double digits. Our overall LatAm business was up 18%, fueled by growth in Peru, Chile, and Brazil. Our company-operated stores posted another strong quarter, up 20%, driven by increased traffic and price increases, while wholesale grew 19% with particular strength in the US. Europe continued to see strong momentum, and revenue was up 3% reported and 15% constant, despite the impact of the Russia-Ukraine crisis. DTC was up 38%, reflecting higher traffic as consumers returned to shopping in-store. As a reminder, approximately one-third of company-operated stores were closed last year in the region. Most countries saw growth, including large markets such as France, Germany, Italy, Spain, and the UK. Asia accelerated and revenue was up 16% reported and 21% constant, despite COVID-related restrictions negatively impacting markets like China and Hong Kong. Wholesale was up 41%, while DTC growth of 7% was led by both mainline and outlet stores. While growth was broad-based, large markets like ANZ, India, and Japan were particularly strong. Thailand also transitioned from a license to a directly operated business in April, contributing to results. Overall revenue growth in Asia has tripled operating profits and delivered an operating margin of 8.6%. Other brands' net revenue was up 61%, driven by growth in Dockers and the addition of Beyond Yoga, overall operating profits were also up 66%. Turning to balance sheet and cash flows. Inventories increased 29% from the prior year, consistent with our internal plan and our strategy to more effectively meet demand by investing selectively in core products that can be sold across multiple future seasons. A third of the increase includes the planned acceleration of receipts for our upcoming seasons to mitigate longer lead times. The acquisition of Beyond Yoga and the transition of Thailand business from a license to a directly operated business also contributed 3 percentage points to the year-to-year increase in inventory. Roughly 20% of the total inventory is comprised of products in transit. We are comfortable with the overall level, composition, and quality of inventory on hand. Cash and liquidity remain strong, with end-of-quarter net debt of $306 million and overall liquidity of $1.5 billion. Our leverage ratio remained at a multi-decade low of 1.1 times. Adjusted free cash flow, which we now define as cash flow from operating activities less property, plant, and equipment was $13 million, down from $148 million in the second quarter of the prior year, primarily due to higher spending on inventory. In the second quarter, we returned approximately $80 million to shareholders. The company paid a dividend of $0.10 per share, 64% higher than one year ago. In the quarter, we repurchased shares of approximately $40 million. Going forward, the company declared a dividend of $0.12 per share, a 20% increase from last quarter. As I mentioned in June at Investor Day, the Board of Directors also authorized a new $750 million share repurchase program. Moving onto our guidance for fiscal '22. Against a backdrop of continued macroeconomic volatility, we are focused on controlling the controllable and delivering results with strong execution and discipline as we have done in the past. We continue to see strong demand for our products across geographies and categories, and our teams remain focused on executing on our strategic priority to capitalize on these opportunities through the balance of the year. The underlying trends we are seeing in our business support our continued expectation for 11% to 13% annual reported net revenue growth to $6.4 billion to $6.5 billion. This is allowing us to offset 100 basis points to 150 basis points of incremental headwind from currency and lockdown restrictions in China from when we last shared guidance with you in April. This represents 13% to 15% net revenue growth on a constant currency basis, well above our expectations coming into the year. Looking at our reported net revenue outlook by region, we now expect the Americas to be up low-teens; Asia, mid-teens; and Europe, flat to slightly down. In constant currency, Asia, excluding FX would be up approximately 20%, and Europe, excluding FX and Russia would be up low double digits. Our full-year expectation for adjusted gross margin expansion of 20 basis points to 40 basis points, EBIT margin expansion of 20 basis points to 30 basis points, and CapEx of $270 million has not changed. We are planning for a tax rate of approximately 20% for the full year, up from our prior outlook of mid to high teens. We are also maintaining our expectations for adjusted diluted EPS of $1.50 to $1.56 as the quarter two EBIT and underlying strength in our business are helping offset incremental headwinds from when we last guided in April, including $0.02 from foreign exchange, $0.02 from the higher tax rate, and $0.04 impact from more protective lockdowns in China. Regarding our expectations in the second half, I'll share some color on SG&A expenses and the tax rate. We currently expect Q3 to show some deleverage, given lower relative investment in the prior year as we continue to invest in new stores and advertising and promotions. Q4 will be around prior year as a percentage of revenue. We also expect the tax rate in the mid-20s in the third quarter due to the continued anticipated impact of COVID-related restrictions in China. Finally, as we upgrade to our new on-the-cloud ERP system in early quarter two of next year in the US, following successful implementations in both Mexico and Canada, we will be building mostly core products in Q3 and Q4 to protect shipments to our customer. This upgraded ERP will be instrumental in increasing speed and agility, providing us real-time visibility to inventory across our network and setting us up well to accelerate our direct-to-consumer business. In summary, we continue to see momentum across the business. We've been able to build on our phenomenal '21 to deliver a very strong performance in the first half of '22. We are on track to deliver a solid '22 while making progress across our strategic priorities, setting us up well to deliver on our longer-term financial targets. I will close with three key messages. First, the broad diversity of our business across geographies, channels, and product categories provides us with the control and optionality to successfully navigate the challenges of the external environment. This positions us to deliver in both good and tough times. Second, the strength of our brand, strong execution by our teams, and disciplined cost management have allowed us to expand and sustain gross and EBIT margin expansion. Third, we have made great progress on our commitment to return cash to our shareholders, increasing our dividend by 20% from last quarter, completing our $200 million share repurchase program in the quarter, and announcing a $750 million repurchase authorization at our Analyst Day. Year-to-date, we have returned close to $200 million to our shareholders, a 400% increase over last year. These three factors have allowed us to deliver a strong first half in '22 and reaffirm full year guidance despite all the headwinds in the marketplace. With that, I'll now go ahead and open the call for Q&A.

Thank you. The floor is now open for questions. Our first question comes from Matthew Boss from J.P. Morgan. Your line is open.

Thanks, and congrats on another nice quarter.

Thanks, Matt.

So Chip, on the continued momentum and strength of the brand, could you maybe speak to drivers behind the acceleration, notably that you're seeing in the Americas? Maybe what's driving the combination of both average unit retail and unit growth? And just how do you see Levi's positioned to take share in this dynamic backdrop as now we move forward?

I’ll address the second part of your question first. Levi's brand is very well positioned in this dynamic environment to continue accelerating and gaining market share, and I have a lot of confidence in that based on our strong quarter. Several key drivers contribute to our success. Focusing on the US, the ongoing trend towards casualization is evident globally, and that has benefited us significantly. The US jeans market saw a 19% increase over the last 12 months ending in May, outpacing total apparel growth. As the market leader in the US, we are clearly at the forefront of this growth. Recent consumer research indicates that more people are now wearing jeans in professional settings, even in places like banks, where it has become acceptable for employees to come to work in jeans, which is a significant shift from the pre-pandemic era. More than half of respondents in a global survey reported they can now wear jeans to work, highlighting the major change from before the pandemic. The trend towards casualization is indeed beneficial, along with a new denim cycle that emphasizes straight, loose, and baggy fits. Looking at our business, the performance of our 501s, which is our most iconic item, is a strong indicator of our brand’s strength, as they saw a 40% increase this quarter across both men's and women's lines. The brand has never been stronger, as reflected in unit growth and average retail growth. On a global basis, our average unit retail increased by 8%, and unit growth rose by 11%. We successfully managed to pass through pricing, which has allowed us to maintain our gross margin at levels comparable to last year despite various challenges, including reduced sales in Russia and China, high air freight costs, and increased cost of goods. This all underscores the power of the Levi's brand. We are also continuing to connect with consumers in a relevant and authentic way, which has strengthened our brand significantly over the years. While we cannot control inflation or interest rate fluctuations, we will focus on the aspects we can control and continue to execute effectively on connecting with consumers and building our brand.

Congrats again on the momentum.

Thanks, Matt.

Thank you. Our next question comes from Kimberly Greenberger of Morgan Stanley. Your line is open.

Thank you very much. I have a two-part question. Harmit, you mentioned that the ERP implementation is taking place in the US in the second quarter of next year. Could you explain how we might see that affect inventory growth? I know you've been building some inventory proactively to ensure timely delivery during the implementation period. When can we expect inventory levels to rise, and when do you anticipate normalizing them on a quarter-by-quarter basis? Any insights you can provide would be appreciated. Chip, we've noted some slight softening in retail sales among certain US retailers over the past month. Do you have any information regarding customer orders in the US or insights into how customer behavior might be evolving in terms of future order commitments? We would love to hear anything you can share. Thank you.

Sure, I'll address the ERP question. The US will be the third market to implement the upgrade, following successful implementations in Mexico and Canada. The US is our largest market. Several other retailers have already upgraded in the US, and we are introducing a new cloud-based SAP system that offers clear advantages. Our approach to inventory management in the US, which is a key market where we offer products across multiple seasons, anticipates building approximately $100 million in inventory between Q3 and Q4, with that inventory decreasing in Q1 and Q2 of the following year. We plan to implement this early in Q2 of 2023. We have a dedicated team focused on this significant implementation, and our commercial teams are actively engaging with key customers. Collaboration is essential, and we believe that together we can achieve our goals, accurately predict consumer demand, and maintain satisfactory fill rates. Over to you, Chip.

Kimberly, I'll try to keep this pretty brief. Our wholesale results in the quarter were very, very strong, as we talked about in the prepared remarks. On our core Red Tab business, Levi's, I'm going to focus here on the US specifically, we really have not seen any softening or have heard any concern about Levi's Red Tab from our customers. So the one soft spot in our business in the second quarter was on Signature and Denizen in our value brands. Not surprisingly, those businesses were down mid-single digits. And as you know, those businesses represent a small part of our total revenue, some kind of low single digits of our total revenue. But those two brands, which were up in the first quarter, were down mid-single digits in the second quarter. So there's some evidence that the value consumer, the low-income consumer is really starting to feel the squeeze, which is going to be a surprise based on the results from Walmart and Target. But Levi's Red Tab at Target is still doing really well. We feel really good about our position right now in wholesale. We haven't seen any signs of cracks, and I think, again, that speaks to the strength of the Levi’s brand.

Great color. Thank you so much.

Thanks, Kim.

Our next question comes from Omar Saad of Evercore ISI. Your line is open. Thanks.

Thanks. Good evening. It's great to hear so many different pieces of the businesses performing well. It's also great to hear you guys are allocating more resources and talent to build out the digital organization. But maybe to push in a little bit deeper on the digital performance in the quarter, guys. I think it was plus 3% overall. Maybe you could also dive into a little bit e-commerce versus digital wholesale? And then given the importance of digital and DTC to the elevated longer-term growth algorithm you guys laid out not that long ago, maybe talk about the e-commerce performance and where you think it should go and where you think it can be. I'm also wondering, are there any supply chain and inventory hindrances holding that channel back? Thanks.

Yeah, Omar. Digital overall was up, while e-commerce was down. It was also down because you're lapping some real strong numbers, as well as the consumers head back to stores as a bit of the online shopping shifting to the stores, and we saw that in the form of higher traffic. In terms of the puts and takes, if you think about the world, Americas generally strong on digital, Europe slightly weaker. There are some retailers like Zalando that have reported weaker sales. Asia is still strong. To the question about what we'd like to do and where we'd like to go, we are in the early stages of really accelerating the business with the announcement that Chip made on getting a Chief Digital Officer. You have somebody in the company beside folks in the commercial side of the business waking up every morning trying to drive and grow this business. As we said in the Investor Day that our goal is to triple the size of the business from 7% to about 15%, which will also help EBIT margin. We think there is a huge opportunity. We just rolled out the app in the 10 countries where this app needs to be. We still get a small percentage of people buying through the app, so the opportunity in that is immense, and our loyalty program is just getting started. We have 19 million consumers around the world, a brand that Levi’s definitely has trend. Beyond Yoga continues to grow e-commerce. Dockers e-commerce growth is accelerating. So the real work is to get levi.com to where we like it to be.

Got it. It sounds like with loyalty accelerating, a key to accelerating the e-commerce will be translating that loyalty to transactions.

Correct.

Thanks for the color. Good luck.

Thanks, Omar.

Our next question comes from Laurent Vasilescu of Exane BNP Paribas. Your line is open.

Good afternoon, and thank you for taking my question. Harmit, I believe you mentioned in your prepared remarks that China and foreign exchange will present an incremental headwind of 100 to 150 basis points for the full year. I'm curious about China specifically—how did it perform in Q2, and what are your expectations for the year regarding that 100 to 150 basis points? Additionally, if I may ask a second question, you referred to the fourth-quarter revenues in the transcript, which still seems to be incorrectly populated. How should we view the revenues for the third and fourth quarters in the latter half of the year?

Yeah, sure. So China, Laurent, as we mentioned at Investor Day, it’s a small piece of our business. We started the year at about 3%. We think we end the year at about 2% of our business on China. We have a wonderful team on the ground and they're working through all the puts and takes. China was down, I believe, close to 50% in quarter two, largely because stores were in lockdown, and we don't have a large e-commerce. We're just trying to build that. So, we could offset the stores being closed. The 100 basis points and 150 basis points of headwind that I talked about, largely in the second half, especially driven by foreign exchange and China being the two pieces of it, FX being the Euro and Pound. As you think about Q3 and Q4, I think Q3 is mid to high-single-digit growth relative to '21 and Q4 in the mid-single-digit. I think the good comparison is to relate both the Q3, Q4, H2 to 2019 and you will relative to 2019, we are doing in the low-double-digit, and I can definitely give some more color on the inventory questions on that later on.

Very helpful. Thank you very much, Harmit.

Thank you.

Thank you. Our next question comes from Paul Lejuez of Citi. Your line is open.

Hey, thanks. It's Tracy Kogan filling in for Paul. Can you discuss store traffic and conversion rates in each of your regions compared to 2019? Also, specifically regarding China, how has store traffic changed since the lockdowns ended? Thank you.

Yeah. Tracy, store traffic is growing relative to a year ago generally across the board. It's very difficult to go country-by-country because different countries have different elements of geopolitical COVID uncertainty, but traffic we saw build. That's why Chip in prepared remarks talked about the growth we're seeing in our brick-and-mortar stores, especially in key cities. We see tourist traffic beginning to improve. The Chinese tourist is absent, but I’d say that we're beginning to see tourist traffic improve. Having said all that, traffic relative to ‘19 is still below '19 levels, right? So traffic hasn't gone back to '19 levels. Conversion rates and higher units per transaction, because now we have a lot more to offer from head to toe perspective help offset the traffic decline relative to '19, especially in the US. We're opening doors. We should have 70-odd doors on a net basis open this year. The US is also opening doors, and we talked in the Investor Day of how we think we can open, on a net basis, about 80 new doors from '23 onwards. I mean, structurally, the economics are a little different. In brick and mortar, obviously, we've negotiated rent reductions, lower rents in new doors, et cetera, because we're one of the few retailers that are continuing to open doors. I think structurally, the economics are slightly better and help offset some of the traffic decline.

Thank you.

Thank you, Tracy.

Thank you. Our next question comes from Will Gartner of Wells Fargo. Your line is open. Again, Will Gartner, your line is open.

Why don't we move to the next caller and come back to Will.

Absolutely. Our next question comes from Jim Duffy of Stifel. Your line is open.

Thank you. Good afternoon.

Hey, Jim.

Nice work in the quarter. I want to ask, there has been a lot of volatility in the commodities market, though the recent correction has been sharp. When do you lock in costs for the first half of fiscal '23? And does the correction we've seen in the commodities landscape have you rethinking the rate of price increases that you had talked about for the back half of the year at all?

We finalize our purchasing plans twice a year. For the first half of 2023, those plans are mostly set, though unfortunately, they've been based on higher commodity prices. The positive aspect is that recent futures indicate cotton prices starting in December have fluctuated, at one point being below $0.90 and then rising above it. The average cotton price is currently between $0.80 and $0.90, and we hope this trend continues, which would certainly benefit us in the latter half of next year. Regarding pricing strategy, we have been deliberate in our approach. I made some pricing adjustments in the second half of the year, keeping 2023 in mind. It's crucial for us to address cost increases carefully and strategically. Despite the price adjustments we've made, our products continue to deliver significant value to consumers. This is reflected in our balanced revenue growth, which comes from both increased unit sales and average unit pricing, showing that not all of our revenue growth results from price increases; product mix also plays a role.

Great. And just one more if I may. Are you feeling any more or less confident in the promotional environment as you look to the back-to-school season and holiday season?

The brand is very strong, the strongest it's been, and Dockers and Beyond Yoga are also strong brands. In the second quarter, our gross margin included about 100 basis points of incentive units. Ideally, we would sell every unit at full price, but we did sell some incentive units, and we anticipate a similar pattern for the second half as we plan for back-to-school. We believe our product offerings and marketing strategies will attract consumers. We will be mindful of promotional levels; we don’t intend to be uncompetitive, but we will be careful as we approach the back-to-school and holiday seasons. Prime Day is also approaching, and we have been deliberate in our planning for that. Overall, considering the strength of the brand and our analysis of promotion levels using AI and machine learning, I believe we will be in a good position.

Thank you very much.

Thank you.

Our next question comes from Brooke Roach of Goldman Sachs. Your line is open.

Good afternoon and thank you so much for taking our question. Can you talk to the trends that you're seeing in your business in Europe, especially in the context of the choppy macro environment? What are you seeing there now that gives you confidence to raise your underlying, ex-FX and ex-Russia guide for the region for the year? Thank you.

Hi, Brooke, the brand is strong. One could argue pre-pandemic, the brand was strongest in Europe and the execution was probably the best. They continue to leverage both the strength of the brand as well as execution and driving strong performance. Couple of things. One, in Europe, we have wholesale retailers do commit. They have a pre-book process, pre-booked in the second half is in the high single digits, which is good news. So that gives us some confidence, as well as great execution. I think that balances the consumer sentiment and other stocks that we'd be seeing with the fact economies are opening, tourism is in with a big bang in Europe. I think other things that give us a little bit of confidence, besides the strength of brand execution and the wonderful team there.

Great. Thanks so much. I'll pass it on.

Thanks, Brooke.

Thank you. Our next question comes from Robert Drbul of Guggenheim Securities. Your line is open.

Hey guys. Just, I have two questions. The first one, can you talk a little bit about just the wholesale channel inventory levels that are out in the market, just sort of where you think your brands are and where sort of the category is generally? And then Chip, you're usually pretty good with some of the trends. I was wondering if long jean shorts appear to be trending, and I'm just curious if you're seeing that within your business?

Okay. Your second question brings smiles all around, Bob, I can tell you that. To answer your first question, we don't view trade inventory as a topic for discussion between our sales team, commercial teams, and our wholesale customers. Where we have visibility, we compare trade inventory to '19 or '21, depending on availability. In the US, trade inventory has mostly aligned with '19 levels. Regarding '19, I want to emphasize that inventory growth in the second quarter was reported at 29% over '21. However, '21 is a tough comparison due to supply chain challenges. We assess inventory levels relative to '19, which shows an increase of 24%. Considering early receipts and longer lead times, we aim to meet consumer demand effectively. Approximately 10% of that 24% is from early receipts, and Beyond Yoga and talent acquisition account for an additional 3 percentage points. If we exclude those factors, the inventory growth of 11% aligns broadly with our expected growth rate in the second half compared to '19. Chip, what about the question regarding long shorts?

Bob, if that's what you're wearing, that is clearly what the trend must be.

No, not tonight, but I was thinking about it.

Okay.

Thank you, Bob.

Next question, please?

Thank you. Our next question comes from Dana Telsey at the Telsey Group. Please go ahead.

Good afternoon and nice to see the progress. Two things, as you're thinking about the supply chain, it looks like the supply chain costs were higher in the second quarter than in the first quarter. How are you planning for the balance of the year going into the back half of the fiscal year? And then the wholesale strength is impressive, unpacking the wholesale strength, looking at price, door growth units, how does it differ by region? And what is your outlook? Thank you.

Dana, hi. To your question on supply chain costs, I mean, I think if you think about costs in quarter two, air freight was higher, were 80 basis points higher. It is a combination of two things. One, very low air freight in quarter two of last year. This year, we were getting our product, just the seasonal product to make sure that we were able to satisfy demand. Our expectation on air freight is that it begins to taper down. Supply chain issues are getting better; we're not going to be out of the woods this year. Hopefully, next year, it's getting better. The other costs are commodity costs, commodity costs in the second half are higher than the first half as the cotton was, and we're offsetting that with higher average unit retail driven by pricing and mix. To your question about wholesale trends, it is difficult to, again, go around the world. Again, I think the fact that the brand's strong, Red Tab is really strong. The trends tailwinds that Chip talked about casualization and as people get back to the office is a more casual environment definitely helps us. I talked about pre-book in Europe, which is a good indicator, so I think that's how we look at it.

Dana, the only other thing I would add on the wholesale thing is US wholesale. We talked about this before Dana. We put a lot of work into just remapping, rebuilding our footprint. Our focus on premiumizing our wholesale footprint has paid off in big ways, and the target expansion has paid off in big ways, getting incremental floor space in key customers like Kohl's and Macy's over the last two years or so. It's also played an important role. So we're seeing that play out, and put that together with the strength of the brand. The brand shows up better in their stores; we're going to sell more of Levi's, and that's where our focus has been.

Thank you.

Thank you, Dana.

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

I want to thank everyone for dialing in and wish you all a happy and healthy summer. I look forward to talking with you at the end of our third quarter. Thank you all very much.

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