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 up 2% versus 2019 with gross margins up as well. There are two main drivers to the slowdown of our U.S. wholesale business. First, the macro effects of higher inflation and a slowing U.S. economy has put increased pressure on the price sensitive consumer. Second, as we have mentioned for several quarters, our inventory backlog created supply chain challenges in our U.S. distribution centers resulting in our inability to fulfill all demand. The lower fill rate resulted in higher customer out of stock and less newness on the floor the last few quarters. We're taking a number of actions to address these issues, regain competitiveness and restore growth to our U.S. wholesale business. First, we are taking surgical price reductions on a select number of our Red Tab Tier 3 wholesale offerings, which we know are most price elastic and where the price gap versus competition widened too far. Importantly, we are not taking price reductions in U.S. mainline full price stores, nor the vast majority of our U.S. wholesale assortment including the 501 and women's fashion fits, which are all less price sensitive. Finally, we are not taking any price reductions on our international businesses where we continue to demonstrate strong pricing power as seen by the results. Second, with the ERP implementation behind us, and as our inventory levels continue to improve, we are seeing an improvement in order fill rates, now nearly back to historical levels, which will result in better sell-in for us and in stock positions at retail. Further, this will allow us to deliver the strong newness we have lined up to hit floors in July for the key back to school and holiday seasons. We are confident that these actions will improve our U.S. wholesale results going forward. Now let's turn to the progress we achieved in executing our three strategic priorities, starting with our first priority, leading with our brands. Due to the ERP shift, I'll speak to the brand's results for the full first half. The Levi's brand grew low single digits on top of 22% growth last year. Levi's bottoms grew low single digits with women's growth slightly stronger than men's. We continue to drive denim trends with products like our super low boot giving women more options for looser fits with lower rises. In the U.S, we're seeing strong demand with the $100,000 plus income consumer, particularly in our mainline stores, helping drive share gains in the premium end of the jeans category in the U.S. We've also maintained our share leadership with the key 18 to 30 year old demographic and for U.S. jeans overall, we gained market share across men's and women's. The greatest story ever worn marketing campaign and celebration of the 501's 150th anniversary generated billions of impressions globally and drove strong 501 demand, with revenues up low double digits in the first half against more than 40% growth last year. Moving on to our second priority, being DTC first. As I mentioned, global DTC delivered strong double digit growth in Q2, led by broad based positive comp sales and traffic growth across company operated stores in all geographic segments. U.S. DTC was also strong, led by our mainline stores, which saw continued strength in flagship and tourist destinations. We're also seeing the benefits of our investments in digital and the impact of our new Chief Digital Officer, Jason Gowans. Our e-commerce business grew 21% in Q2, driven by both higher traffic and better conversion. Strength was global and across all brands as we continue to expand the breadth of our offering online, while improving the user experience and customer journey. Consistent with driving growth in DTC and e-commerce, we just opened a state of the art digital fulfillment center for the East Coast in Kentucky and we'll begin shipping from there this month. This completes bringing our U.S. e-commerce business in-house, which will drive more agility and inventory positioning, reducing lead times, improving customer satisfaction and accelerating digital margin expansion over time. We are also continuing to expand our loyalty program, with over 26 million members, up 40% over prior year. Loyalty member transactions and average transaction values grew across all segments, a positive signal as we drive continued growth in membership. Overall, our digital and e-commerce businesses remain underpenetrated versus peers and the channel represents a tremendous sales and profit opportunity for the company. Our third strategic priority is to continue to diversify the business. On a first half basis, our total company women's and tops revenues grew 1% and 3% respectively, both on top of more than 20% growth last year. Women's was driven largely by the Levi's brand, particularly in Asia. In addition to ongoing strength in denim fits for her, including lower rises, women's also saw growth from newly launched dresses, cargoes and overalls. Tops were driven by strength in Levi's men's. We remain enthusiastic about our opportunity to significantly grow these businesses as we continue to diversify our offerings. As for our other brands, Beyond Yoga's revenues accelerated double digits versus Q1, growing 28% in the quarter, driven by continued DTC strength. Overall, first-half sales were up 19%. The brand saw notable success with sports bras and dresses and it opened two additional stores in Southern California, bringing the total store count now to four. Dockers was also impacted by weakness in U.S. wholesale, while the brand experienced continued strength with DTC up 22% and international up 10% in the second quarter. Adjusting for the ERP shift, Dockers would have been flat in Q2 with sales up 8% in the first half. Before I turn it over to Harmit I wanted to share my conviction in our future and the strength of the Levi's brand around the world. Michelle and I have traveled extensively this last quarter, visiting a number of key international markets, including Mexico, India, China and Japan. And everywhere we have been the Levi's brand is incredibly strong and we are winning. We've met with consumers, customers and franchise partners and we’re inspired by their view of Levi's and our future. Our strength in DTC and international combined with the actions we're taking to fix our U.S. wholesale business give me confidence that we can accelerate as we go into the key holiday season and end-of-the-year with momentum heading into next fiscal year. Finally, also giving me great confidence in our future is how Michelle has come up to speed on the business, organization and opportunities. Her current remit is big, the Levi's brand globally, all of our commercial organization through which the Levi's P&L rolls up and the digital organization. She has dug in and has played a key role in figuring out our path forward on U.S. wholesale. She is also all over our tops and women's businesses and I am confident you'll see a lot more good work as those products come to market later this year and into 2024. She is also starting to make some smart organization moves to set the company up for the long-term. As I said before, I was confident when we hired her that she would be a great successor and now after six months I'm even more sure of myself as she will take this company to the next level when she becomes CEO. With that, I will turn it over to Harmit.

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 to maintain 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 now provide more color on our Q2 performance and then move to our outlook. Total company revenue of $1.3 billion decreased 9% versus prior year, down 2% when adjusting for the ERP shift. Our DTC channel posted 14% growth on top of 22% growth in Q2 2022 with continued broad-based positive comp sales growth across geographies, driven by higher traffic and volume. Company operated e-commerce also accelerated, up 21% with growth across all segments and brands. Global wholesale was down 22%. Excluding the shift, the channel declined low double digits on top of nearly 20% growth last year. Growth was strong in Asia and Latin America, but more than offset by softer performance in the U.S. and Europe. Adjusted gross margin was a record 58.7% up 50 basis points against last year's record Q2 performance. Favorable channel and geographic mix, price increases, lower airfreight and FX more than offset the impact of lower full price sales and higher product costs. As a reminder, our H1 2023 gross margins are approximately 300 basis points higher than 2019. We continue to expect several transitory cost headwinds to abate in the second half. I'll provide more color momentarily when discussing our outlook. Adjusted SG&A expenses in the quarter were $753 million, up 6% to last year. The increase was primarily to support DTC growth with company-operated store count up 6%, as well as A&P investment to support our 501 marketing campaign that largely ran in H1. Adjusted EBIT margin was 2.4%, in line with our expectation and adjusted diluted EPS was $0.04. Here are the key highlights by segment. In the Americas, net revenues declined 22% on top of 17% growth a year ago. DTC, growth of 6% was driven by all markets. Latin America, in particular, saw continued momentum with 18% growth driven by the strength in Mexico, Brazil and the Andes. Europe again grew, excluding Russia, up 1% on top of a 15% increase last year due to broad-based DTC growth across all countries. DTC, excluding Russia was up 14% on top of more than 60% growth last year. Europe saw growth across most countries led by increases in Italy, Germany, the UK, Poland and Spain. Asia’s very strong performance further accelerated with revenues up 27%, driven again by growth across all channels, particularly DTC. We are encouraged by the improved trends we are seeing in China, which saw sales return to pre-pandemic levels and growth across all channels with notable strength in mainline brick and mortar. Thailand, Turkey, Japan and India were also highlights. Asia also saw operating margins expand 370 basis points to 12.3% due to higher gross margin and stronger SG&A leverage. Now looking to our balance sheet and cash flows. We continue to make progress on our plan to sequentially improve inventory levels. Q2 inventory dollars were up 18%, up 15-point improvement from last quarter and units were up 8%. Importantly, inventory improvement did not come at the expense of margin and current inventories are healthy, with gold co-products representing more than two-thirds of total inventory. We continue to expect sequential improvement and to end the year below prior year levels ahead of our plan. The peak of inventory is behind us and we're taking a prudent approach going forward, focused on moderating receipts and leaning into our ability to chase, a benefit of our globally diversified supply chain. Inventory management will be aided by our recent IT investments, including our ERP, enabling real-time visibility to our inventory on an omnichannel basis and across our network. Adjusted free cash flow was $211 million in the quarter, up from $13 million in the second quarter of prior year. As we continue to improve our inventory throughout the year. We also expect to end the year with positive free cash flow. Our cash flow generation also allowed us to repay $100 million of outstanding ABL borrowing this last week. In the quarter, we returned approximately $48 million in capital to shareholders via dividends, which increased 20% from Q2 last year. Dividends are up 20% in H1 versus prior year and for Q3 2023 we have declared a dividend of $0.12 per share, in line with last quarter. Now moving to our updated guidance for fiscal 2023. While we have experienced stronger than anticipated trends in our international and DTC businesses where we expect continued strong momentum, we are lowering our outlook due to softer U.S. wholesale trends. We are now guiding revenue growth of 1.5% to 2.5% as compared to growth of 1.5% to 3% previously. We expect full year adjusted EPS to be within a range of $1.10 to $1.20 from a prior range of $1.30 to $1.40. There are three fairly equivalent factors driving the change in guidance. First, our slightly lower revenue expectation and the resulting fixed cost deleverage. Second, lower expected H2 gross margin mainly due to our targeted pricing actions. And third, non-operating FX losses and a higher tax rate. For the year in reported dollars by segment, we now expect a low-single digit decline in the Americas despite continued strength in U.S. DTC and in Latin America. U.S. growth is still expected within the previously guided range of up low-single digits and based on the stronger trends for Asia, we now expect low-teens growth, an improvement from the low double-digit growth in our previous guide. Adjusted gross margin is now expected to contract approximately 90 basis points from prior year's 57.6% as compared to an expectation for a 50 basis point decline previously. The incremental 40 basis point decline is due to the strategic pricing actions we are taking to drive volume and capture market share in U.S. wholesale. Despite all the puts and takes during 2023, we expect that gross margins will end the year, up almost 300 basis points versus 2019. To put it into context the new guidance, I'll provide some color around our H2 expectations in total. We expect revenues to grow mid-single digits. As mentioned versus 2019, H2 sales will maintain the same run rate as H1. Similarly, we expect U.S. wholesale to maintain the plus 2% growth rate versus 2019 we delivered in H1. Adjusted gross margin is expected to be flat to up slightly in H2, driven by lower product costs and freight, partially offset by our targeted pricing actions. However, because the pricing actions are evenly distributed between the corridors and the benefit of lower product costs doesn't fully materialize until Q4, we expect Q3 gross margins to contract slightly more than 200 basis points year-over-year with Q4 gross margins up slightly more than 200 basis points over the prior year. Looking at H2 in total, adjusted EBIT margin is also anticipated to expand nearly 100 basis points to roughly 11.5%, but with Q4 adjusted EBIT margin significantly higher than Q3. Lastly, we expect an H2 tax rate in the low double digits versus 1% last year. To conclude, we expect to end the year structurally stronger, setting us up well for 2024 and beyond. Our stronger growth, higher gross margin, premium DTC and international businesses will account for a greater share of our revenue, nearly 45% and 60%, respectively. Driven by our ongoing execution in surgical pricing action, U.S. wholesale will stabilize and end the year as a smaller share of our business at less than 30%. Inventories are expected to end 2023 below prior year levels. Our 2023 gross margin is expected to remain 300 basis points higher than 2019 and we will exit the year with Q4 EBIT margins north of 12%. Importantly, we continue to return cash to our shareholders with a payout ratio of 150% of free cash flow substantially higher than our targeted 55% to 65% communicated at our Investor Day. Lastly, while we are lowering our H2 outlook because of U.S. wholesale, we expect the strong growth in our large, fast-growing DTC and international businesses to continue, which as U.S. wholesale stabilizes and COGS improves will position our unique business model to generate significant financial leverage beyond 2023. With that, we'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 of JPMorgan. Please go ahead, 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 start by discussing the overall category, then I’ll provide more detail on market share and the differences between the U.S. and Europe. First, regarding the category, we only receive quarterly data in the U.S., and we don't have access to market share data internationally. Therefore, our insights are based solely on U.S. data. Since the pandemic, we've observed significant fluctuations within the category, with extreme highs and lows. Looking at the past 12 months through May, we faced a comparison against a notable spike in category growth; specifically, there was over a 20% increase from May 2022 compared to May 2021. Currently, when examining the past year, we have seen a slight decline compared to that peak. However, it is important to note that the U.S. denim category is now 12% larger than it was in 2019, measured in dollar value. As we discussed in earlier remarks, the U.S. market reflects contrasting trends between channels: U.S. wholesale is weak, while our U.S. direct-to-consumer (DTC) business is performing strongly. This is intriguing since our mainline business, which represents the most premium aspect of our brand, is thriving. In U.S. wholesale, we are facing two main issues we can influence. First, lower-income consumers are being financially squeezed, leading to heightened price sensitivity. Our value brands are down significantly, and U.S. wholesale has also experienced a decline. Additionally, we've encountered internal supply chain challenges, affecting our inventory levels and customer service, which, in turn, led to stock shortages. However, as we normalize our inventory, our service levels are improving, which is positively impacting our stock situation and sales. For the first half of the year, our U.S. wholesale business remains up 2% compared to pre-pandemic numbers, indicating it's against a robust base despite current declines. In contrast, DTC is showing much stronger performance, with our mainline and e-commerce channels doing particularly well. DTC comp sales are in the low to mid-single digits for both the second quarter and the first half of the year, with e-commerce seeing double-digit growth in Q2. Regarding market share, we did grow this past quarter. Our market share for men's clothing rose 2 percentage points to 22%, significantly surpassing the second place brand. We also gained market share in women's apparel for the first time in many years, now holding 7%, making us the only major brand to increase share in this segment. Additionally, we maintained our leadership among our targeted consumer demographic of 18 to 30-year-olds and increased our share in the premium tier of products priced at $60 and above. Turning to Europe, although we have less information on market size and share, I believe trends may be similar to the U.S. Excluding Russia, Europe experienced a 2% increase, coming off a strong 15% base. DTC in Europe is also very robust, with double-digit growth excluding Russia, and overall traffic in our channels has increased mid-single digits. Our comparisons for the second half will be easier, providing a positive backdrop for both U.S. and European numbers. However, similar softness in wholesale was seen in Europe, as customers are cautious about their spending. Overall, while our data isn't as robust outside the U.S., we observe comparable dynamics, with Europe being more of a premium market where wholesale typically features higher-tier products.

Yes. Let me discuss the areas where we can take further action. Overall, as you've noted, as conditions tighten, we can effectively reduce expenses. A good example was during COVID when we adjusted our expense structure to align with the new revenue landscape. This year has been characterized not just by a split between halves, but also by differing conditions across markets and channels. Our international and direct-to-consumer channels are performing well, so we are reallocating resources to support those areas while cutting costs related to U.S. wholesale. Additionally, we are focusing on discretionary spending and have implemented several measures. For instance, we have reduced travel and limited new hiring. We still prioritize essential travel to meet our customers and consumers, although most other travel is paused. Regarding hiring, we are only bringing on critical positions. If conditions worsen, we will reassess our hiring strategy and take a closer look at fixed costs, similar to our approach during COVID. Aligning our cost structure with anticipated revenues is crucial. We have already made significant adjustments, but we are committed to running this business with a long-term perspective. It's important to note that there are some factors now acting as tailwinds. For instance, commodity costs and logistical challenges that were headwinds in the first half of the year are expected to become favorable as we look towards the end of the year and plan for 2024. Maintaining our cost structure is essential to drive profitability and achieve the EBIT margin target set during our Investor Day.

It’s great color. Best of luck.

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 earlier, three factors are influencing the adjustment in our guidance, even though we expect growth in the second half. Gross margin in the second half is relatively flat but significantly higher compared to 2019, and EBIT margins have improved considerably. The factors include a slight reduction in our revenue outlook, gross margins being lower than anticipated primarily due to the targeted pricing actions mentioned by Chip, and slightly higher tax rates. Regarding Q3 and Q4 comparisons, both sales and gross margins are expected to improve sequentially. Our forecast shows low single-digit growth in Q3 and high single-digit growth in Q4. The benefits of reduced product costs, mainly driven by cotton, will not be realized until Q4. We still need to sell through the inventory purchased at higher cotton prices in Q3, while new inventory will be at lower prices. In fact, we expect improvements in cost of goods sold with the new pricing to be about 200 basis points. This will be evident not only in Q4 but also in 2024. We anticipate SG&A expenses to rise in the mid-single digits during the second half, primarily in Q3, and we expect EPS in Q4 to be about double that of Q3 due to revenue growth and gross margin expectations. Additionally, I want to highlight some recent trends. Our results are current as of May, but we have observed positive trends in wholesale sell-through, especially as we are fulfilling orders and ensuring adequate stock. We are seeing similar patterns in direct-to-consumer and outlet sales. As we address the stock situation and implement the upcoming price reductions for our targeted fits within the next 30 days, we believe we can better cater to price-sensitive consumers and enhance consumer demand while continuing to increase our market share.

Thank you.

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. It's an important question because it highlights a paradox. Our U.S. direct-to-consumer business, including e-commerce and especially our mainline stores, is performing exceptionally well. This is a key strategic focus globally. We have control over the brand, the consumer experience, store focus, and assortment. Consumers come to our stores wanting to buy Levi's, and our results reflect that success. On the wholesale side, some of the decline is attributed to consumer behavior. Our value brands have seen double-digit declines, and U.S. wholesale is down by double digits as well. The moderate to lower-income consumers are under pressure, likely feeling the trade-offs of spending money on experiences like summer vacations instead of new clothing. They are making tough choices about their purchases. However, there are also factors within our control. We've faced customer fill rate issues due to overloaded inventory, but as inventory levels normalize and distribution center congestion eases, our fill rates are improving week by week. As we move into the third quarter, we are seeing these fill rates improve, which helps reduce out-of-stocks and boosts sell-through. Additionally, we are considering selective price reductions on certain items. Over the past two years, we’ve increased prices globally, including in U.S. wholesale, which has widened the price gap compared to other brands. We recognize that on some price-sensitive items, this gap is too large, and we plan to address it. Specifically, we are looking at six items in wholesale out of over 60 items sold in U.S. wholesale and more than 120 total items sold in the U.S. This represents less than 10% or even less than 5% of our total assortment, affecting less than 15% of the total volume. Our analysis and customer engagement suggest that closing this price gap could help stabilize our business further. Combining improved supply chain confidence in our deliveries with addressing this price gap should stabilize our wholesale business and potentially lead to growth in the second half of the year, providing momentum heading into the critical holiday season and the next fiscal year.

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, I have two follow-ups regarding the margin guidance. I understand the significant decline in gross margins in the third quarter due to the pricing actions. However, I am a bit unclear about why the margins will improve in the fourth quarter compared to both last year and 2019 as a result of these pricing initiatives. Could you also confirm if SG&A is expected to rise in the mid-single digits year-over-year in the second half? That seems a bit high in relation to the guidance you're providing. Thanks.

Yes. The gross margin should improve in Q4 because we will fully realize the impact of lower costs of goods sold. That's the significant change. In Q3, we still carry over some inventory that we have not cleared. We managed our inventory effectively, as it is primarily core inventory, so we avoided deep discounts. Instead, we reduced future orders to align with demand. This is why we still have some older inventory to sell in Q3, while new inventory with updated pricing will enter in Q4. Consequently, you're noticing a substantial difference in pricing. From this angle, pricing remains relatively consistent; we typically adjust pricing about a month from now, which means you will see some effects in Q3 and more in Q4, primarily driven by the cost of goods sold. I anticipate our gross margins in the second half to exceed 56%, concluding the year around that same figure. Compared to 2019, this represents an improvement of 300 basis points in the second half. In 2021, some of you inquired about our margins, which had improved by 400 basis points relative to 2019, and I estimated that two-thirds of that improvement was sustainable long-term, with one-third expected to gain gradually since we haven't been pushing inventory hard, keeping it quite clean, etc. That trend is continuing. At that time, predicting commodity prices was challenging. What has been a significant challenge in the first half is turning into a benefit in the second half. Currently, cotton futures appear stable for 2024, which should serve as a positive factor moving forward.

And the SG&A in the back half?

The SG&A for the third quarter is expected to be in the mid-single digits, with a low single digit forecast for the fourth quarter, and for the second half of the year, we anticipate low to mid-single digits, leading to a mid-single digit estimate for the full year. This reflects our current outlook. We are continuing to open stores, which is a significant factor driving these numbers. We opened about 20 stores net in the first half, and in the second half, we expect to open around 50 to 60 stores. This expansion is largely contributing to the SG&A, which is positioning DTC for long-term success. However, as I highlighted earlier, discretionary costs and similar expenditures are being kept under control at this time.

Great. 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, etc. Black Friday will happen, but it's very targeted. And the same cadence we have for our outlets, too. And some of the pricing on 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 would like to highlight that our direct-to-consumer channel is benefiting from newness, especially as we approach the end of the season. If you shop online or compare options, you will notice a lot of sales as retailers prepare for the next season. Our new products will start arriving in stores later this month, which positions us well for back-to-school. We are really enthusiastic about the upcoming season and the new products we've planned, including some exciting collaborations. Newness is clearly effective, and we have no issues selling out our products at full price when they are fresh and appealing.

Thank you.

Thank you. Our next question comes from the line of 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.

I will address the CapEx question first and then hand it over to Chip for the value channel. Regarding CapEx, we previously mentioned an expectation of around $290 million to $300 million. This aligns with our earlier discussions and is primarily focused on new doors and technology investments aimed at enhancing our e-commerce operations. Additionally, we have plans for some infrastructure CapEx, including the launch of a digital direct-to-consumer channel, upgrades to our ERP system, and the development of an omnichannel distribution center in Europe. These infrastructure investments are intended to support and facilitate the growth outlined in our strategy.

Yes, I might be forgetting the second part of the three-part question, but the mass channel is currently weak. Overall, it's softer, and the balance of wholesale includes Amazon, which is performing strongly at the moment. However, our value brands and the mass consumer market are facing significant economic challenges, as reflected in their latest quarterly results. Specifically, our signature brand, which sells in that channel, is down by double digits. We do have Levi's available at Target, and it's performing about the same as Levi's in other wholesale channels. Our main focus with Target is to build on the success we've had over the past few years with Levi's at Target. Over time, we plan to trade out floor space for Denison for more floor space for Levi's. Did you have another 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 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.

Thank you very much for taking my question. I have two follow-ups. First, regarding Ike’s question, Harmit, last quarter you provided a helpful breakdown of the gross margin, noting that product costs were a 20 basis point headwind and promotional activities accounted for about 300 basis points. Could you break that down for the second quarter? Also, how much do you anticipate in terms of promotions for the second half of the year? Secondly, it's great to hear that China has returned to pre-COVID levels. Harmit, could you share some insights on what you're observing in China? Are you witnessing consistent monthly improvements in that market?

In the second half, I noted that gross margin is flat to slightly up compared to last year. The pricing impact is about 70 to 80 basis points negatively affecting us. A year ago, the cost of goods sold in the second half balanced this out, resulting in a generally flat situation overall. While there is a slight benefit from airfreight, the key factors are pricing and the benefit from COGS. This benefit from COGS is lower in the third quarter but increases in the fourth quarter, allowing us to finish the year with a higher COGS benefit that will carry into 2024. Regarding China, Michelle, Chip, and I, along with our teams, recently visited. The second quarter was strong for them, with business levels exceeding those of 2019. Looking ahead, our guidance for Asia is in the high teens for double-digit growth, reflecting a mild recovery in China as well as in the wider Asia region. We will monitor developments in China before setting expectations for 2024. The team that operated pre-COVID remains intact, and the Chinese market presents some differences from other Asian markets, particularly in the premium segments, which we are focusing on enhancing in our product offerings, and this strategy appears to be effective.

Very helpful. Thank you very much.

Thank you.

I think we're going to wrap it there. 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.