Levi Strauss & Co.

Good day, ladies and gentlemen, and welcome to the Levi Strauss and Company second quarter earnings conference call for the period ending May 24, 2020. All parties will be in a listen-only mode until the question and answer session, at which time instructions will follow. This conference is being recorded and may not be reproduced in whole or in part without written permission from the company. A telephone replay will be available two hours after the completion of this call through July 13, 2020. Please use conference ID 217-9823. 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 Ida Orfin, Senior Director, Shareholder Relations and Risk Management at Levi Strauss & Company.

Thank you for joining us on the call today. Joining me today are Chip Berg, President and CEO, and Harmeet Singh, Executive Vice President and CFO. We have posted complete Q2 financial results in our earnings release on the IR section of our website, investors.levistrauss.com. We'd like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. In particular, at this time, there is significant uncertainty regarding the duration and extent of the impact of the COVID-19 pandemic on the company's business, financial condition, cash flow, and results of operations. Our actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC, in particular the risk factors section of the Form 10-Q that we filed today, for discussion of the factors that could cause our results to differ. Please note that the forward-looking statements

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The most directly comparable GAAP financial measures are provided in the 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 one hour. Please limit yourself to one question at a time. And now I'd like to turn over the call to Chip.

Thanks, Ida. Good afternoon, everyone, and thank you for joining our Q2 earnings call. This quarter has been defined by the coronavirus pandemic and the economic fallout from it, which dramatically impacted our business during the quarter, with virtually all of our retail stores and most wholesale doors closed for the vast majority of the quarter. I'm proud of how the team stepped up in response, prioritizing consumer and employee safety while accelerating our activation of key e-commerce and omni-channel capabilities, proactively cutting costs, smartly managing cash, and finding more innovative ways to connect the Levi's brand with its fans. I'm going to let Harmeet take you through all of the details from the quarter so that I can focus my comments on two key areas. I'll start with the current environment and how we've managed through the pandemic and into early recovery. And then after Harmeet reviews Q2, I'll share some thoughts on how the pandemic will impact both the retail landscape and consumer behavior and why I'm optimistic and confident that we are ideally positioned to win in the post-COVID world. We now have roughly 90% of our stores open globally, and performance during the reopening phase has tracked better than we expected. We are cautiously optimistic about the early trends we're seeing in our reopened stores and the strong performance of our e-commerce business. Having said that, there are still a lot of uncertainties. Will there be another wave? How bad will the economic downturn be? How long will the recovery take? We are already seeing consumers think, act, and buy differently while holding greater expectations and demanding more from the brands they buy. Let me highlight four key points for us as we've navigated the pandemic and early recovery. They are, first, continuing to build our brand and deepen our connection with consumers. Second, investing in and accelerating e-commerce and omnichannel capabilities. Third, accelerating the pace of digitizing the company and leveraging AI and data. And fourth, driving product newness and excitement. Let me walk you through some details on each one of these. First, we continue to invest in brand building by maintaining a deep connection with our consumers, engaging with them virtually at unprecedented levels on social media through live music streaming and do-it-yourself customization, launching new collaborations that made waves in the industry with immediate sellouts, and partnering with global influencers as we told immersive stories on our blog. which has seen record high viewings. We continued our 501 live concert series on Instagram, live streaming performances from some of our favorite artists. And in celebration of 501 Day, we threw a virtual music festival with a full day of content featuring live music, style tutorials, and Levi's history reaching 147 million impressions. And we continued to pilot new channels for commerce that are particularly relevant with Gen Z, We were one of the first brands to launch on TikTok's new Shop Now program in the U.S., partnering with influencers to showcase Levi's FLX laser technology, which drove 5.5 million video views on TikTok, as well as increased traffic and sales to our site. Our recently launched mobile app represents an evolution of our online shopping experience, aimed at fostering and growing the brand's connection with our consumers. Online enrollment rates have nearly doubled since entering shelter-in-place. And due to strong response, combined with the increased importance of building deeper connections with our fans, we just rolled out our loyalty program nationally. Second, we have invested heavily to strengthen our position as a leading world-class omnichannel retailer. And during the quarter, we accelerated a full suite of omnichannel capabilities in the U.S., some that had been in the works and others that we quickly launched in response to consumer preferences. Here are a few examples. While they were closed, we turned our stores into micro-fulfillment centers, leveraging our ship-from-store capabilities to fulfill online orders and move through inventory. 30% of our online demand was fulfilled by stores in the month of May, contributing to e-commerce growth of 79% that month. We rolled out curbside pickup and are now live in 80% of our stores. We launched a new virtual concierge, offering consumers the chance to have one-on-one interactions with a store associate in the comfort of their own home, and we're seeing strong conversion rates. This work has continued into Q3 as we pulled forward the rollout of buy online, pick up in store in 20% of our stores and plan to complete the rollout to the remaining US stores in the coming months. We've begun testing appointment scheduling in select stores, enabling consumers to skip the line and get immediate access into the store. And in the next few weeks, we will begin piloting same-day delivery for our consumers. This program, along with others that we are exploring, will offer our consumers several forms of contactless retail shopping, expanding the way consumers can shop with us. We're also rolling out omni-channel capabilities in various markets around the world in phases, and we'll keep you updated on that work as it progresses. The third focal point has been to accelerate our overall digital transformation and leverage the use of data, analytics, and machine learning in more aspects of our business. We're applying a data-driven approach to determining appropriate promotion levels. As just one example, During a major e-commerce promotion event in Europe, we were able to amplify revenues, units sold, and profits four times what we did in the previous year. We are also using AI in our US stores to ensure we're optimizing margins and fulfilling orders in the most efficient way, which has been critical with the recent rollout of ship from store. And we're using AI to enable us enable personalized benefits in our newly launched loyalty program, further cultivating loyal fans. Our FLX laser finishing technology enables us to reduce lead times to better match inventory to the current demand trends. And we've accelerated the use of digital and virtual design and product development tools that have helped us maintain our creative activities during shelter in place, which will also provide advantages in time and resources pointing the way to a future without samples. And fourth, we've continued to deliver new product and a number of exciting collaborations across channels. We launched a spring collection which focused on youthful optimism in partnership with Hailey Bieber and Jaden Smith. Our collaboration with New Balance sold out everywhere within seconds of the product launch, including NewBalance.com, Tmall, and more. And consumers camped out virtually and lined up in Harajuku for the Levi's by Golf Lang release, which sold out in minutes. Our 2020 Pride collection, which we dropped exclusively on our app, exceeded expectations on conversion and average order value. And for summer, we've introduced cool, relaxed, and easy summer pieces in soft new earth tones and 90s-inspired denim finishes. Our product continues to resonate with consumers during the shelter-in-place period on our broader digital footprint. We were recently selected by Amazon to be featured in their Big Style sale at the end of June and saw our second biggest selling week on their platform. And our reversible face masks became a number one bestseller on Amazon in mid-June. Complex Magazine recently listed Levi's among its best brands of 2020 for our relevancy and for the creative freedom we grant in collaborations like what we did earlier this year with industry renowned Doc C on NBA All Stars and Tremaine Emery of Denim Tears. And although our brand and balance sheet remains strong, the substantial revenue impact from the health crisis requires us to adjust our cost structure so we can continue to fuel high ROI investments that drive our business in digitization, brand building, and other areas that are working for us, which will accelerate our rebound. That's why today we announced the difficult decision to reduce our workforce by approximately 700 people. which represents about 15% of our global non-retail, non-manufacturing headcount. This will allow us to respond to the immediate business impact of COVID-19 and give us confidence in our cost structure during the potential extended recovery. This is by far the most difficult aspect of this situation, made especially hard because we had been building such strong momentum before the pandemic hit. And many of our colleagues who are being impacted by this difficult but necessary reduction were critical to our success. Finally, before I turn it over to Harmeet, I want to take a moment to acknowledge the ongoing call to action in the US and around the world for all of us to stand up and confront the reality of systemic racism. Our company has long stood for inclusivity and has a history of fighting for equality. In just the last five years, LS&Co and the Levi Strauss Foundation together have invested $37 million in organizations advancing social justice and equality in the United States. In June, we hosted a series of conversations with Black leaders on our Instagram Live to elevate voices in the Black community. We've taken important steps, but we know it is not nearly enough. Over the last few weeks, we've taken a hard look at ourselves and made a number of commitments to encourage more diversity at all levels of the company. I look forward to updating you on the progress on these commitments going forward. Ramit, over to you.

Thanks, Chip, and welcome to everyone joining our call. I hope everyone is continuing to be safe and healthy. Before I discuss our financial performance, I would like to thank our teams around the world for the tremendous efforts in helping the company manage through the different crises while remaining focused on how we will immerse stronger on the other side. I've been very impressed and energized by how everyone has come together to understand and take swift actions to address current challenges and adapt to new ways of working while remaining guided by our values as we serve all our stakeholders. It's been an unprecedented quarter like no other that I've seen. However, I'm confident and optimistic that we as a company will grow market share and improve our structural economics as we move through it because of the following factors. We have great brands, products that consumers love, and strong talent. We've been agile in responding to the impact of the pandemic on our business as Chip described. We have a strong balance sheet and ample liquidity and responded quickly to address cash flows by reducing capex and costs and by taking steps to optimize working capital efficiency. And while we're cutting costs and capital spend, we are focused on driving structural improvements in our cost base to drive stronger EBIT margins and reallocating resources towards high ROI investments, such as automation, AI, and digitization. Now I'll share some color around our Q2 results. While everyone's comparisons to prior have been substantially impacted by the economic fallout of the pandemic, our fiscal second quarter was comprised of March, April, and May. This yielded a tougher full quarter comparison than most given stores, both ours, our franchises, and our customers were closed in almost in all markets for nearly 10 of the 13 weeks beginning in mid-March. All told, we estimate a weighted average of less than 40% of our operational footprint was open for business in the quarter. With this backdrop in mind, we delivered net revenues of $498 million, a 62% decline from prior year. As we'd expect, most of this revenue was booked in the first half of March. Once those had closed, April and May were light as markets only began to reopen in May. We opened about a third of our doors progressively throughout May, most of which were in Europe, and did so slowly and cautiously, prioritizing consumer and employee safety. As wholesale customers reopened, shipments were minimal, as the vast majority of them were only beginning to work through the inventory they had received prior to the lockdown. The highlight for revenues was our own e-commerce business, which for the total company grew 25% for the quarter. Total company e-commerce was slightly down to prior year in March as consumers focused on stocking necessities as they prepared to shelter in place. But in April, we saw a return to double-digit growth, and this accelerated to 79% growth in May, a month in which our U.S. e-commerce growth hit triple digits. The substantial increase e-commerce growth drove leverage on the investments we've been making in that channel, resulting in e-commerce being profitable for both the second quarter and year to date. Should trends continue, we expect our e-commerce business to be profitable for the full year ahead of expectations. Turning to gross margin, reported gross margin of 34% included COVID-related charges of $87 million. Excluding the charges, Adjusted gross margin was 51.5%, down just 180 basis points from prior year. Gross margin was bolstered by the benefit of the price increases we have taken, which held even in this environment, demonstrating the value of our products to our fans. An adjusted gross margin for our direct-to-consumer business overall held strong and was also in line with prior year, as promotions were not a significant driver in the quarter. Wholesale margin declined by a few points, primarily reflecting higher proportion of discounted sales in Europe as they actively managed down inventory levels. Adjusted gross margin in the Americas was flat to last year, while Asia was up at China's higher gross margin, which held strong at flat to last year, comprised a higher share of Asia's revenues this quarter. Turning to SG&A. which on a reported basis at 551 million included 88 million in COVID-related charges. Excluding these, adjusted SG&A was 462 million, down more than 150 million from prior year, a 25% decline. Adjusted SG&A was down across the board, all regions, functions, and categories of spend, primarily reflecting the cost reduction initiatives we swiftly instituted. About 20% of adjusted SG&A is variable. Think distribution and other expenses tied directly to revenue. And these were down in line with revenue decline. The remaining 80% is not directly driven by revenue and in traditional terms is a fixed cost base. However, as I've said in the past, in a crisis, nothing is fixed and our actions to reduce these costs resulted in a more than 15% reduction. Specifically, To reduce selling expenses, we furloughed many of our hourly workers from our stores while they were closed and engaged with our landlords globally to renegotiate rent. Given that the Levi's brand is a traffic driver and that we are one of the few companies that continue to open new stores, we are using this crisis to not only ensure that we get the best locations, but also structure more favorable lease terms. Our efforts are focused on abatement of rent for the day stores are closed, relocation to better spots where desired, and rent reductions on the remaining term given the expected major disruption of the real estate market. In advertising, we cut spend in April and May that had been planned to drive traffic to physical stores, but retained and concentrated spend to stay connected to the consumer online. In administration, we cut executives, leaders, and board members' compensation, including the reversal of fiscal 2020 incentive accruals. And in IT, we rebalance our portfolio by cutting discretionary and non-urgent projects while accelerating our digital transformation to drive a better consumer and employee experience. We're also broadly maintaining our ERP rollout plan as we believe this will help digitize our processes. Turning to adjusted EBIT, the substantial decrease in adjusted SG&A was not sufficient to offset the COVID impact to revenue. And accordingly, adjusted EBIT for the quarter was a loss of 206 million. Adjusted net loss was 192 million and adjusted diluted loss per share was 48 cents. Now let's move to the balance sheet and cash flows. First and foremost, our liquidity position remains very strong. $2 billion, which is higher than it was at the end of Q1. We executed a $500 million add-on to our 5% U.S. dollar bond due 2025. It's callable at a small premium, which is worth it for the flexibility. This bolsters our liquidity, allowing us to play defense should things turn worse or offense as we emerge on the other side. We had previously drawn $300 million against our revolver, but with the incremental cash on hand from the bond raise, in addition to generating positive cash flow sooner than initially expected, we paid the revolver back in late June to reduce our interest burden. Independent from the bond raise, our working capital, cost reduction, and CapEx actions in response to the crisis radically mitigated our cash burn, which totaled around $160 million for the entire quarter, reflecting the roughly 10 weeks stores were closed. As stores have reopened, we are no longer burning cash and June was positive from a cash flow perspective. Working capital efficiency has been a big part of this and I applaud our teams around the world for rising to the call to enhance liquidity. We have aggressively pursued collections throughout the crisis. We have brought our payment terms in line with industry and market practices around the world while ensuring that our direct vendors have access to supply of financing if needed. And most importantly, we took swift action on inventory early on as the magnitude of the crisis became clear. Despite a drop of more than 60% in sales, quarter and inventory dollars netto reserves are only up 10% year over year. Asia drove the bulk of the increase as inventories in the Americas was only up 5%, while Europe was up 13% to prior year. An overall inventory composition between core and seasonal is similar to where we were pre-COVID. Our agility to quickly curb the inflow of inventory is part of the equation, as we will be working through inventory for at least a balance of the year. Given the inventory overhang in the sector, we anticipate our sales of excess inventory in the back half of fiscal 2020 to pressure adjusted gross margins, which we expect will be lower than prior year, particularly in the third quarter. We will sell in-season products wherever possible, and despite the majority of our inventory being core, we do not plan to pack and hold a material amount. As we move to the back half of 2020, we will strike a balance between revenues and gross margins. And to this end, we have the advantage of the ability to clear inventory through our network of outlets. We have and will continue to invest in future growth via capital expenditures on stores, our omni-channel and other digital initiatives, AI and data analytics, as well as the upgrade of our ERP. A revised CapEx estimate for 2020 is now around $160 million. substantially lower than the 200 million we originally guided for 2020. We now expect that we'll open around 70 company-operated doors this year. We're already open 30 doors year-to-date, primarily internationally, and we'll continue to open doors selectively through the balance of the year. And most of the stores we are opening this year will be digitally enabled, transforming our stores from just a place to buy Levi's into an immersive environment omni-channel brand experience, giving our consumers an authentic, compelling, and consistent expression of the Levi's brand. And under the umbrella of organic M&A, we have been busy since we last spoke. We have taken ownership of our business in Singapore and are converting that market from third-party to company-operated. And we have taken back a handful of franchise doors in other markets into our store networks. And we are pleased to announce that we have finalized the agreement to take back our U.S. wholesale mainstops license for Knits and Woven products in 2021. Before starting the current trends, we are seeing post-quarter close. Let me briefly describe the COVID-related charges we took this quarter. Impacting gross profit, we booked inventory reserves of $87 million. Impacting SG&A, we took a charge of $28 million for receivables, due to the impact of COVID on our wholesale customers and recorded $60 million in store-related impairment. We also took a restructuring charge of $67 million in the quarter, consisting of severance and related benefits for the employees we have announced today will be leaving the company in the coming months. This was a very difficult decision, but unfortunately it was necessary to reduce our fixed cost base while reinvesting some of the savings in accelerating the digital transformation of the company so that we continue to expand adjusted EBIT margin as we emerge from this crisis. We anticipate this action will result in an analyzed reduction of $100 million in compensation costs beginning in quarter four. As we exited the quarter and moved through June, we saw encouraging trends. As we speak to you today, about 90% of our stores are now open, and almost 40% of the open stores are comping positively to prior year. The overall weekly productivity of our store fleet is improving sequentially, and in the final week of June, productivity approached 80%. While performance differs depending on the market, stores that are normally heavily trafficked by tourists are down more than the others. Conversion is high as the revenue decline is lower than the traffic decline, showing that consumers are coming back with a high intent to buy. Our e-commerce business continues to do really well, growing nearly 70% in the month of June, even as brick-and-mortar stores reopen. This is more than three times the growth rate we were seeing pre-COVID, which speaks to the stickiness in consumer shopping trends Chip mentioned. And at wholesale, nearly all doors in most markets have reopened, and we're starting to get a few summer and fall orders. Some market-specific color includes the following. In the Americas, two-thirds of the region's stores are open, with productivity around 70%, and a third of the doors come positively in the final week of June. In Europe, nearly all our doors are open, with performance better among franchisees, outlets, and stores, located in smaller cities, and stores are moving towards last year's revenue level, with a third of those comping positively to prior year, though it varies by market. And in China, all our stores have reopened, and our company-operated store network comped positively in the final week of June. China remains a huge opportunity for us. Given these trends, which are better than our expectations, and absent the second wave, we're expecting revenue performance versus prior year to improve sequentially by quarter. Having said this, looking ahead to the remainder of the year, it's still too early to speculate when the size of the apparel category will return to pre-COVID levels. Given the recent surge of COVID-19 cases in some parts of the US and in international markets like India, there remains quite a bit of uncertainty on the pace of revenue recovery and resultant cash flows. And we do not expect revenues to return to pre-COVID level until sometime in 2021. Accordingly, we continue to suspend guidance and will not be paying a dividend in the third quarter. We will reassess dividend payments for the fourth quarter as the situation evolves. Either way, with our strategies, strong connection to the consumer and trifecta of brands, products, and people, we believe will emerge with the largest share of the category at whatever size. Our digital business will be a bigger piece of the pie, as will our brick and mortar store fleet. And while COVID is accelerating wholesale disruption, a smaller wholesale footprint on the other side is likely a healthier one, and we're continuing to expand our wholesale distribution. And as revenues do return, we are confident that the steps we are taking to sustainably reduce our costs and drive greater efficiencies in working capital will enable us to further expand adjusted EBIT margins and drive cash flows. By focusing on what we can control, it will help ensure that our growth algorithm is healthier and sustainable over the long term. Before we take your questions, I'll turn it back to Chip for a look forward.

Thanks, Armeet. And as we look to the future, I want to share some major themes we're seeing. and why I'm confident that these play to our strengths and position us to capitalize in the post-COVID world. First, the pandemic and subsequent economic crisis are causing changes in consumer preferences. Consumers want value and values, which does not necessarily mean consumers will trade down. The pandemic is convincing more and more people, especially young people, that it's better to buy fewer, more versatile, higher quality products of value items the consumer can imagine wearing for years, like a trucker jacket, before handing it down to their grandchildren. I've long said that Levi's is the opposite of fast fashion. As consumers gravitate toward products that are well-made, sustainable, and built to last from season to season and year to year, Levi's will be at the top of their list. Consumers want brands they know, love, and trust, and this is our heritage, values that our company has been built on. And the days of conspicuous consumption are gone. It's all about conscious consumption. And because of this, sustainability is going mainstream. Consumers are increasingly valuing sustainability, which will be a primary focus of our marketing campaign this fall. We continue to innovate with a focus on comfort, style, and sustainable design practices. We're also introducing exciting innovations in sustainability, such as cottonized hemp denim, as featured in our latest fashion fits, the high loose and the stay loose, as well as truckers and denim shirts. Consumers are increasingly moving toward casualization, and for the fall season, we've infused the casualization trend with style influences from the 80s and 90s, including looser, more relaxed silhouettes across bottoms and tops. And for those that are seeking a lower price point, our signature Invenizen brands deliver great fits, fabrics, and fashion, for the price, making fashion available to everyone. The second major theme we're seeing is that the consumer shopping behavior has been changed for good. And here too, we are well positioned to address the change in consumer attitudes about shopping in stores. With approximately 85% of our stores in the US located in open air venues, such as strips, outlets, and off mall, we expect these locations will be more preferred shopping venues as consumers consider health and safety. These store locations also complement the execution of our rollout of buy online, pick up in store initiatives, including curbside pickup, and more consumers are increasingly allocating a larger share of their discretionary spend to online purchases. We expect these shifts in consumer shopping behaviors and the conveniences they've grown accustomed to will stick, and we're positioned to take full advantage. And as a final theme, we expect the pandemic will fundamentally alter the competitive landscape, especially here in the U.S. Wholesale disruption and department store door closures will accelerate, and this creates an opportunity for us. We will be aggressive in pursuing incremental and diverse distribution opportunities with a focus on elevating Levi's, including in premium doors, and on expanding our distribution into value channel, where we have significant opportunities to capture market share. As doors close and malls close, we are confident we can remap distribution over time, both with the existing customers and new ones. There is substantial growth opportunity across all of our brands, categories, and consumer segments to expand our head-to-toe lifestyle expression and win share of closet. Elevating the Levi's brand and distribution remapping will also be addressed through the ongoing expansion of our company-operated store base. There remains plenty of white space and we anticipate opening more than 100 smaller footprint mainline doors in the US over the coming years. In summary, we are confident that Allison Co is well positioned to benefit from the shift in consumer behavior and changes in the retail landscape. We are pleased with the strong response to the numerous initiatives we've employed during the COVID crisis and this gives us even greater confidence in our ability to capture the market opportunities So remain ahead. With that, we'll now take your questions.

Thank you. The floor is now open for questions. If you have a question, please press star, then the number one on your telephone keypad. Due to time constraints, the company requests that you ask only one question. If you have an additional question, please queue up again. At any point your question has been answered, you may remove yourself from the queue by pressing the pound sign. Your first question comes from Bob Durbel with Guggenheim.

Hi, good afternoon.

Hey, Bob. Hi, Bob.

Hi, Chip. Hi, Harmeet. I guess the question that I have is for Harmeet. On the $100 million cost reduction program, I don't know if you said this, but can you break down the cash versus non-cash, and will it stick in terms of the permanent cost reductions that you see going forward? Can you just maybe elaborate a little bit more on the various cost cuts that you've made? Sure.

Sure, Bob. Thanks for asking the question. As a reminder, the savings, we believe, will begin in quarter four. To your question about cash and non-cash, I would say cash would be about two-thirds non-cash, which is long-term incentives, stock, et cetera, is about a third. We're using this crisis to reshape the P&L structurally. so that we squeeze costs that we have to and invest in areas where we need to. So our focus will enable us to get to the 12% plus goal of adjusted EBIT margins as and when revenues recover. We believe that our longer-term growth algorithm will be healthier and drive sustainable longer-term growth. Specifically, we believe that where we will invest in areas like brand building and digitization of the consumer experience, our recent actions will also improve longer-term profitability. The other thing to say, Bob, on the cuts is we are cutting areas that are seeing a revenue drop, and as Chip said, these are largely corporate folks. We continue to invest in areas that will drive growth, which largely are focused around digitization, investing in AI technology, and, you know, other principles or disciplines that will accelerate the digitization of the company.

Your next question comes from Matthew Bals with JP Morgan.

Great, thanks. Chip, maybe what's your view on overall demand for denim in the U.S. and Europe as we break down the 80% brick-and-mortar productivity and and 70% e-commerce growth that you're seeing today. And Harmeet, what's the magnitude of gross margin pressure that you're expecting in the third quarter relative to 180 basis points that we saw in the second quarter?

Okay, Chip, why don't you go first?

So we've got the data that we have is best in the U.S. where we get data on a monthly basis, and the overall apparel category is down. But denim has maintained its share of apparel sales, and it's unchanged. If you just look at the three-month period post-COVID versus the same three-month period a year ago, that percentage hasn't changed. So we're not seeing a negative impact and also not seeing a huge positive impact. I will say one of the trends that we have seen, particularly as we've started to emerge, our women's business continues to outperform, particularly in Europe. where it now is more than half of the business. And then the other thing I would say is, remember, we're more than denim. We also have tops and outerwear and a bunch of other categories. Our tops business was not as impacted as our bottoms business during this past quarter. So we haven't seen huge fundamental shifts in either direction. The last thing I would say, Matt, is I'm really confident we're going to build share through this. There are a number of brands that have already declared bankruptcy. There are a lot of share donors out there right now. And given our commitment to continue to invest in building the brand and emerging stronger, I'm confident we're going to grow share through this period of time.

And to your question on gross margins, Matt, we closed the first half of the year in with gross margins at 54.7 on an adjusted basis. It's 70 basis points higher than a year ago, and that's despite the 180 basis points decline in quarter two. To your question about the second half of the year, I would say our effort is to progressively have cleaner inventory on the seasonal inventory side as we progress through the year. So we end the year with absolutely clean inventory. We already have, if you look at our evergreen products, products that we could sell in the season or beyond, that's still around what it was in the pre-COVID level, a little over 70%. So our expectation is that gross margins, probably slight pressure in quarter three, but structurally no major change to what I said a quarter ago. And, you know, as a direct-to-consumer business, as our e-commerce business continues to accelerate, that's creative from a gross margin perspective. So, you know, while we probably end the year slightly down, structurally we feel that once we have inventory clean or cleaner than what it is today, you know, we are in a better spot. The other thing we're doing on gross margin is, you know, we are – Scaling up FLX, which is accretive to gross margins. We are driving more productivity in our assortments. You know, so, you know, that would tend to drive higher gross margins. And we continue to work with our vendors. And that tends to, you know, make a big difference. We've also not scaled back pricing that we took. And, you know, I think once we come to the crisis, you know, that will definitely help.

Your next question comes from Omar Syed with Evercore ISI.

Good evening. Thanks for taking my question. I wanted to dive in a little bit deeper on some of the digital growth and strength you're seeing. You know, differences across regions. Are you seeing anything in the data there? Is it new customers, existing customers, shopping more, any category trends that you're noticing in digital? And then also, have you been able to use the inventory in your stores to fulfill digital demand in the quarter? whether it's online orders that you ship to people's homes or online pickup and store. I'd love to see where you are on that curve.

Thanks. Yep. Why don't I take that? Good evening, Omar. Good to talk with you. So as we alluded to in the prepared remarks, our e-commerce business has really continued to accelerate. During the quarter that we reported in May, our e-commerce business was up 79%. It was up over 100%, more than double in the US that month of May. And we've seen it continue into June. Our e-commerce business globally was up 70 plus percent in June. So I can't promise continued growth rates in the 70 plus percent range forever as our stores continue to reopen. But we do expect that the pace of growth will be significantly higher than pre-COVID levels. especially as we continue to invest and accelerate the digitization of the consumer experience. Just for perspective, our e-commerce business used to be about 5% of our total revenue. It's now tracking at 9. June was 13%. On the question about who the shopper is... During Q2, 70% of our e-commerce shoppers in the U.S., this is U.S. data, 70% of the e-commerce shoppers were new to e-commerce in Q2. So we are picking up a lot of incremental new users. Obviously, during the quarter, they couldn't go to the store. But as I said, I really do think that this is going to be sticky. The other, I guess, data point I can give you is remember we launched the app back in December, and the download rate of the app during Q2 was more than double what it was in Q1. And, you know, we're starting to see orders coming in through the app here in the U.S. as well. The app is not just a way to transact and a simple, easy way to keep Levi's on your phone. It is also more experiential, as we said on the prepared remarks. We dropped our pride collection exclusively on the app, and it still did really, really well. So we're trying to make it more experiential, and we're linking our loyalty program to that. Last on your question about ship and store, I think we said it in the prepared remarks, but during the lockdown when our stores were closed, we had the store managers going into the stores and fulfilling e-commerce orders, and about 30% of our orders in the U.S. during the month of May were fulfilled from our stores by the store managers, and that was a great way to help us manage inventory. We actually used AI to steer the orders to where we had the biggest opportunity to clear that specific inventory, and that's a capability that we've built, and we're going to continue to leverage that on a go-forward basis.

Your next question comes from Jay Soil with UBS.

Hi, thanks so much for that question. Hi, guys. Chip, can you just talk about what the flow of deliveries is like right now to your wholesale partners and maybe how it's differing in North America versus Europe? And maybe, you know, can you compare what you're seeing now versus what it was like, say, a month ago?

Yeah, it's still – As we said in the script, Jay, it's still relatively slow in terms of actual deliveries. Most of them have only had their stores open for a couple of weeks here in the U.S. We are starting to see orders starting to come through for late summer and fall. And so that is saying we're seeing sell-through. We're also seeing replenishment orders come in right now from our wholesale customers here in the U.S., And I would say it's pretty consistent both here and here in the U.S. as well as in Europe.

Your next question comes from Paul with Citigroup.

Hey, thanks, guys. I'm curious if you could talk a little bit more about the department store closing that you're seeing out there. Maybe just based on the number of stores that have been announced thus far from some of your key partners, do you have a sense of what percent of your sales are going to have occurred through those doors, the percent that you really have to make up in other channels. And also, I think you mentioned 100 new stores, mainline stores. What was the timing on that? Thanks.

I'll take a shot at that, Harmeet. Feel free to pile on. I mean, You all know exactly the same as we do in terms of what's been announced by our key department store and wholesale customers in terms of door closures and the rough timing around that. But we do expect we're going to see a couple of hundred wholesale door distribution points disappear over the next 12 months or so. We have experience in dealing with this going all the way back to the Mervin's days. And then as Sears kind of was axing their doors, we have a lot of experience in remapping our business on kind of a store by store, case by case basis. I don't have a specific percentage number to give you in terms of what percentage of our business is impacted by those door closures. you know, obviously these guys are cutting from the least productive doors up. So in the majority of our business is done, it's classic 80, 20 and wholesale. And, um, you know, so there will be some impact obviously from those closed doors, but we're pretty confident we can remap that distribution to other points. Um, on the hundred doors, you know, we've talked about this before, um, Our mainline business here in the U.S., as a percentage of our total store base, is relatively small. Think about it as, in rough numbers, we have about 210 doors here in the U.S., and about 32 of those doors or so are mainline doors. And we've got a model now for mainline that is very productive, delivers a really strong ROIC performance, that's based on great location and a relatively small footprint. Think of it as a 3,000 to 4,000 square foot footprint. And we are in the process of opening some doors this year that matches that profile. And we see a significant opportunity to accelerate that as a way to continue to premiumize the Levi's brand, given the strength of the brand equity in this market. giving us more distribution points for our better and best Tier 2 and Tier 1 product. So we're on that. The other thing I would say is the real estate opportunities are going to be pretty significant, I think, as we look at the commercial real estate market. With the number of brands that are going to have to close doors, we're working with our largest landlords, as Harmeet said, both in terms of rent renegotiation but also in terms of opportunities for better real estate and, you know, better locations. And that gives us an opportunity to capitalize during this period of time where I think we're going to see the commercial real estate market get pounded pretty heavily. And that creates an opportunity for us to improve our footprint and better map to the consumer given the wholesale dynamic that we're going to face. The last thing I would say is there are still wholesale opportunities for us and where it's either total white space or where we've got a smaller footprint today with that particular customer where we have opportunities to continue to expand. And we're working all those. It's premature to say anything right now, but I expect we'll be able to talk about it as we get further down the road this year.

And your next question comes from Heather Bowski with Bank of America.

Hi, thank you for taking my question. So first, I was just curious what you're seeing in some of the U.S. markets like Texas and Arizona where there are some surges in COVID cases and how those trends compare to the rest of the country. And then just a second question on your efforts to come out of this a more profitable company. Would you foresee SG&A savings beyond $100 million that you just announced? Thanks.

Chip, you want to take the first and I'll take the second.

Yeah, just on the stores, we have been, I don't want to say scientific, but we consulted with epidemiologists to put together a very objective data-based framework for us to decide when to open our stores. And that's why you know, still less than 90% of our stores here in the US are open. There are a number of stores that are still closed to this day because they don't kind of get a green mark on those criteria. And we're using those same criteria to evaluate whether we need to close any doors. And I will say at this point in time, we have not closed any other doors, any of the doors that we've reopened. However, there are about 40 doors right now that are in areas where the virus seems to be spiraling out of control. And we looked at it three times a week, Monday, Wednesday, and Friday. We made the decision yesterday not to close any stores. But if the virus continues to spread in some of these hot spots, I think it's quite possible we may be closing, again, some stores on a temporary basis until the virus subsides in those areas. You know, hopefully it doesn't come to that because that will suggest that the pandemic is continuing to get worse. But we're prepared to do it if we need to because we have right from the very beginning put the safety of our employees and our customers at front and center. And if we need to close doors, we will.

On the second, Heather, about costs, you know, we are focused on reducing costs both Temporarily, but more important, structurally, so that the cost reductions are more permanent. And our mindset is we emerge from the crisis with a lower percentage of SG&A to revenue as and when revenue recovered to pre-COVID levels. So besides the actions that we talked about in headcount, you know, let me talk a little bit about, you know, variable costs and then fixed costs. So variable costs will follow revenues, though in a COVID world where digitization is here to stay, we will drive productivity where we can. So if you assume travel was variable, I would say in a post-COVID world with more digitization, more leveraging of technology and work from home at some element, we think our travel costs will be lower as a percentage of revenue. Other costs, we talked about comp reductions, but things like incentive reversals and IT deferrals, those are temporary. You know, on a fixed cost basis, the other thing that we talked about is our rents. And we think because we are opening stores, we think because we are a traffic driver and bring traffic in, we are looking at... structuring our rentals or, you know, our leases that we currently have more favorably over the next few years. And the new stores that we're adding, we're getting, you know, substantial breaks on rentals that existed, you know, in the pre-COVID days. So we think structurally as revenues come back, that's accretive to EBIT margins. And then e-commerce, which is a drain on profitability, is now making money. And as that accelerates, that also drives profitability longer term.

Your next question comes from Carla Casella with JP Morgan. Hi.

You talked a little bit about the department stores and some of your retail customers. Did you give the number of your retail or percentage of your customer, I guess your wholesale customer doors that are still closed or any kind of a tracking of how the ones that are opening are performing versus pre-COVID levels?

So, Carla, we haven't specifically given the number of wholesale doors that are closed yet. They are, you know, 90% of our doors are open. I'd say wholesale doors are broadly similar. We haven't given numbers on their productivity because, you know, we don't necessarily disclose, you know, customer-specific data. But what we can say is progressively the sellout trends are improving as the weeks go by.

Your next question comes from Laurent Vasilescu with BNP Paribas.

Good afternoon. Thanks for taking my question. In the prepared remarks, it was noted that the licensed U.S. men's tops business will come back in-house for 2021. Could you possibly quantify the size of that business on a wholesale equivalent basis? And then it was also noted that you're taking in-house your Singapore operations. Are there any other larger third-party markets you're willing to take on back in-house going forward over the next year or so?

Yeah, so, you know, we'll give specific numbers when we talk about 21, which is in two quarters from now, but I'll give you a bit of a backdrop. In the U.S., Lorraine, you know, our top business consists of woven tees and knits. And for U.S. wholesale, it was broadly licensed. We have taken back, we've decided to take back the woven and knit starting 2021. The teased license only expires in 2022. And we will give you the specifics on the impact on revenue in a couple of quarters. The thing to note here is what it does for us, and whenever we've taken, we took the women's tops license that was sold into wholesale a couple of years ago. What it allows us to do is to engage with the customers at the same time we engage on a discussion on bottoms, and that really allows us and the customers to grow or accelerate the growth of the category big time. That's what we've experienced, and we think the same thing will happen you know, for the licenses we are taking back. On Singapore, Singapore was a distributor market. We've had a wonderful distributor who've been with the brand for about 30 years. And there are about 30-odd stores. We're in the process of taking it back. We believe that we can accelerate the growth of our, you know, brands, especially with all the wonderful products we have. as well as profitability over the next couple of years. So that's what we're looking at doing. In terms of other opportunities, there are a couple of markets in, you know, there are a few, there are a couple of markets in Asia and a couple of markets in Latin America. And again, you know, we love our distributors, we love our franchisees, but, you know, we look at this, you know, take back as a, you know, when it's a win-win for both sides and that's how we look at it. So what we're doing During the crisis is building a playbook for organic M&A, which is franchises, licenses, as well as distributors. And as things evolve, we will share that with all of you.

Your next question comes from Dana Telsley with Telsley Advisor Group.

Good afternoon, everyone. As you mentioned the price increases that you took, Where are you now on the price increase path? What do you see? Do any not hold? Do most of them hold? And where are you on the innovation path and what we should look for for holiday, how you're thinking about holiday? And just lastly, anything on the progress of Asia, then Europe and North America in terms of the recovery of reopening? Thank you.

Chip, you want to go pricing or...

Yeah, sure. I mean, we have taken pricing kind of late last fiscal year into in some parts of the world very early this fiscal year. We are seeing our AURs going up. The pricing has stuck. We don't have any plans to roll it back. Again, we're using AI and data science to give us more informed decision points around pricing. We think we still have other pricing opportunities as we go forward, but we don't see pricing pressure right now and we don't have any plans to roll back the pricing. So it has stuck.

On the question about regional recovery trends, you know, three regions, America, Europe and Asia and the Americas, two thirds of the region stores are open. Productivity is around 70%. A third of the doors calmed positively in the final week of June. And as Chip mentioned, digital is accelerating. In Europe, nearly all our doors are open. Again, performance is better among franchises, outlets, and stores located in smaller cities. And again... You know, a third of the doors are comping positively. We're also seeing in Europe a return of young shoppers to our stores. And, you know, it's the momentum we saw pre-COVID that continues. In Asia, you know, our digital footprint sell-through momentum is very strong. You know, markets like South Korea and Australia and New Zealand are driving strong comps. And we've seen traffic recover, especially in China and in mainland doors, mainly in malls. So I think that's a little bit more color by region. You know, India is still slow because of the acceleration of COVID cases, but India is largely a franchise business for us.

And your final question comes from Kimberly Greenberger with Morgan Stanley.

Okay, great. Thank you so much. It sounds like your direct-to-consumer revenue is sort of recovering more swiftly, if I could paraphrase, with stores doing fairly well and e-commerce obviously re-accelerating here. I'm wondering if you could give us just a little more color on the revenue metrics. In terms of the retail store network, I think you talked about 80% productivity there. Is that where they're currently running or is that the average since reopening? And then secondarily, could you break that direct-to-consumer revenue bucket down for us between store revenue versus e-commerce revenue just to give us a relative size? And then lastly, on the wholesale side, I think you indicated that you're starting to see some late summer, early fall wholesale orders come through. And I'm wondering if you, you know, look out over the next two, three, four quarters, how long do you think it takes for that wholesale revenue growth rate to normalize post-COVID? Thank you so much.

Yeah, Kimberly, I'm going to try and address those questions. You know, when we talked about store productivity, that was – latest trends for our stores as a percentage of last year. So it's not, uh, you know, the average store productivity, uh, uh, since the store open, those are the latest trends. So assume it is, uh, the last week of, uh, of, um, of June, uh, uh, you know, as a, as a percentage of last year, uh, e-commerce was about 13% of the business. And so if you think about direct-to-consumer being 45%, 50% of the business, you know, you could do the math on e-commerce. And that's our e-commerce. It doesn't include e-commerce from the digital ecosystem, which is, you know, pure players like Amazon or Zalando or Tmall, et cetera, or Wholesale.com. In terms of... Wholesale trends, again, as I mentioned earlier to the question that was asked, difficult to talk about that with any precision because wholesale doors are opening progressively. They're opening around the world. All we can say is the sell-through trends we are seeing are progressively getting better.

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

Okay. I want to thank everyone for dialing in and also being patient. I realize we went long by about five or ten minutes here, but we wanted to get everybody's questions, which I think we did. Thank you all for dialing in, and we will be giving you another update in a couple of months. Have a nice summer.

Stay safe.

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