Levi Strauss & Co.

Good day, ladies and gentlemen, and welcome to Levi Strauss & Company's first quarter earnings conference call for the period ending February 28th, 2021. 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 April 15th, 2021. please use conference ID 588-9497. 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 at Levi Strauss & Company.

Thank you for joining us on the call today to discuss the results for our first fiscal quarter of 2021. Joining me on today's call are Chip Berg, President and CEO of Levi Strauss, and Harmeet Singh, CFO. We have posted complete Q1 financial results in our earnings release on our IR section of our website, investors.levistrauss.com. The link to the webcast of today's conference call can also be found on our site. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular the risk factor section of the quarterly report on Form 10-Q that we filed today, for the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today, and we assume no obligation to update any of these statements. During this call, we will discuss non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in today's earnings release on our IR website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our IR website, and a replay of this call will be available on the website shortly. Today's call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And now I'd like to turn the call over to Chip.

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

Good afternoon, everyone. I hope all of you, your families, and loved ones are safe and healthy. We had a very strong quarter, beating our expectations despite store closures, mainly in Europe. The structural economics of our business continue to improve with ongoing and outsized digital growth, record gross margins, and a reduction in base operating costs while reallocating dollars to strategic choices that will accelerate growth. The first quarter was again profitable and generated positive operating cash flow despite the double-digit revenue decline versus prior year. And while we continue to manage our business prudently, as we operate through ongoing uncertainty, particularly in Europe, I remain convinced we will emerge from this crisis a significantly more profitable and cash-generative company, with ROIC in the mid-teens, an adjusted EBIT margin of at least 12%, much higher than our pre-pandemic margin of 10.6%. As I walk you through additional detail of our first quarter results, my comments will reference constant currency comparisons on a year-over-year basis in US dollars, unless I indicate otherwise. We published the details of our results in today's press release, so I will not repeat all of those here. First quarter net revenues of $1.3 billion declined 16%, and adjusted diluted earnings per share was 34 cents, both beating our guidance. Black Friday week, falling in the first quarter of prior year, hurt year-over-year revenue comparison by 3 percentage points, taking into consideration the adverse Black Friday impact and the fact that doors in Europe were closed Three months in Q1, as compared to one month in Q4, our estimated Q1 revenue decline was more like high single digits, a sequential improvement from last quarter's double-digit decline. Consumer spending continued to shift towards online shopping due to the changing retail landscape. As Chip mentioned, total digital growth was really strong, especially in Europe. Within digital, growth of our own e-commerce business was approximately 27% when adjusted for the Black Friday calendar shift. During the quarter, our e-commerce growth accelerated, reaching 55% for the month of February. And it was again profitable on a fully allocated basis. Our first quarter adjusted EBIT was $174 million, and adjusted EBIT margin was 13.3%, driven by the acceleration in gross margin while holding SG&A at 2019 levels. We were pleased to deliver adjusted EBIT margin in the low teens, while keeping in mind it benefited a couple of points from advertising at only 5% of revenue below our expected annual 7% target. Let me now give you some color on the details. Adjusted gross margin expanded 200 basis points to 57.7%, the highest adjusted gross margin we have ever posted. FX contributed about 70 basis points of the favorability, reflecting a weaker US dollar against international currency. The remaining 130 basis points was driven by the improving structured economics of our business. Levi's AURs rose in all global channels, demonstrating the intrinsic health of our brand. Price increases and a higher share of business from our own e-commerce channel contributed to the expansion. We've also reduced promotion, both in depth and breadth. On the strength of the brand, and our healthy inventory position. And gross margins were particularly strong at wholesale, reflecting a strong customer mix, including from growth in digital and healthy retailers, as well as a favorable shift in product mix towards higher margin products. Adjusted SG&A was down 85 million from prior year, a 13% decline. And at $579 million, this represents a return to 2019 levels. Notwithstanding, a substantial increase over the past couple of years behind the areas driving our growth, namely direct-to-consumer and technology, we're able to deliver adjusted SG&A at 2019 levels because of the structural cost reduction initiatives we have taken. Now I'll share a few highlights from our three regions. First quarter revenues in the Americas declined 13%, better than the overall company. Our focus on building a healthier wholesale business in the US is gaining traction as wholesale revenues grew slightly and delivered higher gross margins compared to last year. The full digital ecosystem in the region grew 16%, and nearly a fourth of the region's sales was digitally driven. Our own e-commerce growth rates in the U.S. accelerated through the quarter to 29% for the month of February. Our next-gen store rollout in the U.S. remains on track, and these stores continue to outperform. For example, our new Scottsdale store is the top-performing store in our fleet. And finally, the region's operating income grew 6% despite the revenue decline on the back of stronger gross margins and cost control. Europe's revenue declined 22%. Impressive results given a third of the region's business footprint was closed in the quarter, showing the brand strength and agility to execute a playbook developed over the last year as conditions changed. We are recapturing sales in our own e-commerce channel, which grew 40% in the quarter adjusted for Black Friday, and where growth rates accelerated in the quarter to nearly 70% in February. While tourist doors are under pressure, local doors are faring well on higher conversion despite lower traffic, with growth in the markets that were open, including France. Our wholesale channel in the region grew compared to prior year, And we're seeing a strong forward demand signal at wholesale, giving us confidence in a speedy recovery when lockdowns lift. An operating margin of 26% for the region was in line with last year, despite the sales decline, because of higher gross margin, lower variable expenses, and cost discipline. Asia, as a region, declined 8%. the full digital ecosystem in the region grew over 60% in the quarter. India's performance was slightly ahead of the region, and importantly, this market grew compared to Q1 of 2019, driven by the acceleration of the digital ecosystem and the ongoing transformation of our store fleet and franchise network. China posted strong growth as expected versus Q1 2020, and our direct-to-consumer channels in the market posted growth compared to Q1 2019. We continue to transform our business in China and move towards more company-operated stores. Productivity is up on higher capture rates and a higher share of more premium products. Our best-selling jeans are from Made in Japan, Made and Crafted, and Levi's Vintage Clothing Lines. Our beacon store in Wuhan is emerging strongest back to pre-pandemic revenue levels and is selling more tops than bottoms. We are elevating our fleet and open four new next-gen doors in China in the quarter. And the franchisee reset in the market continues as we clean up unprofitable doors. Our business in China is being transformed and is headed to a mix of 70% direct-to-consumer growth and 30% franchisee about a year from now. Three years ago, it was the inverse of this mix. We continue to be pleased with our progress in this key market, which at only 3% of total company revenues remains one of our biggest long-term opportunities. Turning to balance sheet and cash flows. Inventories at the end of the quarter net of reserves were 2% below prior year and 9% below prior year in the Americas, reflecting our ongoing discipline inventory management. Inventory composition remains healthy, with more than two-thirds able to carry over into future seasons. Cash and liquidity remain strong, and at the end of the quarter, net debt was negative. Adjusted free cash flow in the first quarter was negative $9 million, only a $6 million decline over prior year, despite much lower revenues and adjusted EBIT. We refinanced half a billion of our 5% U.S. dollar notes, obtaining a substantially lower coupon of 3.5%. And in March, we paid down most of our 5% notes. The lower coupon and debt reduction will save us $20 million annually in interest expense. We expect to pay down the remaining $200 million of 5% notes in the second half of this year. And with business trends improving, we expect substantial improvement in our leverage ratio as we move through the remainder of the year. We continue to return cash to our shareholders. Last quarter, we reinstated our quarterly dividend payments at $0.04 per share. Based on our strong first quarter performance, I am pleased to announce that we are increasing the second quarter dividend to $0.06 per share. As business trends continue to improve, we will consider increasing dividends further. Before sharing our Q2 outlook, let me take a moment to provide an update on our sales performance through March. As a reminder, the economic impact of the pandemic really started to hit us in March of last year, right after the end of our first fiscal quarter. For the three-month period of January through March, revenues were slightly up compared to the same three-month period of 2020. Now turning to our Q2 outlook. Based on our first quarter outperformance and our confidence in the stronger trends we are seeing headed into Q2, we are banking our Q1 revenue and EPS beat, and we are raising our outlook for the second quarter. We now expect reported revenues for the first half of 2021 will grow 24% to 25% versus prior year. significantly higher than the 18% to 20% growth estimate we shared last quarter. A higher first half outlook includes our second quarter reported growth estimate of around 140%, a substantial increase from the 120% implied by our prior guide. And we expect to deliver another 7% to 8% of adjusted EPS in the second quarter, bringing first half outlook adjusted EPS to 41 to 42 cents. Our outlook is on a reported basis and incorporates the expectation that currency will again benefit revenue and adjusted EPS comparison to prior year. Our perspective balances our confidence in what's within our control with the uncertainty in the marketplace related to the virus variant, vaccine rollout, and the consequent impact to markets and our distribution footprint, particularly in Europe, where we have assumed current store closures will persist through mid-May. This equates to a weighted estimate of around 35% to 40% of our stores in Europe. A few color comments on our key second quarter assumptions beyond revenue. We expect gross margin to remain substantially higher than prior year. Due to seasonality, we expect second quarter gross margin to dip below first quarter gross margin by at least 200 basis points, a similar trend to what we have usually seen in the years prior to the pandemic. SG&A continues to track around 2019 levels. As it did in 2019, second quarter SG&A will increase notably compared to Q1 due to the timing of our advertising campaigns. Interest expense will be lower than Q1, reflecting our recent refinancing and debt paydown. And on taxes, the exercise of stock appreciation rights will benefit our tax rate in the second quarter. Based on recent and potential additional exercises, we expect a tax rate of less than zero and could see it in the negative double digits in Q2. This benefit will also help our annual tax rate, which we now expect will land in the low teens. And finally, as we shared on our last call, due to the uncertainty introduced by the impacts of COVID, we are planning our current fiscal year in two halves and expect to guide the second half in our July earnings call after our planning process is complete. But although we have not yet completed our planning process, the encouraging trends we are seeing suggest that we may see a return to pre-COVID revenues a month or two sooner than our previous thinking, primarily driven by strength of the U.S. consumer and key markets in our Asia region. Accordingly, we are not confident that fourth quarter revenues will be slightly above 2019 levels with some of our individual markets getting there sooner. We continue on the path of emerging a stronger company. Then we entered the pandemic a year ago with a sustainable annual adjusted EBIT margin of 12% plus once we return to pre-COVID revenue. With that, we'll now open it up and take your questions.

Thank you. The floor is now open for questions. If you have a question, please press star then the number 1 on your telephone keypad. Due to time constraints, the company requests that you only ask one question. If you have an additional question, please queue up again. If 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 Matthew Boss with JP Morgan.

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

Sure. First, on the denim resurgence, I do believe that this is both us and industry-wide, and it's being driven by a couple of dynamics. Number one is this continuing trend towards casualization. And we've seen it here recently. Now that consumers are starting to get vaccinated and people are starting to go out again, there are now occasions that people are planning for. They're going back out and they're buying denim and they're buying the brands they know and trust and are largely reaching for us. I think the other thing that's driving it, as I said in the prepared remarks, are these new fits and silhouettes. We launched this high rise loose fit in early 2020, just as the pandemic was happening. And it was a relatively small collection at first, and it really just took off. And so we've expanded it and have continued to build on it. It's now been followed by all of our key competitors. And I think it is clear to say that it is a big trend, which we've led. But importantly, as consumers start thinking about going out again, it gives people a reason to go out and update their wardrobe. If the it look now is this high-rise, loose-fit jean, and that's true for both men's and women's, by the way, it gives them a reason to go out and update their wardrobe. And I think that's a big driver as well. In fact, just as a small little side story on that, our relaxed men's fits – the 550 and the 559 are two legacy fits that we've had for years. And literally just a couple of years ago, we were talking about potentially discontinuing them because they were so out of style back then. And those two fit blocks grew 50% versus prior year in this most recent quarter. So, you know, maybe we're heading into a new denim cycle. The last denim cycle was really started by the skinny jeans. And that was over a decade ago before I joined this company. So I think we may be looking at the, at the start of a new denim cycle. I guess the last thing I'd say about, uh, the denim resurgence is, uh, don't forget. We have, you know, not only are we the leader in denim, we have enormous opportunity in non-denim as well. And, uh, and we're trying to capitalize on that on the stronger demand signal in Europe. I think that one's pretty straightforward. Our brand is red hot in Europe, and it has continued to be despite the challenges of the pandemic. And you see that just in the business results with a third of our doors closed. And our DTC business is half of our business in Europe, and they still posted relatively decent results. Their e-commerce business was up 40% in the quarter when you adjust for Black Friday. But importantly, it was up 70% in February. So consumers are really reaching for Levi's. And I think there's just a lot of pent-up demand. And wholesale customers recognize that. And as they reopen, they want to be ready for it. And we're seeing it. But I think it really does trace back to the strength of the brand overall.

Great to hear. Best of luck.

Thanks, Matt. Our next question comes from Paul with Citi.

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

So about the, you know, the U.S. wholesale mix, you know, as we got into the pandemic, you know, strategically we had said when we get out of the pandemic, it will be a healthier wholesale mix where the percentage from traditional retailers, the non-digital piece will be lower, but a stronger share and a higher mix from the others, which is a combination of a couple of things. One is higher and more premium product, number one. Number two, higher AURs because given the health of the inventory and given the strength of the brand, we have progressively reduced dilution across the board. We've also taken pricing. We talked about taking pricing in U.S. wholesale women sometime in the middle of last year, and that has stuck. We started 20 with, I think, a 2% or 3% pricing increase across U.S. wholesale, so that's stuck. And the ongoing partnership and the scale that we're seeing with Target is also helping. And I think as we come out of the pandemic, our focus on this, plus the fact that even with traditional retailers, we're focused on the top doors. We're also focused on building more of a lifestyle orientation. So I think Chip referenced in his call, if you think about the top 10 wholesale accounts, and, you know, quite a few of them are in the U.S., our women's business continues to grow. It grew in quarter three of last year, grew in quarter four. and continues to grow. So your question about women, you know, that business is doing, you know, fairly well. TOPS as a mix, company-wide is largely the same, about a fifth of our business. But if you think about Europe, you know, and in some other parts of the world, we are seeing growth in TOPS on a unit basis. It clearly continues to be an opportunity for us. We still... sell, you know, four bottoms for every top. Our goal is to get to one-to-one at some stage. And, you know, that's embedded in our non-denim growth that we've talked about, et cetera, et cetera. So, you know, if you think about international, our direct-to-consumer business, lots of market stops are at parity with bottoms. So clearly it continues to be an opportunity.

Got it.

Thanks, Amit. Good luck. Thanks.

Our next question comes from Jay Sol with UBS.

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

Yeah, I'd say, you know, it was a headwind largely because, you know, the average gross margins in Europe, are higher than the average company gross margin, and stores' gross margins are higher. And we didn't recapture, you know, 100% of all the lost sales as stores have, you know, closed in Europe. So it was a headwind, but overall, if you think about gross margin strength, gross margins were up big time, you know, a record gross margin. So other factors like you know, pricing initiatives you've taken, the continued growth in AURs, and the improvement in channel and geographic mix continue to work in our favor. We also were helped by FX, you know, in the quarter. We don't expect the FX benefit to continue. But the other factors broadly I think should flow through the year. I would also say, as I mentioned in the call, The record gross margins don't bank it on a full year basis because it adjusts in quarter two. It's normal seasonization quarter two gross margins are about 200 basis points lower than quarter one. That's been our history. But we do think we end the year from a gross margin perspective much stronger than we were in 19 and 20. Got it.

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

Yeah, so we're watching this carefully, the potential bottlenecks in the supply chain. We have experienced delays, but the good news for us, because, you know, geographically we have a portfolio and we have a brand that's really strong. We've been able to offset delays. the impact of the delay, both in quarter two, and we think we can in quarter, sorry, quarter one, and we think we can offset that in quarter two. In terms of costs, you know, as I mentioned in the last quarter, we negotiated capacity and that allowed us, you know, as allowing us to offset some of the increases that we can see. We have had to increase our air freight, but given the strong gross margins we had overall I think that's, again, been offset, you know, at least in the short term. Longer term, you know, we are seeing inflationary pressures, you know, but we feel good about 2021 largely because, you know, our product prices are locked in, our, you know, broader fulfillment cost prices are locked in, and as we think about 2022 and beyond, given the price increases they've taken and where we are in pricing. We think as a brand, you know, we have the opportunity. We have the pricing power. It's evident by the initiatives we have taken on pricing. It's also evidenced by the strength of the brand that Chip indicated and our market leadership position. So I think overall we should be fine in 21, and we'll offset any inflation we see in 22 with pricing.

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

Thank you.

Our next question comes from Omar Saad with Evercore.

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

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

Great. Thanks for the color.

You bet. Our next question comes from Bob Durble with Guggenheim.

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

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

Great. I guess just to follow up, on the target relationship, I know you guys did the home offering this most recent quarter. Any update on the target relationship, what you've learned so far, and really what you've learned from the home capsule that you guys did both online and in the stores? That would be very helpful.

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

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

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

Well, Lorraine, I would say that we do believe that we've got continued upside from an AUR standpoint. And as Harmeet indicated earlier, with the prospect of inflation coming, it's good to be in a position where you don't need a prayer meeting to take pricing. But we think we can get it a lot of different ways. You know, mix is important, even at the store level. Continuing to mix up our business and our mainline doors represents a significant opportunity. Driving down promotions, which is something we've been able to do pretty successfully over the past two or three quarters now, we've pretty much walked away completely from the off-price channel, if you will, the Ross's, TJ Maxx's of the world for flushing inventory because we've managed our inventory so well. So we are focused on growing AURs. We do think we've got continued opportunity there. We've taken price increases in the last quarter or in the last two quarters on women's. We took a $10 price increase and it stuck. We're seeing our pricing stick when we take it. And, you know, even as you think about our assortments on parts of our business where we've been really, really successful, and I'll take T-shirts as an example. We have basically one price point of T-shirts in our stores. There's an opportunity to tear up there. So we're looking at it very aggressively, but we do think given the strength of the brand on a global basis, we've got continued upside opportunity here.

Thank you. Our next question comes from Kimberly Greenberger with Morgan Stanley.

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

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

Fantastic. Thanks so much.

Thanks, Kimberly.

Our next question comes from Laurent Dazilescu with Exane BNP Parida.

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

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

Very helpful. Thank you very much.

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

Good afternoon, everyone, and congratulations on such nice, improving results. Thank you, Dana. In the past, as you've talked about the DTC channel and the split between e-commerce and stores, what's the update on the store formats, next gen, and how you're thinking about the omni-channel initiatives there, whether it's shipped from store or any of the other activations?

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

Great. And then, Chip, just to follow up on, you had Target, obviously, in the new home collection. You've had collaborations that have been successful. What should we be looking for in either the next few quarters in terms of activations for the brand? Any collaborations, new products that we should be watching? Thank you.

We do have a number of collaborations coming. Just in this last quarter, we had more than 10 different either regional or global collaborations. In fact, the Pokemon launch, which was back in February, was one of our strongest collaborations of all time, and it drove 20% of our app revenue in February. So these collaborations, you know, the way I've talked about them before is they bring a lot of heat to the brand, and they drive a lot of interest, but most of them are relatively small in terms of volume and revenue, but they just drive a ton of excitement and interest. There's one in particular that I think should be on everybody's radar for the second quarter, and that is our second collaboration with Valentino. So we're launching 517 units of Levi's Valentino Vintage 517, but we're also doing 5,107 units of a re-edition of the 517, which is a replica of the original vintage orange tab 517 jeans, both adorned with co-branded patches and interiors with Valentino. The re-edition 517 is now live online for pre-order. You know, we talk about premiumizing the brand. It's a unisex jeans. It's going to be sold at Saks, Neiman Marcus, Bergdorf, Luisa Villaroma. Saks has already sold out of this collaboration at a pre-order price of $990 per pair. So, you know, it's another example of it's not a ton of units. but it's going to bring a ton of excitement and heat, and it's just another way to continue to premiumize the brand.

Thank you.

You're welcome. Thank you, Dana. Yeah, we'll end it there. We're right at 3 o'clock or so West Coast time, and I want to thank you all for dialing in, and we'll look forward to talking to you again on our Q2 earnings call in a couple of months. Thanks very much, everyone.

Thank you. Stay safe. Healthy.

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