Levi Strauss & Co.

Good day, ladies and gentlemen, and welcome to Levi Strauss and Company second quarter earnings conference call for the period ending May 30th, 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 July 15, 2021, one week after call for telephone replay. Please use the conference ID 378-4584. This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for one quarter on the company's website, LeviStrauss.com. I would now like to turn the call over to 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 second fiscal quarter of 2021. Joining me on today's call are Chip Berg, President and CEO of Levi Strauss, and Harmeet Singh, our CFO. We have posted complete Q2 financial results in our earnings release on our IR section of our website, investors.levistrauss.com. The link to the webcast of today's conference call can also be found on our site. We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular the risk factors section of the quarterly report on Form 10-Q that we filed today, for the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today, and we assume no obligation to update any of these statements. During this call, we will discuss certain 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 over the call to Chip.

Thanks, Ida, and good afternoon, everyone. Our second quarter performance was better than we expected, reflecting broad-based strength across our business as we continue to see recovery from the pandemic. Our results reflect the enduring power of our brand in a time when consumers are seeking out authenticity from companies that reflect their own values. In addition to seeing strong denim and casualization trends, we are also benefiting from the ongoing execution of our strategic initiatives, and we are excited to see consumers returning to our stores as markets reopen with sequentially improving traffic trends. While the pandemic continues to impact our business, we are encouraged by accelerated revenue recovery in the quarter, with all regions and channels growing versus prior year. And compared to Q2 2019, reported revenues are down only three points. The recovery was led by the US, and sales exceeded Q2 2019 levels in more than 10 markets across the globe, including China. For the third quarter in a row, we delivered a record gross margin, which led to our highest second quarter adjusted EBIT margin ever, despite continued investments behind advertising and our growth initiatives. As we look ahead, we are confident the strength of our business will continue. In fact, we are now expecting growth versus 2019 levels one quarter earlier than previously anticipated with better structural economics. Let me share a few highlights from the second quarter. Demand for our brands remains strong globally, Our men's bottoms business continues to gain traction and has nearly returned to pre-pandemic levels. And our women's bottoms business has now exceeded Q2 2019 revenue, up 9%. The looser fits that we launched pre-pandemic are continuing to drive growth and increases the percent of both men's and women's bottoms assortments, now representing nearly half of each. We launched our multi-platform global marketing campaign, Buy Better, Wear Longer. We partnered with leading influencers and changemakers like Jaden Smith, Emma Chamberlain, Marcus Rashford, and more to raise awareness and be voices for change in implementing more environmentally sustainable apparel production and consumption methods. The reaction to the campaign has been overwhelmingly positive. generating strong growth in our average daily brand mentions across global social platforms and a significant lift in brand consideration and purchase intent after consumers experienced and engaged with the campaign ad. Building off the success of our 501 Live series, the Levi's brand threw a global virtual festival on May 20th to celebrate the birthday of the Levi's 501 gene, which has provided effortless, cool style to working men and women, rock stars, and everyone in between for decades. Broadcast around the world from our official Levi's Instagram account, the festival featured musical performances, meaningful conversations, and do-it-yourself denim personalization and repair sessions with in-house tailors. The celebration resulted in hundreds of PR stories and generated 4 billion impressions. And we continue to bring energy to the market through a number of exciting high-profile collaborations with Valentino, Miu Miu, and Denim Tears, yielding strong sell-throughs and elevating the brand with distribution and premium doors and features across leading publications. In our DTC channel, we've continued to accelerate our omnichannel capabilities to ensure that our consumers can get product wherever and whenever they choose. Our company-operated e-commerce business grew 42% on a reported basis, a great result considering we're lapping strong growth in the prior year. We were particularly pleased that the growth rate remained strong even as brick-and-mortar stores reopened in the second quarter. We're investing in leading technology and expanding our fulfillment capabilities, and earlier this month, our largest distribution center in Henderson, Nevada, became our first owned and operated facility to fulfill orders for e-commerce, retail, and wholesale channels. Over time, we expect to increasingly leverage our own DCs to fulfill e-commerce orders, which will drive more agility in inventory positioning, reduce lead times, and accelerate expansion of e-commerce margins. To ensure a seamless and frictionless experience across all channels, we continue to invest in our omnichannel capabilities. In the U.S., demand served by ship from store grew versus 2020. Internationally, we continue to expand ship from store in Europe, successfully launching in Belgium, the Netherlands, France, Spain, and Denmark. We're now accepting PayPal and Venmo in all of our U.S. stores as it extends our reach, especially for Gen Z. We've implemented pivotal improvements to our buy online, pick up in store program, like the shop the store function, And we saw an increase in both this volume and higher units per transaction after it was launched on the site. Shop the Store is expected to launch on our app in Q3. We continue to look for ways to enhance the consumer experience and have made significant progress in optimizing our return capabilities, including contactless returns, allowing consumers to easily return merchandise at more than 2,500 drop-off locations within the U.S., Physical stores remain an important part of our business to build awareness and connect with consumers in a meaningful way, including driving higher loyalty member enrollment. As traffic to our stores continues to increase, conversion and AURs remain strong, and we're seeing better full-price sell-throughs. As store productivity levels continue to recover, we are confident in the outlook of our DTC business, and we will continue to invest in growing all segments of this channel. We also remain focused on diversifying our business. Lapping one of the most unusual quarters in our history, all regions, channels, and categories grew significantly versus last year. The U.S. was by far our strongest market this quarter with growth of 4% versus Q2 2019 on strong wholesale and e-commerce performance. And China returned to growth compared to 2019. As one of our largest growth opportunities, we remain focused on maintaining this momentum. In Europe, it's clear that consumer demand for the brand remains strong. As was the case last fall, when Europe reopened in May, revenues bounced back quickly and posted strong growth versus 2019. Our global wholesale business neared 2019 levels and is much more profitable with a higher share of digital. Our wholesale strategy is working, and we saw robust results in the U.S., which saw sales up versus 2019. Demand for our premium products remains strong, and we continue to expand that business with premium retailers, including Nordstrom, where our men's and women's products can now be found in all stores. Our other brands, Dockers, Signature, and Denizen, all had strong quarters. Dockers grew over 100% versus Q2 2020, with a much higher gross margin. And the Signature brand even exceeded Q2 2019 by nearly 30% due to success with Walmart and continued expansion on Amazon with Signature Gold. We're using digital data and AI to dramatically improve the consumer experience and deepen connections, leveraging every touchpoint to better connect and engage our fans. We will continue to deliver compelling consumer experiences digitally We just launched our global TikTok channel, which generated more than 100 million views in the first six weeks since its launch. And we held our first shoppable live stream event on Levi.com in the beginning of June. Through data and AI capabilities, we've created a more cohesive and personalized consumer experience on our app and with our loyalty program. Our app continues to exceed expectations with a 20% increase in downloads compared to Q1. We're also seeing increases in average order values sequentially, and the app contribution to e-commerce revenue continues to increase. And in our loyalty program, consumer lifetime value of members remains substantially higher than for non-members, as is units per transaction. In terms of digitizing our own business, we are transforming the way in which we plan, with AI now forecasting initial demand for each product next season. Results from our first wave test show that AI-driven demand forecasting improved accuracy. So scaling it should enable more precise inventory investment, lead to less markdowns and clearance, prevent waste, and enhance sustainability, all of which will improve our margins. This will be powerful in combination with the ongoing work AI has been contributing to pricing and promotion. Before I turn it over to Harmeet, we know that in order to thrive in a digital-first future, we need to invest not only in technology, but in our people. This quarter, we launched a digital upskilling initiative, which included the industry's first machine learning boot camp, an immersive training in coding, machine learning, and agile ways of working, uniquely designed for Ellison Co. employees. After graduation, these practitioners, now data scientists, return to the business to apply their skills and create momentum around our digital agenda. By the end of the year, we will have upskilled more than 100 employees globally. Let me now hand it over to Harmeet for a review of our second quarter financials and our guidance outlook. Harmeet?

Thanks, Chip. Good afternoon, everyone. I hope all of you, your families and loved ones are returning back to the new norm. As economies recover, the vaccination pace accelerates globally and consumer demand for apparel improves. The momentum of our business continues to accelerate as we significantly outperform our revenue and profit expectations in the quarter. The structural economics of our business has sustainably improved versus 2019, and I'm confident of achieving our adjusted EBIT margin target of 12% plus. I'll share more on guidance in a few moments, but we are thrilled that the recovery is happening faster than we thought, and we're now poised to deliver total company growth versus 2019 in quarter three. a full quarter earlier than previously expected. And that's even before we are firing on all cylinders, given store traffic and tourism have not yet fully recovered. As I walk you through our second quarter results, my comments will reference constant currency comparisons on a year-over-year basis in US dollars, unless I indicate otherwise. Where meaningful, I will also share comparisons to 2019. Second quarter net revenues of 1.3 billion grew 148% compared to second quarter 2020, and adjusted diluted earnings per share was 23 cents, both exceeding our guidance. Compared to second quarter of 2019, constant currency revenues were down only 4%, a sequential improvement in sales. An adjusted diluted EPS was significantly ahead of 2019, driven by improved structural economics of the business. Let me share some color on the details. Despite an increasing number of markets opening, our e-commerce business, which represents 8% of our total revenues, grew 37% in the second quarter, Compared to prior year, we are really pleased with this given we are lapping strong growth. Compared to second quarter 2019, our e-commerce business has grown 71%. Total digital ecosystem sales growth also accelerated to 68% over prior year and represented 23% of sales in quarter two. And compared to second quarter 2019, our total digital business has nearly doubled. DTC brick and mortar is still recovering given many markets have not fully reopened. We are seeing traffic return and importantly, our key performance metrics at retail remain strong. Compared to quarter two 2019, global wholesale was down only 2% and U.S. wholesale was up by 6%. Importantly, U.S. wholesale gross margin and profitability is the strongest it's been in a while. Our second quarter adjusted EBIT was $115 million, and our 9% adjusted EBIT margin was a second quarter record high, despite higher advertising as a percentage of revenues showcasing our record gross margins. Relative to 2019, reported adjusted EBIT margins were up 280 basis points. The record adjusted gross margin of 58.2% represented a 670 basis points expansion compared to quarter two 2020. AURs grew across channels, genders, products, and regions. Compared to second quarter 2019, gross margin expanded 490 basis points. The bulk of the increase for both comparisons was driven by several sustainable attributes, including a higher proportion of sales from our DDC channel, the price increases we have taken across all channels and a number of geographies, a higher share of women, which now has sustainably higher gross margins than men, and COG savings from a globally diversified supply chain. The quarter's gross margin expansion also reflected some other temporary benefits across all channels, including wholesale, like a higher share of Denim's Bottles, lower levels of promotions, and other off-price selling, which collectively amounted to roughly 100 basis points of benefit to gross margin. These benefited in the quarter to a higher degree than we previously anticipated. To reinforce, the majority of the factors driving margin expansion are structural and sustainable. DDC sales, both brick and mortar and digital, have our highest gross margin, and our strategies will drive DDC to a higher percentage of our total business in the years ahead. It is also pertinent to note that even after the price increases we have taken, both in the past and for the second half of 2021, we still have pricing power to not only offset cost inflation, but to also improve our gross margins as well. Importantly, we have negotiated most of our product costs through the first half of 2022 at very low single-digit inflation. Adjusted SG&A was $628 million, excluding an unfavorable currency impact of approximately $8 million. Adjusted SG&A was in line with Q2 2019. This is despite higher incentives as we are exceeding our expectations and higher ROI growth investments towards advertising, DDC, AI, and technology, as those increases were funded by savings that we have actioned last year. Now I'll share a few highlights from our three regions. Second quarter revenue in the Americas increased 150% compared to prior year. Compared to the second quarter of 2019, America's revenue grew 4% led by wholesale and digital. Expansion of wholesale gross margin underscores the healthier business we built in the region. Versus Q2 2019, Company e-commerce grew 51%, and the full digital ecosystem grew 61% and represented nearly 20% of sales. Total revenues from brick-and-mortar stores in the region nearly reached 2019 levels, despite the significant impact of tourism not having yet recovered. And the region's operating income was 153 million, up 52% against the second quarter of 2019, reflecting substantially stronger gross margin and ongoing cost controls. Within the Americas region, the U.S. business is structurally a lot stronger today than it was pre-pandemic for several reasons. It has a larger digital business, a higher share of revenues, with financially healthier and more premium customers, more full-price sales, pricing power, and a higher retail productivity, especially critical as we open more full-price stores. We are confident we can continue to grow the US business over the long term. Turning to Europe, revenues increased 165% versus 2020, reflecting strong demand as markets in the region reopened. Compared to the second quarter of 2019, Europe's revenues were down 12% as direct-to-consumer, brick-and-mortar, and franchise remained down, given more than a third of those were closed during the quarter. These declines were partially offset by growth in our e-commerce business and digital wholesales. Company e-commerce grew 80% compared to 2019, while the full digital ecosystem in Europe has doubled and now represents over a third of the region's sales. Importantly, Europe exited the quarter with revenue in May growing high single-digit compared to May 2019. Operating margin has expanded 80 basis points since Q2 2019, despite the sales decline reflecting higher gross margin and cost discipline. Asia revenues grew 113% compared to prior year. Compared to the second quarter of 2019, Asia's revenues were down 13% as the pandemic continued to negatively impact several of our significant markets. We're roughly half. the decline in the region attributable to India. But we're seeing growth in several important markets and continuing growth in digital, fueling our optimism. China grew 3% versus Q2 2019, reflecting double-digit growth in our direct-to-consumer store network in e-commerce, which we expect to continue into the second half. Our markets in Australia and New Zealand were another bright spot, up strong double digits from Q2 2019. And company e-commerce doubled in size from second quarter 2019, while over the same time period, the full digital ecosystem in Asia grew 79%, and now represents 15% of the region's sales. Turning to balance sheet and cash flows, inventories at the end of the quarter were 12% below prior year, essentially driven by double-digit declines in both America and Asia. Inventories remain healthy and primarily comprise of products that can carry into future seasons. Compared to the end of the second quarter of 2019, inventories were down 4%. Cash and liquidity remained strong, and at the end of the quarter, net debt was negative $46 million and overall liquidity was $2 billion. Adjusted free cash flow through the first half of the year was $60 million, representing a 54% improvement versus the comparable period of 2019. And we continue to return cash to our shareholders. I'm pleased to announce that we are again raising the dividend to $0.08 per share for the third quarter, up from $0.06 per share, and in line with pre-pandemic levels. Before sharing our second half outlook, let me take a moment to provide an update on our sales performance through June. As a reminder, to improve comparability with calendar reporting companies, we've decided to indicate revenue performance to calendar quarters when relevant. For the three-month period of April through June, revenues were up low single digits to the comparable period of 2019 on a reported basis. with the month of June up mid to high single digits compared to June 2019. Now turning to the outlook for the second half and full year 2021. Given the structural and sustainable improvement in the business and the momentum headed into the second half, we expect a much stronger full year in both revenue and EPS than previously anticipated. We expect reported revenues for the second half of 2021 to grow 28% to 29% versus second half 2020. This equates to reported revenue growth of 4% to 5% versus second half 2019, which includes a currency benefit of two points. From a regional perspective, relative to 2019, we expect second half reported revenues to grow in the Americas by mid-single digits and in Europe by high single to low double digits. Asia, despite strong growth in China, will still be below 2019 due to the ongoing prevalence of the pandemic there. From a quarterly perspective, we expect ongoing sequential improvement in our quarterly growth rate versus 2019, with Q3 growth below and Q4 above our second half growth rate. In terms of profits, we expect second half adjusted EBIT margin of 12%. And we expect to deliver adjusted diluted EPS of 72 to 76 cents in the second half, which will bring us to $1.29 to $1.33 for the full year. Compared to 2019, this equates to second half EPS growth of more than 26% and full year growth of more than 15%. A few color comments on our key second half assumptions beyond revenue. We expect a second half gross margin in the range of mid 56%, an increase of nearly 300 basis points above second half 2019. As per usual, we expect sequential quarterly improvement in gross margin So Q3 lower and Q4 higher than the second half average. With the strong second half gross margin outlook, combined with our Q2 gross margin outperformance, we now expect a full year gross margin of around 57%, higher than our prior expectation of 56%, and more than 300 basis points above full year 2019. And we are increasing our investment in adjusted SG&A. Second half adjusted SG&A will be about 100 million higher than it was in the second half 2019. About 30 to 35 million reflects our estimate for unfavorable currency effects from a weaker U.S. dollar. The remaining 65 to 70 million splits roughly equally between advertising and selling. We're increasing our advertising investment to drive our initiatives and market share goals as we fuel and elevate our brand. We expect second-half advertising dollars at 7.7% of second-half revenue. This is 70 basis points higher than second-half 2019. And we'll also have higher selling and variable expenses related to raising our second-half revenue outlook. which is largely comprised of DDC revenues. The incremental adjusted SG&M will support accelerating profitable growth without impacting our adjusted EBIT margin target given the associated higher gross margin and leverage from higher revenues. And finally, with respect to taxes, given the significant tax benefits we recorded in the second quarter, we now expect a lower full-year tax rate of around 10 or 11%. This implies a second half tax rate in the very low team. Before we go to Q&A, I'd like to leave you with three key thoughts. First, we beat our second quarter expectations and are raising our full year outlook. Achieving this will result in our full year revenues nearly approaching 2019 levels. with second half adjusted EBIT margin tracking 12%, and fully adjusted diluted EPS substantially higher than 2019. And we're getting to the improved profitability in a high quality way with higher revenue, gross margin, and disciplined cost management. Second, structurally, our business is stronger than it was in 2019, driven by a higher share of digital revenues, a healthier U.S. wholesale business, and technology investments that have accelerated our DTC business while connecting us directly with more consumers. Over the past two years, we have reshaped our P&F with higher sustainable gross margins and cost cuts, which are fueling our A&P growth and other growth investments while delivering higher adjusted EBIT margins. This gives us great confidence to continue market leadership growth driven by the strength of our brand and our products, especially as denim resurges and casualization trends accelerate. We remain confident that we will deliver a fully adjusted EBIT margin of 12% plus in 2022. And third, we have a very strong balance sheet with net debt below zero. We've driven this through our renewed focus on cash, which has improved our cash conversion cycle significantly as compared to 2019. As a result, we continue to have substantial liquidity to grow this business, both organically and inorganically, while returning cash to our shareholders. With that, we'll take your questions.

Thank you. To ask a question, please press star 1 on your touchtone telephone. Again, that's star 1 on your touchtone telephone to ask a question. To withdraw your question, press the pound key. We ask that you please ask one question, then return to the queue. Please stand by while we compile the Q&A roster. Our first question comes from the line of Matthew Boss of J.P. Morgan. Your line is open.

Thanks, and congrats on another great quarter.

Thanks, Matt.

So maybe, Chip, in light of the global momentum, could you elaborate on current trends in the denim category and just your confidence in sustainability of this strength as we think about pent-up demand? I know you've talked about size profile changes. Maybe that relative to the fashion and silhouette fit drivers of a potential multi-year denim cycle that I think you coined first on last call.

Yep. Well, I think with one more quarter underneath our belt, I think we can confidently say that we're in the early innings of a new denim cycle. I've got a lot of confidence in the sustainability and our ability to continue the momentum that we've seen through this quarter. The strong results reflect an industry-wide denim resurgence. It is being driven by several things. One is the continuation of the casualization trend. And I would say that that's occurring more on a global basis than just inside the U.S. As the pandemic continues, uh, fog lifts and more people get vaccinated, the return to social activities as the lockdowns lift, you know, people are now starting to go back to the office in many parts of the world. Uh, all of this creates a new wardrobe opportunity. Uh, and I have talked about the fact that this is us data, but about 35% of consumers in the U S have changed waste sizes. Um, And some of it is up and some of it is down. But either way, it creates another reason for people to go out and update their wardrobe. But importantly, I do think the new silhouettes, which we've led, actually, before the pandemic, we launched our first kind of baggy fits. And it really took hold. And then as the pandemic kind of started to happen, we just kept doubling down on it from one season to the next. But we are seeing on both the men's and women's business, that these are big drivers of our business. The looser, baggier fits are almost half of both men's and women's sales this past quarter. And that's a pretty significant change, especially on women's from Q2 two years ago. And, you know, As bottom silhouette changes, it also has an impact on tops. It has an impact on footwear. And it really does present an opportunity to update people's wardrobes broadly beyond just the denim bottoms. You know, on top of all that, we've also talked about the importance of extending beyond denim. And we saw really good results there. Some of our newer styles, such as the XX Chino, that was up 246%. And our shorts offerings are up. On the women's business, we've seen really good results on dresses. And that has also helped quite a bit this past quarter. So I think we are in the early innings of a new denim cycle driven by this new silhouette. That's kind of a throwback to the early 90s. I think it is fundamentally being driven by the casualization trend. And it gives me a great deal of confidence as we go forward into the next couple of quarters.

Great. Congrats again.

Thanks, Matt. Thank you. Our next question comes from Bob Durbel of Guggenheim Securities. Your question, please.

Hi. Thanks. Good evening, guys. Hope you guys are well. A couple of questions, really. On Chip, the I guess, can we talk a little bit about pricing, just if you could elaborate on pricing? You know, are they sticking? Are the recent pricing actions sticking? How much pricing are you taking in the second half? And can you really just talk to, like, the sustainability of these price increases and how you guys are approaching it? Thanks.

Hey, Harmeet, you're on mute, I think. I think Harmeet wants to answer here, Bob. There we go. Okay.

So Bob, uh, on pricing, um, you know, as you've said in the past, we are in the early innings of pricing. Uh, we've been more proactive on the back of a brand being hot and a products being relevant as Chip talked about, you know, our view is you take pricing when the, when the brands resonating with the consumers, not when you need to. Um, and, uh, We have taken pricing during the pandemic. It's ticking. If you look at our first half, pricing probably helped about a point on revenue. And we think of the quarter, about a quarter two, pricing was about a point of gross margins. Thinking forward, the other piece is Chip talked about the loser-baggier fit. There are higher AURs. There are better gross margins. I talked about women's piece of the business which is under-penetrated and growing. That has higher gross margins because we did take some pricing last year, especially in the U.S., relevant to wholesale. The other piece in the pricing bucket is the reduction in markdowns. We are using AI data analytics as well as lean inventories. We're making sure that our products are marked down appropriately. That's definitely helping Do you think of AUR generally across the system? In quarter two, they were up about 5%, and it's across geographies, across channels. So our view is that pricing is ticking. We're also prepared for any cost inflation if it happens. I talked about the fact that we've been able to negotiate IH1 cost of goods at very low single-digit inflation. which is a little higher relative to the previous years, but we're more than prepared for inflation if it comes down that far. And I think the other piece is if you think of the industry, prices have largely been deflationary over the last two decades. And as market leaders, when denim is resurging, I think it's an opportunity to lead the industry.

Great. Thank you very much.

Thank you. Our next question comes from Jay Sol of UBS. Your line is open.

Hi, good afternoon. This is Mauricio Sarna on behalf of Jay Sol. I wanted to ask about Europe. You mentioned that sales in May improved versus May 2019. I think I heard like up double digits, so I just want to understand how that number improves throughout the quarter and Sorry, if you could also like say it again, what you're seeing for the third quarter by region, that would be very helpful. Thank you.

Sure. You know, pre-pandemic, Europe was our strongest market. We were market leaders by a mile, executing really well, growing double digit. Before the last resurgence, the recovery in Europe was also the strongest. And unfortunately, countries had to go into lockdown. And so during the quarter, about a third of our stores were closed in Europe. As we exit the quarter, a lot of them have reopened. So when we talked about exiting the quarter, we talked about May sales in Europe being, I believe, in the high single digit. If you take a market like the U.K., which, where retail is open, you know, we have seen, if you take the last two months, we've seen double-digit increase in sales. So there is, the brand's very strong and is largely, the performance has been light only because stores have been closed. The European team has done a great job also pivoting to making the business more digital. So I talked about the company e-commerce business in the quarter going close to a little over 90%, and the full digital ecosystem becoming a third of the business. So our view of the world is it's difficult to predict when and how lockdowns happen. We all heard about Japan this morning, but our view of the world is our execution capability of our teams on the ground, you know, our focus on driving agility, on the back of the consumer and employees being safe, and we're able to recover pretty quickly. And so that's how we're thinking about Europe and other parts of the world over the next 12 to 18 months.

Great. Thank you.

Thank you. Our next question comes from Laurent Vasilescu of Essene BNP Paribas. Your line is open.

Good afternoon. Thanks for taking my question. Harmeet, I think you've mentioned that June is up mid to high single digits. And then if I remember correctly on the 2H guide, which I think implies on a two-year stack it's 4% to 5%, but that 3Q would be a slower growth rate. Just trying to square away, how do we think about June? It sounds like June would be the driver and then there's a sequential slowdown. Just trying to understand the mechanics here. And then any updated thoughts on the Target partnership as we head back to school would be very helpful. Thank you very much.

Great. I'll take the June and the second half question, and then I'll pass on the second question on Target and CHIP. But to your question, June was a good indication of, you know, what happens when lockdowns lift. And, you know, what we are seeing is consumers come back and come back big, especially to brands that have relevant products as well as brands they can trust. And you're right, the numbers in June were pretty strong. But we also feel, you know, part of that is pent-up demand. Part of that is people getting back to the new norm. So as you think of the second half of the year, you know, our expectation, clearly higher than a quarter ago, clearly reinforcing that we not only return to growth relative to 19, but we get to growth in Q3, which is a quarter ahead of our expectations. So that's how we're thinking about it. The other piece to note is there are various parts of the world that are still closed. I mean, Asia, and I just referenced Japan today, you know, we have not won the battle against the virus yet. There is still, you know, work to be done on that front. And so, It's important to ensure that that's incorporated in our outlook as we think about the next six months.

Yeah, and on target, Laurent, you know, the headline thought is we continue to be really happy with that relationship. And I think if you were to ask them, they would say the same thing. We're currently in about 300 doors with Levi's Red Tab and about another almost 1,500 doors with Denizen. We are expanding to 500 target doors in time for back to school. So that is already in motion. So our Q3 results will include some distribution expansion of Levi's Red Tab to 500 target doors. And then on top of that, and most of those doors will also have Denison. And then Denison will be exclusively in another 1,275 or so doors. So total target distribution of about 1,775 stores or so. But we will be expanding Levi's Red Tap to the 500 target doors in time for back to school. Great to hear. Thank you very much.

You bet. Thank you all. Thank you. Our next question comes from Paul Lajuez of Citigroup. Please go ahead.

Thank you. It's Tracy Kogan filling in for Paul. I was wondering if you guys could update us on any supply chain issues you're currently seeing, and maybe if supply chain issues have affected your inventory levels or constrained your demand and when you think it might improve. Thanks.

Yeah, we have experienced some impacts, although I would also be very quick to say that I think we are managing through this better than most. I would say the impact to the quarter was about a half a point of growth for the total company. So kind of in the range of seven to $8 million in the quarter. Our expectation for the second half is there will continue to be challenges, but we're gonna be air freighting more. That's already built into our gross margin guidance, which we've given. And we are working around some of the biggest challenges. There's still a challenge in Long Beach, We're now shipping most of our product into the U.S. through the East Coast. Only about 20% of our U.S. freight is coming through the West Coast right now, and we've built the delays into our lead time. So we're fully expecting that we're going to be able to manage the back-to-school volume as that comes upon us and holiday as well. The team has done really a great job of contracting and getting guaranteed space on vessels. You know, a lot of people are talking about not being able to get containers, not being able to get onto a ship. The team has done an extraordinary job on getting us guaranteed space, guaranteed pricing as well, which is helping us to control our costs. So This is a big challenge for the industry. We're hearing it from a lot of our customers. We are all over it, and I think we are, in part because we've got such a diversified supply chain, I think we're managing through this better than most.

Great. Thanks very much.

You bet. Thank you. Our next question comes from Dana Telsey of Telsey Advisory Group. Your line is open.

Good afternoon, and congratulations on the progress. Given the improvement in margin that you've seen, how do you think about the DTC margin, e-commerce versus stores? Is there improvement being seen in each of those channels, and how do you think about that going forward? And then just lastly, in terms of product inflation and raw material costs, how are you planning those going forward? Thank you.

Thanks, Dana, and thank you for the insight on CNBC today. I'd say to your question on gross margin, you know, DDC continues to be a tailwind. Our gross margin, both in stores as well as e-commerce, is higher than the company average. And we have said strategically, one of the pivots we made during the pandemic was that we will accelerate our direct-to-consumer operations You know, we had about 40% of the business today is directed to consumer, but, you know, we hope to get it to about 60%. So that clearly helps our gross margins. We also, as I talked earlier, we're selling a lot more full-price product. We are also being very thoughtful about and disciplined about our promotions, all these factors. will help. We're seeing an increase in AURs I talked about. That's making a big difference. There is a piece on the gross margin side that I think may be temporary. I mean, it's small, but it's there. And we called it out. I think that's why gross margin in the second half, even though the 300 basis points higher than 2019 are slightly more moderated than the you know, 670 or 500 basis points rather than 19 that you've seen here. To your question about cost, you know, given the scale that we have and given that we have wonderful, you know, partners and vendors around the world, we've been able to negotiate, I would say, cost increase on product to very low single digit for the first half of 2022. And that gives us confidence about continuing or maintaining gross margin growth as we get into 2022. And we are seeing inflation in media costs. We're seeing inflation in fulfillment costs. We're seeing inflation in media, but manageable from our perspective. And given that our brand has pricing power, if we ever need to, take more pricing than we think we can.

Thank you.

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

Okay, great. Harmeet, I wanted to ask you about the gross margin. 57% full-year gross margin this year, obviously a really exceptional accomplishment. I know you called out the 100 basis points of temporary benefits here in the second quarter. And I can't recall if you gave that in Q1. But if you could just take a look at the full year out of that 57%, is there a 25 basis point or a 50 basis point, you know, sort of give back next year? I'm just wondering what the sustainable, if we were to think about the more structural benefits you're delivering in gross margin this year versus some of the temporary ones, if you could help us understand the breakdown within the 57% target this year, that would be great.

Yeah, definitely. You know, we're not ready to give a guidance for 2022 or talk about a growth algorithm because things are still stabilizing, but we feel good about, um, ensuring that gross margin continues to be accretive year over year. We demonstrated that even last year when we were in the heart of the pandemic. I think to your question, difficult to call out, Kimberly, but in this quarter we felt probably there were temporary benefits of about 100 basis points, which annually, if you equate, it's about 20, 25 basis points. But Chip referred to us saying air freighting product in the second half. And we've built in that into our gross margin guidance. You know, our assumption is longer term, we will revert back to the old norm of, you know, shipping the product. So we may not need to air freight as much. So there are some puts and takes as we think about the year. Broadly, I think registering three companies quarters in conductive fashion or record gross margin just talks about how strong the brand is. And so that's what I would kind of leave you with is the thinking that we'll probably continue to grow gross margin annually. How much that will be, I'll probably talk to you more in a couple of months, maybe early next year when we talk about 2022. But I think the broader perspective also is our confidence of delivering a 12%, you know, EBIT margin or operating margin and growing from there, you know, beginning 2022. So I think I'd say, you know, our view of the world is gross margin continues to be accretive. We continue to invest on things that matter, ANP, et cetera, but that does drive leverage and improve operating margins.

Very clear. Thank you so much.

Thanks, Kimberly.

Thank you. Our next question comes from Lorraine Hutchinson of Bank of America. Your question, please.

Thanks. Good afternoon. I had a question about how you're thinking about future orders and how you're trying to strike a balance between meeting the outsized demand that you're seeing, particularly in some of these new fashion items and tops, with maintaining all this progress you've made on gross margin. So, uh, where are you coming out in terms of, um, planning your, your production and your inventory levels for the coming seasons?

Yeah. The, uh, you know, we're doing some, a few things structurally that will continue to improve our inventory management. Uh, we're moving from two seasons to four chip talked about, um, you know, implementing AI-driven demand forecasting that leads to better inventory management, but also ensuring that we minimize the miss on sales. You know, so there are quite a few things. The other thing that we're doing is we are raising the percentage of common assortments around the world because it allows us to move inventory faster you know, between countries and between affiliates. The other muscle that we have built is the muscle of chasing, you know, thanks to the wonderful work of our supply chain folks and operators on the ground. Now I think we can chase more into demand as against ordering everything and keeping it, so that leads to better inventory management and obviously lower markdowns because you're not necessarily buying product before you see those trends. And so the way we think about inventory levels, you know, Lorraine, I think the 12% decline that you've seen is not here to stay. We probably have inventory at par in Q3, and as we start planning 2022, inventory levels will probably be slightly higher, mid to high single digit. But the good news for us is, as you've seen even during the pandemic, two-thirds of our inventory is core, or what we can sell from season to season. So, you know, our view of the world is that, you know, we will have inventory that will allow us to grow this business. We'll probably be chasing, if the recovery continues at the pace it is, we'll probably be chasing demand, and that's not a bad place to be. Chip has said a couple of times, we'd rather lose the sales and have a lot more inventory that we'll have to mark down.

Thank you.

Thank you. Our next question comes from Carla Casella of JP Morgan. Your question, please.

Hi. I'm curious. You mentioned that Ladies has a higher gross margin at this point, and I'm wondering what's that attributable to? Is it the mix or something else?

I'd say a couple of things, Carla. You know, in the good old days where, you know, we were not growing women, it was dilutive to all company margins. Then we introduced, you know, a wonderful women's product and had, I don't know, 15 quarters of double-digit growth. So the product was relevant. It was resonating with her. And then we continued to innovate, introduced new styles. We took pricing. we had the volume and we leveraged the volume to drive better cost of goods sold. So all those factors have really contributed to higher gross margins for our women business. It's underpenetrated, so we think this will grow. And I think as it grows, it continues to be accretive. And so we think the gross margins are sustainable as we continue to grow our women's business, which today is about a third, a little over a third of our business, you know, and we have stated publicly, you know, our intention is to grow this to at least, you know, half our total business over time. There are countries that do it effectively today. I think Australia, you know, has a very, you know, has a women business that's at par with a men's business and other markets in Europe. So I think it's clearly possible.

Okay, great. And then can I ask this one on travel? Where would you say you are in terms of travel if you look at today versus pre-pandemic? How much more upside is there as travel reopens worldwide?

Are you talking about travel as in travel expense?

No, sales.

Tourist sales. Oh, you're talking about tourist sales. I'd say tourist sales are are, uh, practically non-existent. The way, uh, I think you'll see a little bit in Q2, but it's very small. Uh, if you think about our doors, uh, uh, you know, um, what the team is, teams around the world are doing a wonderful job is reaching out to more local consumers. So I think, you know, and we're reaching out to a lot more younger consumers around the world to try and offset some of the, um, tourist decline. Um, It's difficult to predict, but I'd say it's varied by country. Every country has a different rule for allowing tourists. You'll probably see things get back to normal probably a year, a year and a half from now, but our view is that we're able to mitigate where we can.

Okay. That's great. Thanks a lot.

Yeah.

Thank you. At this time, I'd like to turn the call back over to President and CEO Chip Berg for closing remarks.

All right. Well, thank you, everyone, for dialing in and for the terrific questions. We will look forward to speaking with you again at the end of our third quarter. Thanks very much and enjoy the rest of your summer.

This concludes today's conference call. Thank you for participating. You may now