Levi Strauss & Co.

Good day, ladies and gentlemen, and welcome to the Levi Straussen Company third quarter earnings conference call for the period ending August 28, 2022. All parties will be in a listen-only mode until the question and answer session, at which time instructions will follow. This conference call is being recorded and may not be reproduced in whole or in part without written permission from the companies. This conference call is being broadcast over the Internet, and the 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, Vice President of Investor Relations at Levi Strauss & Company.

Thank you for joining us on the call today to discuss the results for our third fiscal quarter of 2022. Joining me on today's call are Chip Berg, President and CEO of Levi Strauss, and Harmeet Singh, our CFO. We have posted complete Q3 financial results in our earnings release on the IR section of our website, investors.LeviStrauss.com. The link to the webcast of today's conference call can also be found on our site. We'd like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular the risk 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 certain non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our IR website, and a replay of this call will be available on the website shortly. Today's call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And now I'd like to turn the call over to Jeff.

Good afternoon, and thanks for joining us today. As you know, and I've heard from other companies, macro conditions deteriorated since we last spoke with you in early July. As we move through the third quarter, a confluence of pressures from inflation to falling consumer sentiment to rising interest rates began to result in softer consumer demand, while our industry continued to experience supply chain disruption and a heightened promotional environment. Not surprisingly, this made for a challenging quarter. Despite this, we were able to deliver solid results with net revenue growth of 7% on a constant currency basis, which translates to plus 1% on a reported basis. While this was below our own internal expectations for the first time in several quarters, our teams responded to this very dynamic environment by focusing on controlling the controllables. We took quick action to both stay competitive and protect the bottom line, resulting in a double digit adjusted EBIT margin of 12 plus percent. I've talked before about the importance of strong brands during uncertain times. our brands remain very strong, delivering strong growth despite the challenging environment. Specifically, excluding the impact of foreign exchange, we delivered constant currency growth across our key brands with Levi's plus 6% and Dockers plus 13%. But beyond the revenue results, there are other key proof points that underscore the strength of our brands. First, this quarter we delivered the Levi's brand highest third quarter revenue in a decade, with growth across categories and genders. We've made meaningful progress winning over the next generation of fans, continuing to gain share with the 18 to 30-year-old age segment in the U.S., while maintaining our leadership position across consumers of all ages. And our unaided brand awareness remains well above competition across most markets. Second, the strength of the brand has equated to pricing power. AURs were up mid-single digits in a more promotional environment, and the pricing we've taken to offset inflation has largely stuck. Third, and as a result of our pricing power, our gross margins, though off modestly versus a year ago, primarily due to currency and discounting, remain strong and are still nearly 400 basis points higher than pre-pandemic levels, as we have successfully offset significant inflationary cost increases. Fourth, our direct-to-consumer business continued to deliver at outside growth of plus 8% in constant currency, which, by the way, Harmeet and I will continue to refer to in the balance of our remarks, driven by increases across our stores and e-commerce business. Having strong, powerful brands and a diversified business with scale mattered during these volatile times. These advantages allowed us to grow global wholesale by 6% and total U.S. company revenue by 5%, despite a number of U.S. wholesale customers slowing orders. To put the U.S. results in context, we significantly outperformed both the overall jeanswear market, which based on NPD data, declined by mid-single digits during the June through August quarter, and the overall US apparel market, which slowed to only 1% growth. I think it's also important to note that despite the past three month decline in the jeans wear category, it is still up mid single digits versus pre pandemic. Despite the quarterly category softening, we remain confident about the long term trend of casualization continuing to be a tailwind for the business. In addition, Even with continuing supply chain constraints, our team took swift action to minimize the impact to just $30 to $40 million, or about two to three percentage points of revenue growth. As the operating environment becomes more challenging and supply disruptions continue, our unique and durable competitive advantages will continue to set us apart from the competition. Let me walk you through the progress we made across our strategic priorities during the quarter. again, all in constant currency. Our first strategic priority is brand-led. As mentioned, Levi's brand grew 6% versus prior year and almost 10% ahead of 2019. We're driving growth in our bottoms business by delivering a pipeline of fresh and innovative products as we define new trends and introduce new fits. We continue to build upon our success with looser fits with the launch of our new baggy dad, a signature 90s style which delivered strong performance, as did our new bootcut and straight fit launches. The trend toward looser fits in women's was also accompanied by a shift from high to mid-rises, which were up 20%. The iconic 501 family again posted double-digit growth across men's and women's. After 149 years, this fit continues to resonate. We continue to position the Levi's brand at the center of culture by partnering with leading brands and cultural icons on product collaborations. The Ghani collaboration returned this year and was featured on the runway at the Copenhagen Fashion Week and sold out in two weeks. And the new Levi's Denim Tears collection was worn by Golden State Warriors guard Steph Curry on the cover of October's Rolling Stones. We also recently launched the second iteration of our Buy Better Wear Longer campaign designed to inspire shoppers, both young and young at heart, while highlighting the quality and the timeless style of Levi's. Additionally, this campaign underscores the durability of a pair of Levi's, important in today's environment where consumers are looking for quality and value for money. This is the highest scoring ad in copy testing that we've had since I joined the company over a decade ago, reflection of how much this message resonates. Moving on to our second priority, total company DTC channel grew 8%. Owned and operated mainline and outlet stores grew in the third quarter, mid-single digits, with traffic and AURs both up versus prior year. Again, another sign of the strength of our brands. And even as consumers returned to our stores, e-commerce grew 16% driven by the Levi's brand in Asia, Beyond Yoga, and Dockers. Overall, e-commerce was up 64% versus 2019, with the Americas and Europe segments up double digits and Asia more than doubling. Globally, the Levi's app continued to achieve increased engagement with monthly active users, again up double digits. along with 17% growth in revenue. And we made progress in deepening our direct personalized relationships with our consumers via our global loyalty programs, which saw double-digit growth in total members and revenue. We also grew our global wholesale business by 6%, driven by the Levi's brand across Asia and the Americas. In the US, the Levi's brand was up low single digits with strong growth in women's new fits. This growth was offset by a 12% decline in our value brands, Signature and Denizen, which are most sensitive to changes in consumer discretionary spending. Further, this business was impacted by a reduction in Denizen women's distribution at Target as we've expanded Levi's Red Tab. As a reminder, our values brands only comprise a mid-single-digit percentage of our total net revenues. Our third strategic priority is diversifying our portfolio, and we continue the strong momentum we have achieved in each of our major growth opportunities, with women's, tops, international, and our other brands, Dockers and Beyond Yoga, each contributing positively to third quarter growth. Our total company women's business grew 8%, above men's strong performance of up 6%. The women's business was driven by Levi's Bottoms, which were up 7% and saw notable strength in the Americas. Additionally, the small but growing women's business on Dockers was completely additive, as was Beyond Yoga. For the total company, tops saw 12% growth as we continue to diversify our offering. Levi's tops were up 8%, driven primarily by men's, which grew 14%. We continue to see strength in tees, wovens, and polos, while our Levi's women's business saw positive growth across non-graphic tees, dresses, and sweaters. Our international business grew 8%, even as we navigated a more challenging consumer environment in Europe and in China. We saw encouraging strength across Asia, which excluding China, was up 68%, as well as in several of our largest and important European markets, notably the UK and Spain. Our updated Dockers brand with its California casual aesthetic posted 13% growth driven by both AUR and volume while also delivering strong profitability that exceeded our plan. The brand delivered growth across major geographies and channels. The US was up 2% and international brick and mortar and e-commerce saw notably strong gains. Dockers Women's and Topps businesses also saw strong growth and grew as a percentage of the brand's sales. Beyond Yoga contributed $22 million to net revenue with solid consumer demand in the quarter with company-operated e-commerce sales up strong double digits on a pro forma basis. It launched at 28 colleges across the country as the brand continues to build awareness and reach new consumers. Perhaps most exciting, at the end of last month, Beyond Yoga opened its first permanent store located in Santa Monica, showcasing the brand's full array of category offerings for the first time. While we're just getting started, we believe there is an attractive long-term opportunity to grow the brand's presence through retail. Finally, one of our most important company-wide objectives is leading the industry in environmental stewardship. Last week we released our annual sustainability report, which includes a comprehensive set of disclosures and introduces a new slate of sustainability goals, 16 in all, that cut across our three main pillars of climate, consumption, and community. You can find the report online in the sustainability tab of our website. In closing, we continue to achieve steady progress against our long-term objectives. as we navigated a more difficult environment in the third quarter. While we expect it to remain challenging over the next few quarters, I'm confident in our ability to navigate the near-term headwinds and importantly deliver on our long-term goals for the following five reasons. First, we have really strong brands. Second, our categories are structurally attractive with long-term tailwinds from the casualization trend and denim cycle. Third, we have the global scale to react to disruptions and manage through inflationary pressure with competitive sourcing. Fourth, we have a diversified business model where some of our biggest opportunities are gross margin accretive and generate higher AURs. And fifth, we have a seasoned and proven team that has delivered excellent results while managing through challenging times. Ellison Co. has separated itself from competition in challenging times in the past, by making the right moves. We believe the current environment is an opportunity for us to do this again. We will operate with discipline and lean into our strengths to further expand our lead for the years to come. Now over to Harmeet.

Thanks, Chip. Let me begin with three thoughts before we get into the numbers. We delivered a solid quarter. With net revenues up 7% in constant currency, demonstrating the power and resilience of the Levi's brand. We delivered these results even in the face of higher FX headwinds, transitory pandemic-related supply chain issues intensifying in the U.S., resulting in our inability to fulfill orders, as well as stiffening ongoing economic and inflationary headwinds impacting consumer discretionary spending in the U.S. and Europe. Thanks to the strength of our brand, our diversified business model, and operational agility, we were able to swiftly manage expenses and exceed expectations for adjusted diluted earnings. We made progress against our long-term strategic plan, delivering growth across our attractive high-margin opportunities, including women's tops, direct-to-consumer, international, and our Dockers and Beyond Yoga brand. By exercising control of the controllables, we are navigating the short term while continuing to invest in our compelling long-term growth initiatives and returning capital to our shareholders. Now, let's get to some additional Q3 financial details. Net revenue grew 7%, primarily driven by the U.S., Asia, and Latin America, with broad-based increases in AURs. Direct-to-consumer channel net revenue grew 8%, driven by positive com store sales across our mainline and outlet stores, including in the U.S., due to increased traffic, higher AURs, and UPTs. And despite strength in the stores, our e-commerce business was up 16%, and net revenue through all digital channels were up A adjusted gross margin in reported dollars was 56.9%, up more than 390 basis points versus 2019, yet contracting 60 basis points year-over-year. Due to a 30 basis points unfavorable currency exchange rate impact, as well as the impact of higher product costs and lower full price sales, particularly in the U.S., relative to last year. partially offset by price increases and a favorable channel mix. Moving to SG&A, adjusted SG&A expenses in the quarter were $675 million, up 6% from last year, at the lower end of our expectations. As we began to see the impact of the softening macro environment, we minimized spending in the quarter by reducing discretionary expenses like travel, delaying non-essential hiring and projects, and we're continuing to do the same as we moved into quarter four. As a percentage of revenue, adjusted SG&A was 44.5%, reflecting higher distribution expenses and ongoing strategic investments in IT and our direct-to-consumer business and our lower-than-expected revenues. Adjusted EBIT margin was 12.4%. contracting 240 basis points on a reported basis and 200 basis points on a constant currency basis. Adjusted EBIT dollars were down 15% on a reported basis and 8% on a constant currency basis. The effective income tax rate was 7.2% for the third quarter, compared to 4.8% in the same quarter of the prior year. The lower effective tax rate relative to the company's full year updated outlook for mid-teens was driven by the planned acceleration of certain tax-related initiatives. Adjusted net income was $161 million compared to $197 million in the same quarter of the prior year. The decrease was due to lower operating income. Adjusted diluted EPS was 40 cents which includes a 4 cent negative impact from foreign exchange, of which half was incremental to the outlook we provided in July. I'll now take you through key highlights by segment. Recall the regional segments include our Levi's brand, Levi's, Signature, and Denizen, while the other brand segment includes Dockers and Beyond Yoga. In the Americas, revenues grew 3% driven by higher AURs across channels. DTC growth of 8% was driven by company-operated mainline and outlist stores, which benefited from increased traffic and AURs in addition to new stores. Wholesale growth of 2% was driven by international and the Levi's brand in the U.S., which as Chip mentioned was partially offset by lower revenues of our value brand. Overall, the Americas segments saw growth across all markets, with the U.S. up 2% and notable momentum across Latin America, led by the strength in Mexico. In Europe, revenues were 9% lower on a constant currency basis, which includes a 4% negative impact from the suspension of our business operations in Russia. While macro pressures, including inflation and extreme heat, negatively impacted the region, several of our large markets posted growth. Our successful pricing actions delivered high single-digit AUR growth, which partially offset softer consumer demand. Though we continue to anticipate pressure from the macro environment, we remain confident in the strength of the brand in the region, and Levi's remains by far the most popular denim brand in Europe. Asia again accelerated with greater than anticipated revenue, up 53%, despite COVID-related restrictions negatively impacting markets like China. Volumes and AURs both increased strongly, and wholesale and direct-to-consumer both partially benefited from lapping wider-spread COVID-related door closures last year. E-commerce was up 33%, while our company-operated stores saw gains from traffic, AURs, and new stores. The Asia segment, excluding China, grew 68% with broad-based growth across markets led by India, Malaysia, A&Z, Indonesia, and Thailand. And overall revenue growth and higher gross margins have delivered better than anticipated operating margin expansion of nearly 2,000 basis points to 7.4%. Other brands' net revenues are 44%, driven by 13% growth in Dockers and the addition of Beyond Yoga. Turning to balance sheet and cash flows, reported inventories increased 43% on a dollar basis. However, there are a few items that are driving that increase and are worth noting. Approximately one-third relates to COGS inflation and the normalization of last year's abnormally low inventory levels. Another third of the increase relates to the intentional earlier receipts of co-inventory to mitigate supply chain risk and the U.S. implementation of a new ERP system in the second quarter of fiscal 23. And the final third was driven by an increase of goods in transit. Co-products which can be sold across multiple future seasons represented approximately two-thirds of total inventories and we are comfortable with the composition and quality of our inventory. As we build inventory for 2023, and we look forward to respond to changing demand, we have reduced inventory buys for the first half of 2023 by approximately 25%. These actions should enable us to return to normalized inventory levels in line with net revenue growth by the end of quarter 2023. Cash and liquidity remain strong, with the end of quarter net debt of 372 million and overall liquidity of 1.4 billion. Our leverage ratio remained at 1.1 times. Owing to investments in inventory and inflation, adjusted free cash flow which we define as cash flow from operating activities, less property, plant, and equipment, was negative $12 million in the third quarter. However, we expect adjusted free cash flow for quarter four and the full year to be positive. In the third quarter, we returned approximately $74 million to shareholders. The company paid a dividend of $0.12 per share, nearly 50% higher than a year ago. And in the quarter, we repurchased shares of approximately 26 million. In quarter four, the company declared a dividend of 12 cents per share in line with last quarter, and we currently have 690 million remaining under our share repurchase program, which has no expiration date. Now let's turn to guidance. While we're confident in the strength of our brand and deep consumer connections, we are not immune to the macro headwinds the sector is experiencing. And though in the month of September, we're continuing to experience momentum in our U.S.-directed consumer business, which is up 10%, we are tempering our outlook for the remainder of the year to reflect ongoing supply chain disruption and macroeconomic pressures. For fiscal 22, we now expect reported net revenues to grow 6.7% to 7%, representing approximately 11.5% to 12% net revenue growth on a constant currency basis. Our outlook includes three points of incremental FX pressure since we guided in July. On a reported basis, we now expect Americas to be up high single digits, Asia mid-teens, and Europe down high single digits. In constant currency, we expect Asia to grow in the low 20% range. Excluding FX and Russia, we expect Europe to grow high single digits. We also now expect adjusted diluted earnings per share of $1.44 to $1.49, despite incremental FX headwinds of 5 cents since we reported back in July. In total for the full year, we now expect more than 250 million of unfavorable FX impact on net revenues and 13 cents in adjusted diluted EPS. To put our latest full year adjusted diluted EPS guidance in context relative to where we started in early 2022, adverse FX, Russia, China are estimated to have impacted adjusted diluted EPS by over 20 cents. By focusing on what we can control while building this business for the longer term, we have managed to offset nearly 75% of this downside. We expect our full year adjusted gross margin slightly down versus last year's 57.9%, nearly 400 basis points higher than 2019. The change from our prior outlook is driven by foreign exchange and lower full-price sales, as we expect the broader marketplace to be more promotional through the end of the holiday season. As a result, we now expect our adjusted EBIT to be 11.6% to 11.8% for the year, which is approximately 60 to 80 basis points lower than prior year on a reported basis, but 100 to 120 basis points ahead of 19. We continue to expect 270 million in CapEx for the year as we expand our direct-to-consumer business and continue strategic investments in IT. We expect our full-year effective tax rate to be in the mid-teens, which implies a mid-single-digit tax rate for quarter four. As specifically related to quarter four, this implies our fourth quarter net revenues will be slightly down on a constant currency basis and down approximately 6% on a reported basis. Our outlook reflects a more cautious view with regard to supply chain challenges, particularly in the U.S., into the fourth quarter. We expect adjusted diluted EPS to be between 29% and 34%. As I did in the beginning, I want to leave you with a few key points. A vision for a long-term future remains unchanged. While we expect conditions to remain challenging in the near term, we are confident in our ability to leverage our strengths to deliver sustainable, profitable, long-term growth and emerge in a stronger position. Our brands and the structural economics of our business remain as strong as ever. On top of our resilient core, We're making good progress in attractive, growing, and high-margin areas, including our women's tops international and direct-to-consumer business. We are focused on controlling the controllable. We're reducing discretionary spending, but not at the expense of any of our strategic investments that continue to fuel our brand and which will enable us to deliver on a long-term growth plan. And finally... We're financially strong with a solid balance sheet and a strong, diversified, and scaled business model to generate the cash flow to reinvest for long-term growth while continuing to return cash to our shareholders. And with that, operator, I would like to open it up for questions.

Thank you. The floor is now open for questions. If you have a question, please press star then 1-1 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. Our first question comes from the line of Bob Durbel of Guggenheim Partners. Bob Durbel, your line is open.

I guess, Chip and Harmi, just when you look at the quarter, can you talk a little bit more, I don't know, like, geographically you know how it materialized when you think about you know the the changes in the quarter and sort of how you missed your expectations or you know just the dynamics that unfolded and i'd be a little bit you know be interested to hear just how you think wholesale inventories are you know of the categories with some of the changes in the category that you talked about as well um throughout the quarter thanks good bob uh thanks for asking

The difficult question. But as you know, we delivered a solid quarter up 7%. And Levi's in quarter three hit a record revenue for that quarter in a decade. But you're right, we missed our own internal high bar. You know, things progressed fairly quickly through the quarter. The moment we saw headwinds, incremental headwinds in FX, supply chain continued pressures and demand softness, especially in the Western world. You know, we focus on the controllable. So if you think of revenue, I'd break up the myth to our own internal expectations in the following way. A third was foreign exchange. A third was supply chain constraints that persisted and honestly limited our ability to service demand that was out there. So that was about 30 to 40 million in revenue. And then the macroeconomic environment which weakened in the U.S. and Europe. Asia and Latin America were the standouts geographically. You know, they grew. You know, we continued long on those businesses. As we think about, you know, the impact on EPS and profitability, I'd say the, you know, the drop to our own expectations and revenue, which is about $0.12, we quickly focus on, you know, the controllables. and other things like tax rates. And, you know, our tax rates are, you know, in the mid-teens. We hope to sustain in the high teens longer term. So, you know, that's where we kind of offset it. In terms of your question on wholesale and U.S. wholesale, if you think about the quarter, U.S. wholesale was up low single digits. If you back out a mass channel, which is, you know, two retailers that we sell Signature and Denizen, which is down at Chip mentioned, about 12%, U.S. wholesale actually was up in the mid-single digits. So overall, fairly okay. We do monitor trade inventory levels. You know, we measure it in months. And as the end of quarter three trade inventory levels in the U.S. with wholesale customers was largely similar to what it was in 19. Now, there are obviously some customers are higher, some customers are lower, but that's, you know, the way, you know, we see the data. Great.

Thank you very much.

Thanks, Bob. Thank you. Our next question comes from Paul LeChouet of Citi. Paul, please go ahead. Your line is open.

Thanks, guys. I'm curious if we could talk a little bit more about inventory, maybe if you can provide any color, maybe breaking it down by region, tops versus bottoms, men versus women. You might have mentioned something about how much is seasonless product. but also curious if you think there are any places where you have more than you'd like, where you have to be a little bit more promotional to clear through it. Thanks.

Sure. So, you know, I tried to break out the inventory, the drivers of growth, you know, and the prepared remarks occurred was largely negative. driven by inflation in COGS, which is up, as you know, cotton was higher, and, you know, a lower inventory base because last year things were very tight. A third was largely driven by us bringing earlier things because of longer lead times as well as the ERP, and a third was largely goods in transit. In terms of the thing that we're doing, you know, Paul and the team, we are, you know, and most of this inventory is largely coal. So we can work through season. About a third is seasonal. We don't have a lot of obsolete. The way we do have obsolete, we are, you know... Marking that down and selling it, and that was what was, you know, impacted our gross margins in Q3. You know, we went in thinking gross margins, you know, based on the items that we wouldn't be selling full price would be impacted about 100 basis points. This is probably 130, 140 basis points impact. We affected that in Q4, too. So where we can, you know, we are... moving quickly around the world to mask things down. The other thing that we're doing is that we did reduce our bias for the first half of 2023 big time. It's, you know, right now it's down 25% because as we build inventory for the ERP installation, it's important to reduce that. In terms of geographic split, Paul, the buildup is largely in the U.S., which is primarily a core market. And, you know, the reason for that bill is also driven by the fact that it's largely core and it's the ERP that's helping drive that. You know, what happens with the ERP implementation is we do stop shipping for about six to eight weeks, and that's why we're trying to work through it. And so to your point, you know, a third of the inventory is seasonal. It varies by geography. But the U.S. is more core than seasonal.

Got it. Thank you, guys. Good luck.

Thanks. Thank you. Our next question comes from Omar Saad of Evercore. Please go ahead, Omar Saad.

Thanks for taking my question. Good afternoon. I wanted to see if you guys could talk about the denim cycle, especially as it relates to your outlook for next quarter. Are you seeing a slowdown, a broader slowdown in the denim cycle? There are other companies out there in the category also seem to see a little bit softer trends in retail. And, you know, especially in light of the reopening, if people, you know, get dressed up again and maybe getting a little bit more dressy again, are you seeing that affect the casualization trend? Thanks.

Yeah, we've referred to some of this in the prepared remarks, Omar, but just to give you some real hard category data, and I'm quoting NPD data, on a past 12-month basis, this is all through the end of August, on a past 12-month basis, Total apparel is up 11. Venom is up 10. By the way, we were up more than that on the past 12-month basis. And then in the script, we referred to the most recent three months through the end of August, so June, July, August, where there was a significant slowdown with Venom down mid-single digits and total apparel Well, I'm not crazy about those numbers. What is good is it does kind of validate the narrative that has been out there, which is that there has been this transitioning into more formal attire as people go back to weddings and back into the office, et cetera, et cetera. And that data does validate that. And you can put our results up against that. And we clearly outperformed Denim and outperformed Total Apparel too during that same three-month period of time. I don't expect it's going to stay that way for long. You know, and that data, by the way, is U.S.-only data. You know, the casualization trend, we talked about this for quite some time. It's no longer just a U.S. trend. It is a global trend. It is real. You know, our business skews to men. Men are going back into the office wearing jeans. And we expect that, you know, that it's going to recover. You know, I've said many, many times before we're the market leader, and I believe it's incumbent upon market leaders to drive category growth. And we're going to continue to focus on doing that on the things that are within our control, driving innovation. We're going to continue to focus on innovation and continuing to support the business with strong marketing and marketing support. And the combination of those things should drive growth. Let's not forget, too, that weather probably played a factor during this period of time as well. As the season changes, that's generally pretty favorable. The last thing I would add is Harmeet referred to it in the script, but we did kind of put out there the September U.S. direct-to-consumer sales, which were up double digits. So, you know, I don't think we're going to see the category get back to double-digit levels of growth that we've seen over the last 12 months, but I do expect that the long-term trend for denim is going to be kind of mid-single-digit levels of growth over the long term. And You know, the shorter the time frame you look at, the more volatility there is in the data. And I suspect over time we're going to see Denon bounce back to kind of that mid-single-digit level, you know, over the next few months. So hopefully that addresses what you're looking for.

Thank you for the color, Chip.

Thank you. Our next question comes from Matthew Boss. of JP Morgan. Please go ahead. Your line is open, Matthew Boss.

Hey, Lateef, let's go to the next caller and come back to Matt.

Okay. Okay, our next caller comes, our next question comes from Chris Nardone of Bank of America. Chris Nardone, your line is open.

Thanks for taking my question. Can you discuss expectations for the trajectory of your European business relative to your 3Q results, even looking out to the first half of next year? And are there any particular countries that are showing notable weakness in any difference in how you're thinking about wholesale and DTC in the region? That would be great. Thank you.

Yeah, I would say, you know, all cards on the table here, Chris. We're probably most cautious about the business in Europe as we look ahead. As we talked in the script, we saw some countries in Europe and Q3 perform quite well. Both the UK and Spain were up nicely. We also had a number of smaller markets across Europe also perform well coming up versus prior year on a constant currency basis. But there were other markets that were notably soft. particularly Germany and some other markets in the north. If you strip out the impact of Russia, Europe was down by a big single digit, 5% for the quarter. And as we look ahead, the guidance that we provided does kind of build in some cautiousness, I guess, with respect to Europe. And I suspect, you know, we'll see more as the winter, you know, begins to hit. You know, what is the impact on the consumer over there as they face, you know, much steeper, not just a much steeper inflation, but much steeper energy costs as well. So, you know, the good thing about having such a broad global portfolio is, you You know, we've got other markets, as Harmeet said, that are performing exceptionally well that can help to offset some of the softness. The brand is still incredibly strong in Europe, but we're seeing our wholesale customers being cautious to their open-to-buy budget and how they're planning inventory. And, you know, we are seeing, as I said, some bifurcation in our business even through the third quarter, and we're kind of playing that through as we think about the future.

Thank you.

Our next question comes from the line of Alex Stratton of Morgan Stanley. Your line is open. Please go ahead, Alex Stratton.

Thanks for taking my question. Can you just talk about the flexibility your wholesale partners have as it relates to canceling orders if they were to see more of a slowdown? So put differently, at this moment, can they cancel any of their fourth quarter orders, your fourth quarter, the first quarter or the second quarter, and by how much? And also, what kind of support would you guys offer should your retail partners have too much inventory as it kind of builds up in the broader space? Thank you.

Well, first, I'll answer your last question first. As we said on the call, inventory levels across wholesale, broadly speaking, here in the U.S. in particular, are generally in line with where they were pre-pandemic. And so, you know, relatively reasonable. Now, it does vary from customer to customer. You know, most customers are kind of on their own after they own the product. They manage their promotion and markdown budget. We support it, but we support it within, you know, traditional guidelines for the customers across the marketplace and are treating all customers equivalently. In terms of canceling orders, let's say that it's a negotiation at the end of the day. If we've made products specifically for a customer, we hold the line very, very tight. So we do a number of products that are very, very specific to a particular customer. And if we're cutting product and making product for a specific customer, You know, they own it at the end of the day. And we try to hold the line very, very hard on that. If it's product that is more marketplace product or it's product that we can put in our outlet stores, then it is a bit more of a negotiation. I hope that helps, Alex.

It does. Thank you.

Thank you. Our next question comes from Ike Boricha of Wells Fargo. Your line is open. Please go ahead, Ike Borochow.

Hey, thank you. So, Chip, I just wanted to go back to the prepared remarks and just dig in a little bit more to something you said. I think when you were speaking to the business at a high level, you know, the business is being guided to negative constant currency growth and 4Q. I think you said you expect things to remain challenging over the next few quarters. I guess I know you're not going to give us guidance for next year, but Can you put some context behind that, how exactly we should think about the business based on the order book or any other visibility you may have right now? Thank you.

Yeah. And by the way, guys, part of the reason I hesitated on that last call, the Blue Angels are in town, and we just got scraped a minute ago. So it's crazy. We've got jets flying right over our heads here. So I guess the way I would characterize the way we're looking ahead, and I talk about this a little bit with respect specifically to Europe, there's just a lot of uncertainty right now. I mean, forecasting during the pandemic was pretty tough, but it's pretty challenging right now to get a pretty good hold on where is the consumer heading and where is the business heading, especially with respect to customers and their open-to-buy budgets. You know, and that uncertainty is caused by some of the noise and confusion and a lot of the economic signals that we're getting. You know, inflation is still relatively strong. You may see that begin to change over the next month or a couple of months. We're at or near full employment, and wages are growing. Wages are growing across all incomes. Bank accounts are still reasonably healthy, thanks to the pandemic impact, particularly in the middle and upper segments of income. So there's some data that you can look at and say things look pretty good, but there is a ton of uncertainty. Inflation continues to have more and more of an impact. As I said, in Europe, a lot of concern about what's going to happen during the winter with energy costs, particularly across that marketplace. But as I said, it is more of these Western markets where we're seeing these impacts. We have other parts of the business that are performing incredibly well. And even within our own portfolio in the West, our DTC business is performing pretty well. And so, you know, our balanced portfolio, the strength that we're seeing in Asia, the strength that we're seeing in Latin America, you know, the strength that we're seeing in our women's business, on doctors, you know, beyond yoga being completely additive at this point, we begin to lock that now. You know, these are helping to offset some of these speed bumps that we're seeing in other markets. But it is too early to comment on guidance. I can tell you guys, honestly, hand on a Bible, I haven't even seen the numbers as we're developing our plan at this point. But, you know, I expect that we will be reflecting kind of the realities as we see it today with some of these uncertainties, at least through probably the first half of next fiscal year. So I hope that helps without giving you any specific numbers.

Ike, Chip, the only thing I'd build on is from a cost perspective what we've seen. So, Ike, you know, On one hand, we built up inventory as we closed the year, but we built up inventory when cotton was you know much lower than what it was for the first half of next year as you as we see the futures of cotton for the second half you know cotton's down to a little over 80 cents which is the normalized so there should be some tailwind there in 2023 the second is you know some um you know um reduction in distribution costs and freight costs as we start thinking through the second half of next year. And so I think those are the things that probably help. But as Chip said, you know, we are here for the long term, and, you know, we'll take that view. You saw our expectations we set in the investor day. And so we have a North Star that we're working on.

Thank you. Thank you. Our next question comes from Laurent Vasilescu of Exane BNP Paribas. Your line is open. Please go ahead, Laurent Vasilescu.

Good afternoon. Thanks for taking my question. Chip, I think you mentioned the value channel in the U.S. was down 12, but at XTAP, the U.S. wholesale was actually up mid-single digit for the quarter. How do we think about those guardrails for the fourth quarter? Do they converge? Does the value channel get a little bit better and the rest of the business gets a little bit worse? Any guardrails around that? And then I think you mentioned ex-China, Asia was up 68%. I presume, obviously, that was on a CEC basis. Just curious to know what you're seeing in China. I know you have a small business there, but any color of what you're seeing in a quarter-to-day trend would be very helpful. Thank you.

Yeah. Yeah, why don't you talk, Chan? I just referenced, so as we think quarter four, and quarter four we're saying constant currency slightly down growth and reported down. Just give us one second to let the Blue Angels do their thing. So, the FX had been very similar to quarter three, and that's reflected in the difference in . You know, the change in the constant currency growth in Q3 down to slightly down in quarter four is driven by, you know, really two factors. Asia has been growing at 50%, 60%. It's going to start lapping the normalized base. So we expect Asia to grow in the high teens, but not at this level. So that's one piece. And the second is, as we think about the Americas, a combination of the supply chain disruption, which we think continues into Q4 and begins to improve Q1 onwards, as well as U.S. wholesale down versus up. That's how we're building the expectation. We're working like crazy to deliver better numbers, but that's the expectation that we're setting aside. Going to China, Chip, over to you. I think China was down in Q3 17%, but it's only 2%, 3% of our business. And as we said in Invest Today, we don't expect this business to be a major contributor to our growth longer term.

There you go. You just answered it.

Thank you very much.

Thank you. Our next question comes from Jay Soley of UBS. Yes. Your line is open. Please go ahead, Jay Foley. Your line is open.

Thank you so much. My question is, if you could elaborate a little bit on the supply chain challenges you experienced in the quarter and maybe help us understand, you know, maybe some of the differences that, you know, that played out versus your expectation at the end of last quarter. Maybe you could start there. That would be great. Thank you.

You know, overall what we'd say is, you know, all the parts of supply chain are indeed improving. We're still feeling the impacts of disruption. We additionally have some congestion within our logistics and distribution network due to inventory build that we did to protect Q1 revenue as well as our ERP transition. In addition, you know, comes a loss of efficiency in our distribution network, and so we think Q4 will be the peak, and we expect to start improvements in Q1. And to offset this and to build, as I said earlier, we're kind of reducing our H1 by big time, and so that by the end of quarter two, inventory levels return back to normal. And the congestion is largely, you know, between the ports, the transloader and goods, you know, on our distribution center lot. So we're working through it. And the majority of it is largely in the U.S. And U.S. is primarily a core market. So we're working through that. We're working through the same with our customers to ensure there's minimal disruption. But it does hurt overall revenue.

Yeah, the only thing I would add is, you know, you've probably heard others talk about supply chain improving significantly. Their starting point was a lot different than our starting point. Our supply chain issues are kind of in line with the issues that we had last quarter, you know. two to three points worth of growth left on the table due to supply chain issues. We didn't have the major supply chain issues the way some of our peers did, you know, nine to 12 months ago because our eggs are spread across more baskets than relative to our peers who have, you know, so much of their supply chain concentrated in one or two markets. So the The change on change is not as significant for us as it has been for some of the others.

Got it. Okay. Thank you so much.

Thank you. Our next question comes from Dana Telsey of the Telsey Group. Please go ahead. Your line is open, Dana Telsey.

Good afternoon, everyone. As you think of the current macro environment and what's happening in the channels, How are you thinking of the level of promotion, whether it's by your own DTC, e-commerce, or store? What's happening on the wholesale side by region also? And with the offsets on the gross margin side, are there offsets in terms of the magnitude, whether it happens to be freight or whether it happens to be anything else that we should note? How do you see the gross margin cadence evolving? Thank you.

Yeah. So, hi, Dana. Thanks for the question. Our gross margin, so, you know, when we started the second half of the year, I think we publicly said we built in probably 100 basis points contraction in gross margin in the second half, similar in Q3, similar in Q4. And that was really saying, okay, what percentage of our products we will be not selling at full price. As the quarter progressed, promotion levels increased. We had some seasonal product that we wanted to mark down in the western part of the world. Quarter three, the gross margin impact was about an additional 30 basis points. And as you look at quarter four, it's about, you know, 30 more. Because we think the environment is a little bit more promotional. and we've got in some inventory that we'd like to mark down and sell. So that's how we're thinking about it. At the end of the day, our gross margins for the year will be slightly lower than last year, but still significantly higher, maybe close to 400 basis points relative to 2019. So we're protecting the premise that we continue to grow our gross margins, you know, in the longer term. Does that help you, Dana?

Yes. And if you see your own channels with stores and online, how do you see the cadence there?

So, I'll take that one. So, let's put it this way, Dana. We're not going to be leading an aggressive promotional environment, but we're not going to be left uncompetitive. Just as we did in the third quarter when we saw that the promotional environment was heating up, we took steps to be competitive. But, you know, we're not in a place where we've got to go out and, you know, passively liquidate a lot of inventory. So we're not going to leave it. But we're not going to be left uncompetitive. That may not mean that we're going to go all the way to 70% off if everybody else is going to 70% off. It may mean that we go for fewer weeks, but we'll be competitive. But we're also, you know, at the end of the day, we are about the strength of our brand. And an overly promotional, hot promotion brand, you know, is not good for brand integrity. And so we're going to do our best to protect gross margin without being uncompetitive in the marketplace.

And just on marketing, what are your plans for marketing and marketing expenses as we go through this time period?

I probably should have hit this earlier, but, you know, whether you're thinking about Q4 or thinking about, you know, next year, we're going to continue to invest in the long term, and we're going to continue to make investments in in BTC and e-commerce, because those are strategic for us, and we're going to continue to invest in building our brands. No matter how tough it gets out there, those are the things that we'll see.

Thank you.

At this time, I'd like to turn the call back over to Chip Byrd for closing remarks.

Okay, let's see. yes sir okay um uh thanks everyone for dialing in uh and uh we will talk to you again not until the end of january so i wish you all happy holidays a good fall and happy holidays and we'll um speak with you at the end of our fiscal year in q4 in uh late january have a good good holiday and thanks for dialing in today everyone not until the

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