Levi Strauss & Co - Q1 2024

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company first quarter fiscal 2024 earnings conference call for the period ending February 25, 2024. All parties will be in a listen-only mode until the question-and-answer session, at which time instructions will follow. This conference call is being recorded and may not be reproduced in whole or in part without written permission from the company. This conference call is being broadcast over the internet, and a replay of the webcast will be accessible for one quarter on the company's website, levistrauss.com. I would now like to turn the call over to Aida Orphan, Vice President of Investor Relations at Levi Strauss & Company.

Aida Orphan (VP of Investor Relations)

Thank you for joining us on the call today to discuss the results for our first quarter in 2024. Joining me on today's call are Michelle Gass, our President and CEO, and Harmit Singh, our Chief Financial and Growth Officer. We've posted complete Q1 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 you that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular, the Risk Factors section of our Form 10-Q that we filed today, for the factors that could cause our results to differ.

Also, note that the forward-looking statements on this call are based on information available to us as of today, and we assume no obligation to update any of these statements. During this call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for our GAAP results. Reconciliations of our non-GAAP measures to their most comparable GAAP measure are included in today's press release. Finally, this call is being webcast on our IR website, and a replay of this call will be available on the website shortly. Please note that Michelle and Harmit will be referencing constant currency numbers unless otherwise noted. 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. Now I'd like to turn over the call to Michelle.

Michelle Gass (President and CEO)

Thank you, and welcome, everyone, to today's call. The year is off to a strong start, with both Q1 revenue and adjusted EPS coming in above our expectations. Revenues of $1.6 billion were down 8% on a constant currency basis due to last year's $100 million shift from Q2 into Q1, related to the ERP implementation in the US. Excluding this shift, as well as the impact from exiting the Denizen business in Russia, Q1 revenues were flat. Adjusted diluted EPS of $0.26 came in better than our expectations, driven by a 240 basis point increase in gross margin and prudently managing our expenses. Our performance this quarter reflects many proof points that our strategies, leading with our brands, operating as a direct-to-consumer-first business, and diversifying our portfolio, are working.

We are fueling consumer demand, resulting in meaningful U.S. share gains in both men's and women's, driven by newness and innovation, as well as continued strength in our core. We are continuing to see strong momentum in our global direct-to-consumer business, where we have now delivered eight consecutive quarters of robust comp growth. Our e-commerce business again achieved strong growth of 12% on top of mid-teens growth last year, and we're particularly excited about the continued acceleration in our overall women's business, which was up 14% in DTC globally for the quarter. We're encouraged by the performance of our largest market, the U.S. We saw sustained progress in DTC, which was up 10%, as well as continued stabilization in U.S. wholesale for the Levi's brand, which was up low single digits.

Stepping back, we are building a stronger business in the U.S., underscored by significant growth and operating margin expansion across channels in Q1. Revenue in the global wholesale channel, while down, was in line with expectations as the actions we have taken to improve this business are working. Importantly, global wholesale gross margins increased as both owned and channel inventory levels are much improved. Through our transformational pivot to operating as a DTC-first company, we are bringing operational rigor and a narrower strategic focus, which will set a solid foundation for sustainable, profitable growth. Through our productivity initiative, Project Fuel, we remain focused on driving cost efficiencies, and during the quarter, we took concrete actions in right-sizing our organization. In addition, we have activated an initial reduction of nearly 15% of SKUs across our Levi's product assortment and are deprioritizing footwear.

These efforts, together with the recent decision to exit Denizen, not only improve our cost structure, but also provide an unlock in simplifying and streamlining how we work. While it's early in the year, we started the year strong and are encouraged by the trends we're seeing in the business. As a result, we are increasing our adjusted diluted EPS guidance for the year. Harmit will share more. I will now talk you through the results of the quarter in the context of our strategic priorities, starting with our first priority, leading with our brands. First, the jeans category has stabilized in the U.S., now flat to prior year after several years of volatility. Importantly, over the same time period, Levi's outperformed the category, growing 2 points of share in men's and 1 point of share in women's.

We are also making progress in our key youth target, gaining share with 18- to 30-year-olds in the past quarter. Levi's picked up share with the middle-income consumer, which is critical, given these are the largest consumers of the category. We are continuing to outperform the category with higher-income consumers, demonstrating the success of our efforts in elevating the brand. Market share growth is being driven by the exciting innovation we are bringing to the category, as well as our ongoing commitment to keeping the brand at the center of culture, driving deep connections with fans around the world. Just last week, we reaffirmed our place at the center of culture with the launch of our global breakthrough and interactive Live in Levi's campaign.

As part of a digitally led 360-degree media activation that kicked off with our advertising film, The Floor Is Yours, we're inviting everyone to participate in a dance open call across social media platforms, for a chance to showcase their talent and Levi's style in an exclusive new music video. Moving to product, we continue to see strong performance in our core offerings, while also introducing newness and innovation in denim and beyond. A clear barometer for the strength of our core business, the 501, was up 23% in DTC, on top of 32% growth in the prior year. We're seeing strength in loose fits for men's and women's, both up more than 40% in the quarter.

For example, we launched 6 new baggy styles for women, for which sales were up 50%, and we continue to see an evolution to low rise and wider leg openings, both performing strongly. We see an incredible opportunity to own the head-to-toe denim apparel lifestyle, and in doing so, we expect to expand our addressable market for denim overall. Denim skirts, dresses, and jumpsuits again saw positive results, increasing triple digits in the quarter. We are also seeing strength in our denim tops assortment, with our iconic women's Western up more than 40%. Looking forward, we are leaning into this opportunity, and we're introducing new denim top silhouettes across blouses, corsets, vests, and more.

As shared on our last call, we are working on an end-to-end reset of our tops business, and we're seeing early success, with tops outperforming the overall business, driven by about 10% growth in DTC. We are building out our core essential assortment in categories like T-shirts, wovens, and polos to provide a perfect pairing to our denim bottoms. We're investing in capability building, including new key leadership hires. We recently filled the newly created role of Vice President, Tops Design, which will be critical in setting the design direction for Levi's tops. We are successfully extending our authority in bottoms to categories beyond denim. We recently launched our Active Tech pant in the U.S., which has been met with great initial response, with demand for the product stronger than expected in both wholesale and DTC.

We are chasing into inventory, and we're excited to continue fueling this new product line with additional innovations planned throughout this year and next, as we roll out this platform globally. As we move through the year, we will accelerate newness and drive innovation by extending our non-denim authority into categories like shorts, skirts, and dresses for the seasons ahead. Given the positive early trends in our Performance Cool and lightweight denim collections, we will continue building out those platforms to bring to the consumer our innovative denim fabrications, giving them the fit and style they love, with a more versatile year-round end use. Shifting to direct-to-consumer, our second strategic priority. DTC continued to grow rapidly, up 8% on top of 16% growth in the prior year. We achieved these strong results by delivering positive comp sales across our stores, growth in e-commerce, and adding new stores.

Increasing productivity and profitability in our stores is a key focus of Project Fuel, and we are gaining traction. Overall, for the quarter, we saw increases in traffic, UPT, and AUR in our DTC channels, and we are building bigger baskets through our focus on having the right assortment in the right stores at the right time, more newness drops, which are driving positive momentum, and better in-stock positions. In addition to top-line growth, we are seeing a greater degree of leverage on our cost base, such as improving our management of controllable retail costs, like optimizing store staffing and scheduling. We're encouraged by these results and have multiple initiatives underway to further improve the four-wall economics of our stores. The success we're having in brick-and-mortar also gives us confidence in our store opening strategy.

The majority of net new stores this year will be in Asia, where we see a lot of runway for growth. One great example is our recently reopened Kyoto store in Japan, in one of the city's most vibrant shopping districts. Delivering consumers an immersive shopping experience, this store is representative of the culture and history of the city and features the best of Levi's. Another example is in Europe, where we are reopening our Levi's flagship store in Paris ahead of the Summer Olympics. Located in the heart of one of the most highly trafficked and desirable shopping destinations in the world, Champs-Élysées, this store will offer Levi's fans from France and around the world the fullest and best expression of our denim lifestyle offering.

These stores, and others coming, are representative of our commitment to bringing elevated shopping experiences to the world's most desirable locations, while also driving a scalable and profitable store portfolio. Our e-commerce business continues to gain momentum, generating 12% growth on top of 14% growth in the prior year. This is a direct result of the investments we've made to enhance the consumer experience, including improved search, navigation, and filtering capabilities. We are also creating a more engaging experience by upgrading our product imagery and videos, addressing a key consumer need, helping people find the perfect fit. As we make our pivot to be a DTC-first company, we remain committed to wholesale, and the actions we're taking to elevate our performance in this channel are gaining traction....

After adjusting for the revenue shift related to the ERP implementation in Q1 2023, the Levi's brand within U.S. wholesale grew for a second consecutive quarter, up low single digits, and was substantially more profitable than last year. We remain encouraged regarding the outlook of our global wholesale business and expect sequential improvement as we move through the year. Improved sell-out trends, along with an expanded wholesale assortment, gives us optimism. Turning now to our third strategy, the diversification of our business. As I referenced earlier, we are pleased with the ongoing momentum we are seeing in our largest market, the U.S. Beyond that, diversifying geographies continues to be a key part of our growth strategy, and today, international comprises nearly 60% of total revenues.

While international was down 2% in Q1, international DTC grew high single digits, and Asia achieved record revenues in the quarter, driven by double-digit top-line growth in many markets. Let me address Europe. We continue to be pleased with the performance we are seeing in our DTC channel, which was up 4%, excluding Russia. We saw notable improvement in our DTC business in response to new floor sets launched, with sequential improvement in the quarter, month-over-month, and February up double digits. This strength has continued into March. While the European wholesale channel has been challenging, our key customers are excited about the amplified denim lifestyle offerings that we are delivering, and we are seeing positive wholesale pre-book orders in the second half of the year. We continue to expect the total Europe segment to return to growth in the second half of this year.

Moving to other brands, where we continue to make solid progress. Both Beyond Yoga and Dockers expand our portfolio and our addressable market. And when we look at our category portfolio, we are excited about the diversification we are making beyond denim bottoms. Dockers sales trends improved versus the prior quarter, down 9%, adjusting for the shift in wholesale, as strong performance in DTC, up 14%, was offset by lower wholesale sales. Inventory levels for the Dockers brand has shown sequential improvement and is now at its lowest level since March of 2023. We're encouraged by the positive customer reaction to our new product launches, including the recently released Dockers Go pant, the brand's first active pant that has quickly become one of the top-selling items in stores across the globe.

Beyond Yoga was up 11% on top of similar growth in the prior year, driven largely by strength in e-commerce. We are making investments to grow brand awareness and unleash the growth potential of this incredible brand. In summary, we have started the year strong. With many of the headwinds we faced the past 18 months resolved, most notably the congestion at our U.S. distribution centers and accelerating momentum across the world, and especially in the U.S., we are well positioned for the year ahead, and I'm confident in our ability to achieve our objectives for 2024 and beyond. With that, I will turn it over to Harmit to cover the financials.

Harmit Singh (CFO and Growth Officer)

Thanks, Michelle. We delivered better-than-expected results in Q1, driven by continued outperformance in global DTC and stabilization in U.S. wholesale. Most importantly, we achieved these results while also improving the structural economics of the company. Together, these established a strong base for profitable growth for 2024 and years to come. In the quarter, we delivered significant gross margin expansion, and we continue to expect further improvement this year and beyond from the structural drivers of our strategies to grow DTC, women's and international, and as transitory headwinds continue to shift to tailwinds. We delivered disciplined cost management while also investing in our key growth initiatives. The productivity initiative we launched in Q1 will drive efficiencies across the company, both in 2024 and 2025, while positioning us to realize the growth potential of our business.

We expect the combination of margin improvement and operating leverage to enable us to deliver sustainable bottom-line growth. The greater efficiency and our active inventory and working capital management is enabling us to generate strong free cash flow. This allowed us to return cash to shareholders through dividends, restart the stock buyback program, and acquire our distributor in Colombia, all consistent with our capital allocation strategy. As we look ahead, based on the trends we are seeing in our business today, we are confident in our ability to deliver accelerated sales in H2 and are positioned to deliver continued improvement in profitability and margin expansion in 2024. As a result, we are increasing our full-year earnings outlook. With that, I will turn to our results.

Q1 net revenues were $1.6 billion, reflecting continued momentum in our global direct-to-consumer channel, which grew 8%, up 25% on a two-year stack, and acceleration from Q4. Gross margin of 58.2% was better than expected and improved 240 basis points year-over-year. Expansion was driven by lower product costs, the shift to DTC, and the fact that wholesale mix was abnormally elevated in the prior year due to the ERP implementation. These factors offset both FX headwinds and the annualization of the strategic price reductions we took in US wholesale in H2 last year. Adjusted SG&A expenses in the quarter increased 1.2% to $766 million, compared to $757 million last year. Slightly better than expectations as we start to see the benefit of our cost control actions, including Project Fuel.

Adjusted EBIT margin declined 200 basis points to 9% compared to 11% in the prior year. The decline was almost entirely due to the sales deleverage resulting from the $100 million ERP shift. Adjusted diluted EPS was $0.26, ahead of our expectations, primarily driven by the outperformance in both revenue and gross margin. Before turning to our segment highlights, let me spend a moment on the restructuring charges we took in the quarter. As you know, we launched Project Fuel in January to accelerate profitable growth while driving cost savings. Since then, we have taken actions to streamline our organizational structure with the elimination of approximately 12% of our global workforce. Other actions being implemented will improve DTC productivity and our SG&A as we deliver savings across indirect procurement and other initiatives.

We've also made the decision to close our manufacturing facility in Poland as we optimize our supply chain to both enable agility and lower costs. After a strategic review of our categories, we have taken the decision to wind down our small Levi's footwear business. This, along with the decision to exit Denizen in last quarter, will help our plans to unlock the true potential of the Levi's brand globally. These actions put us on the path to achieve approximately $100 million in savings in 2024 and more in 2025. Now, let's review the key highlights by segment. In the Americas, 11% growth in DTC was more than offset by a decrease in wholesale, largely due to the shift in wholesale shipments in the prior year.

Operating margin increased 160 basis points to 18% due to increased gross margin across both channels and lower SG&A. This was largely driven by our US business, which is more profitable today than last year. We also just closed our acquisition of our Levi's brand distributor in Colombia, including approximately 40 owned and operated Levi's retail stores. This transaction further underscores the tremendous opportunity that exists to accelerate DTC growth within Latin America and further diversify our business geographically. This follows a very successful 2019 acquisition of our distributor in Chile, Peru, and Bolivia that has significantly surpassed our revenue and profitability expectations, and we're very optimistic on the outlook for the business in Colombia. In Europe, DTC net revenues increased 4%, excluding Russia. Growth was driven by positive performance in company-operated stores and in e-commerce.

Wholesale net revenues decreased 13%, excluding Russia, as wholesale orders from our retail partners remain conservative. As Michelle mentioned, we're encouraged by the momentum we are seeing in our DTC business, and coupled with positive inflection in our wholesale order book in the second half, gives us confidence that Europe will grow in H2. In terms of profitability, gross margins were up 200 basis points, driven by an increase across both channels and most markets in the segment. Asia net revenues increased 5% compared to the prior year and is up 27% on a two-year stack. DTC revenues increased 7%, driven by strength in company-operated mainline and outlet stores and in e-commerce, and wholesale net revenues increased 3%. While a relatively small business for us, we experienced a slower-than-expected recovery in China.

We have several initiatives in place to improve our business performance in this market, including ramping up a local product engine. Excluding China and the impact of the Middle East, this segment was up 8%. We are still long on Asia and remain confident of our plans to drive high single-digit growth in this region. Now looking to our balance sheet and cash flows. Reported inventory dollars decreased 14% or 21%, excluding the impact of the modification of terms with the majority of our suppliers. Comparable inventory in the U.S. remains significantly below last year's level, and we continue to make progress in Q1. Overall, inventory is also expected to end the year below prior levels as we work to further optimize inventories by improving turns and driving more assortment productivity.

Adjusted free cash flow was $214 million in the quarter, positive for the second quarter in a row as we manage inventory and working capital. We also expect to end the year with positive free cash flow. Our improved cash flow position enable us to return $73 million to our shareholders in the form of dividends and the reinitiation of share buybacks. In the quarter, we paid out $48 million in dividends and spent $25 million in repurchasing shares. We also announced Q2 dividends at $0.12 a share, maintaining the Q1 dividend per share. Now let's turn to our fiscal 2024 outlook. Looking forward, we remain confident in the strength of our brand and the execution of our strategy. We are pleased with the trend in both the category and our business that we saw in the first quarter, and these have continued into March.

However, given that we just started the year, we're taking a prudent approach to our revenue outlook while raising our full year adjusted diluted EPS guidance slightly. With that in mind, we are affirming our full year outlook of 1%-3% revenue growth. Incremental headwinds from FX in Asia will be offset with the impact of the Colombia acquisition. We now expect full year gross margins to be up about 150 basis points, which is the high end of our previously guided range. Turning to earnings, we are raising our adjusted diluted EPS estimate by $0.02 to $1.17-$1.27, given our stronger gross margin results and our continued commitment to expense discipline. As we look into the second quarter, we continue to expect revenue to be up high single digits.

The Q2 revenue guidance reflects the shift in the ERP implementation and the exit of the Denizen business. We expect gross margins to be down approximately 50 basis points due to the higher concentration of DTC in the second quarter of 2023, given the ERP implementation that took place in that quarter. Overall, H1 gross margins will be up approximately 100 basis points, and we expect adjusted diluted EPS to be about $0.10 in quarter two, 150% higher than prior year. Before we begin Q&A, there are two points I would like to make. First, we are confident in our ability to grow the top line mid-single digits in the second half. We are seeing continued momentum in DTC globally, green shoots in the wholesale channel, and encouraging trends in the US.

Our product pipeline is resonating with consumers and positions us to continue to grow market share. Based on the strength of our new offerings in European DTC and the positive pre-book in wholesale, we remain confident that Europe will return to growth in the second half. And in addition to the stores we acquired with the Colombia acquisition, we are also on pace to open 100+ net new system stores globally in 2024. Second, we remain focused on driving improved profitability and cash flow while being committed to deliver 15% operating margins over the longer term. We are confident in our ability to drive margin expansion through gross margin execution and expense discipline. The benefits from our Project Fuel initiative are just starting to unfold, which will continue to improve the agility and the efficiency of our business.

We will also continue to deliver positive free cash flow through inventory and working capital management. To close, these actions give us confidence in delivering our 2024 commitments while setting the foundation for profitable long-term growth and enabling the company to deliver solid returns to our stakeholders. And with that, I will go ahead and open up the line for Q&A.

Operator (participant)

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

Bob Drbul (Senior Managing Director)

Hi, good afternoon. I was wondering, I think you mentioned on the call, you know, market share gains and, and some recent category trends. Just wondering if you could share some more, you know, around what you're seeing and, and where you feel like the market share gains have come from. Thanks.

Michelle Gass (President and CEO)

Thanks, Bob. Thanks for the question. Yeah, first of all, we are really excited about what we're seeing in the category right now. So let's start with our biggest market in the U.S., that after a couple of years of volatility, we're seeing the jeans category actually stabilize, and it's now flat to prior year. But I think, most importantly, we're seeing market share gains with the Levi's brand. In the men's category, we saw two points of share gain, and in women's, we are up a point. And then underneath that, some really great proof points around our strategies. First, you know, we continue to be committed to driving the business with youth and our key targets, the 18- to 30-year-olds, we're seeing share gains there.

Around the middle income consumer, which is a big part of the market, 40% of the category, we're seeing the category grow there, as well as grow with Levi's. We're continuing to pick up share with that higher income consumer as we focus on elevating the brand.... I think really attributable to everything we're doing to drive our initiatives in DTC in the U.S. DTC was up 10%. So within denim, we're feeling good, and I think, you know, you can, you can look around even here in the U.S., and it's a denim moment. I mean, there's a lot happening in denim, and for Levi's, you know, we're, we're the top. We're driving the trends. We're excited about everything we're doing, head-to-toe denim dressing, that's really resonating across our male and female customers.

You know, and on that note, we're expanding our addressable market. So we first start with, you know, this evolution from being all about denim bottom to denim lifestyle. Categories like skirts and dresses, those are up triple digits in the quarter. Amazing! Our tops business, which we've been talking about for some time, whether that's denim tops or perfect pairing, that was up 10% in DTC, also outperforming. So a lot of great proof points. And then beyond that, around non-denim, and we're seeing great strides there as well. So non-denim was up 13% in DTC for Q1, representing 42% of our DTC channel. We're seeing that in categories like the XX Chino and our new introduction, the Active Tech pant, which is doing really well, both in wholesale and in DTC.

In fact, exceeding expectations we're chasing into inventory. And then I would just say around women, it's a key focus for us, the third of our business today. We see that over time, getting to half of our business, you know, from fashion bottoms, like I said, skirts, dresses, tops. Women's overall DTC was up 14% for the quarter, but in the U.S, it was up 19%. So I could go on and on, Bob, but there's, you know, there are so many great proof points that our strategies are gaining traction. And the last thing I would say, that's all around the U.S, but as we think about globally, the denim market is expected to continue to grow about mid-single digits.

So, you know, we fully expect to grow with the category, but we also expect to exceed it and drive market share.

Bob Drbul (Senior Managing Director)

Thank you.

Michelle Gass (President and CEO)

Thanks, Bob.

Operator (participant)

Thank you. Our next question comes from the line of Laurent Vasilescu of BNP Paribas. Your question, please, Laurent.

Laurent Vasilescu (Managing Director)

Thanks very much for taking my question. Michelle, Harmit, I know that you're encouraged by trends in Europe. There's a lot of fear in Europe since yesterday morning. Curious to get your take on what you're seeing in that market by region. Should we still see Europe grow low single digits for the year? And then separately, I know, I know Beyoncé's album was just dropped a few days ago, but curious to know if you're seeing any boost from her Levi's titled song.

Michelle Gass (President and CEO)

Great, Laurent. Michelle, here. I'll take, I'll take both your questions. Well, first of all, as it relates to Europe, you know, as we shared on the call, it was really Europe wholesale, where we had a tough quarter there. And I'd say that was largely due to some of the macro pressures, as well as our own product deliveries. We feel like to the product side, we've corrected that. I'll, I'll get to that in a moment. But, you know, overall, we feel really good about Levi's in Europe. I mean, the brand continues to be very strong. You know, we measure, we have many measures against our brand health. Our brand boasts the highest unaided awareness. All of our denim perceptions, remain best in class. We're actually seeing increases in Europe on relevance, preference, and even head-to-toe denim.

So those things are all headed in the right direction. And then, you know, a huge proof point for us, of course, is how the consumer is responding to our direct channels, both our stores and e-commerce. And overall, our DTC business in Europe, excluding Russia, was up 4%. I think importantly, we saw that accelerate during the quarter. And in February, DTC was double-digit, and that carried on into March, and that was largely driven off of our new product drop. So what we're seeing really in, in many markets, though, just elaborating in the U.S., but in Europe as well, the consumer is responding to the fashion we're bringing. So women's fashion, the looser fits, the baggy fits, the low rise, also the rib cage, all doing well. On men's, we're also seeing the baggy trend take hold.

Our tops business is improving. So that new product is what's driving DTC and what we expect will drive also on the wholesale side. So while a softer quarter, this past quarter for Europe and wholesale, we're expecting improvement, especially in the back half. And to me, the biggest evidence of that is that our pre-books for Europe are up for the back half of the year. So we are expecting Europe overall to return to growth in the back half of the year.

Harmit Singh (CFO and Growth Officer)

Laurent, to your question about the full year, yes, we do, you know, affirm that Europe will be up close single digits.

Michelle Gass (President and CEO)

To your second question-

Laurent Vasilescu (Managing Director)

Yeah.

Michelle Gass (President and CEO)

On Beyoncé, you know, I would just say that, you know, denim is having a moment, and the Levi's brand is having a powerful moment around the world. I mean, you see head-to-toe denim everywhere around the world. Western is really trending, and Western is trending in fashion and in music, as you just said. And, you know, one of the things that really, you know, really is significant about the Levi's brand, and we place a lot of emphasis on investment, is making sure that Levi's brand remains in the center of culture. And I don't think there's any better evidence or proof point than having someone like Beyoncé, who is a culture shaper, to actually name a song after us.

So, we're super proud of that, and we're very, very honored that someone like Beyoncé would actually name one of her new songs.

Laurent Vasilescu (Managing Director)

... Great. Thank you very much.

Michelle Gass (President and CEO)

Thanks, Laurent.

Operator (participant)

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

Dana Telsey (CEO and Chief Research Officer)

Hi. Good afternoon, everyone, and nice to see the progress, Michelle and Harmit. As you talked about-

Harmit Singh (CFO and Growth Officer)

Thanks, Dana. Thanks, Dana.

Dana Telsey (CEO and Chief Research Officer)

Hi. As you talked about stabilization in U.S. wholesale, was it, was it department stores, off price, the discounters? What did you see in U.S. wholesale, and what's your outlook going forward? And Harmit, as you mentioned, inventory levels with the gross margin uptick in guidance for the year, any, any specific drivers of gross margin as you go through the year and any shaping of gross margin that we should be mindful of given compares to last year? Thank you.

Michelle Gass (President and CEO)

Great, Dana. Well, I'll take the first one, and then Harmit can take that second question. So as it relates to wholesale, really where we're seeing the improvement is, I'll call it, in full price wholesale. So it is in, you know, our partners largely in department stores, and we're really excited with the progress. So for the Levi's brand US wholesale this past quarter, we were positive. Second consecutive quarter of seeing positive sell-in, and we're also seeing improved sell-out in that channel. And it really is a direct reaction to the actions that we've taken. So, the congestion issues that we had last year in the supply chain are long behind us, so we're filling at rates we need to at normalized levels. I'd say, you know, the partnerships with our wholesale partners are very, very strong.

I mean, this is an important channel to us. Levi's is an important brand to them. And Dana, I would say while we talk about, you know, rewiring the company or, or becoming organized around a DTC first mentality, it's not DTC only. Wholesale will continue to play a really important role to amplify our brand and to reach co-consumers where otherwise we wouldn't. So it's really important that we win together with these wholesale partners. But as I said, you know, we're seeing momentum in both sell-in and sell-out, and the single biggest reason is product. We're bringing a lot of newness to the channel, newness, we call it, in our core denim bottom, and the core is continuing to work.

I mean, I mentioned earlier in the remarks that we're seeing great traction ongoing with the 501, but we're also in this denim cycle of looser, baggier, definitely seeing it in women's, but also seeing it in men's. So we're excited for men's to expand their closet with looser fits as well. And for women, there's so much going on. There's looser, there's baggy, there's low-rise, yet Ribcage, higher rise continues to do well. And then also what's happening in fabrication, fabric innovation. So, having denim that people can wear year-round. So Performance Cool is one of the innovations that actually started to solve a need in Asia with warm temperatures. You know, I'd say last year, we made comments on that. When the seasons got really hot, we didn't have enough offerings to satisfy that need.

We're now expanding performance cool around the world, which we expect is gonna really help, you know, our year as we look ahead, and I think in particular in Europe, as I was just talking about, momentum there and here in the U.S. as well, and that's being picked up by wholesale partners, too. Lightweight denim as well, as part of this warm weather solution. And then, of course, there's non-denim, and we have been so pleased to see the response in the non-denim areas, with our latest innovation being the tech pant, which is just getting started in DTC and in wholesale. Off to a great start. It's exceeding our expectations. We're chasing into inventory, and we have more expansions of the platform to come this year. So there's a lot working.

We'll stay really close to our partners to make sure that we can maintain and build on that momentum.

Harmit Singh (CFO and Growth Officer)

And Dana, to your question on gross margins, strong start to the year, that has allowed us to raise the full year expectation, as you heard. So what's driving the strong start to the year? You know, product costs, you know, coming to normal levels. So if you think about the $240 million, 240 basis points, about 150 basis points is driven by product cost, about 110 is driven by the mix of DTC. Half of that is the SAP ERP implementation that impacted Q1. Half of that is continued growth in, you know, our DTC business, and the structural improvements in, you know, international, et cetera, as well as the strong women's business.

In the quarter, FX was a headwind, and in the quarter, we are analyzing the pricing initiatives that, you know, we, we, reduced prices in quarter three of last year. So that's really Q1. Q2, you know, and as, as you probably know, if you go back and look at history, Q2 gross margins traditionally are lower than Q1, largely due to channel mix, is usually about 100 basis points lower than Q1. However, we expect Q2 to be around 58.2%, and that is practically a record high, right? The only time we had a higher gross margin in Q2 was last year because DTC was a bigger piece of the business.

So the underlying factors, which is product cost, lower product cost, lower air freight, and others continue, you know, through Q2. FX was a bit of a tailwind a year ago. It's a bit of a headwind this year, and is largely a first half issue. So we expect H1 gross margin to be about 100 basis points better than a year ago. Second half of the year, gross margin should be up about 200 basis points, largely because we would have analyzed the price reduction and we and DTC will, you know, momentum, we believe, will continue to accelerate, so that helps gross margin. So that's how we're thinking about gross margins between H1 and H2 and on a full-year basis.

Dana Telsey (CEO and Chief Research Officer)

Thank you very much.

Harmit Singh (CFO and Growth Officer)

Thanks, Dana.

Operator (participant)

Thank you. Our next question comes from the line of Jay Sole of UBS. Your question, please, Jay.

Jay Sole (Managing Director)

Great. Thank you so much. Michelle, you mentioned in the prepared remarks that you saw a lot of opportunity to improve the four-wall economics of the company stores. Maybe can you just elaborate on that a little bit? Where do you see the opportunities? And if you can put that in context, if you list maybe like the top three or four margin drivers that you see that get the margins to that mid-teens level over the next few years, you know, what would those be? Thank you.

Michelle Gass (President and CEO)

Yeah, you bet. You bet. No, it's a huge focus for us. You know, as we think about the future of our business, the growth really coming from DTC, it's critical for us to get the structural economics of the DTC channel to work harder for us. And we have a lot of efforts afoot, both in our stores and on e-commerce. Specific to our stores, you know, I talk about first, the top-line drivers and then some of the other opportunities we have on profitability. But the first and biggest priority for us is to drive the top line. A, you get the top line benefit, of course, but B, it helps you leverage all your fixed costs, as you know, your fixed real estate, fixed labor, and the like.

As it relates to the top-line drivers, I would say a couple things. Some of these are just, they're the basics, like making sure that you're always in stock on the key items. And the teams have enhanced better tools today than they did even a year ago, systems and accountability to make sure that on X number of top SKUs, you know, things like your 511 top washes or your low loose introduction for women or whatever those might be, that we're not out of stock on the key sizes. And doing that has, you know, as we shared the results, that's had a direct effect in some of the results we're seeing even this past quarter. Secondly, is about innovation and newness.

You know, in a store, I'm just thinking about the store, the consumer wants a more comprehensive head-to-toe look. We're getting a lot more disciplined in how we're introducing newness, literally on a monthly basis, making sure it's all through the lens of the Levi's brand. The close-in opportunities we see, and I spoke to it in the remarks, is this whole head-to-toe denim dressing. You know, we are the authority in denim bottoms, and we're expanding that to be the authority in denim everything. Categories like skirts and dresses, they're comping at triple digits. I mean, which just says there's so much opportunity, right? Like, we should have the iconic denim skirt for every woman who wants it, and we're not there yet. I mean, to have triple digits would say there's a lot more upside. Same with tops.

What's the perfect black T-shirt, white T-shirt to go with your bottoms? These kind of things not only can drive traffic, but they drive conversion, they drive UPT and AUR. And we are actually seeing UPT and AUR increases based on the actions we're taking on the product side. In addition to product, it's really around our teams in the store and having them encouraging the upsell and the complementary sell. So they're doing that, we're seeing the upsell. Those are just a couple of examples. As it relates to cost, the single biggest opportunity we have is becoming an expert in labor deployment and how we manage labor from the moment you open the store to the moment you close it, and how you navigate days of the week, et cetera.

And so a lot of focus and effort, we're starting to see the early traction.

Jay Sole (Managing Director)

Got it. Thank you so much.

Michelle Gass (President and CEO)

Okay, thank you.

Operator (participant)

Thank you. Our next question comes from the line of Oliver Chen of TD Cowen. Your question, please, Oliver.

Oliver Chen (Managing Director)

Hi, thank you very much. Hi, Michelle. Hi, Harmit. Women's tops and dresses is clearly a big, nice opportunity. What's ahead for timing of that and how it can and will drive upside to the model and moving the needle even more? And as we think about your DTC first opportunity and strategy ahead, what do you think about speed and inventory management, as well as the reality of markdown management and the cost method of accounting and making sure you're thinking about gross margin return on inventories as you become more agile, and also balance novelty versus core, and also look to increase inventory flows and frequency to be agile with the customer? Thank you.

Michelle Gass (President and CEO)

Okay, thanks, Oliver. I'll take first, and then Harmit will take the second piece. We're seeing traction already, Oliver. I mean, to the comments we made earlier, the DTC to be up 8% in the quarter, 25% on a two-year basis, the momentum is actually accelerating quarter-over-quarter, which is fantastic. As it relates to women's, you know, I called out DTC up 14% overall, up 19% in the US, and that's both tops and bottoms. So bottoms up total company DTC bottoms up 13%, women's tops up 13% total company. So we're seeing traction in both, and that's only gonna grow from here. So, as it relates to bottom strength and things like the 501 continues, but the boot cuts, the flares, the '90s, the Baggy Dads, all doing really well, those fashion fits.

Then on the tops, you know, what's really resonating with her are things like non-graphic tees, woven shirts, outerwear. As I was just speaking to a minute ago, this whole head-to-toe denim on skirts and dresses is off the charts. So we're chasing into what's working today, and the assortment only gets more robust. I'll quickly just answer your question on speed. Go-to-market for us is one of our top priorities as we make this pivot to DTC, and we are looking to literally shave months off of our process from concept to consumer. So I'd say stay tuned on that, and we're already doing that in certain categories as we're chasing into them.

Harmit Singh (CFO and Growth Officer)

To your question about markdowns and inventory turns, Oliver, I'd say that's an opportunity for us. We can turn inventory faster in our stores and our markdown cadence, given all the new products that we're introducing. I think we can get a lot more scientific. That's why we feel that the productivity opportunity in DTC is pretty high and large, and that's what we're working on as part of Project Fuel.

Oliver Chen (Managing Director)

A quick follow-up, Harmit. On your guidance assumptions around margins, what, what was merchandise margin, or what were the merchandise margin assumptions? If there's ones we should be attuned to for the year. Thanks, everybody. Best regards.

Harmit Singh (CFO and Growth Officer)

Yeah, the you know, we haven't gone into those specifics, Oliver, but I'd say, you know, if you're asking specifically relative to markdowns and discounts, the margins are really driven, in our view, by the structural improvements in the business, which is really our women's business and our, you know, growth in our DTC channel. I think those are the factors that are driving the margin, and that's why it's more sustainable longer term.

Oliver Chen (Managing Director)

Thank you very much.

Harmit Singh (CFO and Growth Officer)

Thanks.

Michelle Gass (President and CEO)

Thanks.

Operator (participant)

Thank you. Our next question comes from the line of Christopher Nardone of BofA. Your line is open, Chris.

Christopher Nardone (Director and Equity Research)

Hey, thank you, guys. Good afternoon. Can you help us unpack the strength you're seeing in the North America retail business? I'd be curious if you're able to help us quantify the trends you're seeing in the outlet business versus digital and then versus full price stores. Then as a related follow-up, just curious if you can help us quantify how we should think about the impact to these 100 net new doors to your total sales growth for the full year. Thank you very much.

Harmit Singh (CFO and Growth Officer)

Yeah, I'd say to your first question, the growth in DTC in the U.S. is broadly across all three channels. You know, mainline is really strong, okay? Outlet is probably strong but less stronger, and our e-commerce business is actually, you know, doing fairly well. And so I would just say, if you want to rank it, mainline, e-commerce, and outlet, but, you know, all three strong from that perspective. And broadly, what we're seeing is, it's largely driven by traffic as well as, you know, higher UPT and AUR. Conversion is an opportunity for us. And, you know, that's why we, you know, we feel that this can only get better over time.

And, you know, we are seeing the basket size improve because of newness that Michelle talked about and better in-stock, which is really helping the case, you know, from that perspective. I think you had a second question, Jay. Sorry, Chris. What was the second question, Chris?

Christopher Nardone (Director and Equity Research)

Yeah, sure. I just wanted to see if we can talk about the impact you expect to see from these 100 net new doors. Is it impactful to the 1%-3% total growth you're expecting? And then if you could kinda clarify where these new doors will be opening.

Harmit Singh (CFO and Growth Officer)

Sure. So, you know, the 1-3, you know, is impacted by the 200 basis points of a headwind because of the exit of Denizen and the other things that we spoke about. I mean, the gross number is more 3-5. The 100 net new doors, 70% of them are skewed toward the second half. So you see partial impact this year, but probably more the following year. And as you think about what's driving the DTC business, you know, the number that we have kind of talked about, which is high single digit, low double digit, a large piece of that is comp growth in existing stores, followed equally between e-commerce and new stores.

I think, you know, comp stores being the main driver and then equally split between the other two.

Christopher Nardone (Director and Equity Research)

Great, thank you.

Harmit Singh (CFO and Growth Officer)

You know, we do have, Chris, we have a very disciplined process, where every year we review how the fleet is performing, and you know, determine the return on invested capital. You know, return on invested capital is in the high teens, and so that's encourages us to actually invest more capital and grow the store base longer term.

Operator (participant)

Thank you. Our next question comes from the line of Tracy Kogan of Citi. Your question please, Tracy.

Tracy Kogan (VP)

Hi, this is Tracy Kogan filling in for Paul. I think you guys said Europe DTC was up double digits in February, and that has continued into March. I was just wondering what March versus January and February looked like in the other regions? Then just a follow-up on gross margin. I think, Harmit, you laid out the drivers, the 240 basis point increase, but what were the drivers that drove it above your expectation of up 150 basis points? What came in better? Thanks.

Harmit Singh (CFO and Growth Officer)

Yeah, I think I mentioned, Tracy, to your second question, I kind of broke up the 240. You know, 150 in product cost, lower product cost, and the channel mix, which half of the channel mix was about a little over 100 basis points, but half of that was the ERP-driven shift. And then you had other factors like lower airfare, et cetera, offset by, you know, FX headwinds and offset by the annualization of the US price reduction. So that's really what drove the Q1. What was better than what we anticipated was just the strength in the DTC business. You know, that was strong.

That kind of helped out, you know, as a quarter, and, you know, U.S. was a big piece of that because U.S. was up 10% on DTC. So that was the factor that, you know, drove the upside. To your second question, which was to do about... Yeah, we don't go into the specifics, Tracy, but, you know, Europe started soft and has accelerated. As Michelle said, once the new products were introduced, you know, that, I think, drove, you know, consumer demand and actually has helped, you know, unlock some of the open-to-buy from our wholesale customers. And we're seeing that generally both in the US and in Europe, and so that's, that's a positive sign.

Tracy Kogan (VP)

It has improved, at least generally speaking, in the U.S. and Asia as well, generally similar to Europe. Is that fair?

Harmit Singh (CFO and Growth Officer)

Yeah, I would say, you know, U.S. and Europe, in terms of the exit, strong, you know, stronger. Asia has been strong all along, so, you know, I think Asia generally is performing well other than, you know, China was a little soft, and the Middle East impact we are seeing because Asia also handles the Middle East.

Tracy Kogan (VP)

Thank you, guys. Good luck.

Harmit Singh (CFO and Growth Officer)

Thanks, Tracy.

Operator (participant)

Thank you. Our next question comes from the line of Alex Straton of Morgan Stanley. Your line is open, Alex.

Alex Straton (Equity Reserch Managing Director)

Great. Thanks so much for taking the question. I just have a couple for you. The first maybe for Michelle and, and to piggyback off the last one is just, I mean, taking a step back, how would you describe the state of the consumer, I think now versus three months ago? Just trying to get a sense for it's, if it's the same, better or worse. And then a second one, maybe for Harmit, just on North America margins. They definitely expanded nicely year-over-year. They're above pre-pandemic levels, but they are below where we were during COVID, I think about 20%. So what's holding that back, and, and is that 20% level achievable in the future for North America? Thanks a lot.

Michelle Gass (President and CEO)

I can take... I'll take the first one really quickly. In a nutshell, I'd say we're feeling better about the consumer than we did 3-6 months ago. We're seeing lots of evidence of that, both in terms of our overall category, the denim space, and the stabilization we're seeing there in our biggest market, in particular, the expectation globally in the denim category to be up in the mid-single digits. And then, how we're seeing our own consumer respond, both in our DTC performance, as we've talked about quite a bit, with our DTC business up 8%, U.S. DTC up 10%, the gains with the middle-income consumer and just market share gains across the board. So, we're optimistic, more optimistic than I'd say we were 3-6 months ago.

Harmit Singh (CFO and Growth Officer)

On the profitability in the U.S., yes, you're right. It's, it's a lot more profitable than definitely a year ago, and that's obviously driven by gross margin and better management of labor, et cetera, that we talked about. It's not all the way to 20%, largely because when it was 20%, we were growing at a faster clip, including in wholesale. That's something that, you know, it's an opportunity for us. But as we unlock growth, which we are confident of doing, as the year progresses, you know, that should flow into the bottom line.

Alex Straton (Equity Reserch Managing Director)

Thanks a lot. Good luck.

Michelle Gass (President and CEO)

Thank you.

Harmit Singh (CFO and Growth Officer)

Thanks, Alex.

Operator (participant)

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

Michelle Gass (President and CEO)

Thanks, everyone, and we look forward to speaking with you next quarter. Have a great rest of your day.

Operator (participant)

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