Levi Strauss & Co (LEVI) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Levi Strauss & Co.

second quarter earnings call for the period ending May 26, 2019.

(Operator Instructions) This conference is being recorded and may not be reproduced in whole or in part without written permission from the company.

A telephone replay will be available 2 hours after the completion of this call through July 15, 2019.

Please use conference ID 8261329.

This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for 1 quarter on the company's website: levistrauss.com.

It is -- I would now like to turn the call over to Aida Orphan, Senior Director Investor Relations and Risk Management at Levi Strauss & Co.

Good afternoon, and welcome to our quarterly conference call.

I'm pleased to introduce members of the Levi Strauss & Co management team: Chip Bergh, President and CEO; and Harmit Singh, Executive Vice President and CFO.

Before we begin, let me briefly remind you of a few items.

Our discussion today may include forward-looking statements, including statements regarding our strategies and expected financial and operating performance.

Although these statements reflect the best judgment of our senior management, they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by these statements, as more fully described in our annual report on Form 10-K, our registration statement, today's earnings press release, and our other filings with the SEC, all of which are available on our website at levistrauss.com.

We disclaim any responsibility to update our forward-looking statements.

Other unknown or unpredictable factors also could have material adverse effect on our future results, performance or achievements.

We provide information on our website about how we compile various measures used to describe our business performance.

Participants on today's call may discuss non-GAAP financial measures.

Reconciliations and descriptions of our non-GAAP financial measures are available in the investor section of our website as well as in today's earnings press release.

Finally, today we filed our quarterly financial report on Form 10-Q with the SEC, which is now available on our website.

Now I'll turn over the call over to Chip Bergh.

Thank you, Aida, and thanks, everyone, for joining us today.

Against the difficult backdrop, we had a strong quarter with revenues of $1.3 billion, up by 5% from prior year on a reported basis and up 9% in constant currency.

This brings year-to-date revenue growth to 10% in constant currency.

Growth continued to be broad-based across regions and brands in second quarter, reflecting the strength of our more diversified portfolio.

Here are some of the key themes from the quarter, all in constant currency and versus prior year.

Each of our regions grew revenues and profits, with Europe and Asia growing revenues double digits.

All 4 brands grew.

The men's business grew 6%, and the women's business grew 16%.

Bottoms were up 8%; tops were up 14%; and global wholesale was up 6%, while our global direct-to-consumer business was up 14%.

The Levi’s brand remained strong and grew 10% this quarter.

We grew in all 3 regions across men's, women's, tops and bottoms and continue to strengthen our lifestyle brand appeal with consumers around the world.

In the second quarter, we again dominated Coachella as the go-to uniform for festival season with Levi's 501 cutoff shorts, which were up more than 50% this quarter, taking center stage.

Our successful execution at festival drove a 50% increase in impressions versus a year ago.

In May, we held a month-long 501 Day celebration focused on the birth of the blue jean with customization events taking place around the world and limited-edition product designed in partnership with San Francisco native Heron Preston featuring Hailey Bieber as the face of the 501.

We teamed up with BEAMS in Japan to create a capsule collection combining our iconic design and craftsmanship with BEAMS esteemed Japanese style.

And in Europe we launched Use Your Voice, a new ad that celebrates the power of individuals in igniting change.

I'll now walk you through our second quarter results in the context of our 3 where-to-place strategic choices, which are -- drive the profitable core, expand for more and become a leading world-class omnichannel retailer.

First, on the profitable core business, which, as a reminder, is comprised of men's bottoms, our top 10 wholesale customers and our top 5 mature markets.

Our total men's bottoms business, our biggest business, was up 5% for the quarter.

Performance-focused fabrics with higher stretch content and tapered silhouettes continue to resonate with consumers.

The 502, 512 and 514 drove global growth, while newer products, such as the Levi’s Engineered Jeans performed well internationally, and Dockers grew 1% globally.

Our top 10 global wholesale accounts collectively grew 6%, and our top 5 mature markets collectively grew 6%, inclusive of our largest market, the U.S., which was up 1% while the other 4 markets grew 20% collectively.

Our second strategy is to diversify the business by expanding for more into the tops, women's, under-penetrated markets and with our value brands.

While we've made good progress, the future growth opportunity in these areas remain significant.

Our total women's business grew 16% in the quarter, which was the 16th consecutive quarter of growth in women's, with each of last 10 quarters being double-digit growth.

The business grew across all regions and channels, fueled by the success of our high-rise fits and healthy sales of women's tops.

Tops for both men and women continue to perform well.

Our total tops business grew double digits again this quarter at 14%, driven by strong performance in sweatshirts and trucker jackets.

Graphic tees grew slightly in the quarter.

While tees remain a big business for us, we're still selling the graphic tee per second, our growth in tops this quarter went beyond tees, demonstrating our ongoing diversification in the category.

And our Signature and Denizen brands collectively delivered 9% growth on top of the 60% growth in the second quarter of last year.

While we continue to post growth in the U.S., we're rolling these brands out in new markets as well.

Our performance in China was positive yet remains far from its potential.

Our revenues increased 3% this quarter driven by strong performance in our company-operated brick-and-mortar stores and e-commerce growth, which more than offset a decline in our franchise business as we execute our strategy in China.

We are confident in strategy and the team on the ground, but there's still a lot of heavy lifting to do.

And our business in other emerging markets of India, Russia and Brazil were up double digits.

The third strategy is to become a leading world-class omnichannel retailer.

Direct-to-consumer, which for us includes the brick-and-mortar stores and e-commerce sites we operate, grew 14% for the quarter in total and has now grown double digits for 13 consecutive quarters.

Revenue growth from our brick-and-mortar stores was up 12%, reflecting positive comp performance in ongoing expansion of the company-operated store network, which had 78 more stores by the end of the quarter than in year prior.

Our e-commerce growth was again very strong, up 25% for the quarter, with increased traffic in all 3 regions.

And we continue to enhance our omnichannel capabilities.

We've begun to roll out a ship-from-store program in the U.S., which will allow us to optimize inventory, augment sales and improve store productivity.

Now over to Harmit to review our second quarter and first half performance in greater detail.

Harmit?

Thanks, Chip, and welcome to everyone joining our call.

My comments today will reference second quarter comparisons on a year-over-year basis in U.S. dollars, unless I indicate otherwise.

Second quarter revenue of $1.3 billion grew 5% on a reported basis and 9% in constant currency.

Our growth was broad-based, and the contributions by region, channel and category of the 9 points of constant currency growth were as follows.

By region, 2 points of growth came from the Americas, 5 points from Europe, and 2 points from Asia.

By channel, 4 points came from wholesale growth, 4 points from our company-operated stores, and 1 point from e-commerce.

And by category, 3 points came from growth in men's bottoms, and the remaining 6 points came from women's and tops.

Second quarter gross profit of $700 million represents an increase of $30 million, despite $25 million of unfavorable currency translation.

Reported gross profit for the quarter grew 4%, slightly lagging revenue growth as second quarter gross margin of 53.3% declined 60 basis points.

The margin decline was driven by unfavorable currency impact of 100 basis points as well as product investment.

These were partially offset by margin benefits from our direct-to-consumer growth and lower discounted sales.

Second quarter SG&A expense of $638 million was up 7% over prior year and increased as a percentage of revenues by 90 basis points primarily reflecting the timing of spend for our 2019 advertising campaign that we told you about on our last call.

The increase was partially offset by $19 million of favorable currency impact.

Beyond the higher advertising spend, SG&A as a percent of revenues was flat to prior year as high investments in distribution capacity and direct-to-consumer expansion were fully offset by leverage on our base costs, something we expect will continue as our revenues grow.

Second quarter adjusted EBIT of $82 million was down 4% on a reported basis but grew 3% on a constant currency basis.

Constant currency adjusted EBIT margin of 6.2% declined 40 basis points due to the timing of advertising spend, which, as I noted, was up 90 basis points versus last year.

Adjusted net income of $69 million was down 17% from last year's $83 million, reflecting lower net gains on our foreign exchange derivative and a stronger U.S. dollar.

Adjusted diluted EPS for the second quarter of 2019 was $0.17.

Let me repeat, $0.17, which is down 21% over prior year.

The EPS decline was greater than adjusted net income decline due to the shares we issued in connection with our IPO.

Note that adjusted EBIT, EBIT and adjusted net income are non-GAAP measures that exclude the impact of changes in fair value on our previously cash settled stock-based compensation awards as well as $29 million in IPO-related costs, inclusive of the $25 million underwriters' fee we paid on behalf of the selling shareholders.

Please refer to our press release for reconciliations of the non-GAAP measures we used, including adjusted EBIT and adjusted net income.

Now I'll share more detail on the second quarter results of our 3 regions in constant currency, unless I state otherwise.

In the Americas, net revenues grew 3% on a reported basis and 4% on a constant currency basis, reflecting an increase across both channels.

Wholesale growth of 2% was driven by strong performance in the region's international markets.

Direct to consumer growth of 9% was driven primarily by the expansion of our company-operated retail network and higher e-commerce revenue.

Our largest market, the U.S., was up 1%, as direct-to-consumer growth of 7% driven by e-commerce in new doors offset a 2% decline in U.S. wholesale.

The U.S. wholesale decline was attributable to the impact of the bankruptcies and door closures that some of our customers have experienced over the last year as well as a decline in discounted sales to the off-price channel, reflecting that we're increasing -- that we're carrying substantially healthier inventory in comparison to the prior year.

We will remain focused on optimizing execution in the U.S. wholesale channel going forward, but we do expect ongoing pressure for the remainder of the year due to a weak department store environment, continued door closures and pressure on our customers' open-to-buy budgets.

The U.S. market is unlike any other in the world due to the dominance of wholesale, but our opportunity is to continue to diversify across channels, products, genders and customers as we are doing elsewhere.

Operating income for the full Americas region grew 5% on both reported and constant currency basis as higher net revenues and higher gross margins were partially offset by direct-to-consumer expansion and the planned increase in advertisement.

We are pleased with the momentum that continues in Europe.

Against the backdrop of geopolitical volatility, including Brexit, bankruptcies of a few wholesale customers in the U.K. and weakening economies, the region posted net revenue growth of 9% on a reported basis and 18% in constant currency, and this was on the back of 19% constant currency growth a year ago.

The revenue growth this quarter was again broad-based across genders, channels, markets and product categories.

Wholesale grew 14% and direct-to-consumer was up 22%.

The strong direct-to-consumer growth was driven by higher traffic and conversion rates in existing stores in addition to new company-operated stores and e-commerce growth of 28%.

Levi’s men's bottom growth was strong, up 18%, and women's continues to perform with double-digit growth in both tops and bottoms.

The region's operating income grew 10% on a reported basis and 22% on a constant currency basis, reflecting the net revenue growth and a higher gross margin from a shift towards a direct-to-consumer channel, partially offset by higher direct-to-consumer and distribution cost and an increase in advertising and promotion.

In Asia, net revenues were up 6% on a reported basis and 12% in constant currency.

Traditional wholesale, company-operated brick-and-mortar and e-commerce each grew double digits, supported by higher traffic in the region.

Most markets grew double digits, with the biggest dollar contribution coming from Levi’s men's bottom, which grew 10% over prior year.

China's revenues grew again on strong performance of company-operated stores and e-commerce channels, and we continue to make progress in that critical market, though we still have more work to do in the franchise channel over the next year.

The reasons -- the region's operating income grew 4% on a reported basis and 15% on a constant currency basis, reflecting the net revenue growth and SG&A leverage, partially offset by lower gross margin, reflecting higher product cost.

With 2 quarters behind us, I'll now review our year-to-date results.

First half revenues grew 6% on a reported basis and 10% on a constant currency basis, reflecting broad-based growth across all 3 regions.

Global wholesale grew 7%, while global direct-to-consumer was up 14%, both in constant currency.

We have further diversified the business: international is now 58% of total revenues; direct-to-consumer is 39%; women's is 32%; and tops is 21%.

Gross margin of 54% for the first half of the year was down 40 basis points primarily driven by 90 basis points of unfavorable currency impact.

The currency-neutral margin expansion primarily reflected direct-to-consumer growth, which more than offset margin pressure from product investments.

Our first half SG&A rate of 44.4% declined 30 basis points from prior year despite higher direct-to-consumer investment, reflecting leverage on our base cost.

As a percentage of revenues, advertising spend was in line with prior year, as we discussed last quarter.

First half adjusted EBIT of $288 million grew 8% on a reported basis and 16% on a constant currency basis, and adjusted EBIT margin expanded 20 basis points on a reported basis and 60 basis points on a constant currency basis.

Dollars in margins were benefited from the higher revenues and SG&A leverage.

Our first half adjusted net income of $220 million grew 32%, reflecting the $22 million adjusted EBIT increase as well as the fact that last year we recorded a $38 million tax charge on undistributed foreign earnings in connection with the U.S. tax law change.

Adjusted diluted EPS for the first half of 2019 was $0.55, which is up 27% over prior year, again, reflecting some increased dilution from first half adjusted net income growth due to the shares were issued in connection with our IPO.

On to balance sheet and cash flows.

In dollar terms, inventory was up 6% compared to a year ago, which is in line with revenue growth.

Year-over-year inventory growth has steadily come down over the last 2 quarters, from 16% at year-end and 11% in -- at Q1, reflecting the deliberate measures we have taken in recent quarters.

Accordingly, our inventory is very healthy headed into the second half of the year.

Total available liquidity at quarter end was more than $1.7 billion, comprised of cash of $861 million, short-term investments of $80 million and $806 million available under our credit facility.

The higher cash balance reflects the proceeds from our recent IPO.

Net debt at the end of the second quarter was $82 million, down from $359 million last year, and our leverage ratio declined to 1.4% compared to 1.5% a year ago.

Cash from operations for the first six months of 2019 of $162 million was $66 million lower than the first 6 months of 2018.

The decrease primarily reflects our inventory build at the end of 2018.

Higher payments in Q1 2019 were employee incentive compensation earned on our 2018 performance, and the $25 million underwriters' fee we paid on behalf of the selling shareholders in our IPO.

These uses of cash were partially offset by lower contributions to our pension plan, which we funded last year before the new U.S. tax law went into effect.

Adjusted free cash flow of $39 million for the first 6 months of 2019 represents a $42 million decrease compared to the first 6 months of 2018.

This is primarily due to the $66 million decline in cash from operations I noted a moment ago, $16 million higher capital expenditure, and our first half dividend payment of $55 million, which was $10 million higher than last year.

With the first half of the year behind us, we are updating our full year guidance in constant currency.

Recall, we have been guiding full-year revenue growth in the mid-single digits.

We now expect to deliver at the high end of that range.

Growth will be broad-based, with all regions and channels growing.

While underlying business trends remain positive, they're a few reasons we expect second half sales growth to moderate relative to the first half, particularly in the United States.

First, the lack of a Black Friday in Q4, which we expect will adversely impact the second half by roughly 100 basis points.

Additionally, we anticipate that pressure in the wholesale channel will adversely impact us by roughly 200 basis points in the second half due to the bankruptcies and door closures since a year ago, the overall softening, U.S. wholesale environment and the lower off-price channel sales, reflecting our healthier inventory position.

We reaffirm our expectation that gross margin and SG&A as a percentage of revenue will both be slightly up on a constant currency basis primarily reflecting continued growth and investment in the direct-to-consumer channel.

And given our strong first half performance, we now expect constant currency adjusted EBIT margin to be slightly up to prior year in the range of 10 basis points.

This is despite an adverse full year impact of 25 basis points due to the absence of Black Friday.

Finally, we now expect the lower effective tax rate for the full year of around 21%.

With respect to currency, we anticipate that the unfavorable currency translation impact to revenue and adjusted EBIT will be much less significant in the second half of the year.

We now expect full year unfavorable impacts of 250 and 400 basis points to our revenues and adjusted EBIT growth rates, respectively.

Before turning to Q&A, I want to take a moment to discuss the potential impact of tariffs.

Tariffs have been on again, off again recently, and it's difficult to predict what the future holds for tariff policy.

But as we have previously communicated, we have taken steps to insulate our business from the long-term negative impact of these kind of measures.

Should additional tariffs be enacted on imports to the U.S. from China and Mexico, we can mitigate the financial impact to our business over the near term.

With that, we'll take your questions.

(Operator Instructions) Your first question comes from Matthew Boss with JPMorgan.

Congrats on a nice quarter, guys.

Thanks, Matt.

Thanks, Matt.

So Chip, maybe can you elaborate on the brand's global momentum, maybe how you see innovation fueling the next leg of top line growth?

And just touch on some of the incremental growth drivers as we think about F.L.X., data analytics, CRM and loyalty.

Great question, Matt.

First, I'd like to say this company was founded on innovation and innovation is kind of in our lifeblood.

And when we're successful innovating, it does drive our business results, and that's why -- and you've been there.

That's why the very first investment we made, when I became CEO, was the Eureka Innovation center right up the street to really send the signal about the importance of innovation.

So it is in our lifeblood.

Now I'd like to think about it in a couple of different buckets.

There's kind of the product bucket.

There's the commercial bucket.

And then in this new world, there is the digital disruption bucket, which kind of spills over to everything.

So it is -- in the digital disruption piece, is one of my top agenda items.

I really do believe it's got to be something driven from the top from the CEO.

So let me focus on that one first.

You mentioned F.L.X.

That is digital disruption of how we finish a pair of jeans.

We use lasers instead of hand finishing and over time, that is going to drive a fairly significant savings in production cost because we're finishing it with a machine instead of people.

And it should over time also deliver some balance sheet benefits from a supply chain and inventory benefits as well.

Today, about 25%-or-so of the Levi’s denim bottoms business on a global basis is finished with F.L.X.

and that should ramp -- the full potential is about half of our total bottoms business.

And so we should ramp from 25% to that full potential over the next 2 years or so so through 2021.

The other thing, we've already announced this and I think you will see it this quarter here in the U.S. We're going to begin to give our consumers an opportunity to personalize or customize their own jeans online using the F.L.X.

technology.

So they'll be able to go online and design their own jeans and in a couple of days, it will arrive in their -- on their doorstep.

We'll charge a premium for it.

It's going to be a really cool experience.

Some of you have had an opportunity to experiment with it yourself and that's to roll out here pretty quickly in the United States.

As I said, we're going to premium price that.

Another big opportunity area for us is to really take advantage of all the data that we've got.

We collect a ton of data that we really have not done a lot with.

We recently hired Katia Walsh as our SVP of Strategy and AI.

She's really a machine learning expert.

Dr. Katia Walsh, I should say.

And if you think about opportunities for us to leverage data to just get better and smarter at where and how we operate, some of the big buckets of opportunities to leverage machine learning are pricing where we've got a number of opportunities, assortment strategy both at a macro level, kind of on a global basis, how we assort our line, but also down to -- literally down to the store level and how we optimize our assortments down to the store level.

We've tested this already.

We've seen pretty significant improvement in store-level results where we optimize based on the consumer that's shopping in that store.

There are also opportunities to get better at forecasting using machine learning.

The computer can do it better than people can most of the time, and so we'll leverage that.

And there -- the opportunities are really almost endless, and we're testing using machine learning to help us predict -- do a better job predicting future store locations based on changes in traffic patterns in markets like China.

So enormous opportunities there.

We've got opportunities on CRM and loyalty programs.

We do have loyalty programs in a couple of parts of the world.

We're going to be testing a new loyalty program here in the U.S. Unlike a lot of loyalty programs where they're point based, they can give a discount, we're going to really try to link our loyalty programs back to giving our biggest fans great Levi's experiences and really tapping into the experience network and -- that we really can drive, so making it really something only Levi's can do.

So we've got lots of room for innovation as you think about it from a product standpoint, from a commercial standpoint, from a go-to-market standpoint, leveraging e-commerce and some of the innovation that we're doing in e-commerce, including the F.L.X.

personalization which will happen coming up real soon that gives me confidence that innovation is going to continue to drive our momentum.

Your next question comes from Paul Lejuez from CIBI (sic) [Citi].

Paul Lejuez, Citi.

Can you guys talk about the growth that you're seeing in China business, whether you saw more volatility over the quarter just given the recent trade talks?

Curious how that's affected your business.

And you've talked a lot about the long-term China opportunity, but I'm curious what is your research showing about how the brand is viewed there.

And when do you expect an acceleration in China?

So yes, let's just cover the facts first.

So China is about 3% of our business.

It's about 20% of the apparel category globally.

So clearly, it represents a significant untapped opportunity for us.

We have been growing there now for the last couple of quarters.

But as we said in the prepared remarks, it is a little bit of a heavy lift.

We spend the last 18 months or so on closing a number of poor-performing doors, mostly franchise doors, cleaning up our store footprint.

There is still more work to be done there, to be clear.

We've cleaned up inventory about a year ago.

So we've got a pretty good, clean inventory position.

And as we said in prepared remarks, we were pretty pleased with the results that we delivered in our owned and operated stores and our e-commerce business.

But growth was 3%.

The strength that we saw in the businesses that we control just offsets softness, continued softness in the franchise network.

So we do have a strategy.

Actually, our last Board meeting was in China and Hong Kong.

We spent a full day in the market with our Board of Directors.

We actually split them and we went to 3 different locations.

One group went to Hangzhou, one group went to Shanghai, and one group went to Wuhan and spent a full day in the market and then we did our meeting in Hong Kong and reviewed our strategy for China.

And I, as I said, feel very, very strong about the team that we've got in place there as well as the strategy.

We should see accelerated growth in the next 12 months or so.

We still have some cleanup to do.

We still have to optimize our franchise partners, and there is some work going on there.

We still have some doors to clean up but we're also starting to focus on building the right kind of doors.

So one of the reasons one of the groups from the Board of Directors went to Wuhan is we're going to open our largest store in China in a couple of months in Wuhan with one of our best, strongest franchise partners there and it's going to provide a beacon for what is possible from Levi's.

So on your question about are we seeing any blowback from the trade tension and I think you're really asking about consumer blowback, the short answer is no.

There's been no negative Chinese consumer backlash against the Levi's brand.

Our business was up this quarter there and our owned and operated business was up even more, and there hasn't really been any significant negativity in the press or anything else about Levi's or strong American iconic brands.

I know that market really well, too.

So -- and I spend a lot of time there.

My wife was born and raised in China, and our business is strong.

The equity in the brand there is very, very strong.

We've seen that.

Now we just have to build on it.

Your next question comes from Alex Walvis from Goldman Sachs.

I wanted to dig a little bit into the U.S. wholesale business.

You talked about the growth rate there being kind of soft.

Maybe you could help us out with some of the headwinds that you're seeing in the business.

I wonder if you could help us to parse out between how much the headwind is from bankruptcies and store closures versus existing doors and ongoing doors.

Could you parse between off-price, mass and department stores?

And then perhaps you could give us a little bit more color on what's embedded in the outlet -- in the outlook for the North America or U.S. wholesale business specifically in each of those areas?

Alex, in terms of the decline in the U.S. in terms of U.S. wholesale, about 2/3 was what I call a combination of bankruptcies, store closures and a softer environment.

About 1/3 was the fact that we reduced our discounted sales or incentive sales.

And we feel good about that thanks to having healthy inventory from that perspective.

So if we think about the U.S. and business in the U.S. and how we are focused on growing it, U.S. is different from the rest of the world because they're dominant in wholesale.

It's, in the men's bottom businesses, a larger piece of the business.

And we are focused on growing direct-to-consumer.

Direct-to-consumer has also been great.

Our -- we are focused on growing and expanding product categories.

Our women's business is growing.

Our tops business is growing but it's still pretty small relative to other parts of the world.

So as you think about the U.S. business and what gives us real confidence, it is about protecting our core, which is growing the U.S. wholesale business by growing and doing that by focusing on customers outside the top -- or the big 4 or the big 5 as well as driving category and product expansion.

Chip talked about innovation.

F.L.X.

is an example.

It's being rolled out in the U.S. and that will over time allow us to chase faster into trends.

So I think long term, we feel good about it but structurally, there are clear opportunities as we diversify the business.

Your next question comes from Omar Saad with Evercore ISI.

Congratulations, another great quarter.

Thanks, Omar.

I wanted to ask my question about digital marketing, marketing more generally.

I binged-watched Stranger Things with my kids over the holidays.

It's great to see you guys continue to do interesting collaborations like that, putting the brand at the center of culture.

But it still seems like there's marketing and advertising and getting the word out that Levi's is back in such a big way with such great products across men's and women's, and getting that word out seems like it's still such a big opportunity for the company.

The number of followers on Instagram, for example, seems pretty low for a brand of this stature.

From the consumer standpoint, there's still no Levi's app.

Is greater marketing spend, especially in digital, is it -- is this the biggest near-term opportunity, medium-term opportunity for the company?

Should we expect you guys -- if there's continued revenue upside to be piling that back into the business in the digital marketing and more marketing spend broadly speaking?

Is that the right way to think about it?

And maybe kind of any other kind of thoughts you have to expand on the topic.

I'm seeing here Omar smiling.

Like it's music to my ears.

I think the short answer is yes.

We've put a lot of emphasis on our digital marketing but there's still a lot of opportunity there.

I'd like to say the very best marketing going all the way back to beginning of time is word-of-mouth, and word-of-mouth today is Instagram and Snapchat and that's how consumers are learning about things and shoppable social media is coming really, really fast and it already exists in a big way in China.

And we've got to be all over that.

So it does represent an upside opportunity.

I should have mentioned it when I was talking about innovation but we have a Levi's app coming real soon, too.

So you'll see that before the end of the fiscal year as well.

But it does represent a big opportunity.

Now television advertising still works and we will continue to do TV advertising.

But continuing to double down on digital -- and that's how to connect with the young consumer and we're doing our best and I'm hoping any and all great ideas.

I'm glad you loved the Stranger Things collaboration.

I actually got an SMS from my son in Singapore saying, "I can't believe you've done that.

That is so cool." So it's really resonating and it does speak to the power of some of these collaborations at how it can just put us right at the center of culture when we nail one like that.

Your next question comes from Heather Balsky from Bank of America.

I was hoping if you could dig in a little bit more on your commentary about overall softness in U.S. wholesale.

Is that just a remark related to what you've been seeing for a while?

Or has there been any sort of change in sellout trend or how your wholesale partners are managing inventory?

Or is there just -- is there any commentary to explain what you're seeing and whether you're sort of outlook has changed in that channel?

So U.S. wholesale has been a challenging dynamic for now a couple of years, right?

We've been talking about U.S. wholesale for a long time and the industry has been talking about it.

It's a little bit of a melting iceberg.

But the reality of bankruptcies that have happened over the last couple of months and the acceleration of door closures associated with that and other customers trying to pare back their store footprint has become more and more of an impact here of late.

And our U.S. wholesale business was down 2%.

It's the first quarter in a while where we've actually gone backwards.

I think it's $7 million in total dollars but it's still going backwards.

And customers are managing their inventory tighter, and the way they do that is they tighten up their open-to-buy budgets.

What we have going for us relative to a lot of other brands in the marketplace today is we do have a lot of momentum.

We can point to our owned and operated retail stores in the U.S. and point to growth there.

So we've got proof points even in the same market that the brand is resonating and that they should be allocating their smaller open-to-buy budgets to us and allocating more space to us, and that's a big part of what we're trying to work with our biggest customers and partners.

We've also been trying to offset or mitigate some of these headwinds by expanding our footprint in U.S. wholesale.

So we've expanded more premium business.

I believe our premium business was up 3% this quarter in U.S. wholesale.

So that's good.

That's progress.

It's not enough to offset the declines in some of the bigger customers but it's going to continue to be challenging.

As customers close doors, they're closing from the bottom of their list going up and they're starting to cut in the bigger doors that represent bigger business for us and -- but I guess what I would say is the good news is we are all over this.

We don't have our head in the sand.

We are -- we've got strategies in place and we are trying to mitigate and offset the impact of door closures and bankruptcies by expanding our footprint with other customers, testing innovative things with customers.

So we've been testing our concession model with Macy's, for example, in 6 stores.

That looks very, very promising, a potential to expand that.

We've been testing Levi's in Target.

That looks promising, the potential to expand that.

These can all help offset softness in some of the other more challenged wholesale customers.

But it's going to continue to be a tough slot.

There's no question about it.

When you think about it, U.S. wholesale is about 1/3 of this company's total business.

So we've got to figure out how we mitigate the risk of the headwinds which we know are inevitable.

I mean the only thing I'd add, Heather, you've seen the diversification of the business happen over time.

So the fact that we can grow at the pace we are growing despite the U.S. wholesale declining 2%, I think, speaks for the broad-based and global footprint that we have.

Even if our men's bottom business is soft in one market, we're making that and more by expanding in different product categories.

And we're doing that in a way that margins are over time either flat or accretive and not dilutive.

So I think that's the more important piece of how we think about our story.

Your next question comes from Bob Drbul with Guggenheim.

I guess Harmit, could you talk a little bit more around gross margin performance and maybe the buckets, positive or negative?

And can you just give us a little bit of color around the expectations of gross margin, the outlook for gross margin in the back half maybe ex currency?

Yes.

Sure, Bob.

Thanks for asking that.

Our gross margins for the quarter were down 60 basis points.

It is largely driven by 100 basis points impact of unfavorable currency.

So excluding that gross margin, we're up 40 basis points for the quarter and I believe 50 basis points for the first half of the year.

The growth in constant currency gross margins is largely driven by the growth in our direct-to-consumer business.

We have reduced the incentive sales that's making a big contribution.

So markdowns are lower.

We did invest in some -- in products.

So our LEJ, or Levi's Engineered Jeans, that was launched internationally cost us a little bit more.

We are taking pricing now in Asia and Europe to offset that in the second half.

And so those are the factors that are contributing to constant currency margin increase in the first half.

As you think about the second half, your question about what is gross margins in the second half ex currency, I would say about 50 to 60 basis points increase, second half to second half, second half '19 to second half '18.

And the prime drivers of that is 4 basic things.

We think the impact of currency would be less but I've talked about constant margin.

So the constant margin is this incentive sales in the second half.

We are taking pricing -- we've taken pricing in Europe.

We've taken pricing in Asia.

We've taken some pricing in the U.S. and continued growth of our direct-to-consumer business especially as wholesale is under pressure.

So I think those factors contribute to the growth in gross margins in the second half on a constant currency basis.

Your next question comes from Kimberly Greenberger with Morgan Stanley.

Okay.

Great.

Thank you, Harmit.

That was a really helpful rundown on gross margin.

I guess I just wanted to follow up on it.

So if you think about sort of your expectations 6 months ago, for example, on gross -- on the way gross margin would come out, did you -- I guess how did the second quarter gross margin differ from perhaps what you might have expected?

Largely currencies, I would say.

Currencies and the impact of the euro was a lot more dramatic both in quarter 1 and quarter 2. And as you know, the euro started weakening in the second half of last year.

So that's where we think the expectation for the second half is probably not as much.

We did make some product investments about a year ago as we started largely in -- on product side, as mentioned, Levi's Engineered Jeans as well as we have broadened our products in the tops category.

But we're taking pricing.

And as we've said during the roadshow and we're reinforcing it, we think we have pricing opportunities whether it's -- as we roll out F.L.X.

and as we are able to put in more investment in our products and obviously price first.

So I think over time, you will see pricing becoming a bigger piece of our gross margin driver.

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

Congratulations on a nice quarter.

As you think about the other categories, tops and women's, the value brands, what are you seeing there?

Does it differ by region?

And when -- Harmit, when you just talked about taking price, is it on those categories also?

And how much of a price increase would you take?

Yes.

So taking pricing on some of the value brands is difficult because it's a pretty competitive environment.

So we spend the time ensuring our products across our value brands and Signature denims and -- are relevant.

And if you have the opportunity to rate some of those products, you'll appreciate what I'm saying.

In terms of expanding our value brands, our value brands over the last couple of years have really grown well, and that's largely because we've been able to bring up more relevant products and also expanded distribution in the U.S. And we're now expanding distribution of these brands in some of the emerging markets.

So we launched Denizen across wholesale channel and a value retailer in India.

We've taken -- we expanded Denizen and Signature in Mexico and we've taken -- we're testing Signature in China.

So we are expanding but we're doing it in a way that we ensure it doesn't, in any way, cannibalize or denigrate the main product, which is the Red Tab.

And your final question comes from Hale Holden with Barclays.

Chip, last year, you guys had a very active presence on Amazon Prime Day.

And I was wondering if this year, given the lower flow-through of sales to the discount channel, we'd see a change in that.

Or is that just a separate discussion?

Short answer is it's a separate discussion.

Amazon is a good -- they're really good and very valued customer, one of our fastest growing customers, but I really -- for competitive reasons right now don't want to talk about what's going to happen on Prime Day.

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

All right.

I wanted -- I'm conscious of time.

We want to wrap this up before the top of the hour, and I want to thank everyone for dialing in and for your great questions.

And a shoutout to Omar for giving me a good reason to go back and talk to the marketing folks about buckling down on digital.

So thanks very much everyone and have a great evening.

Talk to you soon or next quarter.

Thank you, folks.

Thank you.

This concludes today's conference call.

Please disconnect your lines at this time.