Levi Strauss & Co. (LEVI) Q3 2019 Earnings Report, Transcript and Summary

…ladies and gentlemen, and welcome to Levi Strauss & Company Third Quarter Earnings Conference Call for the period ending August 25, 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 two hours after the completion of this call through October 14, 2019. Please use conference ID 6988596. 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. 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 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 good afternoon, and thanks to everyone for joining us here today. We delivered strong third quarter results and remain on track to achieve our full year expectations. Revenues of $1.45 billion in the third quarter were up 4% on a reported basis and 5% on a constant currency basis. This brings year-to-date revenue growth to 8% in constant currency. Our strategies to strength the Levi’s brand and diversify the business beyond U.S. Wholesale and men’s bottoms to faster growing markets in categories have helped us deliver these results and offset the challenging U.S. wholesale dynamics. Our strategies are working and we are confident in the future. I’ll briefly touch on some key highlights from our third quarter, all in constant currency and versus prior year. Our international results were again very strong. Europe grew 18% on top of 17% a year ago, and Asia grew 12% on top of 10% a year ago. The global direct-to-consumer business was up 12% and has now grown double-digits for 15 consecutive quarters, and within that our e-commerce business grew 21% with increased e-commerce traffic in all three regions. Our total women’s business grew 12% which was the 17th consecutive quarter of growth in women’s with each of the last 11 quarters being double-digit growth. And our total tops business was up 17%, a 15th consecutive quarter of double-digit growth in tops. The Levi’s brand continued its momentum delivering 8% revenue growth in the quarter on top of 12% growth a year ago. Levi’s brands strength is driven by our ability to bring the brand to life for our fans to reading product and marketing. With a history of nearly 150 years for Levi’s brand is both iconic and relevant as we continuously re-invent the brand and lead the industry through new fits, innovations and bold marketing. We launched a number of exciting collaborations with iconic partners in the quarter, including Hello Kitty and Stranger Things, which generated billions of impressions for the brand and gave consumers a reason to make repeat visits to our store. We continued our investment in digital innovation by launching Future Finish, an online customization experience on Levi.com that leverages our FLX technology which makes it easy to create a custom pair of Levi's and puts the power of personalization directly into the consumer's hands, and we're premium pricing it. At the end of the quarter, we again collaborated with Nike showcasing the power of these two celebrated brands this time with a focus on customization. We worked with the ‘Nike By You’ program to allow consumers to create their own case custom Nike's with Levi's fabrics and trends using our FLX technology. And we also partnered with them to design exclusive co-branded sneakers available in select Levi's Stores, which sold out in three days. We have a number of other prominent collaborations in the pipeline for Q4. We just introduced the next iteration of our Trucker Jacket with Jacquard by Google which uses advanced technology and patented conductive fibers, woven into the fabric of the jacket to seamlessly and wirelessly connect your trucker to your smartphone. This latest version features an ever expanding range of digital technology. And we recently announced the much anticipated collaboration with Disney's Star Wars, which will be available in our stores and online on November 1st. These strategic collaborations with other iconic brands underscore the strength and relevance of the Levi's brand with consumers of all ages and backgrounds. Levi's is the number one denim brand in the world by a mile, and we are maintaining our share leadership position by putting the consumer and our values at the center of everything we do. Before I review our strategies, let's talk a moment about the U.S. which I know is on everyone's mind. As a reminder, we manage the U.S. as a marketplace using both channels direct-to-consumer and wholesale to drive our brands. Our success in direct-to-consumer continues to be the best indicator of the Levi's brand strength in the market. In the U.S. our DTC performance remain very strong, up 7% with e-commerce outlets and full price stores all growing. Our DTC strategy in the U.S. will include testing some smaller footprint stores in great locations around the country in the coming quarters. Growing our U.S. direct-to-consumer business allows us to move towards premiumizing the marketplace, and remains one of our important strategies to offset headwinds in U.S. wholesale by continuing to reduce our concentration in that channel. When I joined the company eight years ago, U.S. wholesale was almost half of the company's entire global business. Today, it's around 30% of the company's business, and this will continue to trend down as other parts of the business grow at a faster pace. As anticipated, U.S. wholesale in the third quarter faced a tough comparison to prior year, for the reasons we've shared previously. Anniversarying, selling associated with the relaunch of one of Docker’s key product lines in 2018, reducing sales to the off-price channel in 2019 due to our healthier inventory, and lapping stronger sales in 2018 to a large financially distressed retailer, and the overall softness in U.S. department stores and chains primarily due to the well-publicized traffic trends there. The first three factors, which collectively, adversely impacted third quarter U.S. wholesale comparisons by about six points, are not indicative of our underlying performance in the channel. Adjusting for these, U.S. wholesale declined 4%. We continue to work with our customers, leveraging the brand strength and diversifying categories on the pad, to show up much more as a lifestyle brand, including more women's and more tots. We're bringing some of what's working in our DTC business to U.S. wholesale, including better merchandising, brand environment and service, and we're investing in our on-floor presentation at some of the top doors of key accounts to achieve this. And by doing so, we're winning in a tough marketplace with sellout trends better than each of the banners themselves. We're also taking a segmented approach to U.S. wholesale overall, to drive the business within the broader channel, deploying various strategies to capture growth and these strategies are working. Examples include, securing incremental distribution, including with premium customers, which is helping to premiumize the marketplace, and expand access to our better and best products to U.S. consumers. Expanding our pure play digital and wholesale dot.com business, while maintaining brand integrity and healthy margins, and growing with our partners in the mass channels bringing quality products to consumers at great price points. Even with these strategies, comparison to prior year are going to be lumpy on a quarter by quarter basis, due to the timing of shipments, store closures, product launches etcetera. So it's important to evaluate U.S. wholesale performance over a longer time horizon. For now, we see the third quarter as the toughest comp for the full year. And while we'll have the tail of the Dockers impact, and lower off-price sales again in Q4, we expect that U.S. wholesale comparisons to prior year will improve in the fourth quarter. We expect that U.S. wholesale will remain challenging, but we are strategically evolving our approach to the channel, and we'll exit the year with a structurally, stronger, wholesale footprint than we had today. Now turning to our where-to-place strategic choices, which is a reminder or drive the profitable core, expand for more and become a leading world class omni-channel retailer. First on the profitable core business, which comprises men's bottoms, our top 10 wholesale customers, and our top five mature markets. Revenues in each of these three components of the profitable core grew in the third quarter, when adjusted for the Dockers and off-price impacts to U.S. wholesale that I just discussed. Most importantly, we've grown revenues in each of the three components of the profitable core, low single digits on a year-to-date basis without any adjustments. Turning to our second strategy, which is to diversify the business by expanding far more into Tops, women's under penetrated markets and with our value brands 4% growth in our women's business was fueled by the success of our High Rise Skinny fits, an ongoing growth in women's tops. Total tops growth of 17% was balanced across men's and women's, driven by truckers, sweatshirts and tees as we continue to diversify within the category. Graphic Tees remain a hot item, up 6% in the quarter after being up more than 40% in the third quarter last year. Each of our emerging markets of India, Russia, and Brazil posted another quarter of double digit growth. And in China, net revenues grew 2%. Our company operated doors in China grew mid-single digits from positive comp performance and a shift towards more full price stores. And this was on top of double-digit growth last year. Franchise performance was mixed as we continue to work to turnaround that part of the business. Last week, in collaboration with the franchise partner, we opened a new 7000 square foot store in Wuhan. This is now our largest store to date in China, allowing us to showcase a broader assortment, including super premium products, and early consumer response has been very strong. And on the heels of our recent rollout of Levi's customization services on WeChat, we have joined forces with the hugely popular music and dance game, QQ Dance to create a 3D rendered wardrobe for its game characters, so consumers will be able to dress like their game avatars. Check it out on Youtube by searching for Levi's QQ Dance. Not only do partnerships such as these provide consumers with a fun, interactive shopping experience, allowing them to define and design their own cool, but they also support our endeavor to position the Levi's brand at the center of culture. China remains on track to post growth for the full year after being flat last year. You have the right people and strategies in place to accelerate China's growth in 2020. Our third way to place strategic choice is to become a leading world class omni-channel retailer, direct-to-consumer growth of 12% reflected strength in each of our three regions. Global DTC for us includes the brick-and-mortar stores, and e-commerce sites that we operate. Revenue growth from our brick-and-mortar stores was up 10% globally. Performance of existing stores improved both internationally and in the United States, in our outlets and full priced stores. And we continue to build out our store network, which has grown by 90 stores since last year. In the third quarter, we opened the largest Levi's flagship in Asia and Tokyo's Harajuku district, the center of Japanese youth culture and fashion. Globally commerce growth was even stronger, up 21% for the quarter with increased traffic and double digit growth in all three regions. We continue to enhance our omni-channel capabilities. Our rollout of ship-from-store continues, and we are now also leveraging RFID technology at more than 500 stores across 17 countries and growing. Both of these initiatives allow us to optimize inventory, augment sales and improve store productivity. We're seeing an uplift in stores where we have rolled this out. Looking forward to the fourth quarter, in the U.S. we're launching new ways to connect loyal shoppers to the best of the Levi's brand with a new loyalty program an app, which will give consumers access to frictionless shopping, exclusive product, loyalty rewards and style inspiration. These platforms allow us to get closer to the consumer and we will be rolling them out globally over the next year. Our strategies to diversify our global business are clearly working domestically and abroad. Our international business is approaching 60% of total revenues. Direct-to-consumers heading to 40%, women's is nearly a third of total revenues and tops is almost a quarter. In all of these areas, there remains a long runway for growth. And we're achieving all of this while keeping our commitment, to doing right by people on the planet. In August, we released a global strategy to reduce our water usage by half, and water stressed areas by 2025. We're also setting the standard for other apparel companies with our industry leading targets to reduce carbon emissions. And our long history incorporating sustainability, in everything we do not least of which is the supply chain disruption we’re driving with project FLX continues to reduce our reliance on precious resources, driving innovation across our business and resonating with younger consumers, whose passion for the planet has been particularly visible of late. Now over to Harmit to review our third quarter performance and update our full year outlook. Harmit?

Thank you, Chip. And welcome to everyone joining our call. My comments today with reference third quarter comparisons on a year-over-year basis in U.S. dollars unless I indicate otherwise. Third quarter revenue of $1.45 billion grew 4% on a reported basis, and 5% in constant currency. The contributions by region, channel and category of the five points of constant currency growth were as follows; by region 5 points of growth from Europe and two points from the Asia, were partially offset by lower sales in the Americas. By Channel, three points came from our company operated stores, one point from e-commerce and one point from global wholesale. And by category, 6 points of growth generated by a diversification into Levi's, women's and tops was partially offset by a decline in Dockers. Levi's men's bottoms were flat for the quarter. Third quarter gross profit of $767 million represents an increase of $25 million despite $11 million of unfavorable currency translation. Gross margin of 53% declined 20 basis points on a reported basis due to currency headwinds, from a stronger U.S. dollar. Excluding all currency effects, both translation and transaction, gross margin expanded by 40 basis points driven by the margin benefits of our direct-to-consumer and international growth. We are also starting to see benefits of the price increases, we have taken globally, was substantially mitigated, the product investments we have made. Third quarter SG&A expense of $596 was up 2% or prior year. SG&A as a percentage of revenues improved by 60 basis points. High investments in direct-to-consumer expansion, technology and distribution capacity were more than offset by higher incentive expense -- compensation expense last year, reflecting performance significantly ahead of internal expectations in 2018, and a lower impact from previously cash settled stock-based compensation awards. Additionally, we drove leverage on base cost this quarter, reflecting our cost discipline. Third quarter operating income of $171 million was up 8% on a reported basis, and up 9% on a constant currency basis. Operating margin expanded 40 basis points to 11.8% due to the lower incentive compensation expense. Adjusted EBIT which excludes the impact from our previously cash settled stock-based compensation awards was $176 million in the third quarter up 2% on a reported basis, and up 4% on a constant currency basis. Adjusted EBIT margin was strong at 12.2% reflecting our cost discipline as the 20 basis points decline compared to the prior was due to the currency headwind in gross margins. Adjusted net income of $128 million for the quarter was down $5 million as the prior year benefited from $11 million in discrete tax benefits that did not repeat this year. Adjusted diluted EPS for the third quarter of 2019 was $0.31, a $0.03 decline as compared to $0.34 in the prior year. The prior year tax benefits I just mentioned in combination with the increase in our share count this year adversely impacted the year-over-year adjusted diluted EPS comparison by $0.05. Now I’ll share more detail on the third quarter results of our three regions in constant currency, unless I state otherwise. In the Americas, net revenues were down 3% after being up 9% last year. Direct-to-consumer in the region grew 9% reflecting the strength of the Levi's brand and execution in our stores where performance was positive, including positive comps in U.S. outlets, and which was augmented by strong double digit growth in e-commerce. We anticipate our recently announced acquisition of the South American distributor will give us the opportunity to accelerate growth in this important region, where the Levi's brand really resonates with the consumer. In anticipation of the acquisition, we didn't ship additional product to the distributor in the third quarter, and that adversely impacted growth in the Americas by about a point in this quarter, which was about half a point to the total company. Beyond this impact, underlying performance in the Americas regions, international markets remain strong. Within the U.S. strong direct-to-consumer growth of 7% partially offset the U.S. wholesale decline. This year, we are comping the Docker’s line reset and sales to a financially distressed retailer, and we are reducing sales to our price, all of which we do not consider indicative of our underlying performance in the channel. Collectively, this adversely impacted U.S. wholesale comparisons by about six points in the quarter, and we expect these factors to be of similar dollar magnitude in the aggregate in the fourth quarter, primarily driven by lower off-price sales. Excluding these factors, U.S. wholesale declined 4% in the third quarter reflecting the ongoing challenging environment in the channel. Importantly, given the diversification of the business over the last few years, this only equates to one point for the company overall, which we have been more than able to offset by areas of opportunity that are growing at a faster pace. U.S. wholesale remains an important profitable channel, but keep in mind that our revenue algorithm does not assume growth in the U.S. wholesale. Our strategies are targeted towards managing it to flattish overtime, and they are working. U.S. Wholesale is about flat year-to-date on an adjusted basis and we expect the full year to be similar. And even with the decline this quarter, the Americas as the region has grown 3% year-to-date right in the middle of the range for this region in our growth algorithm. Third quarter operating income for the full Americas region declined 7%, more than the region revenue as higher selling expenses offset a higher gross margins. Europe, again posted outstanding growth. 14% on a reported basis and 18% in constant currency. And this despite a backdrop that remains challenging as retail amidst an increasingly uncertain macroeconomic climate. Revenue growth this quarter, was again broad based across the region with double digit growth in men's and women's all product categories and both channels where wholesale and direct-to-consumer each matched the region's 18% growth rate. The brand continues to be hard in Europe, and the team continues to do an amazing job executing across all channels to support the brand's momentum. Europe's operating income grew 34% on a reported basis, and 39% on a constant currency basis reflecting the net revenues growth, a higher gross margin and leverage on SG&A. Asia also posted a strong quarter, not withstanding macro volatility from tariff talks and protests in Hong Kong. The region's net revenues grew 9% on a reported basis and 12% in constant currency. Traditional wholesale, franchise and e-commerce each grew double digits. Most markets in the region grew. The strongest growth in Asia this quarter was in India, partially due to a seasonal change in shipments within the prior year. China grew modestly and remains a huge opportunity as it still represents only about 3% of total company revenues. Hong Kong was a notable exception in the region. The ongoing protest there impacted traffic and caused some of our stores to close temporarily costing the region a vital point of growth. Asia's operating income grew 18% on a reported basis, and 25% on a constant currency basis, reflecting the net revenues growth and SG&A leverage. Turning to balance sheet and cash flows. In dollar terms, inventory at the end of the third quarter was nearly flat compared to a year prior, reflecting the deliberate measures we've taken in recent quarters to reduce and maintain the health of our inventory. Adjusted free cash flow of $28 million for the first nine months of 2019 was $42 million higher compared to the first nine months of 2018, despite higher CapEx investments and paying a higher dividend in the first quarter this year. Speaking of dividends, you may have seen our press release a couple of weeks ago, announcing an increase to the dividend we've been planning to pay in the coming weeks. At $0.15 per share, we now estimate a total payment of approximately $59 million, a 7% increase as compared to the previously announced $55 million. Returning capital to shareholders is a key component of our total shareholder return. A higher dividend payment will bring fiscal 2019 dividends up to approximately $114 million, a 27% increase compared to 2018. With three quarters in the books, we are solidly on track to achieve our full year guidance. We expect full year constant currency revenue growth in the range of 5.5% to 6%. We are tightening our range now that we have only one quarter to go, and incorporating the impact of the distributor acquisition we announced in August. As regards currency, due to a stronger U.S. dollar, we expect currency translation will adversely impact the full year reported revenue growth by about 275 basis points. Given year-to-date constant currency revenue growth is 8%, our constant currency guidance implies fourth quarter about flat to slightly down compared to the prior year. This reflects an adverse impact of about 500 basis points collectively from lack of a Black Friday, lower off price sales. The distributor acquisition in South America, and the unrest in Hong Kong. None of these factors detract from the underlying strong health of the business. Turning to gross margin. We affirm our full year guidance and wanted to further clarify the currency impact embedded in our gross margin expectations. On a reported basis, we expect full year gross margin roughly in line with prior year’s 53.8%. Excluding all currency effects, both translation and transaction, we expect full year gross margin expansion in the range of 40 to 60 basis points in line with our growth algorithm reflecting our geographic and channel diversification strategy. With respect to adjusted EBIT margin, on a reported basis, we expect full year adjusted EBIT margin roughly in line with prior year’s 10.5%. And keep in mind, that this year we won't have the 25 basis point benefit to full year adjusted EBIT margin that we normally get from Black Friday. Excluding the currency effects from translation, we expect adjusted EBIT margin to expand approximately 10 basis points. With respect to adjusted EBIT dollar growth, we expect currency translation would adversely impact the full year reported adjusted EBIT growth rate by about 450 basis points. In view of our year-to-date tax rate, we now expect a full year effective income tax rate in the range of 19% to 20%. Our 2019 CapEx expectation remains in the range of $190 million to $200 million and we continue to expect nearly 100-store openings on a gross basis this year. It is pertinent to note that our full year constant currency revenue guidance taking into consideration lack of Black Friday, the distributor acquisition and our strategic decision to reduce sales to off-price in support of brand equity represents an organic growth rate of over 7%. Ahead of our growth algorithm and this is on top of 14% last year. Before turning to Q&A, a reminder on tariffs, while it remains to difficult to predict what the future holds for tariff policy, we have proactively taken steps to insulate our business from the long-term negative impact of these kind of measures. As such we believe we are less exposed than other and we estimate the impact of tariff on imports to the U.S. from China will have a negligible financial impact to our business. With that, we'll take your questions.

Thank you. The floor is now open for questions. [Operator Instructions]. Your first question comes from Matthew Boss with JPMorgan. Go ahead with your question.

Thanks for all the color, guys. Maybe just on U.S. wholesale revenues as we think about the 4% adjusted underlying decline in the third quarter that you laid out ex some of those items. I guess what's the magnitude of improvement that you're expecting as we think about the fourth quarter? Maybe help us to think about underlying U.S. wholesale run rate as we think about next year? And just larger picture as we kind of parse through this' with the department store softness does this impact your ability to drive mid-single digit underlying revenues as we think about next year and beyond?

So, I'll answer your last question first and then come back and talk about U.S. wholesale specifically. In short, I think our growth algorithm remains completely intact. Our ability to grow LSA in the 2% to 4% range remains unchanged. And it's fundamentally driven by the underlying strength of the Levi's brand across the whole region, which is best evidenced by the strength of our DTC business. On wholesale, excluding those one-time dynamics that we talked about, which was worth six points, the balance of the underlying trend of negative four as we said in the prepared remarks, we do expect that this is going to be the toughest comp for the quarter -- for the year, toughest comp quarter for the full year. I think it's fair to assume over the long haul that we are going to be able to manage our U.S. wholesale business to be about flattish. That's what we been saying all along. We've really been focused on structurally evolving our U.S. wholesale business to be sound than it was as we enter the year. So things like exiting as much as possible the off-price business which comes at a really low gross margin and is not healthy for the brand as we do that that strengthens our business structurally. And things like testing the brand in Target, which still is continuing to do really, really well at a very good price point by the way. So, I'm confident that we're going to be able to maintain that business in the flattish in terms of total dollars and as a percentage of our total business it will continue to decline as we grow our faster growing businesses of DTC and international.

Hey, Matt, as I'd mentioned, on adjusted basis you can take the three factors out. Our U.S. wholesale business is fattish on a year to-date basis and we expect the same for the year. In terms of anniversary [ph], Dockers reset is going to be fairly minor in quarter four, and we're resetting off-price, we expect to reset off-price by Q1 of 2020. So we anniversary most of these one-time factors over the next quarter or so

Great. And then just one follow-up. On the gross margin maybe, Harmit, could you just walk us through the drivers of gross margin expansion in the fourth quarter, and then just as we think multi-year just maybe the puts and takes on the gross margin line? Thanks.

Sure. So I think if you think of the quarter, our gross margin ex currency was up 40 basis points. I would say the expansion of direct-to-consumer and international helps gross margins 40 to 50 basis points. We have taken price increases globally in the U.S., Europe and Asia, and those price increases are offsetting our product investments. And then there is just saving from sourcing and the like. So that's really what's driving us in quarter four because we're upping the top end of our gross margin range, ex currency to 40 – from 40 to 50 to 40 to 60. That's largely driven by the fact that we expect lower off-price sales in quarter four. And as Chip mentioned, those sales come at lower, much, much lower margin. So that really benefits us. And currency I think in quarter four will be a much lower impact as you've seen in quarter three. It's kind of progressively come down over the last couple of quarters. Does that help you, Matt?

We'll take that as a yes. Next question.

Your next question comes from Paul Lejuez with Citigroup.

Hey, thanks guys. Can you talk a little bit about Europe business? I'm curious on the wholesale side that revenue growth -- how much of that is being driven by new doors this quarter versus same-store sales. And same question for DTC, the percent driven by new store openings versus comp growth in that region. And then I guess just one follow-up on the U.S. wholesale channel. Can you maybe break out for us how growth in the channel, contraction in the channel looks by department stores versus the mass channel versus specialty? Thank you.

So, first question was about Europe, right?

Yes, sir.

So, if you think about a business in Europe, our business in Europe was up 14% on top of mid-teens growth. Last year it was across all channels. So wholesale was up 18. I think. Direct-to-consumer was up 18. The channels are fairly -- really work together fairly harmonious from that perspective. In terms of is it more doors or is it comp sales? I would say, our comp sales performance in Europe is probably the strongest around the world. We've had generally positive traffic in quarter three in Europe and in Asia. In the U.S., traffic in the outlets is slightly down, but more than offset through better conversion, and conversion and increased unit per transaction leading to positive comp. So I think it's a combination of both new doors as well as comp sales. The fun fact in Europe is between franchise and company doors. We're opening one new door a week on a gross basis, okay?

Okay. And just same on the wholesale side, is it mostly the new accounts? Or is it same accounts, same chains that you're just selling more to?

It's largely same chains we're selling more to, but we're selling more of lifestyle, as women's business and our tops business continues to grow to build more of a lifestyle. So we are selling more products and obviously taking more floor space given the strength of the brand.

Got you. Thanks from me.

The question, Paul, just to answer your question on U.S. Wholesale, Chip talked about incremental penetration in premium retailer. So our premium business in U.S. wholesale is up 8% for the quarter, 16% year-to-date. We're also growing our digital footprint in the U.S. and that's across pure players as well as wholesale.com and that business in quarter three was up 20%. So again, our strategies are to grow premium and to continue to grow digital, and that's offsetting some of the traffic declines in traditional department stores.

Got you. Thank you. Good luck guys.

Thanks.

Your next question comes from Bob Drbul with Guggenheim Securities.

Hi. Good afternoon. Just a couple of questions from me. The first one is, can you just elaborate a little more on the Target test. And I guess specifically, are you seeing any cannibalization with other retailers or do you think it's purely additive with the Red Tab? And I would also just be curious to know within Target do you think that it's impacting the Denizen brand at all?

Okay. So, Hi, Bob. So, the Target test just to take everybody back. We started with the 20-door test early in the calendar year. They actually came to us. They had consumer research with their guest that indicated that the brand that they most wanted to buy in Target but couldn't buy was Levi's, the most searched item on target.com that people couldn't buy was Levi's. And so, we started with a 20-door test just on men's and in those 20 doors, we pulled Denizen. And so, Levi's was purely incremental at really good price point. So it was Levi's men's. It was bottoms, tops and some trucker jackets. The bottoms, we included some of our latest, most contemporary fits like the 502, which was priced around $50. We quickly learned that their guests loved finding Levi's in their stores. We work with Target to have great in-store presentation. The merchandising is really well done. And the test in short it worked. We look very, very carefully at the impact of cannibalization because this was purely a left pocket right pocket, we're just shifting Levi's from one customer to another and not gaining incremental share from this. We weren't interested in pursuing it. And we -- so we drew a five mile radius around every test store, and we'd look at the incrementality of the test, and it was incremental. So we have now -- since now expanded to 50 doors on men's and we have started a 20-door test on women's, which is also off to a very good start. May recall last quarter I said, at full potential, this is we're really focused on the urban doors and the college town doors. And one of the things we're learning is we're converting a younger target consumer who isn't shopping at the malls and they're discovering Levi's at their Target, and we're converting them on some of our premium wholesale product. So feels really, really good. And it does appear to be truly incremental. So, full potential, this is probably somewhere in the range of a couple hundred doors, 200 doors or so, but we're continuing to work with the Target team, but feel really good about the progress that we've made. And this is part of as I said in those prepared remarks. This is part of evolving the structural nature of our U.S. wholesale business and this one seems to be a good one for us.

Got it. Great. And just the second question is on the marketing side, can you just talk about the plans for the fourth quarter and sort of how you're managing the marketing budget even as you look in the next few quarters into the next year?

Yes. From a financial standpoint, what we've guided is that we expect advertising to be about flattish for the full year around 7% of revenues and that implies that it's a little bit heavier in the fourth quarter, which is normal given the seasonality, and so we are going into the holiday season, loaded and ready to bear. As I said, we've got a number of really strong collaborations connecting with consumers digitally around the world is really, really important. I talked about the collaboration that we've got with QQ Dance in China, which really is awesome and we're connecting with the young consumer through that, and really marrying the virtual world, the digital world and the physical world with product that consumers can put on their avatar in the game and buy for themselves. So we've got a lot of exciting things but just continue to put the brand at the center of attention. And we will continue to double down on our marketing every time we do it, it appears to be working. So we feel really confident as we go into the holiday that we've got a really strong program lined up for the fourth quarter and through the holiday season.

Great. Thank you very much. Good luck guys.

Thanks Bob.

Your next question comes from Alexandra Walvis with Goldman Sachs.

Hey guys. Thanks so much for taking the question. I wonder if you could dig a little bit more into the strategy with respect to off-price. So could you remind us when the decline in sales to that channel started, perhaps your views on how long that will continue? Any color on how big off-price is a percentage of the American business today would be would be helpful. Where do you see that going over time?

Okay. So, hi Alex. So first of all, just to back up, we don't make the full off-price. There are a lot of apparel manufacturers that see that as an ongoing channel. They build products, specifically to hit those price points and they're kind of in there on an ongoing basis. We do not do that. We treat off-price purely as a channel for selling distressed inventory. We sold a lot last year because part of the Dockers reset as a matter of fact we had to get rid of a lot of inventory. So, we have a lot of it in the base period. We kind of -- our inventory position really started to get very clean as we were coming into Q2 of this year. So there will be some hangover on off-price going through Q1 of next fiscal year. But our objective as we continue to manage our inventories pretty aggressively is to avoid using off-price. We will only go to off-price when we are trying to get rid of distressed inventory. It's not healthy from a brand management standpoint, it's not, certainly not attractive financially, but finding Levi's in one of these off-price customers at $14.99 [ph], just makes it really, really hard to sell Levi's at full-priced in this market. So that's how we're trying to manage it. The off-price cycle will end in Q1 of 2020 from a lapping standpoint. Is that answer your question?

It does indeed. Thanks so much. That's very helpful. And one more if you wouldn't mind me sneaking in and follow-up to some of the earlier questions. Could you give us any color on how fast your Signature grew this quarter and then perhaps also Denizen given some of the measures that you're taking in Target?

Yes. So both of those brands we didn't even talk about it in the prepared remarks. Both brands were essentially flat for the quarter. One of the things in Target, I did say that as we tested Levi's Red Tab in Target, we pulled Denizen. We have had a conversation with Target about going back in testing Denizen, because it plays in a very different price point and Target is a very different consumer. So going back into some of those original test stores and seeing what happens when we put Denizen back in incrementally.

And Alex the flat for the quarter was on the back of a 15% growth in quarter three of last year.

Awesome. Thanks guys for all the color.

Thank you.

Your next question comes from Kimberly Greenberger with Morgan Stanley.

Thank you so much. I'm wondering if you could just talk about the accounting impact when you acquire a distributor. Is there a sort of subsequent benefit in future quarters to revenue to EBIT dollars? If you can just sort of walk us through how to think about the impact? And then understanding that you're not giving 2020 guidance today, I'm just wondering if you have a view of how we should on a preliminary basis think about FX impacts going into next year? And then lastly, China, you indicated grew modestly in the quarter. I'm wondering if that sort of meeting your expectations. And what are sort of puts or takes in China as separate from Hong Kong? Thank you.

Okay, Kim. Let me answer one and two and then Chip can answer China. So let's take the first one which is the acquisition. Our distributor model is very similar to the wholesale model which is it's a sell-in model. So we sell into the distributor, they mark up and book the consumer revenue at their end. As we -- when we announced the transaction and the transaction is very consistent with capital, our philosophy to deploy capital to growth as business and actually growth in markets where we think we can drive the business faster than in some of our partners. So, the reason we stopped selling in quarter three and quarter four was largely to avoid the accounting issues that you're talking about, plus the distributor had enough inventory. And so in terms of the change in the business model what will happen is post the acquisition, the business model will move from wholesale business model that we were recognizing the revenues based on sell-in to a consumer business model where we recognized revenues based on sell-out. So that's the change. We will give a perspective on the impact of the acquisition in 2020 when we talk about 2020 guidance in early 2020, when you report quarter full earnings. We're in the process of taking a hard look on what is the impact of the business conversion, plus importantly what are the dollars and cents we have to invest, whether its in advertising, whether it's in organization. But intrinsically, we believe that this transaction is accretive to EPS over the long term and does accelerate growth in that market. So that's the question on the acquisition. To your question about FX, if I could predict FX, I'd be probably doing something very different. But what I would say right now is -- it's probably best to use today's rates as the best proxy. When we close out the year and talk about 2020 at that point, we'll indicate the impact on 2020. But I think the best indicator is probably current spot rates. And the last question I think was on China.

Okay. So on China, I think just backing way up since we're new to a lot of you. China is still a huge opportunity for us. It represents about 3% of our total business overall. As we said in the prepared remarks, it grew 2% in the quarter primarily driven by the strength of our business in company-operated doors. We've been evolving our China business over the last couple of years. Go back two fiscal years, we declined in China. Last fiscal year we were flat. We took a number of steps in China last year to set ourselves up for success long term in China. So we took back a number of franchise stores in Beijing and Shanghai where we own and operate our own doors. We stopped heavily discounting in Tmall and now we're basically selling predominantly full-priced products, and we are now moving to premiumize and super premiumize that marketplace, because that's what's working there if you look at other, particularly look at other brands. So I talked a little bit about this new store that we opened in Wuhan. It's 7,000 square feet. It's over three levels. That store features expansive sections for all of our premium collections including Levi's Made and Crafted, Levi's Authorized Vintage and Levi's Vintage Clothing. It's also got a massive tailor shop. So we're putting kind of customization and personalization right at the forefront of everything and we're going to continue to focus on strengthening and premiumizing the way that Levi's brand shows up in that marketplace. We've got a brand new team on the ground and that's been -- that's led by Amy Yang who we hired about a year ago. She's Chinese. And we're very, very optimistic that we've turned the corner and we expect kind of much stronger results over the next couple of years as it represents one of the biggest opportunities we've got.

Terrific. Thank you.

Thanks Kim.

Your next question comes from Omar Saad with Evercore ISI.

Thanks for taking my question. I guess I'll ask -- I wanted to ask about tops. Looks like it accelerated to the mid -- from mid-teens to high-teens. It's an area in your business where maybe there's been some skepticism about the sustainability, in the fashion quotient there. But the Graphic Tees piece, I think you said was only plus six. So maybe help us deconstruct what's really working in that business; men's, women's, international. Is it all trucker jackets? And help us to think about some of the strategies going forward for that category? And clearly you're being able to sustain the level of growth at a high rate, you know maybe perhaps higher than somewhat expected? Thanks.

Thanks Omar. Clearly an under penetrated opportunity for us, the acceleration quarter-over-quarter from that perspective is largely driven. If you think about our tops business, think about a third being Tees, made up the bulk of it Graphic Tees. A third truckers and sweatshirts and a third, woven and other stuff that we don't sell a lot of and there's a huge opportunity. I think polo T-shirts from that perspective. The acceleration in quarter threes relative to quarter two was driven by truckers and sweatshirts really growing at a much faster clip than the average that we indicated of 17%. And as you think about our longer term opportunity and just get a preview of what's coming down the pike for H1 and H2 of 2020, I think is really focusing on the other opportunities we have. I think is what makes us confident that we can continue to grow this for a long, long time.

There is time for one more question.

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

Good afternoon everyone. As you think about the wholesale -- if you think about the wholesale business and the shift that's going on whether to more premium or to Target, how do you see department store penetration changing? Will we see a shift in the account base of wholesale? And just lastly on price increases that you mentioned, which began to be initiated. Is that globally? And how does it range by category? Thank you.

Yes. I guess I'll take the wholesale footprint piece. I mean, as we've said before the channel, especially department stores and the large chain stores, which is the bulk of our legacy wholesale business, its facing structural headwinds and challenges. And one customer has gone bankrupt, that customer used to be our biggest single wholesale customer not even 10 years ago. And they are almost gone. And so there's going to continue to be door closures. We're going to continue to see these customers that are over store cutting from the bottom up. To-date, fiscal year to-date we've faced over 700 doors that have closed where we were in distribution and that is going to continue for the foreseeable future. And so, our commitment has been to continue to run this business, to try to manage the revenue which is profitable revenue in this channel to be about flat over time. I think it's inevitable that we will see a shift in what that footprint looks like as some of these bigger legacy customers close doors that they need to close, and we are mapping the market and trying to preserve our wholesale business by being in the right place at the right time. And I can't crystal ball exactly what it's going to look like in three years or five years, but our commitment is to -- and what's built into the growth algorithm is that we will be able to maintain this business about flattish over time. And if you look at our track record, that's what we've been able to do despite all the headwinds over the last three plus years. So I'm confident in our ability to be able to continue to do that. And then quickly to answer your question about pricing, we had more during the road show as well as when we had met with all of you last couple of weeks we had said pricing is an opportunity for us. The brand has pricing power. We have taken several pricing actions globally, for example in the U.S. we raised prices on some of our fits, the 502, the 514, the 527 by $10 and it's largely sticking. We've taken several actions in Europe and Asia. In Europe in different markets we have taken pricing between 3% and 5%, similar in Asia. That's generally speaking, we're seeing an increase in AURs and that's indicative, plus, just the performance if you look at what's happening in Europe and Asia there's this indicator of the fact that the brands how [ph] can we able to take pricing. So as we think about pricing strategies longer term, it’s all about pricing for inflation and trying to offset currency as one bucket. It's about reducing markdowns where we can. And thirdly, it's about pricing for innovation. We did price in the second half for our Levi's engineer jeans in Asia, and for example that's also helping.

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

I was just about to go there. So with that, I suspect we will probably be the first earnings call to wrap by wishing you all a happy holiday because we won't be back with you all until after the holidays when we report our fourth quarter. So I wish you all very happy holiday. We'll talk to you again in the new calendar year. Thank you all for dialing in today.

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