Levi Strauss & Co. (LEVI) Q3 2020 Earnings Call Transcript

Levi Strauss & Co. (NYSE: LEVI) Q3 2020 earnings call dated Oct. 06, 2020

Corporate Participants:

Aida Orphan — Senior Director, Investor Relations and Risk Management

Chip Bergh — President & Chief Executive Officer

Harmit Singh — Executive Vice President & Chief Financial Officer

Analysts:

Matthew Boss — J.P. Morgan Chase — Analyst

Paul Lejuez — Citigroup Inc. — Analyst

Robert Drbul — Guggenheim Securities — Analyst

Omar Saad — Evercore ISI — Analyst

Jay Sole — UBS — Analyst

Laurent Vasilescu — Exane BNP Paribas — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Kimberly Greenberger — Morgan Stanley — Analyst

Alexandra Walvis — Goldman Sachs — Analyst

Presentation:

Operator

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Co.’s Third Quarter Earnings Conference Call for the period ending August 23, 2020. [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 today through October 13, 2020. Please use conference ID number 7768738. This conference call also is being broadcast over the Internet, and a replay of the webcast will be accessible for one quarter on the company’s website, levistrauss.com.

I would now like to hand the conference over to Aida Orphan, Senior Director Shareholder Relations and Risk Management at Levi Strauss & Co.

Aida Orphan — Senior Director, Investor Relations and Risk Management

Thank you for joining us on the call today to discuss the results for our third fiscal quarter of 2020. Joining me on today’s call are Chip Bergh, President and CEO of Levi Strauss; and Harmit Singh, our Executive Vice President and CFO. We have posted complete Q3 financial results in our earnings release on the IR section of our website, investors.levistrauss.com. The link to the webcast of today’s conference call can also be found on our site.

We would like to remind everyone that we will be making forward-looking statements on this call, which involve risks and uncertainties, including risks and uncertainties as a result of the COVID-19 pandemic. There are significant uncertainties about the duration and extent of the impact of this pandemic. The dynamic nature of these circumstances mean that what is said on this call could change materially at any time and that actual results could defer materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please review our filings with the SEC, in particular the Risk Factors section of the quarterly report on Form 10-Q that we filed today for a discussion of the factors that could cause our results to differ.

Also note that the forward-looking statements on this call are based on information available to us as of today’s date. We disclaim any obligation to update any forward-looking statements except as required by law. During this call we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the earnings release on our IR website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our IR website and a replay of this call will be available on the website shortly.

And now, I’d like to turn over the call to Chip.

Chip Bergh — President & Chief Executive Officer

Thanks everyone for joining us today. Our third quarter results were substantially better than we expected, demonstrating the strength of our brand, the power of our diversified business model and the resilience of our teams around the world. Our brand is the strongest it’s ever been and as the lockdowns lift, we’re seeing consumers coming into stores on a mission. Levi’s remains the clear number 1 brand in the denim category and has grown market share during this period driven by our success in women’s. Levi Strauss is an iconic lifestyle brand also positions us to benefit from the casualization trends that have been accelerated by the pandemic. Through it all, our values have guided our actions, reinforcing that how a company gets through a crisis is just as important as getting through it.

Although the pandemic is changing the apparel industry, our results reinforce my confidence and optimism about our future. We are transforming our business by focusing on the areas that will drive our success, including first, elevating our brand from product innovation, deepening our connection with our consumers, and leaning into our values. Second, accelerating the digitization of our business, including leveraging our use of data and analytics and accelerating the rollout of omni-channel capabilities. And third, diversification across geographies, product categories and distribution channels with an increased focus on direct-to-consumer. Beginning with elevating our brand, during this pandemic we’ve held our share of leadership in men’s and we’ve grown share in women’s in Europe and China.

In the U.S., we grew our total apparel share in digital and also gained share in key accounts as we outperformed competition. We continue to launch collaborations that drive energy and buzz for the brand. Just last week for Fashion Week the surprise Levi’s by Valentino collaboration unveiled on the runway in Milan featuring an updated version of our 517 boot cut jeans that we originally released in 1969. And as people seek out more casual comfort, we’re defining and leading trends with the launch of new looser, more relaxed silhouettes across bottoms and tops, including our women’s non-graphic tees which grew in Europe driven by our soft and comfortable perfect tees and baby tees. At Levi’s we’ve always believed that making a difference in the world is also good for business. We have a strong track record and take our responsibility to the environment very seriously.

Our fall campaign is focused on sustainability and features our newly launched collection featuring cottonized-hemp, a leading fabric innovation that saves a substantial amount of water and uses fewer pesticides in cotton. And just yesterday in the U.S. we launched Levi’s Secondhand, a first of its kind buyback and re-commerce program, which creates a marketplace that will allow consumers to purchase previously launched Levi’s directly from us, as well as turn in worn jeans and jackets in-store for credit for its future purchase. We developed secondhand with Gen Z in mind as they search for uniqueness and character in their clothing to assert their individuality. More than half of Gen Z shops in the secondary market and they’re looking for the real thing.

As one of the most sought after brands in the secondhand space we’re excited to engage with all our consumers post purchase and capture demand for previously owned Levi’s. We also recently partnered with Ganni for a first ever rental-only capsule centered on circular design, which is available in both the United States and the UK and which was inspired by Levi’s vintage archives. And we just launched our new sustainable Puffer Jacket made from recycled plastic bottles and waste. Not only do these jackets look and feel great, you can now warm up while keeping landfill and energy usage down. Beyond our efforts in e-commerce and sustainable fashion, we continue to drive real progress on issues such as climate and water, which is both good for business and what our consumers will be looking for going forward.

We’ve also been outspoken about the need to address structural racism and its intersection with other issues such as gun violence prevention and voter access. We’ve teamed up with Rock the Vote to make sure consumers are vote-ready and have turned over our Instagram platform to activists and nonprofit leaders to share how they’re helping to get the boat out this fall. We’ve partnered with Hailey Bieber and filmmaker Oge Egbuonu to create a powerful PSA and portrait series with key activists and celebrities spotlighting the importance of voter education and participation. This video has generated 2.8 billion impressions with $43 million in media value. These efforts build on our leadership of the Time To Vote movement, which now includes more than 1,300 companies who have pledged that their collective 10 million plus employees will have time to cast their vote in this year’s election. And we’re laser focused on our own commitments to become a more diverse company as well, carrying out the commitments first announced when we released our diversity data in June.

Our or second area of focus is accelerating our digital transformation. We are seeing tremendous moment in digital selling. Our full digital sales footprint grew more than 50% in the quarter and comprised nearly a quarter of total company revenues. We’ve upgraded our e-commerce sites in Canada, Europe and the U.S. They are faster and feature improved navigation and search functionalities allowing consumers to quickly find products and the streamlined cart and checkout capabilities are driving increased conversion. We are also revolutionizing the way consumers can connect with the brand and shop with Levis on other digital platforms. For example, we re-envisioned the back-to-school season with a more digital approach with Gen Z in mind.

We teamed up with Kohl’s to create a unique virtual closet experience on Snapchat, enabling consumers to browse an additive assortment of Denim, Truckers and Tees and then virtually mix-and-match options to create new looks. Importantly, our accelerated rollout of omni-channel capabilities position us for a successful upcoming holiday season. Buy Online, Pick-up In Store, which has been very successful will be in the majority of our U.S. fleet before the holiday shopping season begins. In Q3, shipments store fulfilled 20% of all e-commerce volume and drove optimization of margin in stores. We’re expanding our U.S. loyalty program into all U.S. stores and Levi.com. We now have more than 1 million loyalty members with increased acquisition rates across all channels and repeat purchase rates have risen to 40%. Transaction size and frequency of purchase are higher for royalty members and we’re using AI to personalize offers to each consumer, further cultivating loyal fans.

And on our mobile app download and acquisition rates continue to increase driven by more frequent exclusive collaborations and early product access opportunities. 70% of those downloading the app are new users. They are sticky and conversion with them is nearly double. We’re making good progress leveraging use of data analytics and machine learning in more aspects of our business. The ways we deploy AI go well beyond loyalty and mobile. At our stores, AI is enabling local stores in China and the U.S. to better curate their assortments by predicting demand based on the specific profile and preferences of consumers in the vicinity of each store, which will thereby optimize the profitability of these smaller mainline doors.

And we’ve expanded our successful AI enabled e-commerce promotions in Europe, significantly increasing profits, revenues and units in these promotions, and adding to the share gains in women’s products. By the end of this year, all e-commerce and store promotions will be AI powered across 17 countries in Europe. Internally, we’re also digitizing our ways of working. We are preparing to execute our second digital global line launch for the Levi’s brand this month using digital tools to assort the line and drive increased efficiency. And in June, we opened our omni-channel digital showroom in Europe, initially planned as a small-scale test for a handful of accounts. We accelerated this capability due to COVID and conducted full digital sellings for spring and summer 2021 with our top 200 wholesale and franchise partners in Europe.

Due to the great success we had, we are rapidly evolving this functionality and will begin scaling it globally over the coming months. We believe we are positioned to stay ahead of competition in this comprehensive digitization of our go-to-market capabilities. Third, we continue to diversify our business across geographies, distribution channels and product categories. Revenue from International is nearly 60% of total. Direct-to-consumer revenues were around 40%. Women’s is more than a third of revenue and tops is nearly a quarter. Going forward we expect these areas of our business to continue to drive outsized growth and to represent even higher percentages of total revenues in future. On the International front, more countries are emerging from lockdown. Europe which has been our fastest growing market over the past few years is recovering strongest. While traffic remains down particularly in tourist locations, many countries in Europe are ramping up quickly with consumers patiently lining up outside our stores.

And in China which represents a huge opportunity for us we’re strengthening the business by accelerating our move away from underperforming franchisees. In our company operated stores which now comprise more than half of our revenues in China we’re seeing double-digit growth outside Beijing, which was impacted by a second wave of the virus during the quarter. Just last month we opened the brand’s pinnacle NextGen store in China in the heart of Shanghai’s popular shopping district on Nanjing Road. Though early days, we’re seeing stronger than anticipated traffic and higher than expected conversion of youth and up market consumers, elevating the brand in the market. The global women’s business continues to show strength as women’s share of total revenues grew to 37% of the total. The business showed pockets of growth.

In our top 10 wholesale accounts, the women’s business grew 13%. Women’s shorts in both traditional 501 Denim and fashion styles grew double-digits. Women’s bottoms delivered half of the quarter’s total Levi.com growth with strong performance in 501 shorts, cropped, ribcage and 721 high rise fits. New woven tops performed well as we increased our assortment of blouses expanding the reach and broadening the appeal of the Levi’s brand to her. From a channel diversification perspective, we’re increasing our focus on direct-to-consumer. We’re thinking and acting DTC first as we accelerate our investments in our own direct-to-consumer and e-commerce businesses. E-commerce grew at the fastest rate ever this last quarter. Meanwhile, our store expansion strategies remain intact. Physical stores are and will be an extremely important part of our business.

We make our best impression with consumers through our Levi’s stores and we’ve been transforming them from traditional stores into an immersive omni-channel brand experience. And while sales remain down versus prior year, we’re mitigating ongoing traffic declines by driving meaningfully higher conversion. We’re elevating the brand stature as we roll out multiple store formats globally, including our NextGen stores, which offer leading customization techniques and enhanced digital features to drive storytelling and sales. In the U.S., we recently opened NextGen stores in Century City, Scottsdale Fashion Square and Stanford Mall. We have two additional NextGen stores opening this fall. There remain substantial whitespace for profitable mainline stores.

In the coming years, we plan to open around 100 smaller footprint mainline doors in the U.S. from the 30 plus we have today, some of which will be NextGen. About a fourth of our current full price network in the U.S. are smaller footprint, and they’re working delivering ROIC well above hurdle rates. While growth in our direct-to-consumer business will outpace that of our wholesale channel, we continue to see opportunities to reach new consumers with new and expanded wholesale distribution, which will support elevating the brand and diversify growth in wholesale, particularly in the U.S. Our new distribution, we are excited to announce that we’ve just launched the Levi’s brand into Dick’s Sporting Goods starting online and at 11 of their top flagship stores, supported by a media strategy in coordination with Dick’s.

The product assortment is focused and elevated, showcasing the strength of the brand, with higher AURs and an appeal to younger consumers. Given this will be a premium priced offering, we expect this business to be incremental to our existing wholesale business. This is a big opportunity, and we expect to learn from it and identify ways to expand the partnership next year. On the expansion front, the success of our partnership with Target is one of the important opportunities before us. We’re very pleased with the positioning of our brand at Target, a focused assortment of men’s and women’s resulting in higher than average AUR’s and today we’re announcing an expansion of our partnership from 140 doors to 500 doors by fall of 2021.

Particularly encouraging is that in the doors open to date, we’re seeing new consumers discovering our brand without cannibalizing our business with other wholesale accounts. Denizen will remain in Target stores to address the more cost conscious consumer. We are selectively pursuing additional wholesale distribution expansion and we’ll share more in the coming quarters. We believe these strategies will support future growth as well as our goal to elevate the brand in the market. And we continue to gain space within the top doors of existing customers, leveraging our expanded lifestyle portfolio and the strength of our brand to drive traffic. By focusing on their most productive doors, we seek to mitigate the impact of the inevitable closures of underperforming doors in the future.

With that, I’ll now turn it over to Harmit to walk you through the results of the quarter. Harmit?

Harmit Singh — Executive Vice President & Chief Financial Officer

Thanks Chip. Good afternoon, everyone. I hope all of you, your families and loved ones are safe and healthy. Despite revenues being below prior year, due to the pandemic, we saw substantial sequential revenue improvement from the second quarter, and we far outperformed even our own expectation. Our financial results were solid, as we delivered higher than prior year gross margins, made money in the quarter and generated even stronger cash flows than prior year, a trifecta driven by the financial discipline we’re executing as a team. Consumers remain hungry for our brand and our structural economics are sound and improving, as our cost and working capital actions have put us on a clear path to emerge from this crisis, a significantly more profitable and cash generated company with ROIC in the mid teens.

As I walk you through additional detail on our third quarter results, my comments will reference constant currency comparison on a year-over-year basis in U.S. dollars, unless I indicate otherwise. We published the details of our reported and constant currency results in today’s press release, so I will not repeat all of those here. Third quarter net revenues were down 26% due to the impact of the pandemic. We mitigated brick and mortar declines in wholesale and direct-to-consumer channels from lower traffic with strong digital business growth. Our total digital ecosystem comprised of the e-commerce sites we operate, and the online sites of our wholesale accounts grew more than 50% in dollars in Q3 and comprise 24% of total company third quarter revenues, double the share of what it was a year ago.

Specifically, our own e-commerce business grew 53% and comprised 8% of total company revenues for the third quarter, also double what it was a year prior. And the per unit metrics in our e-commerce business are very strong. Average revenue per unit is double that of wholesale. Gross margins are more than 20 points above wholesale, and the profit per unit is higher than wholesale. Our e-commerce business on a fully allocated basis was again profitable in the third quarter and year-to-date. And we expect full year profitability in 2020 a year ahead of schedule. Adjusted gross margin expanded 60 basis points. Given the environment, we were exceptionally pleased with this as it underscores the intrinsic health of our brands and channels. The price increases we have taken are sticking and we have had a higher share of sales from our direct-to-consumer channel, particularly e-commerce.

Wholesale gross margin held strong and in line with prior year as we’re running the business with a low volume of promotions, and managing through inventory by leveraging our outlet network, and more than 20 new pop ups without resorting to extreme discounting or increased sales to the off price channel. Levi’s AURs around the world rose slightly, demonstrating the strength of the brand. Even at higher prices our products continue to represent exceptional value, providing more opportunity to increase gross margin in the future. Adjusted SG&A was down $105 million from prior year, an 18% decline. Adjusted SG&A was again down across all regions, functions and categories of spend, primarily reflecting the cost reduction initiatives we instituted last quarter.

Turning to profit, we were able to offset the lower revenues with our stronger gross margin and cost saving actions and delivered adjusted EBIT of $84 million and adjusted EBIT margin of 8%. The strong adjusted EBIT yield is adjusted net income of $31 million and adjusted diluted earnings per share of $0.08 for the quarter, bringing both metrics back into positive territory year-to-date, a full quarter earlier than we had anticipated. Adjusted EBIT and adjusted net income were therefore only negative for one quarter because of the pandemic. Now, I’ll share a few highlights from our three regions. Third quarter revenues in the Americas declined 27% in line with the total company, with the U.S. better than this, given Latin America was largely closed for the quarter. The business further diversified towards women’s, which was 37% of the region’s total revenue in the quarter, up from 31% last year.

The signature brand delivered double-digit growth in the quarter, reflecting the strength of our value offering. Total U.S. wholesale was only down 20% with higher gross margin than prior year. Our U.S. e-commerce business grew 61% and although traffic remained challenged in brick and mortar stores, conversion and AURs outperformed prior year in both our full service location and outlets. Europe was our strongest performing region with a revenue decline of 17%. Wholesale and retail store declines were broadly similar, but the highlight of the region was e-commerce growth of 35%. Recovery has been slower in tourist locations with non-tourist site cities on a stronger recovery trajectory. Our pop-ups in the region helped us work through inventory. And while traffic remains down, conversion and higher units per transaction reflected the consumers’ high intent to buy when they came out.

Our brand equity is the strongest it has ever been and Levi’s remains by far the most popular Denim brand in Europe. Asia as a region declined 41%, largely driven by the fact that India, one of our largest markets in the region was effectively closed in the entire quarter. In India, we proactively took back inventory from closed franchisees and reallocated it to pure play e-commerce, which yielded nearly 50% digital growth over prior year. We are also taking the opportunity to close underperforming stores and to upgrade and expand others into better locations, thereby retaining our net floor space in the market. Excluding India, the remainder of Asia was down 24% roughly in line with the total company though performance varied notably by market. E-commerce was a bright spot in Asia as it grew 27% for the quarter. We continue to believe Asia represents a huge opportunity for us as high brand awareness suggests there is significant room to increase our sales.

Turning to balance sheet and cash flows, inventories at the end of the third quarter net of reserves were 1% higher than a year prior on a reported basis, achieving near parity with prior year a quarter sooner than expected. Our recent organic acquisitions in Singapore and South America represent three points of inventory. Excluding this, year-over-year inventory was down. America’s inventory was 5% below prior year offset by Asia, which is higher. Inventory at quarter end was healthy, with more than 65% able to carry over into future season. We anticipate ending the year with total inventory down to prior year, even including the impact of the organic acquisitions. And after burning cash last quarter, our cost and working capital actions yielded strong adjusted free cash flow, a $195 million increase as compared to third quarter last year, driven by higher cash from operations and lower capex.

We ended the quarter with $1.4 billion in cash and another $600 million available under our credit facility bringing total liquidity to an ample $2 billion. Looking forward, our views on the balance of the year and beyond assume no significant worsening of the virus or dramatic re-closure of the global economy. First, given the improving strength of the business and having exceeded our own third quarter performance expectations, we see that outperformance extending into the fourth quarter. So we are banking our third quarter beat into our internal full year expectations and raising our expectations for quarter four. We started the quarter well, with much improved trends in September on revenues, gross margin, EBIT and inventory. Accordingly, we anticipate first quarter revenues will be down to prior year in the range of 14% to 15%.

We expect Q4 adjusted gross margin will be flat to slightly up compared to prior year’s 54.3%, yielding full year adjusted gross margin above prior year’s 53.8%. And we anticipate delivering Q4 adjusted diluted EPS in the range of $0.14 to $0.16. This includes lower Q4 adjusted SG&A of as much as $80 million to $100 million compared to prior year, despite an acceleration of advertising to around 8% of fourth quarter revenue and the incremental expenses from our fiscal 53rd week falling in the quarter. Please note that our fourth quarter estimates assume no significant foreign currency fluctuation during the fourth quarter. Our revised capex estimate for 2020 remains $160 million. Two thirds of the investment is going towards technology and our digital transformation in areas like e-commerce, omni-channel initiatives, AI and data analytics and our ERP upgrade.

And regarding stores, we have opened more than 60 doors year-to-date, primarily internationally and have added another 85 doors to our network from our organic acquisitions. We expect to selectively open about 30 more doors through the balance of the year in Type A locations, most of which will be digitally enabled, and generally would rent at much better rates than we had pre-COVID. And while recovery trends are encouraging, there remains uncertainty about the future, and therefore, we will not be paying a dividend in the fourth quarter. If our positive business trends continue, we anticipate a return to paying quarterly dividends in 2021. Turning to 2021 and beyond, I want to share some thoughts on where we intend to take this business. We still believe a return to pre-COVID revenues will occur at some point in the second half of 2021.

And the revenue recovery trajectory has improved considerably from what we thought three months ago. On our next earnings call, we expect to have more clarity on the specific timing. And while we expect recovery in various markets to remain uneven, Europe as a whole could get back to 2019 levels in the first half of 2021, given our brand and execution strength. Irrespective of revenues, our cost actions give us tremendous confidence that we will emerge from this crisis a significantly more profitable company. In fact, we now expect to achieve our adjusted EBIT margin North Star of at least 12% when we return to pre-COVID revenue levels, several years sooner than we previously anticipated and much higher than 2019’s 10.6%.

This substantial EBIT margin increase assumes a higher adjusted gross margin, as well as structural cost savings of around $200 million, including the headcount, rent, travel and negotiated vendor savings we have discussed previously. We plan to reinvest roughly half the cost savings to fuel investments that are driving growth and drop the remainder to the bottom-line. Beyond 2021, we anticipate our strategies and execution will drive a structurally stronger business. More than half our total business will come from DTC and franchise channels with structurally sound economics. Specifically, we anticipate that adjusted EBIT margins for company-operated e-commerce will be at par with the total company when e-commerce is double its current size. Women’s will become half our total business as it grows at a faster rate than men’s.

Our global digital footprint will double to more than a third of our business with our own e-commerce comprising about half of that. And importantly, U.S. wholesale will be significantly healthier. In Q3, the non-digital business with our largest traditional brick and mortar department stores was less than 10% of our total revenue. And that’s more indicative of what we expect going forward. As Chip mentioned, we are shifting our business away from their less productive doors and growing with them in their most productive doors and in the digital business. And this will complement our many opportunities to grow in healthy wholesale distribution with pure play, premium, value and the new and expanded distribution we have announced.

With that, we will now open it up and take your questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And your first question comes from the line of Matthew Boss with J.P. Morgan.

Matthew Boss — J.P. Morgan Chase — Analyst

Great. Congrats on the nice progress guys.

Chip Bergh — President & Chief Executive Officer

Hi, Matt.

Harmit Singh — Executive Vice President & Chief Financial Officer

Thanks, Matt.

Matthew Boss — J.P. Morgan Chase — Analyst

Chip, so on the top line, can you speak to the Denim, maybe the Denim market, Levi’s lead position and how do you feel today relative to pre-pandemic? And then Harmit, on the bottom line on the 12% plus operating margin target for the timeline, are you saying that you basically plan to reach that level by the second half of next year or when revenues are back to the pre-pandemic base? Just, how best to think about an annual margin expansion algorithm from here would be helpful.Chip, so on the top line, can you speak to the Denim, maybe the Denim market, Levi’s lead position and how do you feel today relative to pre-pandemic? And then Harmit, on the bottom line on the 12% plus operating margin target for the timeline, are you saying that you basically plan to reach that level by the second half of next year or when revenues are back to the pre-pandemic base? Just, how best to think about an annual margin expansion algorithm from here would be helpful.

Chip Bergh — President & Chief Executive Officer

Sure. On the top line, through the pandemic, what we’ve seen is an acceleration of the trend towards casualization globally and we obviously are set up to capitalize on that. So while Total Apparel, the Total Apparel category has declined during the pandemic, Denim’s share of Total Apparel is unchanged. And as you know, we are by far the leading brand globally. We lead overall as a brand. We lead in men’s and we lead in women’s. And as you’ve heard during our prepared remarks, we’re growing share in women’s in Europe and China.

And a big part of that is being driven by a continuation of casualization on the women’s business. Shorts was a very big part of our business this past quarter. So, I would say, compared to pre-pandemic, I’m even more confident about our future. We’ve said this, right from the very beginning, that crisis creates an opportunity. And I think what we’re demonstrating is strong brands are really resonating with consumers, and our brand and the agility, which we’ve demonstrated through the pandemic, is positioning us to set up to win over the long-term. So we’re very, very confident.

All of the vectors of growth, which we talked in the past and which we talked about in the prepared remarks, in our women’s business was 20% of our business when I joined the company, it’s 37% now and on our way to 50 as we set huge opportunities for growth internationally and growth outside of Denim and our Tops and Outerwear business as well so very, very confident that we’re going to accelerate from here. Harmit, do you want to talk about bottom line?

Harmit Singh — Executive Vice President & Chief Financial Officer

Sure Matt, and the question of the 12%, as you know, when we did the IPO we said, our North Star goal was to get to 12%, didn’t have a timeline. We’ve spent the last few months taking a hard look at our cost structure. And we believe, structurally, we can save about $200 million on an annual basis, we got to be investing in things like high advertising, the digital transformation and omni-channel. So probably spend part of that back. But, we’re confident we can drop about $100 million and are even during the crisis, we’ve continued to grow our gross margin.

So we think, growing our gross margins annually in the same way 40, 50 basis points, a combination of the two gets us to the 12% at least. And to your question of timing, Matt, our view is when we get back to, and we believe we will, when we get back to the annual revenues we made in 2019, we believe our operating margins will be at least 12% driven by the combination of the two things. We think we’ll probably get back to 2019 levels sometime in the second half of 2021.

There are markets or regions like Europe that can get there faster. So I think, think about the operating margin number being when we get to annual revenues of ’19. Structurally, we’re going to be making progress towards that this quarter, even though revenues were down 27%, I think our operating margins were 8%. So I think we’ve got a path, we’re confident of getting there and doing it in a way that we continue to grow and unlock the top line and grow market share. So the combination of market share growth, plus more profitable business is going to be, something that we’re geared towards making happen.

Operator

Your next question comes from the line of Paul Lejuez with Citigroup.

Paul Lejuez — Citigroup Inc. — Analyst

Hey, thanks, guys. Can we talk a little bit about the Target assortment? I’m curious, just about the size of the assortment relative to what you currently have in the 140 stores that you’re selling through Target? Also, relative to what you would have what the consumer would see in some of your other partner doors in terms of the skew and price range and just what is the timing of when that business will roll out to those 500 stores? Thanks.

Harmit Singh — Executive Vice President & Chief Financial Officer

Chip, I think you’re on mute.

Chip Bergh — President & Chief Executive Officer

I’m on mute, yes. You would think after doing this for seven months I would figure out the mute button. It’s a great question and I was saying if you haven’t been into a Target to look at the assortment, I’d encourage you to go. It’s a very tight assortment. The pad on both the Men’s business and the Women’s business is relatively small, about 30 to 40 items on the pad. But it’s a good assortment of tops, and bottoms, tees, sweatshirts, trucker jackets, and then a tight assortment of bottoms on both the Men’s and the Women’s business and the AUR’s out the door or going out at a premium versus on the balance of wholesale.

So we’ve been really pleased and I would say that Target has been really pleased with the performance that we had from this relatively tight, relatively small footprint offering and hence the decision to expand to 500 doors over the course of the next year. And we’ll do it in waves. But we’re kind of committed collectively with Target to get to 500 doors by the fall of 2021. So we’ve been really, really happy with it. They’re happy with it. It’s good for the brand. We know that we’re picking up incremental new consumers to the Levi’s brand with this and we’ll continue to have Denizen on the floor too representing the value offering at Target. So it’s a really good play for us and we’re very excited about the expansion.

Paul Lejuez — Citigroup Inc. — Analyst

Thanks Chip, just as a follow-up. Have you seen any negative impact on the Denizen side of the business in those 140 doors and then just has this Target assortment compared to what you all have indexed? Thanks.

Chip Bergh — President & Chief Executive Officer

Okay, great. So, no negative cannibalization. In fact, when we first started testing Target, with the Levi’s Red Tab business, we pulled Denizen out of the store, and to make room for Levi’s and collectively, we concluded that was a bad idea. We went back. We tested Denizen back in those same doors and it proved that these are two different consumers. And so we’ll continue to have an assortment of both Denizen and Levis as we expand the target relationship. Dick’s is a completely different offering. We’ve talked before about kind of good, better, best within our product range and if you were to think about it, our better and best assortments tend to be what we have in mainline and in most of Europe and in most of Asia.

And what we’re going to have in Dick’s is our better assortment. So the price point is going to be significantly higher than wholesale on average. The bottoms are going to be priced around $79 compared to, roughly $40 in wholesale broadly. So it is a much more premium, again, a very tight assortment, a relatively small pad, but very highly curated just as we’ve done at a Target. And we’re going learn, but we’re really excited about this because it is, again, an incremental opportunity with a wholesale customer that is winning right now. And we expect we’re going to see incremental consumers and incremental new consumers and that this business is going to be really incremental.

Operator

Your next question comes from the line of Bob Drbul with Guggenheim.

Robert Drbul — Guggenheim Securities — Analyst

Hi, good afternoon. Nice quarter.

Chip Bergh — President & Chief Executive Officer

Hey, Bob.

Robert Drbul — Guggenheim Securities — Analyst

Harmit, just following up on the path to 12% EBIT margins, can you elaborate a little bit just about what you’re seeing right now on the e-commerce profitability, the progress you’re making and sort of how that fits into the progress that you’re seeing on the profitability side?

Harmit Singh — Executive Vice President & Chief Financial Officer

Yeah, sure. Thanks, Bob, great question. Understanding profitability by channel is something that’s near and dear to our hearts. And we’ve been doing it now for years, especially as we started investing to build the e-commerce business. So we’ve been tracking it religiously for a long time. I think our e-commerce business holistically is profitable. And when we talk about profitability, we talk about it on a fully loaded or allocated basis. So it includes all advertising costs, it includes all technology costs, etc. And it was a drag, pre-pandemic. It’s now in the black and profitable. And if you think about the unit metrics on e-commerce, for every incremental unit, every new unit, our average revenue is nearly double than that of wholesale, our gross margin at 20 points, above wholesale or 15 above company average and profit per unit is higher.

And so as the puck moves towards there driven by digitization of the consumer experience, I think we feel really good about e-commerce, helping overall profitability for the company. The only other piece I’d say is when e-commerce was losing money to the drag it is making money, so it’s helping but to be accretive to our 12% or get close to the 12% e-commerce business will need to double and we feel good about that. And that’s where we think long-term we’ll be able to grow ecommerce without cannibalizing our brick and mortar experience. In terms of actual costs, the shipping costs are not a drag for us. The fact that we’re shipping now from our own stores is making a difference. We’ve kind of locked in shipping prices through the end of the year. Returns are down post pandemic, so that’s helping and our folks are working to drive e-commerce profitability as we speak and building a lot of efficiency as we implement omni-channel initiatives. So we feel good about where this is going longer term.

Operator

Next question comes from the line of Omar Saad with Evercore ISI.

Omar Saad — Evercore ISI — Analyst

Thanks for taking my question. Nice quarter. Chip, you talked a lot about a lot of initiatives, stores, digital products, partnerships, technologies, channels, regions, which really reflects the opportunity the brand still has, but it’s a lot of balls in the air. And you’ve recently had a corporate headcount reduction. If you could talk to how you’re able to restructure the organization in a way to be leaner but still manage all that growing scale and complexity? And also, how does this kind of doing more with less, feed into the margin story that North Star 12%? Thanks.

Chip Bergh — President & Chief Executive Officer

Yeah, we’ve been saying for a while that we had an opportunity to be more agile, to be more market responsive. And part of what we’ve tried to do through this crisis, and with the headcount reduction is focus our resources, much closer to the market, and build capabilities so that we can be more agile and scale things. And I could point to several examples, even just during the pandemic, where our responsiveness to the rapid changes that we’ve seen in the consumer behavior during the pandemic has really helped our business.

If we look at some of the omni-capabilities, and we’ve been investing in omni now for a couple of years, but we saw this opportunity to shift from store. We built the capability to ship from store. 20% of our e-commerce business was shipped from our stores in the U.S. this past quarter, which is consistent with the quarter before that. We built the ability to buy online, pick up curbside pretty quickly. And it’s just a little bit less than half of our stores in the U.S., but it’ll be in 100% of our U.S. stores by the holidays.

So a lot of this is about candidly empowering the teams close to the consumer, empowering the teams to focus on winning in the marketplace and trying to cut out a lot of the corporate bureaucracy and the things that slow us down. So we’re really focused through this entire transformation on winning with the consumer, leveraging the strength of our brand, leveraging the key capabilities that we have, and that we have built and really the sources of some of our competitive advantage and driving those. And as we reduce costs, it gives us the ability to invest in the things that we know are going to continue to drive our business.

And that was the hard choice that we were faced with a quarter ago is do we carry a bloated organization for the size of the business that we’re going to be through this pandemic, and cut everything or do we right size the organization for the size of the business that we’re going to be, modify our business model, so it’s more scalable with the lower headcount. So that as we grow back, we get more leverage, and really focus on our investments on the things that we know drive growth on this business and that’s effectively what we’ve done. And I think you’re starting to see even after only one quarter some of the fruits from that.

Operator

The next question comes from the line of Jay Sole with UBS.

Jay Sole — UBS — Analyst

Great, thanks so much. I just want to ask you about the wholesale business broadly. [Technical Issues] in the rates compared to the sell through rates, as you went through the quarter and now and [Technical Issues] sales growth in the company was in September?

Harmit Singh — Executive Vice President & Chief Financial Officer

Jay I tried to hear you, I think it was a little difficult, but I think your question was, sell through rates and important with the trends as we closed September. What I’d say is trends as we closed September are much improved both sell-in as well as sell through. September is better than expectations that we’ve talked about for the quarter. We are a little more cautious given uncertainty about holiday, the resurgence of the virus, the stimulus, the upcoming elections. And as you know, we’re slightly disadvantaged from a calendar perspective, because our fourth quarter September through November doesn’t include December.

But as we enter the quarter trends are looking much better and encouraging. Regions like Europe are bouncing back a lot faster and making a difference. And that’s why with our inventory levels being where they are, I think, that’s where we are signaling that gross margins will be flat to slightly better, which drives improved profitability. We do have product for the holiday season. We are chasing some products in some parts of the world because we’ve seen demand surge beyond our own expectations, but we think we’ll be able to service consumer needs so that’s an overall perspective. Difficult to talk to you specifically about September numbers, because it’s in the next quarter, but I think you get the gist.

Operator

Next question comes from the line of Laurent Vasilescu with Exxon BNP Paribas.

Laurent Vasilescu — Exane BNP Paribas — Analyst

And thank you Harmit, for giving us some guardrails on to accompany revenues for the fourth quarter down in the teens. Just curious to know, how do we think, how should we think about that range between the Americas and Asia? And then I think you mentioned that Beijing was — the second lockdown had a slight impact on China revenues for the third quarter. Just curious to know what your thoughts are for Europe. It sounds like its strong, but any thoughts on volatility with regards to potential lockdowns with cities like Madrid and Paris in the news?

Harmit Singh — Executive Vice President & Chief Financial Officer

Yes, it’s — thanks Laurent for your question. I think specifically, I’d say Asia probably a little worse than the company average for the quarter largely driven by the fact that, markets like India continue to be, closed, they’re opening but opening slowly. There are markets, even within Asia, in our Australia region, Malaysia and a couple of other countries that are — Korea is doing a lot better. But I think, as a general trend, our expectation Asia will be slightly worse than the company average, I’d say Europe will be the strongest followed by U.S., followed by, because in Americas you also have Latin America, and most of Latin America was closed is opening.

So, that’s the way I kind of rank it; Europe strongest, followed by Americas, followed by Asia. I think your question about the resurgence of the virus — every country is trying to figure this out, people are dealing with it differently. I think what is important for us is — is keeping the consumer and employee safety at the forefront, servicing demand by driving digital connection to the consumer, as well as ensuring our product and our marketing calendar are focused on the point Chip talked about, which is sustainable initiatives and our products that are hitting home as consumers start shopping for the prolonged holiday period. And I would say Laurent that we are picking up share in Europe and in other parts of the world.

Operator

And your next question comes from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey — Telsey Advisory Group — Analyst

Good afternoon, and nice to see the progress. As you think about this upcoming fourth quarter and it seems so long ago that we were talking about this fourth quarter having two Black Fridays in it, Harmit, how are you thinking of the fourth quarter and the planning with the two Black Friday’s, do they negate each other since this may not be the Black Friday that we had expected? And Chip on the marketing budget, which is revamping where do you see that ramp going to? And what do you see as the new initiatives or new collaborations that we should be looking forward to? And especially given the announcement today or yesterday, where you talked about with secondhand Levi’s and what that potential contribution to-date? Thank you.

Harmit Singh — Executive Vice President & Chief Financial Officer

Yeah, let me quickly address the Black Friday question Dana. Thank you for that reminder. Yes, the two Black Fridays in our fiscal 2020, the first Black Friday was in the first quarter of this year, so that’s behind us. The second Black Friday is in quarter four. I’d say, between Black Friday and 53rd week it’s a couple of points of growth, but it’s such a different Black Friday, right, and so our view is it’s going to be fairly promotional in a longer holiday period. November is largely going to be a holiday season carried into December, so it’s difficult to predict with any precision what, a week or two weeks can do. And so, but the fact that our quarter four indication of our results represent improvement relative to quarter three, I think is indicative of the fact that we do see demand improving. Over to you Chip.

Chip Bergh — President & Chief Executive Officer

Yeah, I’ll be really brief here. As we said in the prepared remarks, we’re going to take our advertising spending up to 8% of revenues in the fourth quarter. Some of that is obviously going to be targeting driving traffic to our e-commerce sites. But from a campaign standpoint, we’re very focused on sustainability. Our whole second half campaign is around sustainability. We’re launching a collection of products using cottonized hemp, which we talked about in the prepared remarks, which is a fabric innovation that is much more sustainable.

Sustainability is really big right now, because of the pandemic gets very, very strong with Gen Z consumers in particular, so a big emphasis there. And our holiday campaign is going to be focused on giving better gifts that last, which plays right to our strength as a brand. We’re very excited about the re-commerce initiative that we just announced yesterday. The re-commerce business today is $30 billion, projected to grow to $60 billion over the next couple of years.

We’re partnering to get this done, but it represents a significant opportunity. It’s the way Gen Z is shopping today. And they’re buying things from thrift stores, wearing them for a week, taking their Instagram photos so that it can be uniquely theirs and then they’re thrifting them again. And it’s a big step forward from a sustainability standpoint too because if we can get Levi’s recycled, and we can capture share of that recycled business, it is a big opportunity for us. So very early, and we’re going to learn as we go on this but it’s something I’m personally really excited about.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Operator

Your next question comes from the line of Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger — Morgan Stanley — Analyst

Great, thank you so much and thanks for all of the details and transparency on the call tonight. Gross margin this quarter was a real positive surprise for us. And I’m wondering, it sounds like you’re expecting more of a flattish gross margin in the fourth quarter, but it gets to a very high level. When you think about the third and the fourth quarter of this year, are there any benefits to gross margin that you think would reverse next year if there were some geographical mix shifts that may not prove to be sticky or some channel mix shift. I’m just trying to think about full year 2021 gross margins and should we be assuming it can actually get back to a higher level than 2019 because the trajectory seems to be one certainly where you could sustain gross margin at higher levels over the medium term?

Harmit Singh — Executive Vice President & Chief Financial Officer

Yeah, Kimberly good question. I think the gross margin accretion is really driven by the intrinsic strength of our brand. The premiumization of Levi’s around the world, the balance that we have struck between driving revenue as well as selling inventory in a very promotional environment. We are using AI now to determine the breadth and depth of promotion. We’re using AI to help us determine assortments in stores. And I think, and we have priced, even during the pandemic, for example, in the U.S., for certain women styles, we took price up by $10 and it is broadly speaking.

So I think the one, tailwind is obviously the growth of e-commerce and the higher, direct-to-consumer business and that might settle down, over time, but I think the combination of pricing pause we have the fact that we continued to premiumize the brand, the fact that we’re going to be growing internationally, faster than the U.S., the fact that in the U.S. we are transforming the U.S. business to more of a DTC business. I think those are all tailwinds that will continue to, work in the favor of growing gross margins longer term. I would probably our growth algorithm on gross margins 40 to 50 basis points I think I’d kind of maintain that, on the long term horizon annually that is.

Kimberly Greenberger — Morgan Stanley — Analyst

Great, thank you.

Operator

Your next question comes from the line of Alexandra Walvis with Goldman Sachs.

Alexandra Walvis — Goldman Sachs — Analyst

Fantastic. Thanks much for taking my question here. Very pleased with the formal name there. I am just wondering if I could ask a formal, a sort of higher level question on the U.S. wholesale business. So could you remind us if you mentioned U.S. physical department stores now less than 10% of total sales? If we take the U.S. wholesale business, what’s the breakdown between channels? And how do you envisage that changing over time? It sounds like there are new distribution opportunities, and you called out a few in mass and in sporting specialty, clearly those might be growth areas, are there also areas where you’re proactively pulling back or seeing natural declines? And how might that affect the shape of the business over time?

Harmit Singh — Executive Vice President & Chief Financial Officer

Yeah, I think, think of us growing the U.S. wholesale business, in areas where we’re connecting better with the consumer, and areas that are healthier. So with the traditional retailers, their top doors, because as we build a lifestyle invitation to a brands is still a huge opportunity for us. And as Chip just mentioned, with new distribution in Target and Dick’s is, as we’re looking at we are feminizing, the brand so there are a couple of other premium customers we’re working on.

So I think the overall the way I would look at it, Alex is our wholesale business, which in the U.S., which is about 30% probably settled in the mid 20s, longer term, but that’s largely because the direct-to-consumer business grows and we grow with the stronger wholesale customers. The non — the 10% really represents the non-digital piece of the traditional retailers because our focus in the traditional retailers is bringing the top doors and in the digital business. So overall, the growth algorithm that you have for wholesale probably becomes stronger and healthier longer term.

Alexandra Walvis — Goldman Sachs — Analyst

Fantastic, thanks for all the color.

Harmit Singh — Executive Vice President & Chief Financial Officer

Yes. And our gross margins in U.S. wholesale for the quarter were actually up earlier. So that represents is the focus between markdowns and the customers we are going to.

Operator

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

Chip Bergh — President & Chief Executive Officer

Okay, I want to thank you all for hanging in. We went a couple of minutes longer than planned, but because we had so many questions, thank you all for joining us. I hope you all remain healthy and safe. Our next earnings call isn’t until after the holidays. Our Q4 earnings call is I think in late January. So wish you all a very happy holiday and we’ll be in touch. Thank you all for joining us today.

Operator

[Operator Closing Remarks]