Levi Strauss & Co (LEVI) Q3 2023 Earnings Call Transcript

Levi Strauss & Co  (NYSE: LEVI) Q3 2023 Earnings  Call dated Oct. 05, 2023

Corporate Participants:

Aida Orphan — Vice President of Investor Relations

Chip Bergh — President and Chief Executive Officer

Michelle Gass — President

Harmit Singh — Chief Financial and Growth Officer

Analysts:

Robert Drbul — Guggenheim Securities — Analyst

Jay Sole — UBS — Analyst

Matthew Boss — JPMorgan — Analyst

Oliver Chen — TD Cowen — Analyst

Laurent Vasilescu — BNP Paribas Exane — Analyst

Presentation:

Operator

Good day, ladies and gentlemen, and welcome to the Levi Strauss & Company’s Third Quarter Earnings Conference Call for the period ended August 27, 2023.

All parties will be in a listen-only mode until the question-and-answer session, at which time, instructions will follow. This conference call is being recorded and may not be reproduced in whole or in part without written permission from the Company. This conference call is being broadcast over the Internet and a replay of the webcast will be accessible for one quarter on the Company’s website levistrauss.com.

I would now like to turn the call over to Aida Orphan, Vice President of Investor Relations at Levi Strauss & Company.

Aida Orphan — Vice President of Investor Relations

Thank you for joining us on the call today to discuss the results for our third fiscal quarter of 2023.

Joining me on today’s call are, Chip Bergh, our President and CEO; Michelle Gass, our President; and Harmit Singh, our Chief Financial and Growth Officer.

We have posted complete Q3 financial results in our earnings release on the IR section of our website, investors.levistrauss.com. The link to the webcast of today’s conference call can also be found on our site.

We’d like to remind you that we will be making forward-looking statements on this call, which involve risks and uncertainties. Actual results could differ materially from those contemplated by our forward-looking statements. Please review our filings with the SEC, in particular, the Risk Factors section of our Form 10-K and the information included in our quarterly report on Form 10-Q that we filed today, for the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today and we assume no obligation to update any of these statements.

During this call, we will discuss certain non-GAAP financial measures. These non-GAAP measures are not intended to be a substitute for our GAAP results. Reconciliations of our non-GAAP measures to their most comparable GAAP measure are included in today’s press release.

Finally, this call is being webcast on our IR website and a replay of this call will be available on the website shortly. Please note that Chip, Michelle, and Harmit will be referencing constant currency numbers unless otherwise noted. Today’s call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed.

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

Chip Bergh — President and Chief Executive Officer

Thank you, Aida. Good afternoon, everyone, and thank you for joining us. I’m delighted to have Michelle joining us on the call today. I’ll start with some high-level comments overall on the business before passing it to Michelle, who will share her impressions and thoughts on the business after nine months. Harmit will then take you through the financials and guidance and I will wrap up before Q&A.

Overall, we had a solid quarter despite the challenging environment. Reported revenues were flat to prior year and down 2% on a constant-currency basis, as the strong double-digit growth of our direct-to-consumer business was offset by continued softness in the wholesale channel, particularly in the U.S.

Gross margins exceeded our outlook even as we continue to make excellent progress on inventory, with inventory growth now roughly in line with revenue on a comparable basis. Our disciplined execution, combined with the margin upside, enabled us to deliver EPS consistent with our expectations.

There are three main points I want to make about the quarter and our business overall. One, the Levi’s brand continues to go from strength to strength and arguably is the strongest it has ever been. This is backed up by several proof points. First, AURs continued to grow despite the pricing action we took in the U.S. wholesale at the end of Q3, primarily driven by mix. We continue to grow share with the higher income consumer and see strength in our full price mainline business, with strong sales momentum of our Tier 1 and Tier 2 products. In addition, the Levi’s brand continues to gain U.S. market share, up in men’s, women’s and our core 18 to 30-year old age group. Finally, we continue to see strength in our brand equity metrics, growing our brand consideration and unaided awareness in denim across key markets. As we look forward to the holiday season in 2024, we have an exciting pipeline of product initiatives and collaborations to build upon the strength of the brand, including partnerships with Crocs, Kenzo, Denim Tears, the K-pop band NewJeans and more. Our other brand segment also shows strength. Together, Dockers and Beyond Yoga are now generating nearly $0.5 billion in the annual revenue. Beyond Yoga had a very strong quarter, up 25% versus prior year. Despite the impairment charge we took on Beyond Yoga, which Harmit will explain in more detail, we remain very bullish about this brand long-term. We will finish this fiscal year with six retail stores, including our first store outside of California and Chicago.

Two, our strategies are right. They are working and they’re driving our results. I just covered our first strategic priority of driving our brands and being brand-led. Our second priority is to strategically focus on DTC, which both Michelle and Harmit will discuss further. The DTC business grew 13% in Q3 versus prior year and comped positively in every region and across mainline, outlet, and e-commerce. Comp traffic was also up in every region and in every channel, underscoring the strength of the Levi’s brand. Our e-commerce results have accelerated with 18% growth this quarter on top of the 16% growth in the prior year quarter. In the U.S., our DTC business grew 10%, and U.S. mainline which sells our most premium product, comped double-digit versus year ago. While DTC is our channel priority and will continue to be a key growth driver for the company, our wholesale business remains important. It amplifies our brands, creates access for consumers, and contributes to the bottom line. However, wholesale will continue to be a smaller part of our mix over time as we drive outsized growth in DTC. Global wholesale was the drag on our business in Q3, down 10% this quarter compared to up 6% in the prior year. We’re focused on the controllables to stabilize this channel and wholesale is showing sequential improvement from the prior quarter. Early indications from the pricing actions we took in U.S. wholesale late in Q3 are positive. Exiting the quarter, we also began to see the impact of our lower inventories and improved fill rates. We expect sequential improvement in U.S. wholesale trends behind the impact of the surgical pricing actions in August and customer fill rates normalizing in Q4. This will also ensure greater newness on the floor as we head into the critical holiday period.

Our third key strategic priority is to continue to diversify the company, driving growth in international, women’s, and tops. Our international business continued to outpace the total company, growing plus 5%, excluding Russia. Asia was again the standout, with strong double-digit growth in our three largest Asian markets, India, China, and Japan. Our women’s business was up driven by a 5% increase in Levi’s women’s bottoms. We continue to see a shift to low-rise and ongoing strength in loose fits where we continue to expand and evolve the assortment. Tops revenue also grew driven by strength in wovens, non-graphic tees, outerwear, dresses and polos.

Finally, we have a strong team around the world to deliver on the strategy and our long-term goals. A big reason for my confidence in the future is my successor. I knew when we hired Michelle late last year that she was going to be a great leader for our company, as she brings 30 years of retail experience, including five years as a CEO.

After working very closely together for the last nine months, I’m even more convinced that she is a great choice. One of my top priorities for this year has been to set us up for a successful and seamless succession. Michelle has been a quick study and as you will hear, clearly sees the opportunities ahead of us, which will allow us to achieve our long-term goals.

Now it’s time you hear from her about her impressions and how she is seeing the future. Michelle?

Michelle Gass — President

Thanks, Chip, and welcome, everyone. Since I joined the Company in January, I have fully immersed myself in our business, getting to know our Company, our customers, our consumers, and our employees around the globe. We have a vibrant global business, phenomenal brands, a fantastic culture inherited and amazing people. It’s an honor and privilege to be part of this incredible organization. Over the past decade, the Company has made great progress and I see tremendous opportunity to build on this strong foundation in the years ahead.

I joined LS&Co. because of the global potential of our business and our brands, particularly the iconic Levi’s brand as well as the Company’s longstanding commitment to profits through principles and doing right by our employees and consumers. Now, nine months in, my optimism and conviction has only grown as I have learned more about the strength of the brand and our growth opportunities. After seeing this business up close and working with our talented team, I believe now more than ever that our strategic choices and goals introduced during our Investor Day in 2021 being brand-led, taking a DTC-first approach, and diversifying our portfolio, are the right ones to generate long-term value for all of our stakeholders.

Today, we are at an important inflection point, and by leaning into our strength, I have strong conviction that we will unlock the next decade of profitable growth for our Company. As part of our strategic pillars, I’ve observed three key areas that will be instrumental in helping us achieve our ambition to become a $9 billion to $10 billion Company. First, accelerating international growth. Second, becoming a Denim apparel lifestyle business, and third, transforming our operating model into a best-in-class DTC-first organization.

First, I’ll start with the growth potential internationally. Levi’s is the number-one denim brand in the world, bigger than the next three global competitors combined. The Levi’s brand has wide appeal with leadership across all generations, is increasingly relevant with a younger and more diverse generation, and is solidifying the next generation of Levi’s fans. We’ve done this by constantly putting Levi’s at the center of culture, driving a strong connection, and building brand Love with consumers around the world through leading products and impactful marketing. This year, Chip, Harmit, and I visited a dozen markets abroad. And in each one, I’ve been inspired by how the Levi’s brand transcends cultures and demographics and is beloved across markets. Over the last decade, our international business has grown more than 50% and we’ve become the number one player in many markets where we’ve invested in growth. And given the immense opportunity we see looking ahead, we are confident in our ability to sustain high-single-digit growth in our international business over the long-term.

Levi’s is not just an iconic American brand, but has become one of the most iconic brands in the world. And today while we are in a 110 countries, there is great opportunity to grow in markets where we already have a strong long-standing presence as well as in new and emerging markets. Let me give you two examples, Mexico and India. Mexico is the Company’s largest market after the US. Sales have grown nearly 40% versus pre-pandemic levels while generating strong profitability. Today, Mexico boasts the highest brand equity in the world. We have done this through strong execution across brand-building, locally relevant product assortment, great real estate decisions, and DTC and wholesale momentum.

Our team did a great job keeping our eyes on emerging trends in the market and capitalizing on center of culture moments, enabling us to connect with authenticity to the local consumer. For instance, we recently opened a House of Strauss in the Mexico City neighbourhood in the heart of the action with the booming design, art, music and architecture community.

We opened our first House of Strauss nearly two decades ago in LA as a dedicated place to build relationships with creative and entertainment communities and interact with those that drive culture and shape future fashion trends that become mainstream. Our House in Mexico City has already generated tons of buzz and high engagement with billions of impressions on social media so far. Next month, we’ll also be front and center at Corona Capital, the largest music festival in Mexico, with an exclusive product release featuring a range of stylish pieces, including limited edition trucker jackets and graphic tees, driving tons of energy through local relevance and overall excitement around the brand. We know there is an opportunity to deploy the same playbook, constantly keeping the brand at the cultural center around the world and our success in Mexico has provided us with great learnings we plan to use at scale moving forward.

India is another country that not only highlights our successful regional expansion playbook but also demonstrates our ability to deliver a true denim lifestyle offering. One of the most exciting consumer markets, India is the fastest-growing major economy in the world in 2023, and with more than half the population under the age of 30, we see India as one of our significant growth opportunities for the Company.

The Levi’s brand has increased nearly 50% in this important market compared to pre-pandemic revenue levels, becoming our sixth largest country and now the largest in Asia. India is primarily a franchise market and the strong growth is largely a reflection of the conviction of our partners in the power of our brands. For example, during the pandemic, our franchisees doubled the Levi’s brand square footage in key malls across India to take advantage of the long-term opportunity they see. When I visited the market earlier this year, I was energized hearing from our consumers about their optimism for the future and how excited they are about the Levi’s brand. And how they see Levi’s, not just as a denim brand, but as a full lifestyle brand.

In India, the team has done a great job curating a diverse product assortment across tops and bottoms, driven both by our global design engine as well as our local product capability. In fact, India has our highest top penetration in the world, selling one top for every bottom. We are further strengthening our connections with the youthful Indian consumers through local collaborations and brand-building, such as our partnership with Bollywood Superstar Deepika Padukone, who has been our brand ambassador since 2021, has become one of the biggest celebrities in the country and worldwide. We see similar brand resonance across many emerging markets and plan to expand our presence in a similar way.

My second observation building on our diversification strategy is that we have an incredible opportunity to evolve from being known as a great jeans brand into a true apparel lifestyle brand. As I referenced earlier, Levi’s is the unequivocal global leader in jeans and by a big margin. And we can take this denim leadership into head-to-toe denim dressing, across skirts, dresses, and more top. We can and will become the market-share leader in all aspects of denim dressing, which is an untapped market for us today. Recognizing this opportunity earlier this year, we chased into denim skirts and dresses for the summer and fall using a new agility capability we’re building. While it’s still a small business for us today, we are seeing promising results with dresses and skirts up nearly 40% in Q3. And looking forward, we are chasing to more product just in time for the holidays and I’m excited about what’s coming in 2024.

We are also uniquely positioned to extend our authority in bottoms to categories beyond denim. For example, we are seeing great success with platforms like the XX Chino, which grew over 40% in Q3. We are continuing to develop this category and we have some exciting new fabric innovations coming next year that we look forward to sharing in the coming months. And, while we have made steady progress over the past few years growing our tops business to over $1 billion annually, with staples like our signature tees and truckers, the opportunity remains much larger. Over the last year, the team has spent time sharpening our strategy on how we can build a more differentiated casual top business. We are investing in design and product development capabilities, reducing our speed-to-market and expanding our vendor base to become more competitive. This work is underway and I am excited about what is coming in tops and outerwear for Q4 and especially about what is in the pipeline for 2024.

Finally, my third area to emphasize is the importance of our transformation into a world-class DTC-first Company. Over the last decade, the Company has made phenomenal progress, more than doubling our direct-to-consumer revenue, while engaging consumers with the highest expression of our brand in our stores. And we see a clear line-of-sight to the mid-teens DTC growth rate target of our long-term financial algorithm. With this strong momentum and consumer permission, now is the time to accelerate our transition to DTC where we will evolve our culture and operating model and our consumer centricity will drive every aspect of how we operate. As I visited many stores around the world, I have been impressed by the passion and commitment of our teams, how they have driven consistent strong comp growth over the last few years and how they serve our millions of Levi’s fans all over the world. However, I’ve also observed that we have many opportunities to drive greater productivity and enhance the consumer experience. It starts with thinking like a merchant and mastering retail fundamentals like having key items always in stock, elevating our in-store storytelling, adopting a chase mentality and broadening our assortment to drive traffic and increase shopping frequency.

We also have the opportunity to streamline our backroom operations so that our store teams can focus even more time on serving customers and less time on administrative and operational tasks. Unlocking further productivity in our stores is a critical enabler to driving overall profitable growth and to accelerate further new-store expansion opportunities globally. I also see tremendous upside in our e-commerce business. We have a great team in place that is focused on addressing the fundamentals, driving quick wins in areas like search and navigation. We are already seeing the benefit today in our results as e-commerce comps are accelerating.

Looking forward, we are focused on expanding our offer to our broadest best of Levi’s assortment as well as enhancing the site experience. We’re also focused on expanding and evolving our successful loyalty program which gained nearly 2 million members in the third quarter to reach 28 million members globally. This successful program is helping us forge deeper consumer connections while developing valuable insights from our most loyal fans.

On the path of becoming a DTC-driven Company, our wholesale business remains an important part of our business and a driver of consumer connection. Wholesale amplifies our DTC strategy and extends consumer reach. We have strong decades-long relationships with our key wholesale partners. And while the recent year has been challenging, I am looking forward to working with our partners to stabilize and return this channel to growth. Near-term opportunities include improving our supply chain execution, ensuring the continued success of our pricing optimization plan and delivering more newness and innovation. The work we are doing today and in the years ahead will help us further drive sustainable, profitable, long-term growth.

I could not be more excited to be here at LS&Co., working with this amazing team to build upon our legacy, feel the momentum we have built over the past 10 years and guide the Company to the next phase of growth.

Now I’ll turn it over to Harmit to walk through the financials for the quarter.

Harmit Singh — Chief Financial and Growth Officer

Welcome, everyone. I will begin my comments today by sharing three key observations about our business and our results before diving into the numbers.

First, we are achieving strong progress in our areas of strategic focus. In the third quarter, we sustained prior year revenues by driving growth in our direct-to-consumer and international businesses. We are seeing our strong momentum in these businesses continue and we exited both July and August with positive overall growth as a Company. I can also share that we are seeing our business in the US improve relative to quarter three, driven by an improvement in US wholesale.

Second, our operating discipline is driving results. In Q3, we brought inventory growth down to just 1% on a comparable basis, but not at the expense of gross margin, which exceeded our expectations for quarter three and enable us to deliver adjusted EBIT in line with our outlook.

Finally, as Michelle mentioned, over the coming year, we will accelerate our transition to a DTC-driven business by creating a more nimble and consumer-centric organization to support our evolution into a global powerhouse in retail and e-commerce, while supporting our low-growth wholesale business.

Given the strategic acceleration to DTC and a smaller US wholesale business, we have initiated a broad-based review of our overall operating model, and our entire cost structure. We expect this review will result in material cost and working capital savings, including increased profitability and productivity of our DTC business. As we have demonstrated in the past, we are confident that these efforts will solidify our long-term adjusted EBIT margin goal and we plan to share more details about the impact of this initiative, next quarter.

Now, let’s turn to our third quarter results. Our DTC channel posted 13% growth lapping high single-digit growth in Q3 ’22, with continued broad-based positive comp sales growth across geographies and all channels, driven by higher traffic and volume. Comp sales have been positive since 2022, reflecting six consecutive quarters of growth. We view our franchisees as a complementary extension of our own direct business, enabling us to present our brand in the best light while driving strong return. Along with our franchisee partners, we have opened 61 net stores year-to-date excluding Russia. And together, our DTC and franchise business comprised almost 50% of total net revenues in Q3, up from 44% in the prior year.

Adjusted gross margin of 55.6% came in better than our expectations driven by the favourable mix-shift to DTC. Versus prior year, gross margin contracted 130 basis points, yet was 260 basis points above Q3 ’19. Overall, the contraction was driven by lower full price sales, higher product costs, and strategic pricing actions to drive volume and capture market share, partially offset by favourable channel and geographic mix, lower airfreight and FX.

Adjusted SG&A expenses in the quarter were $702 million, up 4% to last year, in line with our guidance. The increase was entirely driven by DTC expansion with Company-operated store count up 9%.

Adjusted EBIT margin was 9.1% and adjusted diluted EPS was $0.28, both in line with our expectations. Our adjusted diluted EPS excludes a $90 million non-cash charge related to the impairment of the Beyond Yoga acquisition in conjunction with our annual testing. The impairment was due to strategically investing in the brand and team and slowing previously anticipated expansion in response to the current macroeconomic conditions, as well as an increase in discount rate.

Despite the accounting impact to EPS, Beyond Yoga continued to perform well, up 25% in Q3 and 21% year-to-date. We are being disciplined with our approach to growing the brand and remain committed to driving its long-term profitable growth.

Here are the key highlights by segment, with all revenue growth in constant-currency. In the Americas, net revenues declined 7% on top of 3% growth a year ago. DTC strength with growth of 11% was broad-based, on top of 8% growth in the prior year.

Latin America saw continued growth up 7% driven by all markets led by Mexico and Brazil. While Europe was down 3%, excluding Russia, we saw sequential improvement as we move through the quarter, with both July and August up versus prior year. Despite record temperatures this summer, DTC momentum continued with the channel up 11%, excluding Russia, driven by broad-based growth across countries and a particularly strong performance in our mainline business. Strength in DTC was offset by wholesale softness as customers broadly remain cautious with their open to buy. While we are continuing to focus on accelerating our DTC business, we are also working closely with our wholesale partners to ensure they have the right assortment and deliver newness including lighter-weight denim, more dresses, and tops. Asia, again saw a strong growth, up 18% while lapping very high 53% growth last year, driven by continuous strength across all channels, particularly DTC and almost all markets. Asia’s top market, India, China, and Japan, were all up strong double-digits as where Turkey, Thailand, and several others. Asia’s operating margin also expanded 330 basis points to 12.3% due to strong leverage.

Now looking to our balance sheet and cash flow. We achieved strong progress on our inventory goal in Q3. Reported inventory dollars increased 6%. However, more than two-thirds of the year-to-year increase was driven by the modification of supplier term with us, now taking ownership of inventory for goods being brought into the Americas, closer to the point of shipment rather than destination. This is consistent with existing terms for goods sent to Europe and Asia. This change is enabled by the recent upgrade of our ERP and simplifies our global ways of working with suppliers in line with industry standards.

Adjusting for this change, inventory increased just 1%, representing a 17 point deceleration from last quarter. Inventory in the US is already below last year’s level and we expect to continue to make progress in Q4, with overall inventory below prior year levels by year end on a comparable basis. Though inventories are now in line with expected revenue growth and by Q4 end, will be down year-over-year, we are working to further optimize inventories and improve turns and working capital.

Adjusted free cash flow was a negative $21 million in the quarter, down from $12 million in the third quarter last year. As we continue to improve our inventories through the year, we also expect to end the year with positive free cash flow. We are confident in our cash flow position and have now fully repaid this outstanding ABL borrowing. In the quarter, we returned approximately $48 million in capital to shareholders via dividends, which were in line with Q3 last year. For quarter four ’23, we have declared a dividend of $0.12 per share, in line with last quarter.

Now turning to our outlook. While reported revenue was flat for the third quarter, as mentioned earlier, we exited quarter three with continued momentum in our global DTC business and improving trends in US wholesale in September. However, given the ongoing uncertainty in the macro-environment, we are taking a cautious approach to our outlook for the fourth quarter. For the full year, we are now guiding revenues flat to up 1%. By segment, we continue to expect a low single-digit decline in the Americas despite continued strength in US DTC and in Latin America.

Europe’s growth is still expected within the previously guided range of up low single-digits, excluding Russia. And for Asia, we continue to expect growth in the low-teens. For the fourth quarter, this implies a low-to-mid single-digit revenue increase. We continue to expect adjusted gross margin to contract approximately 90 basis points from prior year’s 57.6%. This translates to up approximately 300 basis points versus 2019 for the full year and the fourth quarter. We continue to expect a full-year mid-single-digit increase in SG&A dollars, yielding an adjusted EBIT margin of up to 9% for the full year and approximately 12% for the fourth quarter. Given these factors, we are narrowing our EPS outlook to the low end of our previous range of $1.10 to $1.20. Lastly, we expect the Q4 tax rate in the high single-digits and inventory levels below prior year by quarter-end on a comparable basis.

I will now turn it back over to Chip for closing remarks before opening up the call for Q&A.

Chip Bergh — President and Chief Executive Officer

We continue to control the controllables while navigating an environment with a heightened level of macro uncertainty around the world. We are confident in the strength of our brand and the newness and innovation pipeline we have coming. Our actions to stabilize US wholesale are working and our continued strong performance in global DTC underscores the strength of our brand and deep connection with consumers and is enabling us to deliver near-term results while laying the foundation for sustainable, profitable growth in the years ahead.

And as you’ve heard from Michelle and Harmit, given our momentum, now is the time for us to accelerate our transition to a DTC-driven business by advancing the organizational structure to support our ambition. My confidence in our leadership and our team remains extremely high and we’re focused on executing with discipline and rigor on our priorities.

Latif, with that, you can open the floor to Q&A.

Questions and Answers:

Operator

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Bob Drbul of Guggenheim.

Robert Drbul — Guggenheim Securities — Analyst

Michelle, welcome. I guess, if I could, just like to focus a couple of questions for Michelle, two-part one question. What surprised you in your first nine months at Levi so far?

And I guess the second part of it would be, just given your background, what steps do you think are necessary to really stabilize the wholesale business? Thanks.

Michelle Gass — President

Thanks, Bob. Thank you for the question. So, first, in terms of being surprised, well, I’d first say that, I just couldn’t be more excited to be here. It is an incredible Company. It’s one of the most iconic brands in the world, awesome opportunities for growth ahead and an amazing team. And so it really is just an honor and privilege to be here. I’d say, what’s been most surprising is, I think back to the seat I held before and I knew Levi’s much more as a U.S. wholesale bottoms business. And I spent last nine months traveling around the world with Chip and Harmit and others of the team and I’ve just honestly been blown away by the power of our brand internationally. The DTC presence, how our brand shows up much more as a lifestyle brand, candidly, and many other markets outside of the U.S., how premium we are, the resonance with youth that [Technical Issues] center of culture, we are across all of our markets.

We have got the power of the global brand, but then how the local market adapts to be highly relevant. And while we’re investing and growing the brand, our partners are too. I mean, as you know, we’ve got many franchisee partners around the world and through our travels have had the opportunity to hear from a number of them. And they are really passionate, really committed, and they too are investing. I mentioned India on the call where they invested a lot of dollars in the pandemic to dramatically grow our stores and grow our footprint. So, yes, so I’d say for me, one of the biggest takeaways has been that and I just see a ton of growth potential. And as I mentioned in my remarks, and I’ll just hit these very quickly, but beyond international, this pivot to DTC is really incredible. And we’re talking about international, the U.S. market is still clearly very important. We’re seeing DTC growth as we talked about earlier on the call, across all channels of DTC, so a lot of upside there.

And then lastly, I’ll just hit on and then may be more questions on this, but this opportunity to continue to build on the work the team has done to really pivot the brand from a jeans brand to a denim apparel lifestyle, I’m happy to entertain further questions on that, but that head-to-toe denim with everything from denim tops to denim skirts to denim dresses and beyond and there is a lot of untapped opportunity there. And then lastly, I’d say, the teams [Technical Issues] is bar none. Just an incredibly talented team, deep bench and then not only with the great talent we have in place, but we’re bringing in new talent to complement the capabilities we have here today. As we’ve talked about before, we brought in a new Chief Digital Officer, we have a new Chief Marketing Officer, and then most recently, a new Head of Logistics and Distribution. So we’re really set up with the team to drive our agenda.

So part two of your question is around wholesale, which indeed, I do have some familiarity with. And while as we look ahead, DTC will be significant growth, wholesale still really important to our business, is an incredibly important channel, it’s big, it’s profitable, and I think strategically, and importantly, it extends our reach with consumers. We’re not going to show up in every single town across America and across the world. And so our partnerships are really instrumental in extending our brand and product reach. We have long relationships with these customers. We are important to them and they are important to us and I’m really excited I met with many of them during my time here. It’s not the year that any of us anticipated, there are clearly headwinds, but we have our arms around the issues.

I’d point to three things. One is the macro issues we’re all familiar with; the second is some value concerns that our customers were talking to us about some of our fits, which we’ve addressed; and then third, we have faced over the course of the year some congestions in our DCs, which are largely behind us. As we’ve addressed the issues, we have seen sequential improvement. I think Chip mentioned that earlier on the call. And so each month across the quarter improved and then even in the early days of this quarter, we are continuing to see improvement there.

I think beyond that, though, so addressing, I call it the fundamentals of the value equation and executing our shipments. It’s about product and it’s about innovation. And we talk about just having this lifestyle expression of our brand in our own stores, that’s unique. And we can do a better job there with our wholesale partners. And so whether that’s head-to-toe denim dressing, bringing more fashion, bringing more innovation and you’re going to see some of that as early as this fall and holiday, where I believe we’re really set up, but I think importantly, as we look into 2024, we have a very deep pipeline we’ve been presenting to customers. We have a new innovation platform that we’ve already started to tease out there. I’ll talk about that at some point in the future. But we’ve got a lot in front of us to believe that we can stabilize and ultimately reinstate growth in this important channel.

Robert Drbul — Guggenheim Securities — Analyst

Thank you. Good luck.

Michelle Gass — President

Thanks, Bob.

Aida Orphan — Vice President of Investor Relations

Thank you.

Operator

Thank you. Please standby for our next question, which comes from the line of Jay Sole of UBS.

Jay Sole — UBS — Analyst

Great. Thank you so much. Harmit, you mentioned going through an overview of the cost structure, maybe outline a little bit more or elaborate a little bit more on what you mean in terms of quantifying the impact that you see. And maybe if you put it in the context of the adjusted EBIT margin guidance of 15% that was given as part of the long-term management targets of the Investor Day in June ’22 that would be super helpful. Thank you.

Harmit Singh — Chief Financial and Growth Officer

Sure, Jay. Michelle talked about how we are making this faster pivot to DTC. And we believe that will accelerate our growth. While it’s early, we recognized that this company has a lot of opportunities to be faster, more agile, to be efficient, including shorter go-to-market calendar. So let me give you an example. Before Michelle arrived, we didn’t have dresses and skirts, and [Technical Issues] of this year. You’ve got it, right? That is acting more like a vertical retailer versus a wholesaler, who has go-to-market [Technical Issues] over 12 to 15 months. We are going to take a hard look at our assortment and drive more productivity. Like a lot of the companies, we also have a lot of tail. But the tail doesn’t move as fast. So taking a hard look at that, I think, is critical.

So we are looking at all processes, we are looking at go-to-market, and we are going to be a lot more consumer-centric. In terms of areas, we think this drives more productivity in our DTC operations and profitability. We think it does drive a better SG&A structure. It improves our supply chain operations, including COGS and clear working capital improvements as we drive higher turns because we are not satisfied. While we get to below inventory level, below last year inventory levels at the end of the year, we think there is a lot more opportunity. And I know I really understand, if I was in your shoes, you want us to quantify this fairly quickly, but what I will tell you is that, give us through the end of quarter four when we release our expectations for next year, we will back [Technical Issues] the impact.

Your question about the 15% EBIT margins, we are completely behind that. We are going to be a Company that has 15% EBIT margins over time. This focus, we are looking at the entire cost structure of the Company, just solidifies our part to get there and get there the right way and get there during the timeframe that we believe is acceptable to our long-term shareholders. So we are committed to the 15%. This helps get us there and [Technical Issues] and then really make this Company a lot more efficient and agile.

Jay Sole — UBS — Analyst

Got it. Thank you so much.

Operator

Thank you. Please standby for our next question. Our next question comes from the line of Matthew Boss of JPMorgan.

Matthew Boss — JPMorgan — Analyst

Great. Thanks. So, Chip, maybe on global health of the brand and category. Could you just elaborate on the sequential sales improvement and speak to current demand trends that you’re seeing across channels in North America and Europe today? And then for Harmit, could you speak to inventory health across distribution channels and just the puts and takes that are embedded in your fourth quarter gross margin outlook relative to three months ago?

Chip Bergh — President and Chief Executive Officer

Sure. First of all, Matt, I’ll try not to be too repetitive with what was in the prepared remarks, but we’re seeing a dramatic or stark contrast between the results in our direct-to-consumer business versus wholesale. So direct-to-consumer up pretty strong double-digits, up in every region, up in mainline, outlet, and e-commerce, plus we comped positively in each chain in each region and each channel on each region. So really strong results there during the quarter, and wholesale down pretty soft. And as we’ve kind of been digging into this, one of the things to consider is, our DTC assortment is very, very broad, tops, bottoms, men’s, women’s. We can also be pretty agile in responding to it. We’re going to work on becoming even more agile, as Michelle said. But it’s been a pretty hot summer as everybody knows. And you all have known me for a long time, I barely talk about the weather report when I’m talking about our business results, but I think there is no doubt that our wholesale business was somewhat impacted by the really, really hot summer, because the wholesale assortment is pretty much denim bottoms. We did take the pricing action late in Q3.

So, we announced it, we first talked about it on this call. We announced it to our customers and it went into effect in early August. Every customer kind of executes it on their own timing and they execute it their own way and that kind of [Technical Issues] throughout the month of August. So what impact we did see on those six items where we took pricing actions here in the US. It was late in the quarter, but I will say that we are optimistic with what we’re seeing. We are seeing an improvement in trends on those items in those customers where we have seen the pricing reflected and that gives us confidence that we did pick the right items. I’ll also say, you all remember, we did not take pricing down on a number of items, 501s being one specifically and the 501s were up this past quarter.

So I think we were very surgical and very strategic. We’re optimistic about that. Our wholesale trends, though they were down 10% [Technical Issues] they were better than they were the previous quarter. And our expectation is that they are going to be better in the fourth quarter in part because of the pricing actions that we’ve taken, having a full quarter’s impact of that, in part because this inventory situation that we’ve had for multiple quarters is now cleaned up and we’re getting back to more normalized customer fill rates, that’s going to help build the pipeline, where there have been out-of-stocks, that’s going to help get new product out onto the floor. As Michelle said, both in the prepared remarks and in the earlier Q&A, we’ve got a pretty strong pipeline coming for the holiday and into Q1.

So we’re cautiously optimistic. The category was soft. The best data that we have is in the US, that’s where we get really good concrete data on a quarterly basis. It was down mid-single-digits, apparel was down mid-single-digits. Again, the consumer being pressured, the combination of that with the hot weather did have a negative impact on the category. But, having said that, we grew share. And we grew share on men’s, we grew share on women’s, we grew share with the critical 18 to 30 year old. So the brand is absolutely strong and we’re in control of it. In our own direct-to-consumer channels, we’re killing it right now. And the issue is fundamentally the wholesale channel. And as I said, we’re making sequential improvements there and I think it’s going to help.

Harmit Singh — Chief Financial and Growth Officer

And Matt, to your question, I think you asked two questions, one was inventory and the second was gross margins for Q4. So, on inventory, we ended the quarter better than where we thought we’d be. The US is actually down relative to last year already, which is great given the large wholesale presence here. We also look at trade inventory in terms of number of months of our key wholesale customers and that is better than a quarter ago. So, that inventory situation is getting better. Inventory in Europe is in a good spot, because Europe was a little soft, so I think overall, largely because a large piece of our assortment is core and we sell a lot of core, I think, we are in a good spot from that perspective. To your question about gross margins, which we are getting better for the business, we beat gross margin expectations in quarter three largely driven by the continued strength in our direct-to-consumer business.

If you think of the puts and takes, I know it’s a key question that my friend Lauren and you asked, which is, you know, so what drove gross margins relative to expectation, largely the growth in DTC, which is structural and here to stay. I think relative to a favourable channel mix, favourable FX, and lower airfreight were the tailwinds. The headwinds were largely the pricing actions that we have initiated and lower full price sales relative to a year ago. Thinking about quarter four, quarter four we expect to be ahead of last year in gross margin, still ending the year slightly down, but quarter four, as I said in the prepared remarks, gross margin should be 300 basis points higher than 2019 and so what are the puts and takes and see the tailwinds on gross margins in quarter four, product costs a little better largely because commodities have come back and you’ll start seeing this benefit essentially in ’20 — in ’24. Lower airfreight and lower promotions relative to a year ago. I mean quarter four last year was very promotional. But our expectation is that, since trade inventory is in a better spot, our inventory is in a better spot, Michelle talked about us, you know, having a better pipeline as we head into a holiday season across both channels, that should drive a lot more innovation interest. So I think those are the factors that we think really help lift gross margins year-over-year in quarter four.

Matthew Boss — JPMorgan — Analyst

Great. Best of luck.

Harmit Singh — Chief Financial and Growth Officer

Thank you.

Operator

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

Oliver Chen — TD Cowen — Analyst

Hi. Thank you. Hi, Chip, Harmit, and Michelle. Our question was about capabilities and the capabilities you may need to prioritize as you become more of a lifestyle brand with non-denim execution as well and that likely ties into your thinking around the agility and chasing capabilities, which will be very powerful.

A follow-up was on fill rate. It sounded like fill rates are where you want them to be. What’s happening there and you don’t expect any more changes there, are you happy with that, because it’s been a work-in-progress for the past few quarters. Thanks.

Michelle Gass — President

Hey, Oliver. Good to hear your voice. Michelle here. So I’ll take the first part of the question on capabilities and then I’ll hand it over to Harmit on fill rate. So, yes, like I said, I’m super excited about the opportunities we have, I’d say both, well, all of the opportunities we have, whether that’s growing our international business, it’s DTC, and then, of course, category expansion and we’re building capability across all fronts, candidly. I think related to I’d put DTC together with the lifestyle category piece in that, in both cases, to operate like a vertical retailer, you need speed and agility. And we talk about more broadly making this pivot, it’s operational and it’s cultural. It’s how we use data to drive real-time decisions. Capability-wise, I’ll go on two fronts, one is it relates to products which I think was largely around your question. It’s really end-to-end.

So we start with our go-to-market timeline. It’s too long today. It was built over years highly successful, but was built to serve a US wholesale bottoms business, that can move a lot slower than if you’re a direct-to-consumer global denim lifestyle business. And there should be multiple tracks of timelines across different products. For example, as you know, tops and especially fashion tops operate on a much faster timeline than say your core 501 denim bottoms. Not saying we’re going to become fast fashion, that we’re not going to, but getting inside of a 12-month timeline is imperative for us to both drive relevance in these categories and then make sure we get the kind of turns that we need in a DTC business. So there is a lots of teams working on kind of unpacking and refining what this new go-to-market process will be and there has already been a lot of great progress. Secondly, as it relates to capability, it’s design, it’s product development, it’s our vendor base.

Again, I’d say over my time here, there has already been tremendous progress. We have deep capabilities today in design and product development. We’re supplementing that. We’re bringing in new talent across these fronts. And I’ve been really excited to see, again in my short time, how we’ve expanded our vendor base, to bring in vendors who have key capabilities and expertise in areas like tops or dresses et cetera. And then to your point, from an end-to-end supply chain, when you’re in direct-to-consumer whether that’s your stores or in e-comm, you want to be able to have the flexibility to chase into things that are working really well or pull back if they’re not and so that’s in the supply chain side of things, but it’s literally like on the floor. So, the last thing I’d say is, really excited about the capabilities we’re building to run a retail organization. So, what’s happening with our stores, our people, training, really putting the stores and our e-comm channel at the center and giving our stores the empowerment to run their business. So a lot to do. I think there’s a lot of good progress already underway.

And then, Harmit, over to you on —

Harmit Singh — Chief Financial and Growth Officer

Yeah. On fill rates. Oliver, let me just start by saying, you know, we really have a lot of great people, a lot of good talent running our DCs around the world and a shout-out to them. It’s been tough, largely because we had more inventory. We really have been working collectively as a team to try and decongest our DCs, so that we could start servicing our customers and our stores. And that sequentially improved as we exited quarter three. It’s got a lot better in September and our view is that by the end of quarter four, this issue is behind us from that perspective. A couple of things, we have opened a new DC, the digital DC in the East Coast and that is a service our e-commerce platform. That makes a difference because we have more capacity. And our focus right now is to service our full price SKUs, to service DTC and ensure that as we get ready for the holiday season, the newness is on the floor. And so, I think to your point, it’s [Technical Issues] every day and the teams are committed to ensure that we don’t miss a sale.

Oliver Chen — TD Cowen — Analyst

Thank you. Best regards.

Harmit Singh — Chief Financial and Growth Officer

Thanks, Oliver.

Operator

Thank you. Our next question comes from Laurent Vasilescu of BNP Paribas.

Laurent Vasilescu — BNP Paribas Exane — Analyst

Good afternoon. Thank you very much for taking my question. And Michelle, it’s great to have your voice on the call. Chip, Harmit, I would love to ask about the strategic pricing actions you took in your Tier 3 distribution in US. Just a little bit more color around just what you saw in terms of price elasticity. Are you confident that it should be isolated in the Tier 3 distribution or would you potentially revisit this across other silhouette styles and points of distribution?

And then maybe just another question, if I may, I would love to hear Harmit, if we go back to 2020, ’21, you talked about $200 million of gross savings. I know you’re not necessarily prepared to talk about it, but could we see some kind of magnitude of that type of savings as you think about 2024 and beyond?

Chip Bergh — President and Chief Executive Officer

Yeah. I’ll take the first question on pricing. And again, I’ll try not to be too repetitive, but I’ll keep it pretty brief because the data is still pretty fresh. As I said, you know, we announced the price increase in early August. Each customer implemented it on their own timing because it was based on sell-in. And so the timing is kind of been rolled out or weaved out customer-by-customer. But where we have seen customers take pricing on these six items, we have seen the trend on those items being flat. We have seen a distinct change in trends. It’s still really, really early though. I mean and we still have some customers, we have one customer that just put the price into place, the reduced price into place this past week. So it is still really early days. And that’s why I’m trying to temper this with a little bit of, not getting too excited about it, but I will say we were very, very disciplined in trying to really understand what were the most price-sensitive items in the line and adjusting the price on those items and those items only. And I feel pretty confident that we picked the right items and that we’re not going to have to go any furthermore. I know that that was a big concern that many had. I think we, you know, we’ve done a good job of isolating where we were really, really vulnerable and we addressed the price-value equation on those items. And our stronger items, as I said, the 501, we didn’t touch the pricing on 501. So I think we’re in a pretty good place right now. My mother said, never say never. So, we’re not saying, we’ll never take the prices down, but at the same time, I’ve got a pretty high degree of confidence that we’re in a good place right now.

Harmit Singh — Chief Financial and Growth Officer

Yeah. And Laurent, to your direct question, I’m not going to get into the numbers. But the fact we’re speaking in the call, the fact that I’ve said is material should indicate to you that this is an important piece of our initiatives that the entire Company is focused on. The difference between this and the last time we did it and we have done it once or twice before, in fact, two times, and it’s made a difference on operating margin. So we have history supporting us. But I think the difference in this case is that it’s towards this pivot to DTC. So we are focused on how to drive more productivity in the whole store — just focus on how to drive more of an improvement in working capital through inventory turns and looking at the cost. And so there is a difference. This is probably going to be [Technical Issues] than the past, but something that will sustain itself and really directed at strategically the evolution of this Company into more of a DTC Company.

Laurent Vasilescu — BNP Paribas Exane — Analyst

Thank you very much.

Harmit Singh — Chief Financial and Growth Officer

Thank you, Laurent.

Operator

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

Chip Bergh — President and Chief Executive Officer

All right. Well, I want to thank everybody. We went over by just a little bit, but thank everyone for hanging in there. Thank you for your questions. I wish everybody, believe it or not, a happy holiday, because the next time we are with you will be in late January when we close Q4 and report our Q4 and annual results. Looking forward to that. And have a good holiday and we’ll talk to you all soon. Thank you very much.

Operator

[Operator Closing Remarks]