Great. Well, welcome everyone. Good afternoon. I'm Jay Sole, UBS's Retailing Department Stores and Specialty Softlines analyst. Welcome. I'm sure you've been welcomed already. I'll just welcome you again to this UBS 2026 Global Consumer Retail Conference. We are honored to have Levi's here with us today. Representing the company is Harmit Singh, Chief Financial and Growth Officer. Also, Aida Orphan is here. She's Vice President of Investor Relations. I think Harmit and I are just gonna have a little conversation, and we'll, you know, we have a lot of questions to get to, so we'll just get started. I guess the first one is, you know, we're gonna talk about two different ways. First, you have two different hats. You have your chief growth officer hat, but also your chief financial officer hat.
I think that the first thing I wanna talk about is just, you know, in your role as Growth Officer, what do you expect will be the most important drivers of momentum as you look ahead into 2026?
Sure. Well, good afternoon, everybody. Thanks for, you know, joining our yin-yang session. Let me just start because, you know, we're in the process of closing quarter one, so, you know, we're in a bit of a quiet period right now. My remarks are not gonna talk about updating trends or, you know, guidance, et cetera, and reflect what we really talked about when we reported earnings a couple of months ago and the guidance for the year. To your question, yeah, you know, one way is two hats, you know. I hope that's the trend for CFOs going forward, you know, because I think, you know, CFOs should embrace growth, and a lot of CFOs do. Just a bit of history. We had a great 2025.
You know, we've guided a strong 2026. If you go back the last few years, our strategies of being brand-led, DTC first, empowering the portfolios, clearly working. Just a bit of stat, you know, our growth has accelerated. We closed last year at 7% organic growth. The year before it was 4%. The year before that it's flat. We've clearly grown market share. I'm happy to talk about it. Positioning ourselves solidly as a mid-single-digit growth company. The second is, while we're growing the top line, we're also accelerating the operating margin. Operating margins 2023 over 9%, you know, 2024, a little over 10%, and 2025, a little over 11%, and we're guiding 2026 as, you know, closer to 12%.
As you think about this pivot from, you know, a company that had its foundation in denim to a company that has its future in denim lifestyle, we have been able to expand our addressable market, which I can talk about. You know, addressable market in the past was probably the denim category, $100 billion. Addressable market going forward is 15x that. I'm happy to share that in a minute. But more importantly, our future is about taking the $6 billion company and making it 10. Taking a company that generates operating margins of, I think, 26%, we were saying, to high 11s, close to 12%, and getting to 15%. We have building blocks that clearly articulate this.
To your question about what drives growth and the growth officer's role, I think a couple of things. We spent the last two years really narrowing the focus, you know, exited dENiZEN, just closed the deal on Dockers, exited a lower footwear business. Really focused on, okay, here's how we grow Levi's. You know, we're accelerating growth and Beyond Yoga, really two pieces. The other thing is a lot of companies have different ways to grow. 2025 is the best example of what I call the power of the and, which is we grew every facet of the business. We grew DTC, we grew wholesale, we grew U.S., we grew international, we grew men's, we grew women's, we grew bottoms, we grew tops.
What I really like to see is growth not only coming from higher AUR, but also coming from selling more units, because that's the way you get market share, and that's what also really happened. You know, I was just at the leadership. You know, we bring our top 250 leaders together once every couple of years, and I really talked about the power of the and, which means that you've got to grow both sides of the business because the result is really magical. We're able to grow our TAM, which I can talk to you in a minute. 1/3 of our 7% growth last year was driven by expanded TAM. Happy to get into. That's the second piece of it.
First narrowing the focus, really focused on a higher addressable market and, you know, growing every facet of the business. If you do this, you know, the 5% mid-single digit growth is here to stay for a long, long time.
Mm-hmm.
That's really, you know, taking a hard look at, you know, where the growth comes from and ensuring you can drive growth, but doing it, you know, with a financial lens, which is it has to be profitable. You know, it just can't be growth for the sake of growth. That's why the areas that we are growing faster, whether it's women's, whether it's direct to consumer, whether it is international, are all accretive to gross margin, and that's important. As we make this pivot to a DTC-first company, I think DTC, we closed last year at 50%. You know, we are aspiring for the DTC business to get to closer to 55-60. DTC EBIT margins are lower than wholesale EBIT margins, but we've been successful in growing DTC EBIT margins. Last year we were up 300 basis points.
Making sure we narrow the gap really drives the operating leverage. That's really what we're focused on.
Okay. I definitely wanna circle back to margins at some point, but I wanna just make sure we pick up this thread of the total addressable market, and how it's increasing as you pivot more into lifestyle. I think you mentioned a third of the growth last year came from, you know, TAM expansion. I guess, how much larger is the opportunity longer term? And maybe if you can also touch on the launch of Blue Tab, you know, your high-end denim collection, how is that doing and what's the opportunity there?
Sure. I'm wearing the Blue Tab denim bottom, the Blue Tab blazer. But
You got cool shoes that match with it too.
Yeah, the collaboration with Air Jordan, which we you know launched as we you know launched the Super Bowl ad. Basically, the denim category is about $100 billion. It's growing you know around a mid-single-digit range. 10% of the denim category is what we call premium denim. What we are internally calling affordable luxury. We've not played in it you know. About a year ago, we launched the Blue Tab. Prior to this, it was largely a made in Japan product sold in Asia, largely men's bottom. Blue Tab is now inspired by Japanese denim, selvedge denim, but it's more. It's more a head-to-toe look, both for him and her. It's growing very nicely.
Last year, we tested it in a few doors. This year, we are scaling the test, and we really scale the business 2027. That's how we are thinking through it. But it's a big piece of the denim category that we don't play in. That's one, you know, I would say organic expansion of TAM. The other thing that we are doing is, you know, most of you are dressing a lot more casually as you go to work, but you're not dressing in jeans every day. We're really making this pivot, especially after the exit of Dockers to drive more non-denim men's bottom. We introduced performance tech with, you know, growing our chinos business. In the U.S., Levi's already sells more chinos and performance segment Dockers ever did, right? As an example.
We're just getting started. That's one area. The second is we've introduced denim skirts and dresses for her, which we never had. Again, denim aesthetic is something that we never played in. I talked about the Blue Tab. The other piece is if you think of waist up, you know, we've really focused on growing our tops business. Our tops business in quarter four was about half our growth, grew about 7% a year ago. It's still only 20% of our business. When we make this pivot to denim lifestyle, there's clearly an opportunity. We leaned in on sweaters, sold out. We leaned in. I mean, we didn't have quarter zip and a lot of, you know, men here wearing quarter zip. We love quarter zip. I love my quarter zip.
We don't have it. We didn't have it. We will probably have it at some stage soon. You know, as you think about shirts, you think about polos, you think about, you know, woven shirts for her, et cetera, and those are the areas we're looking. Made a big play in Outerwear in quarter four. Did really well. I guess the only thing I would say is, you know, this new TAM, which is probably $1 trillion-$1.5 trillion, doesn't mean we're gonna just do apparel for the sake of apparel. It has to be driven by a denim aesthetic. We're not gonna be fashion-forward. We're still gonna be slow fashion because, you know, managing inventory and all that is an important piece of the pie.
That's how we are thinking about the market. That apparel segment is growing also. Sometimes a little higher. The performance is for pieces going higher. I think we've got a you know, growth and a sustainable level of growth for the next. Especially as we make this pivot to a denim lifestyle-driven business. Now what happens is, you know, we are not taking our eye off the ball on wholesale. Wholesale has to grow. When wholesale customers see what's happening in our direct-to-consumer business, they start leaning in. Macy's, for example, in Herald Square, leaned in, and they've given us larger footprint for men's, a larger footprint for women's, more denim lifestyle. We had a few of the key customers come, you know, during Super Bowl.
That's all we talked about is how do they lean in more in women's? Women's is, you know, leading the denim category growth in the U.S. How can they lean into that? How can they lean in? There's a lot more opportunity.
That makes sense. I guess I wanna follow up on that, ask you a question. I don't think I've actually asked you this before, but what strikes me when I walk into the store is that, and you just mentioned it's denim led. If you're gonna do denim, you know, shirts and things that you haven't done before, it'll be denim. There are a lot of denim tops in the store. I think that the part that I haven't asked you is that it feels like a very patient way to grow a brand and gain credibility in other categories which ultimately drive an even bigger lifestyle assortment, and which can capture an even bigger part of the TAM.
Because I think as investors, you know, we don't wanna see companies rush into other categories where maybe the consumer hasn't quite given you permission to play, 'cause that can feel inauthentic and that can turn the consumer off. The question is how intentional has that been? How intentional has it been to say, "All right, we know we can be a lifestyle brand. We know we can be more than a U.S. wholesale men's blue jeans business. We know we can be a global omni-channel men's and women's lifestyle brand across many categories." You know, it takes time to get there and to bring the consumer along with you during authentic and exciting. Just tell us about how the company's managed the brand from a standpoint.
10 years from now, when you walk into the store and you're seeing, like, a whole lot of different options for Levi's. The consumer says, "Of course, that makes total sense," versus just kind of rushing into stuff maybe for the brand.
Yeah. I think that discipline, you know, when Michelle came on board a couple of years ago, and Chip was still around, you know, he said, "Michelle," and heard me because I was looking at the corporate strategy. "Why don't you guys get together, and let's see how we refine the strategy." We sat as a group, got the executive team, and that was really a big aha, was, okay, we are about denim. We were moving into lifestyle, you know, but it was not about denim lifestyle. We were doing lifestyle for the sake of lifestyle. We said, "Okay, no, it has to be about denim lifestyle." If that's the case, what's the role of footwear? You know, probably not. We're not great at footwear. We've got other footwear brands.
We can collaborate with brands like New Balance and Nike, but that's not what we wanna wake up every morning. Dockers was a piece of that and said, "Okay, maybe not." You know, it was a more disciplined approach, and the idea really was whatever we do, we want to be great at because Levi's is known for quality. It's okay to be slow, but it's great to have a strategy going forward. When I talked about Blue Tab, we just didn't get there and say, "Okay, we're gonna own this and take it from whatever, it is to a $100 million business. We are gonna step our way into it." Because what is also more important is we've got to convert the, you know, our associates who used to be used to selling denim bottom.
You know, they've got to come along in this journey. You know, when I talk about commitment, I talk about three levels of commitment. The first is a political commitment. When leader says, "We have got to do this," people normally nod their heads. Very little actually happens, right? The second is the intellectual commitment, where you engage people's minds. A little more happens. But what really makes a difference is when you engage their head and mind and explain what is in it for them. That's why, you know, when we call our 250 leaders together a couple of weeks in San Francisco, and I was on stage, and Michelle was on stage, and our product person was on stage. We were talking about this journey into denim lifestyle.
You know, why is it important? How do you engage people? How do you grow market share? We talked about the new TAM, the 1.3. That's $1 trillion. One of the things I revealed in there. Because we want people to feel that we can be a bigger business, and we can do it the right way while protecting the DNA of Levi's and Levi Strauss. That's why it takes a little time, you know. We've got a large wholesale business. They've got a bunch of other brands. If they have to start giving us more floor space, it's gonna come from somewhere. That takes a little time.
Makes sense. Well, let me follow up with one other too, because you mentioned Blue Tab a couple times. You know, getting into Blue Tab, which is a way to, you know, get into that aspirational luxury, I think, as you called it, and it elevates the brand, you know, to be able to sell things at higher price point. But at the same time, you talk about dENiZEN, you talk about some of the businesses that you've emphasized. And, you know, we know there's been changes in the distribution. You may be getting away from some of the promotions and discounts and maybe channels where you don't feel like the future's as bright as other channels. You know, I don't.
You know, the company doesn't use the term quality of sale very much, and it doesn't really talk about brand elevation necessarily, 'cause other companies will use that term. To me, clearly, Levi's has been on that journey to say, "Hey, we are the best brand in the world when it comes to want to represent that when we go different channels and different." Talk about how much work is done 'cause it feels like a lot of work has happened over the last five years and even now getting to the point where you can do premium denim because a lot of the work that you know you've set yourself up to get to this point because you cut off sort of the bottom end of the distribution where maybe it was holding the brand down.
Can you just talk about all the work that's gone into that and is there still more work to do to be that, to be what Levi's, the best version of Levi's that it's been?
Yeah. You know, when we guided this year, we talked about pruning some club business, talked about pruning some grocery outlet business. When the brand didn't have its moment, was not as strong, we were selling through retailers that we feel we probably should not. We are trying to elevate the brand. You take Target as an example. Target was selling dENiZEN. That was all they were selling, $30. We partnered with them and said, "Let's introduce Red Tab." We tested it. We tested it with 70 stores for men, 20 stores for women. We expanded it, 200 stores. We went to 700 stores.
When we touched 700, we had a discussion and said, "Maybe it's, you know, maybe we don't need dENiZEN." It's a $150 million business. We took a year and a half and exited that. Now, as you know, about a week or two ago, we've decided to expand that to 1,000 stores because it's really elevating the Levi's brand in Target. It's just a bit of a journey as an example. To your point about pruning businesses, I think, you know, we have a large off-price business. It's largely. We don't make for our price. We've never done that. It's largely flush.
As the inventories are healthier, as a consumer is in a good spot, as our products are working, we're, you know, slowly pruning that business off also because it really allows us to elevate the brand. Soon after COVID, we probably pruned, I think 2.5-3,000 different doors in Europe, smaller doors, not, you know, as quality conscious we like it, et cetera. Where we can, we did a little bit in India, I think last year. I think it's a constant evolution, and it takes a period of time. We're not gonna yank ourselves out of large customers. That's not. Some brands have done it. That's not who we are because we wanna drive market share.
We have some real loyal consumers who love us, and so it just takes a little bit of time and discipline.
Maybe, you know, you mentioned on your last earnings call, I think 50-60 net new store openings this year. As you expand stores globally, which markets and countries are you targeting? Maybe if you can talk about the improvement in profitability, which you mentioned before in the D2C channel, what's been driving that? That would be the next couple questions.
Sure. Our model is about 50-60 net new system doors every year. You know, as part of my growth officer role, I also look after all real estate expansion, franchise expansion, et cetera. Having spent my formative years in a franchise business, ensuring that the franchises are able to grow is really near and dear to me, because if you take our 3,300 doors that have a Levi's logo in front of them, we about 2,000, 1,500-2,000 franchises less we operate. It's important to get the entire system to grow. The 50-60 doors on a net basis, I would say 10-12 in the U.S.
In the U.S., the business was largely an outlet business 10 years ago. Now we have about 80 full-price doors. You know, in New York, you have, you know, beside our Times Square door, you have, you know, a door in SoHo, Hudson Yards, 34th Street, et cetera. We opened about four last year. We scaled up, you know, about eight, 10 every year. When we took a bit of a pause because we wanted the stores to be really profitable. The other thing we did was we took our doors and said, "If we really want to accelerate the women's business, we should lead with women." Right? When you walk into a door, you know, the women assortment is right there.
70% of our doors in the U.S. now lead with women, right? Women's is 50% of the D2C business in the U.S. We're just getting started around the world as an example. Because these stores are now very profitable, we are scaling it up to 10, 12 a year. I think we can double that. What it does is, it changes the business in the U.S. from primarily a wholesale business to a business that has D2C and wholesale at an equal footing. I think we ended last year with, in the U.S. D2C was about 45% of the business. I think that's the transformation. Outside the U.S. are the other doors, largely in Asia. Europe is about five, 10 doors a year. The rest are largely in Asia.
I personally believe we can be opening 50, 60 for the next, you know, four or five, six years. You know, really growing the system. The way I think, you know, when I look at the D2C business, I call it a bit of a trifecta. You grow same-store sales. We've had 15 consecutive quarters of growth on that. You open new doors 50, 60 a year, and you grow e-commerce at, in the mid-teens%. That's a good trifecta, and we've been doing that successfully. To your point about D2C profitability, I think we ended last year in the high teens%, and this is like, you know, fully loaded.
You know, we are loading the cost of running stores, including above store in it, and e-commerce, fully loaded technology for e-commerce and advertising. You know, the wholesale margins are probably in the low 30s%. Last year, D2C margins were up by 300 basis points, largely driven by three factors. One is higher revenue per sq ft. You know, I talked about the women's business, for example, really driving and accelerating. You know, we're really focused on converting more. Traffic is probably flattish kind of thing, but we're growing only because we're converting more. This year, we're making a big pivot on driving more units per transaction.
If it's all about lifestyle, you walk into the store, you may walk in for a denim bottom, but you walk out with, you know, a top, denim-inspired top and a bottom. We're really making this pivot to drive more UPT. That's one piece of it. The second is gross margin and direct-to-consumer business are pretty good. We're also narrowing promotions. I mean, one of the things we realized is if our products are resonating, there's no reason we shouldn't be selling more at full price.
Mm-hmm.
We're taking a hard look at our promotions. We're reducing the cadence. We're re-reducing the window of promotions, and we're driving more full-price selling. I think that's an opportunity that'll be here for a while. The third is just getting better at managing costs, labor productivity tools, et cetera. You know, we didn't grow up as retailers, D2C retailers. We grew up as wholesalers. We've got talent. Our commercial officer has spent 30 years in retail. He joined about two years ago. He's brought a few people who've done this for a long, long time. We're really investing in tools that make this and improve the margins and productivity over time.
Makes sense. You know, I think just from my perspective, talking to a lot of investors, you know, a few years ago, the question was, you know, we used to talk about the next gen stores and rolling them out, and it's a new format, is it gonna work? I mean, that was something that was an open question. You know, how successful can Levi's really be with their own-
Right.
Own store format? That's I mean, just the way, you know, talking about the margins and success and all the productivity that you've had. I mean, it's not even I think that people have sort of not really realized that Levi's has unlocked this opportunity. To your point, like, you can see 50-60 doors per year for quite a few years going forward. I don't know if that unlock is truly appreciated, because now you're just like, "Okay, we figured this out. We know how to do this, and we're doing it. It's been very successful, and now we're rolling it out." It's a much different story than a couple years ago when, you know, people were like, "Oh, is this really gonna work? Michelle Gass has kinda overhauled the whole company," and now you're here.
To me, and from what I've understood, is that, you know, in your mind, you always assess a probability of how successful something's gonna be based on the evidence that you have. I mean, the probability of this DTC operation being way bigger and taking advantage of this huge TAM that you're talking about is so much higher, just given what you've proven over the last few years. I don't know. Sometimes I feel like that's lost on people.
Yeah. No, I think you're right. I think the couple of myths, you know, if I could bust, I'd like to bust. One is we're more than just wholesale. You know, we have had wholesale now grow for a while, but we're more than just wholesale. We're more than just U.S. wholesale. You know, that's one. Second is DTC is here to stay and successful.
Mm-hmm.
You know, for example, when we were ramping up new doors, one of the things we did earlier on, and this was in discussion with the board, was two things. One, ROIC became a metric in the long-term compensation of leaders in the company, okay? We had to make people educate people what ROIC really stood for. But every store has an ROIC. We have a threshold. The other thing, and I learned this at, you know, during my retail days at Yum, is, you know, you have to measure the returns on stores. We've got a concept called hit rate, which is again, something I did at Yum years ago, which is how many stores actually hit their revenue and profit thresholds.
We review that with our finance committee of the board every year and with the executive team. Our hit rates have never been better, okay? I'm not gonna get into what it is, but it's pretty damn good. It's all about learning. It's a postmortem without blame and saying, "Okay, here are the stores that didn't work. Here's why it didn't work. Let's learn and get on with it." I think, you know, it's a journey. It takes a little time, but, you know, we're pretty pleased with the progress that's being made. You know, over time, people will. You know, I think the question we get a lot of times is give us your same store sales number, right? Give us your comp sales and, you know, we have the debate internally.
You know, we have talked about the fact that it's positive. At some stage, maybe we, you know, have the courage to, you know, give a number. The thing about a number is once you give a number, then you have to give it every time. You know, the fact I would say is direct to consumer business has been growing high single digit, low double digit for years. It's 50% of the business, and we think it can continue to grow.
Okay. I wanna ask a couple things. I know you mentioned you get a lot of questions. I know a lot of questions about price increases.
Yeah.
Last year. First of all, just remind us what kind of price increases you did take in the U.S. to offset tariffs.
Mm-hmm.
When do those prices, those price increases kick in, and then how much tariff impact is embedded in the guide for the fiscal, you know, FY 2026, the current fiscal year?
So.
That we're in for that.
Sure.
The flat gross margin.
It's, you know, as you know, changing on a regular basis. Our guide is based on an incremental 20% tariff for 2026. You know, pre-liberalization deal in 2025, we were probably paying about 13% tariffs. An incremental 20%, you know, takes it closer to 30%-33%. That's what our guide has assumed. You know, the latest that we are hearing that 20 is probably closer to 15. When we report earnings in April, we will quantify that. Whether we change guidance for that, I don't know. It depends what happens because, you know, it could change, but we'll quantify the impact of it.
The way we handle pricing in the U.S. is we didn't price for, you know. The increment of 20% is about 150 basis points headwind to gross margin. We did guide that the gross margins would be flat for the year in 2026. We've got a couple of things that are offsetting it. One is pricing. We didn't price 100% for the tariffs, but a third of the tariffs is what has been priced in largely in the U.S. That's a combination of pricing on products that are new and rolling out, which is innovation, as well as the core products. We didn't lead. We were not the leaders in pricing. We were thoughtful. We waited.
You know, the department stores have taken up pricing on private label. We wanna make sure that the difference remains, you know, between our pricing and that. You know, we leaned in more to the products that were new. That was one piece of it. It went into effect largely in quarter one, between January and February. So far, no pushback from the customer in terms of what they're buying for the year. The consumer generally is resilient. We're seeing that, you know, as we speak. The other third, we actually try to offset by product cost negotiation. You know, a large piece of our growth last year was volume. You know, 50% of our growth this year should be volume because we're selling more, we're growing market share.
We leverage the volume with our vendors. We have also eliminated a lot of unproductive SKUs. That has led to, you know, improved margins. We also opened the door with a few, you know, new vendors that drove a little bit more competition. Cotton as a commodity, you know, was a little lower than a year ago. A combination of that has led to lower product costs. The other thing about our model, as you grow in women's, you grow DTC, you grow international, gross margin probably improves 30-40 basis points a year. You take the combination of these factors as well as higher full price selling, that's how we were able to offset our gross margin. Gross margin largely flat. Gross margin, you know, hit a record last year.
We closed, you know, I think, very close to 62%. It was, you know, 58% not very long, right? It has grown nicely. Given that the brand has momentum, given the brand's so strong, products are resonating, we think, you know, accretion of gross margins is here to stay. That's how we are kind of addressing, you know, the impact of tariffs, as the year progresses.
All right. I wanna keep moving. I wanna ask you about SG&A.
Sure.
Specifically, I wanna ask you about the changes to your distribution centers in the U.S.
Mm-hmm.
I guess, when do you expect to see the full benefit of your distribution center transformation on SG&A leverage? What have been the issues you have faced relative to SG&A?
Yeah. You know, as we are getting ready to become a $10 billion company from a $6 billion company, the few infrastructure investments we made, one was, you know, like a lot of retailers, we're upgrading our ERP. North America has gone flawlessly. That was part of my remit as CFO. We've done probably half of Asia. The rest of Asia, we're doing Beyond Yoga as we speak, and so far it's going really well. You know, we finish Asia sometime in the next 12 months and then do Europe, and so we're largely done. What it really does is it gives us a foundation for real data unlock. You know, we can accelerate e-commerce, we can accelerate our AI initiatives, et cetera, because now you have, you know, one common platform.
You know, I can sit in my office and I can see how each store in North America or anywhere else is performing on a minute-by-minute basis, how DCs are doing, which I could never do. The other piece is really our distribution network, which was all built for wholesale, not built for omni-channel. Now our European network is built for omni-channel. Take the U.K. DC that we operated that we brought in e-commerce. That was really servicing wholesale and stores till about May of last year. We brought in e-commerce with a third party, and our U.K. business has been on a complete fire. I mean, the retail in Europe is largely flat to down. We are growing double digit because we are servicing faster.
We are, you know, we have one common inventory, and the shipping costs on e-commerce are half. That's just an example. We're in the process of doing that with our, you know, non-U.K. business as we speak. You know, that probably goes live by the end of the first half. Our European results in the second half of last year have been generally good. You know, I think we're generally feeling good about Europe. In the U.S., we had four DCs that we were operating. Two were, you know, 30 years old, built for wholesale, largely manual. We said, rather than, you know, remodel these DCs, which means you have to shut it and spend $hundreds of millions, let's go with a third party. We have signed up with GXO.
Maersk is in the process of ramping up. That's gone a little slower than we expected, largely because technology has taken a little longer to stabilize and ramp up. As that was happening, we were seeing demand, you know, for our products go through the roof. What I did, because Michelle asked me to look after this for a while last year, is we, you know, instead of shutting both the DCs that we were gonna shut, I kept one open. I shut one because we couldn't service the demand. That's where we've had some distribution costs that are, you know, higher than we expected. We were able to drive higher volume on it.
The thinking is, as we said in our guidance, Q4 earnings, the thinking is that stabilizes by the end of the first half. We can shut the DC that's running in parallel, and then we start bringing e-commerce in. I think by the end of the year, we start seeing, you know, benefits. I mean, right now our distribution costs are a little over 7%. You know, I think there's at least a point there, maybe more, you know, as we try and leverage demand, make sure there's inventory efficiency, et cetera. The other thing that has happened is we now have a chief supply chain leader who has distribution experience.
We have also added a couple of distribution experts because what we're realizing is while we manage a hybrid system, some we operate, some operated by, you know, operators like GXO in Europe and Maersk, we really need that experience in-house to really, you know, work with our our third-party providers. It's a huge unlock. In my view, it's probably unlock for top line as well as bottom line. That'll take time and happens over time.
Yeah. I mean, it sounds really powerful, frankly.
Yeah.
I mean, just to be on one global platform.
Yeah
At the end, have the data, have the visibility that you're talking about in your office to see every store and every DC. Now you mentioned AI as part of that.
Yeah.
Can you just talk about how the company's leveraging AI to drive the business?
Yeah. I mean, we're leading and Michelle's, you know, personally taking this as a channel challenge, which is great. You know, we are a retail apparel player, but we work in San Francisco, where that's the city is completely changing because of the AI focus. Where we're leaning in is on two areas. One is how do we drive or engage with our consumers better? That is both online and in the store, right? We've got use cases where we're saying, you know, if you have a chat bot, that person that helps you shop and drive shopping experience, how does that unlock and improve the shopping experience?
For our stores, you know, our associates, you know, require help and training on, you know, the new stuff. We're using, you know, something called STITCH that really helps them, you know, become better sales associates. Internally, the thing we have done this year is we've said no more incremental headcount. We're gonna drive more automation using AI. I've established, you know, what we call talent hubs, global talent hubs in Bangalore, in Warsaw, and in Mexico, and that's beyond finance and technology. Target is a great example. They have 5,000 people in Bangalore, and it's across all functions. The question for us is: how do you drive that across all functions? Take some processes and streamline the processes while automating it. That's what we are looking at doing.
You get great talent. I mean, that's why we're calling it talent hub. I said, you know, we can't call it a global capability center. It's actually a talent hub. We get talent across both genders. We get talent that really knows how to use AI and other tools. That's the other piece that we're doing. You know, forecasting our revenue for the people here, you know, who are in the finance camp, we've got an algorithm that we've kind of rolled out a couple of years ago. Albert has written a business case study. He's taught in the second year MBA program, and it's about using that algorithm to really help improve our revenue forecasting. It's probably predicts one or two points better than, you know, my wonderful, you know, sources around the world.
It doesn't replace the you know human modeling. It just helps improve it. For example, every time I have a forecast and I'm discussing with the team, I have what the algorithm tells me. When I do earnings, I have what the algorithm tells me. We use that as a way to kind of decide what we guide, et cetera. The board is very you know sees it on a regular basis. Now, we're expanding the algorithm to help forecast profit and cost because that's the next journey. You know, while we've got a lot of great growth, I really wanna improve the flow through and the operating margins you know for the company, and I think things like this will just help us get better.
Got it. All right. Well, that's, I know that flow through and margin expansion is very important to you. I wanna get to this question 'cause I know it's very topical, but can you just talk about your Middle East business?
Sure.
Obviously.
Sure. Yeah, no, it's unfortunate what's going on. Our Middle East business is a small business. It's less than 1% of our total business. The product we get through the Strait of Hormuz is probably just serves the Middle East. It's very minor. It's largely a distribution business, so it's in the hands of distributors. So there's the operating leverage or deleverage when the business is down is not pretty high. We'll talk more about it when we talk earnings in a couple of weeks. You know, the teams are game planning this as we speak.
I mean, you know, as you think about the impact of oil in businesses like ours, I mean, Ira and I went back and looked at what happened in 2008, what happened in 2011, what happened with the Russia-Ukraine war. The thing that we saw was sales didn't suffer at all. You know, there was not a dramatic impact. The other piece is what happens to product costs. You know, cotton has remained where it is, you know, got probably a little better. We've locked product costs in for the year. That's not an impact. You know, and then there's the currencies, right? So far that's been okay. As you think about this, depending on how long this goes, we have game planning.
You know, like we had a tariff task force that as part of my transformation office, we've got a task force now game planning this as we speak. But if the consumer remains solid, as you know, no signs yet, I think, you know, we'll be okay.
Okay. All right. Maybe in the last two minutes, I wanna ask one capital allocation question, and it's, how are you thinking incrementally about near-term capital allocation priorities as well as dividends and buybacks as you-
Sure. We spend about 3.5%-4% of our revenue on CapEx. Two-thirds of that is to grow the company. Think about opening doors, remodeling doors. We probably, between opening and remodeling, we're probably doing a door a day for the year, which is great. We also spend on technology. Think about e-commerce. Think about some of the AI investments. That's about two-thirds and about a third for infrastructure, which is ERP upgrade, some maintenance work. That's one piece of it. We're a dividend-paying company. Dividends grow in line with net income. Every year, for the last few years, we've taken up dividends eight odd %. We normally do that in the second half of the year.
We buy back stock to offset dilution. If there's more cash with, you know, our balance sheet is so strong, there's a lot of cash, we return more back to the shareholders. You know, we exited Dockers, probably generated a couple of hundred million in cash. That's all been returned back in the form of an ASR program in Q4 and an ASR program in Q1. That's the way we think about it. If there's more cash, have a discussion with the board and, you know, there's nothing to do because we are now focused on two narrow businesses of Levi's and Beyond Yoga. You know, that's something that we can always explore.
I think that's a great place to stop, Harmit.
Okay.
Thank you so much.
Great.
Always enjoy speaking with you, and, you know, congratulations on the success.
Thank you, Jay. I appreciate everybody taking the time. Thanks a lot.
Thank you, everyone.