Ralph Lauren Corp

NYSE:RL

Earnings Call Transcript 2019-Q2

[Operator]

Welcome to the Ralph Lauren second quarter fiscal 2019 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions on how to ask a question will be given at that time. As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mrs. Evren Kopelman. Please go ahead.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Good morning and thank you for joining Ralph Lauren's second quarter fiscal 2019 conference call. With me today are Patrice Louvet, the company's President and Chief Executive Officer; and Jane Nielsen, Chief Financial Officer. After prepared remarks, we will open up the call for your questions, which we ask that you limit to one per caller.

During today's call, we will be making some forward-looking statements within the meaning of the Federal Securities laws, including our financial outlook. Forward-looking statements are not guarantees and our actual results may differ materially from those expressed or implied in the forward-looking statements. Our expectations contain many risks and uncertainties. Principal risks and uncertainties that could cause our results to differ materially from our current expectations are detailed in our SEC filings.

To find disclosures and reconciliations of non-GAAP measures that we use when discussing our financial results, you should refer to this morning's earnings release and to our SEC filings that can be found on our Investor Relations website.

And now, I will turn the call over to Patrice.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Thank you, Evren. Good morning, everyone, and thank you for joining today's call. We are pleased with our second quarter fiscal 2019 results that reflect continued progress on our Next Great Chapter strategic growth plan.

We delivered both top and bottom-line growth as we continue to focus on returning the company to quality growth and value creation. Our results were driven by double-digit top-line growth in Asia and sequential progress in North America and Europe.

Importantly, we remain on track to achieve our plans for the full year. Our long-term plan is based on our three guiding principles: put the consumer at the center of everything we do; elevate and energize our brands; and balance growth and productivity.

Let me take you through the progress we've made in the second quarter across our five key strategic initiatives, which include: first, win over a new generation of consumers; second, energize core products and accelerate under-developed categories; third, drive targeted expansion in our regions and channels; fourth, lead with digital across all activities; and fifth, operate with discipline to fuel growth.

Starting with the first one, win over a new generation of consumers; in the second quarter, our key marketing initiatives centered around our 50th Anniversary Fashion Show and key sporting events. The show, which took place in New York City's Central Park in early September, captured Ralph's 50 years of bringing authentic and timeless style to the world.

We showcased the breadth of our portfolio with a highly diverse cast of models spanning generations, ethnicities, and gender. We successfully leveraged the show, driving record levels of engagement around the world across digital and social media. We had more than 3 billion social media impressions and over 100 million global views of the show online. Importantly, search volume for the brand increased high single digits versus the same period last year, based on Goggle Analytics. According to ListenFirst, a leading social analytics firm, Ralph Lauren generated more than twice as many social engagements as other brands showing at New York Fashion Week.

Engaging influencers and celebrities, particularly those who resonate with different segments of our consumer base and reflect different dimensions of the brand, was a critical part of our 50th celebration strategy. Influencers across media, business, philanthropy and music from all over the globe joined us. These included: young Hollywood actors, such as Blake Lively, Anne Hathaway, and Ansel Elgort; musical superstars like Nick Jonas with his fiancée Priyanka Chopra, Chance the Rapper, and Bruce Springsteen; to fashion stars like Taylor Hill; and our Asian influencers, such as Akira and Li Bingbing.

In addition to the show, we continued to leverage the power of cultural events. The second quarter included our sponsorship of the U.S. Open Tennis tournament, one of the most widely attended sporting events in the world. We also outfitted the U.S. team at the Ryder Cup, one of the premier golf tournaments globally. Overall, we increased marketing by over 30% to last year in the second quarter and continue to shift our spend to channels that matter most to consumers today, namely digital and social.

Moving on to our second key initiative, energize core products and accelerate under-developed categories. In the second quarter, Ralph and our design team continued to drive excitement in core product categories through limited edition releases, expanded customization options and refreshed fabrications and details.

As part of our 50th anniversary celebration, we partnered with MR PORTER, a leading men's online retailer, on a limited edition capsule. The collection was inspired by some of our iconic men's designs with a mix of pieces from Polo, Purple Label and RRL. The capsule launched on October 15 on the MR PORTER website and at our flagship stores.

In October, we also announced our exciting new collaboration with London-based streetwear brand, Palace, which I'm sure many of you have seen. The Palace founders describe the collaboration as "Palace Ralph Lauren is a timeless collection that represents a love letter from a young London skateboard company to their favorite brand in the universe".

Launching on November 9, the capsule collection consists of menswear pieces inspired by iconic Polo styles that the Palace creators have worn throughout their lives. It will be available: on our own Polo mobile app in the U.S., so this is a great opportunity to download it now, if you haven't already; on our new digital flagship in Europe; and across Palace's retail network. We plan to continue attracting new consumers and driving excitement around product through our limited edition releases and other exciting partnerships going forward.

We also expanded our customization offerings this quarter, both online and in our stores, including a new custom shop at our recently renovated Prince Street store in New York City and at the U.S. Open.

Customization plays well with gifting, and we are excited about its potential as we approach holiday. We plan to further expand our offering and choices for consumers ahead of the season. We will open our second customization shop in Asia in our Omotesando store in Japan in time for the holiday season.

Moving to our under-developed categories that have significant growth potential across our brands; these include denim, outerwear, wear-to-work, footwear and accessories. We launched our first wear-to-work offering in women's Polo this fall, with an initial focus on a select number of directly operated stores and our flagship RalphLauren.com. Early results show a strong consumer response, especially to our blazers and dresses.

In fragrance, we launched our newest fragrance for men with L'Oréal, Polo Red Rush, in the U.S., helping to accelerate growth in our fragrance portfolio. Focused on reaching a new generation of consumers, we had an energetic campaign featuring actor Ansel Elgort.

Moving on to our third key initiative, drive targeted expansion in our regions and channels; we are focused on building a compelling and competitive ecosystem centered around key cities globally. This includes digital distribution as well as new and renovated stores to drive growth.

During the second quarter, we opened 36 new stores and concessions globally and closed 28 locations. This included 25 openings in Asia, with 10 in China, our fastest-growing market. Our China openings were in our key city clusters of Beijing, Taipei, Shanghai and Hong Kong.

Our momentum in China continued in the second quarter. Greater China revenue was up over 20% to last year in constant currency, including over 40% growth in Mainland China, driven by comp growth and new stores. We're pleased with the performance of our new doors, as they are delivering above-average productivity and profitability. Our digital business in China is growing rapidly through Tmall, Tmall's Luxury Pavilion, JD.com, and WeChat.

In the second quarter, we launched Polo on JD's luxury platform TOPLIFE. We also opened our own directly operated digital commerce site in China, RalphLauren.cn. This is the exclusive online destination for our luxury labels, men's Purple Label, and women's collection. The premium shopping experience on this site includes features such as free online and in-store returns, same-day delivery in Shanghai, live chat customer service, and integration with WeChat.

We also opened two new full-price stores in Europe in the second quarter. We opened one store in London and one in Manchester, as we start to build out our ecosystem strategy in Europe as well. We are underpenetrated at brick-and-mortar retail, with only 21 full-price stores across Europe. Our expansion plans include five more openings in the second half of this fiscal year and more than 100 stores in the next five years.

Moving on to our fourth key initiative, lead with digital, our global digital business, including our directly operated sites, department store dot-com, pure players and social commerce, was up 10% to last year in the second quarter, with strong performance across the board.

Importantly, our directly operated North America digital flagship returned to growth as planned and delivered 9% comp increase versus last year. We attribute the improvement to our continued work to reposition RalphLauren.com as our most important flagship. This was driven by a combination of strong brand building, an enhanced consumer experience, and higher quality of sales, all enabled by our new platform that we put in place a year ago and recently rolled out to Europe. New capabilities we added in the second quarter included: new robust brand landing pages; waitlist functionality; and faster standard shipping.

Our improved digital flagship experience was part of the reason for our move up to the number four spot in the L2 Global Fashion Index for digital, up from number 11 last year. L2 specifically highlighted our digital flagship relaunch in North America as well as our digital marketing and social media activity at out 50th celebration. We're pleased to see this external recognition of our digital initiatives and progress, and we continue to work towards best-in-class capabilities and functionality.

In the second quarter, our directly operated European digital commerce sites also moved onto our new platform, as we continue to elevate and improve our digital presence globally. Our team managed the transition well, and our business returned to growth on our European sites by the end of the second quarter. We expect an acceleration of this growth rate in the second half of the year as a result of the significantly improved brand building, consumer experience, and functionality.

In North America, we released our first-ever mobile Polo app during the quarter. The app is designed to engage the most enthusiastic members of our community of consumers by providing insider access to exclusive content and curated products. The limited edition Yankees collection that we launched in September to celebrate Ralph throwing the ceremonial first pitch at Yankee Stadium was available exclusively through the Polo app, and we sold out of the Yankees jacket within minutes of the launch.

And lastly, we officially launched our mid-tier brand, Chaps, on Amazon during the second quarter. And we are encouraged by the early results and learnings.

Finally, let me touch on our fifth key initiative, operate with discipline to fuel growth. In the second quarter, we continued to challenge every cost and improve our efficiencies, especially given headwinds on input costs and tariffs. This enabled us to fund a significant increase in our marketing investment while expanding operating margin and increasing operating profit. Adjusted operating expenses, excluding marketing, were roughly flat in the quarter.

We continue to increase the flexibility and efficiency of our global supply chain as we keep a close eye on tariffs and other trade developments. The tariffs enacted to date have a limited impact on our business, but we are continuing to diversify our supply chain to mitigate the long-term impact of potential tariff scenarios.

In closing, as we execute our Next Great Chapter plan, we are encouraged by our early progress. Our teams around the world are embracing our strategy and are focused on executing with excellence. We've done a lot of work to ensure that every individual at the company clearly understands how his or her work supports our strategy.

Speaking of our teams, I am especially proud to note that Ralph Lauren recently achieved global recognition in the Korn Ferry Employee Engagement Awards. We rank in the top three most engaged places to work across nine different countries, including Japan, China, and Korea. In addition, for the first time, we achieved certified status as a great place to work in the U.S. and were recognized on the Forbes Best Employers for New Grads list, as we focus on attracting the next generation of talent and consumers.

Each member of our diverse and motivated global motivated team is contributing to deliver on our plan. And Ralph and I continue to be inspired by their passion and commitment every day and know that it will take all 24,000 of us around the world to deliver it.

With that, I'll turn it over to Jane, and I'll join her at the end to answer your questions.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Thank you, Patrice, and good morning, everyone.

Our second quarter results demonstrated continued execution on our strategy while navigating a more challenging global trade and cost environment. We delivered on key metrics, including mid-single-digit AUR growth, double-digit growth in digital commerce, and gross and operating margin expansion, all while delivering both revenue and profit growth.

Second quarter revenues increased 2% on both a reported and a constant currency basis. This was driven by strong 13% growth in Asia and 10% growth across digital commerce. Adjusted gross margin expanded 100 basis points in the second quarter and 60 basis points in constant currency, benefiting from reduced promotional activity and favorable product, geographic, and channel mix.

Adjusted operating margin in the second quarter was 13.9%, up 50 basis points to last year on a reported basis and up 20 basis points in constant currency. In this quarter, we chose to make incremental investments in consumer-facing 50th anniversary marketing and social media amplification. We continue to make progress on our long-term objective of increasing marketing to approximately 5% of sales while also focusing on productivity to achieve our operating margin expansion goal.

Moving on to our segment performance, starting with North America, revenue was up 1% in the second quarter and adjusted operating margin was 23.7%, representing a 60 basis point increase to last year. In the retail channels in North America, we posted 1% comp growth in constant currency, as our directly operated digital commerce business inflected back to growth. The 9% increase in our digital comp came as a result of incremental traffic gains. We continue to reposition RalphLauren.com as our most important flagship door with ongoing improvements in product and functionality.

Our brick-and-mortar comps in North America were down 1% in the second quarter, driven by traffic declines, while AUR grew 3% year-over-year. We are focused on reversing the traffic declines through increased marketing, refreshed store environments and improved products, including expansion in under-developed categories. At a more macro level, foreign tourist sales were down about 2% to last year in the second quarter, largely reflecting currency movements.

Moving on to North America wholesale, second quarter revenue was roughly flat, which was partially driven by an increase in off-price sales related to timing of shipments. For the full year, we still plan to reduce our off-price penetration within our broader wholesale channel.

Our goal is to continue to improve quality of distribution and strategically reposition off-price toward an excess inventory clearance vehicle. Our full-price wholesale sales continue to be pressured by our deliberate actions to improve quality of sales and exits from lower quality distribution. While we expect volatility on a quarter-by-quarter basis, our underlying trend is improving. And for full year FY 2019, we expect underlying revenue to be down low to mid-single digits versus the mid to high single-digit declines last year.

Our digital wholesale business continued to grow, delivering 9% growth year-over-year in the second quarter, with continued share gains in core categories. As a reminder, our revenue trend in North America wholesale will look more challenging in the second half of the year, notably in the fourth quarter. This is due to the timing of off-price shipments that I just mentioned, with significant declines planned in the second half. Our focus remains on building high quality growth with our partners in the North America wholesale channel.

Moving on to Europe, revenue was down 1% on a reported basis and flat in constant currency in the second quarter. Adjusted operating margins were up 50 basis points, but were down 110 basis points in constant currency, driven by comp pressure, increased marketing and new store expansion.

In the retail channel in Europe, comps were down 4% in constant currency, representing a sequential improvement from the 8% decline we reported in Q1. Our digital comp on our directly operated European website was flat, impacted by our digital platform upgrade at the end of last quarter. We saw strong quality of sales improvements, including double-digit growth in AUR and a reduction in discount rates and are encouraged by the response to our newly upgraded platform.

As we got back into inventory positions and adjusted product assortments in Europe, notably in outlet, we saw an improvement in our trend with Q2 brick-and-mortar comps down 4%, representing a 5 point increase from Q1. We expect continued improvement in trends in the second half of the year.

Our ongoing efforts to improve quality of sales continued, with AURs up 8% in the second quarter in Europe retail. Wholesale revenue in Europe was flat in constant currency in the second quarter. A shipment timing benefited Q1 and negatively impacted Q2, as planned. Our underlying trend in the channel remains healthy, up low to mid-single digits, including double-digit growth in wholesale digital.

We expect continued volatility in Q3 and Q4 growth based on shipment timing, with growth patterns similar to those of the first half of the year. However, overall second half performance should align with our underlying growth trend.

Turning to Asia, revenue was up 13% on a reported basis and 14% in constant currency in the second quarter. We saw strong performance across every market in Asia, including Japan, Korea, China and Australia. Our product and marketing initiatives are resonating well in this region. And we continue to increase our digital efforts and engagement with local influencers and celebrities.

Our 50th Anniversary Fashion Show in Central Park included many of our key Chinese and Japanese social influencers, who shared our brand with millions of followers. Comps in Asia increased 6% in constant currency in the second quarter. We expect continued comp growth in Asia as we upgrade our distribution network and increase our marketing initiatives to amplify and elevate the brand.

Adjusted operating margin was up 220 basis points to last year in the second quarter in Asia and up 270 basis points in constant currency, as leverage from strong top-line performance more than offset increased marketing investment in the quarter.

Moving on to the balance sheet, our balance sheet is strong and we returned capital to shareholders, reflecting our continued operating progress. We ended the quarter with $1.9 billion in cash and investments and $684 million in total debt. We used a new issue of $400 million of senior unsecured notes to retire $300 million of debt that matured in September 2018. Consistent with our commitment to return cash to shareholders, we repurchased $92 million in shares in the second quarter.

Moving to inventory, at the end of the second quarter, inventory was up 15% to last year. About 60% of the inventory increase is related to higher in-transit inventory and earlier receipt of goods versus last year. We are utilizing less airfreight this year in order to reduce shipment costs and this resulted in a higher level of goods in transit.

We also realigned our wholesale receipt calendar to better match customer demand and maximize full price selling. This also impacted quarter-end inventory level.

The remaining 40% of the increase is related to higher inventory buys to support anticipated growth, including new stores, digital and comp growth. As we mentioned last quarter, we had strategic increases in our European factory stores as we cut too deeply and were out of stock last year. In addition, the second half includes the largest number of our new store openings this year, therefore, the inventory for those new stores was on hand at the end of the second quarter.

As a result, our inventory levels at the end of this quarter and next quarter will be higher than we typically have during this season. We plan to moderate inventory levels by the end of this fiscal year to be better aligned with our sales outlook.

Now, I'd like to turn to guidance for the full year and third quarter of fiscal 2019. As a reminder, this guidance excludes restructuring and related charges. We are on track to deliver our goals for the year. We now expect revenues to be flat to up slightly in constant currency for the full year fiscal 2019. This is based primarily on our strong first half top-line result. We continue to expect a decline in North America and growth in our international businesses.

Foreign currency is now expected to have about 75 basis points of negative impact on revenue growth in fiscal 2019. We continue to expect operating margin for fiscal 2019 to be up 40 to 60 basis points in constant currency, with minimal impact from foreign currency. This guidance reflects our solid performance in the first half and our view of the underlying trends as we execute the Next Great Chapter plan.

It also incorporates the emerging dynamic of tariffs and our plans to better align inventory levels to our sales growth outlook. For the third quarter of fiscal 2019, we expect revenues to be up low single digits in constant currency. Foreign currency is expected to negatively impact revenue growth by approximately 100 basis points in the quarter. Operating margin for the third quarter of fiscal 2019 is expected to be up about 20 basis points to last year in constant currency.

Foreign currency is expected to be a slight benefit to operating margin in the quarter. We continue to expect capital expenditures of approximately $275 million in fiscal 2019, focused on consumer-facing initiatives that have demonstrated a proof of concept and healthy rates of return. Our effective tax rate for fiscal 2019 is unchanged at 21%. Third quarter of fiscal 2019 tax rate is estimated at approximately 22% to 23%.

In closing, we are moving forward in executing our Next Great Chapter plan and we continue to make operational progress in our business while navigating a more challenging global trade and inflationary environment. Our teams around the world celebrated 50 years of Ralph's creative vision and we are passionate about our future. Importantly, our teams are delivering and this quarter demonstrates that we are on the right path toward long-term sustainable growth and value creation.

But before I open up the call for your questions, many of you already know that Evren Kopelman, our Head of Investor Relations, will be transitioning to a new role within the organization as CFO of Club Monaco. On behalf of the entire Ralph Lauren team, we'd like to express our gratitude for everything she has contributed to this role. Evren has led the Investor Relations team with integrity, transparency and passion. And we are confident that she will do the same for our Club Monaco business.

The great news is that our IR function also has an excellent new leader, Corinna Van Der Ghinst, who will be assuming the Head of IR role. Cori spent over a decade as a sell-side analyst at Citi and as a fashion entrepreneur. She joined the RL team seven months ago and is off to a great start. Please join me in congratulating both of them and please reach out to Cori and the team on any communications going forward.

With that, let's open up the call for your questions.

[Operator]

Our first question comes from Paul Trussell with Deutsche Bank. You may ask your question.

[Paul Trussell, Deutsche Bank Securities, Inc.]

Good morning. Thank you for taking our question and congrats on the revenue momentum.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Morning.

[Paul Trussell, Deutsche Bank Securities, Inc.]

What factors drove the return to growth in North America digital and are they sustainable over time? And overall, what inning do you believe you're in with digital?

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Good morning, Paul. Hey, welcome. Welcome to the group. So we're actually pleased with our progress on digital commerce this quarter, both in North America and actually also internationally, but let me touch on the key drivers for the North America progress. It's really three factors for us: one, better brand building; two, an enhanced consumer experience; and then, three, continued work on quality of sales.

So maybe just to give you some flavor, some of the things we drove across each of these factors. On the brand building front, we leveraged the 50th Anniversary Fashion Show with what we called an immersive website experience. We streamed the show live. We told richer and deeper stories, and we're going to continue to do that on product. We integrated our social feeds, and we launched what we've called a dynamic 50th storytelling section on the site, so much more elevated storytelling, much more elevated photography, much more interesting content.

On the consumer experience front, we drove a number of changes, and we know we have significant progress to make here. So just to give you few examples of increased functionality in this past quarter; faster site loading time on mobile. Our loading time improved by 25% to 30% over the past quarter, and we know every second is millions of dollars.

Product suggestions, so we introduced a May We Suggest section. Actually, we reintroduced a May We Suggest section that we had many years back and that we brought back. We've provided enhanced product detail pages. We launched favorites, and we also launched the waitlist functionality.

We are now delivering more elevated packaging on our luxury items, and then we accelerated our standard shipping timings. So those are just a few of the changes we've driven. And obviously, making sure our consumers have an awesome experience on the site is critical for us. Then the third element is we continued to work on quality of sales, driving AURs and reducing our discounting over time.

In terms of innings and Jane is our baseball expert on this team, listen, in terms of innings, I think, Paul, at this stage, we're really in the very early stages of the game. We actually see many more opportunities moving forward. We're planning continued growth now in North America digital commerce in the back half of the year. So we're pleased with the plus 9% we delivered this quarter and expect to continue to grow moving forward.

Then longer term, our biggest opportunities are really in building the omnichannel functionality of our digital commerce operations, so better connecting our retail experiences to where the consumer wants us to show up, better connecting it to our social commerce, and so on.

[Paul Trussell, Deutsche Bank Securities, Inc.]

Thank you for the color. Just to quickly walk down the P&L, you had another solid quarter of gross margin expansion, but guidance does suggest that those gains may moderate somewhat in the second half. So if you could, just help us maybe better understand the puts and takes of this quarter and what we should keep in mind as the year progresses, including just how much you believe you can narrow the inventory to sales spread by year end.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Sure, so welcome, Paul. I'd be happy to take you through the gross margin. What you saw in the second quarter, we were pleased with our gross margin performance expanding 100 basis points in the quarter. The most important driver is what's been really durable over the last two years, and that is that we reduced promotion and we got our AURs up. That's going to maintain over the second half of this year and is the chief driver in expanding our gross margin 75 basis points for the full year. We also had benefits from geographic mix and channel mix. Those are also going to be durable through the second half of the year.

Where we're seeing a switch is really the product cost, which was a slight headwind in the quarter, actually becomes a headwind through Q3 and Q4, and is about 30 to 40 basis points of pressure by the time we exit the year in the fourth quarter. You'll recall last year, that was a tailwind of about 80 basis points. So that's where the dynamic is shifting, and we've been calling that out for a while. And indeed, we are seeing that.

Now importantly, as we think about that pressure, it incorporates the tariff pressures that we're seeing from the existing legislation and incorporates some of the freight and input cost inflation that we're seeing.

And then FX, which has been a nice tailwind to us in the first quarter of about 10 basis points and in the second quarter of about 40 basis points, moves into a headwind in the second half of the year. So those are really the drivers. We're really pleased that we continue to expect gross margin expansion, and we're holding to our guidance on gross margin expansion. But we do see, as we've called out for a while, some of those pressures coming.

As we look at inventory, we expect inventory to more closely align with our sales outlook by the fourth quarter.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

Thank you. The next question comes from Matthew Boss with JPMorgan. You may ask your question.

[Matthew Robert Boss, JPMorgan Securities LLC]

Thanks and congrats on a nice quarter.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Thanks, Matt.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Thanks, Matt.

[Matthew Robert Boss, JPMorgan Securities LLC]

On the expense front, Jane, I guess help us to think about the SG&A efficiencies remaining from here. And maybe just elaborate a little on the timeline for SG&A line item leverage if comps were to turn positive going forward.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

So as we think about big initiatives in terms of what we're seeing in SG&A, we have a number of focus areas across our costs. We're seeing some of the benefits from the procurement initiatives that we instituted. We're starting to see some nice distribution savings that will mostly manifest themselves in FY 2020 from the work that we're doing, and a disciplined approach to overall costs. And overall in the quarter, we've seen our payroll costs reducing. And of course, as I called out, we invested in marketing this quarter.

As I look to the back half of the year, we'll continue to invest in marketing, notably in the third quarter. Now recall, last year in the first half of the year, marketing was down. It was up in the second half. We are going to invest and expect to have increased marketing in the third quarter, but some leverage in the fourth quarter overall. And so I think you'll see the expense flow be a little higher in the third quarter and advantaged in the fourth quarter as we move through the year. But as you saw in our guidance for the full year, we expect operating margin expansion and our revenue to be flattish to slightly up. And so I think you'll see some nice profit accretion top to bottom line.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Simeon Siegel with Nomura. You may ask your question.

[Simeon Avram Siegel, Nomura/Instinet]

Great, thanks. Good morning, guys. And congrats on the progress.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Thanks, Simeon.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Thanks, Simeon.

[Simeon Avram Siegel, Nomura/Instinet]

Jane, any view on how much more room you have to grow AUR? You've obviously been doing a fantastic job there. And then any way to quantify the savings you expect from reducing the airfreight. And then, Patrice, any learnings you can share on maybe favorite question on Amazon, anything that you've seen there with our relationship? Thanks.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Sure.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Sure. So I would say on AUR growth, AUR growth is a key part of our strategic plan that we outlined. So we expect AUR growth as we move through into the second half so that will continue. And then as we look out over the next five years, because we're elevating our brand, we're moving to a more direct-to-consumer distribution, you will see AUR growth through the remainder of the plan. So, we see it as durable. We see it as an important part of the plan. It's a combination of reduction in promotion, selective and surgical price increases, as needed, notably on new products. And overall, assorting into higher AURs, notably in our international markets, where consumers have been very receptive to that.

The shift out of airfreight is a part of our ongoing saving strategy to move to more efficient forms of freight transport. Freight, in total, is about 3% to 5% of our COGS, so it's important. It's a nice shift, but I wouldn't say it's a material driver of overall COGS.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

And I guess on your Amazon question, so maybe just starting with a bigger picture on pure players for us. Pure players is a key building block of our digital commerce strategy. And, actually, this quarter, pure players was the fastest growing part of our digital commerce business.

As far as the U.S. is concerned, we're now live with our Chaps pilot on Amazon. We've been on there for several weeks. We're actually encouraged by the early results, the higher AURs, frankly, than we expected, so we'll see whether that continues. And then the learnings that we're generating together with Amazon, so feeling good about that. But, obviously, very early days and we'll report over time in terms of how we're performing.

And then on the broader Amazon conversation, we are continuing our dialogue with Amazon. We are very clear on the four key principles for us to participate in pure play business. They haven't changed, right: brand building presentation; pricing integrity; making sure that no non-authorized third-party sellers or counterfeit products are available on the site; and working with the partner on access to consumer data. So those four principles are still in place.

We are now there on the balance of the portfolio with Amazon in the U.S. We're actually making progress across many different pure players around the world, including here in the U.S. We just joined Stitch Fix, Olivella in the U.S. and also new customers around the world. So continuing to drive it and continuing to drive the dialogue with Amazon and looking carefully at our experience in our pilot with Chaps.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Great. Next question, please.

[Operator]

The next question comes from Brian Tunick with Royal Bank of Canada. You may ask your question.

[Brian Jay Tunick, RBC Capital Markets LLC]

Good morning. Congrats to the team, and especially Evren on the promotion, very well done.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Thanks, Brian.

[Brian Jay Tunick, RBC Capital Markets LLC]

I think you guys talked about share gains in North America in the department store on the digital side, so curious how do you feel about share dynamics overall in North America wholesale? It's been a while, I think, since you guys talked about share gains?

And then the second question would be, would you expect the off-price sell-ins to be down next year as well or is this really the big cleanup year? Thank you very much.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Well, why don't we tag-team on that one with Jane, Brian. So as far as share is concerned, we believe greatly in share, right. Because ultimately, it's the measure of consumer voting, so it is something that we watch.

As far as the U.S. performance is concerned, so our men's wholesale share is basically stabilized. So it's now been stable for a couple quarters after 13 quarters of decline, so we're encouraged by the stabilization. Obviously, success is not stabilization. Success is growth. We are growing share online on wholesale dot-com so we're actually excited about the progress we're making there.

And we're now all focused on making sure we deliver share in the brick-and-mortar part of wholesale. We're doing that through the marketing investments and engaging marketing activities. We're doing that through, obviously, all the product work that's going on, both on the core and on the newness. And we're doing that through renovating our doors. And that continues to be a program on which we are making solid progress to make sure the brand is presented in a way that's consistent with how we view it and how we want it to show up to consumers in 2018. So I think that's the share picture. Jane, you want to talk about off-price?

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

So, on the off-price reduction, it's going to be down meaningfully this year. As we move out into the out years of our strategic plan, we do plan to reduce our penetration of off-price to our wholesale channel. So we expect it to be compressive, if you will, to our overall growth. We contemplated that with our algorithm as we looked at our five-year strategic plan. Will it be negative or not? I think it's too soon to call. It'll be based on our overall wholesale outlook. And we're managing that channel prudently, but we've acknowledged it is a pressure point to our overall growth algorithm and we've contemplated that.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Kate McShane with Citi. You may ask your question.

[Kate McShane, Citigroup Global Markets, Inc.]

Hi. Good morning. Thanks for taking my questions and Evren and Cori, congratulations again. My question centered around the capsule launches you highlighted in your prepared comments. I just wondered how you were thinking about managing the cadence and availability of these collections going forward and what ROI are you seeing from these specific capsule launches so far.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

So overall, we're excited about the role these capsules play within our overall brand building program. We are very clear that we have to do this at the right pace, because if you do it too frequently, it loses its sense of excitement and interest. We think we have the right drumbeat, so we expect to continue to do these at the pace that I think we've established so far. And, listen, every time we drop one, we're getting immense excitement and great interest.

The latest one is Downhill Skier, so available on our app for those of you who want to access it. And initial results are quite positive behind that. But it is part of our broader brand building program and product program moving forward, right?

If you think about it from a product standpoint, one, we obviously want to drive the core. We're seeing positive results on the core. Then we want to use limited editions in capsules and personalization to bring excitement to the brand. And then, obviously, a third plank is the under-developed categories that we've been talking about.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

From an ROI perspective, Kate, we look at these as really they have a great marketing value. They tend to sell out and sell out at full price. Our teams have gotten very adept at developing them, so the incremental costs are minimal. So we see them as a good product ROI and, more importantly, a great marketing ROI.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Omar Saad with Evercore ISI. You may ask your question.

[Omar Saad, Evercore ISI]

Thank you for taking my question. I wanted to ask a follow-up on the digital inflection. Sorry if I didn't pick up on this, but I'm trying to understand how much of that inflection to positive trends in the digital comps is a matter of kind of cycling the closing down of all the promotions that were driving traffic and sales and just kind of winding that down and not having to comp against that so much versus kind of more offensive measures that are really driving consumer demand and excitement in that channel, maybe if you could help us understand what are the key driver in inflection.

And also on the Polo app, while we're on digital, maybe you could talk about the possibility for a membership program or some sort of loyalty program. We're seeing more brands kind of combine membership and loyalty with their own apps to engage with the consumer more directly. Thanks.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Sure, Omar. I'll take the first part and then I'll let Patrice talk about what we're doing moving forward. What we've seen in terms of our inflection back to growth, there's no denying that we are overlapping a significant reset of our digital business to drive price harmonization, to become less promotional. I think we've accomplished that. And encouragingly in the quarter, what we see is that our full price business on our website is growing nicely, so that's an important part of what you're seeing in terms of the growth.

But what I can't do is break out exactly what's the benefit of the improvements that we've made to the site and how much that's impacting. We did see the key driver is improved traffic and so that we know that that's helping the top line and that traffic is getting a better experience. But I think that the reset that we've done as we look at full price selling, which has been up nicely in this quarter, is an important part of the driver. So I think they really go hand-in-hand.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

And then on the app, I mean, we're actually really excited. We're finally able to make an app available to our fan community around the world. Loyalty point is spot on, Omar, which is ultimately, we will want to have a loyalty program for our best customers. We'll need to make sure that we offer relevant value for them. But certainly, that's consistent with our thinking on this platform.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Michael Binetti with Credit Suisse. You may ask your question.

[Michael Binetti, Credit Suisse Securities (NYSE:USA) LLC]

Hey, good morning, guys. Thanks. And I'll add my thanks to Evren and Corinna. Can we dig in on North America wholesale for a second? Flat in the quarter; I think that in the first quarter, that was down mid-single digits and excluding some one-time shifts and then flat this quarter. Jane, do you feel like that's a pretty comparable number to the underlying negative mid-single digits in 1Q or were there any puts and takes in the second quarter to think about?

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

We saw North America, overall in the first quarter, wholesale business was down low single digits. And we see it flattish in the second quarter, up slightly in the second quarter. I think it's relatively comparable.

What I'm seeing in the underlying trend, the underlying full price trend is that from first half to second half, we're making sequential progress. So we're very encouraged by that. We saw in the first half, sort of, some high single-digit to mid-single-digit declines.

As we go into the second half, we expect to see that improve to be more towards the overall trend, of sort of low to mid-single-digit declines in our full price business, which is a meaningful improvement from what we saw last year. So overall, we're encouraged. Most of the noise is coming from the shipment timing of off-price, but we see sequential progress in our full price North America wholesale business as we move into the second half of the year.

[Michael Binetti, Credit Suisse Securities (NYSE:USA) LLC]

If I roll that forward, just thinking about the math, it looks like revenues are poised to decline mid to high single digits in fourth quarter on the North America wholesale side or on the...

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

That's right.

[Michael Binetti, Credit Suisse Securities (NYSE:USA) LLC]

I'm sorry, on the total company, mid to high singles. Looks like currency will be about a 3 point drag. And then I think you had an Easter shift that maybe is a point there. So underlying, we're low single digits, as the rest of that inflection from third quarter back to negative in fourth quarter? Is that fully explained by the off-price shift that you're speaking about?

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Okay. So we've got a lot of dynamics. Let me just sort of pull them apart. In the fourth quarter, you're exactly right, Michael. We've been calling out for a while. What you're going to see if you step back, first half to second half, you're going to see overall trend improvement.

In the first three quarters, consistent with our guidance of this year, are very positive. Fourth quarter, as we said, has a number of factors that we've called out. One is, the Easter shift, which is 3 points to North America comp and a full point to the total company. This is total company revenues.

We've called out reductions in off-price. And then shipment timing in Europe for their wholesale business is going to be favorable in the third quarter, but it will decline in the fourth quarter, very similar to what we saw in the first half of the year. Those are the three drivers that get you to the guidance squeeze on the fourth quarter, which is our most challenging top line quarter.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Alexandra Walvis with Goldman Sachs. You may ask your question.

[Alexandra Walvis, Goldman Sachs & Co. LLC]

Good morning and thanks for taking the questions, a couple of questions for me on the brick-and-mortar presentation for the brand. So firstly, on the wholesale side, Patrice, you made a comment earlier that the refreshes that you've been making with some of the department store partners have been progressing well. Can you remind us how many of these that you've done, how many of these there are still to go? What proportion of the fleet does that represent and whether there's further momentum that we can expect there?

Second question on brick-and-mortar relates to your own brick-and-mortar business. You've seen this material inflection in your e-commerce, RalphLauren.com business. What needs to happen for the brick-and-mortar comps to inflect materially positively? Is it a case of more store remodels? And you've mentioned previously that we should expect some more omnichannel initiatives, so perhaps that's part of the story, but I'd be interested in your thoughts there.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

So starting with the wholesale renovation, so far over the past 12 months, we've done about 175. Obviously, we're focusing first and foremost on those bigger doors, so not every door is treated equally. Some of these include the doors that our biggest partner is renovating at the same time, their top 50. That represents about 10% of sales. So we're early days in this exercise. Where we have done it, we've seen an acceleration of top line growth and we see a good financial return on it. So we're actually quite encouraged by the early results we're getting behind this.

What we'd like to do, I think we talked it during Investor Day, is over the next three years, we want to get to at least 60% of our business, which will represent the majority of the core doors for the business; so continuing to drive that both here in the U.S. and also doing that around the world. We just redid our Selfridges doors. So those of you who are traveling in the UK, you'll get a chance to see that. That was redone about three or four days ago, and the early indications are positive.

As far as the second part of your question, which is when do things turn from a brick-and-mortar standpoint and what's going to be different relative to e-commerce, I think it's really the key elements of the strategy that we've called out, which is making sure that our marketing is connecting with a new generation of consumers and getting those consumers excited about what we have to offer. It's really around product and getting the right balance between core and fashion and leveraging the capsules and the special partnerships and personalization, as we talked earlier, to drive that.

And then indeed to your point, the omnichannel dimension is critical, so we look at it as a whole, because we need to make sure we're connecting as much as possible wholesale dot-com and wholesale brick-and-mortar because we are encouraged by the progress we're seeing on dot-com, and so it's leverage the momentum that we're building there.

But it's the fundamentals of product, communication, and store. And I am actually really pleased with the way the teams are actually treating against all those three elements. So we should continue to see incremental sequential progress as we put one foot in front of the other in driving the acceleration of the business.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Next question, please.

[Operator]

The next question comes from Ike Boruchow with Wells Fargo. You may ask your question.

[Ike Boruchow, Wells Fargo Securities LLC]

Hi, everyone. Congrats on the quarter. Congrats, Evren and Cori, on the moves. I guess, Jane, I want to focus on Europe, or Patrice, just first thoughts on the overall market. There's clearly been some very unseasonable weather and a lot of partners and brands have struggled there, just what you're seeing from a macro perspective maybe the UK versus the EU.

And then, Jane, I just wanted to ask about the comp forecast for the back half. I think you talked about continued improvement on the comp line at Europe. Is that a return to growth improvement or, is that just less bad, less negative comp trajectory through the year?

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Let me start and then you take on, Jane.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Yes.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

So listen, as far as overall Europe is concerned, Ike, we're actually performing in line with our expectations for Q2. So it's the same thing, delivering sequential progress, I think we talked earlier about the progress we're making on direct comps. We're also seeing good performance on wholesale. So we're not seeing macro dynamics really shift significantly for our business. We've also assumed relatively tame progress from a macro standpoint in Europe moving forward. I think we're assuming basically flat overall growth for the region.

And we have outlawed weather as an explanation for business performance at Ralph Lauren. So listen, weather was not clearly a tailwind, but we have to control our destiny and we've I think leveraged other dimensions of our portfolio and business model to drive the business forward, so all in all, seeing good performance on wholesale.

There are timing dynamics, but low to mid-single-digit performance in European wholesale, better transition than expected on our platform on dot-com, great work by the team there, so feeling good about that. And then, as you saw, sequential progress on retail comps, minus 4% Q2, minus 8% the quarter before that, and we expect that progress to continue.

[Jane Hamilton Nielsen, Ralph Lauren Corp.]

Yes. Ike, as we said, one thing that we might call out is that we do see some weakness in foreign tourists, largely probably based on what we're seeing in the euro. But overall in Europe from a comp perspective, we were very pleased with the 5-point improvement we saw going from Q1 to Q2 in our bricks-and-mortar comps.

And, as you know, we made a significant investment in inventory in that market to get back into more seasonal product, a little more innovation in our product, notably in our outlet stores, and we're seeing that working. And so we expect our bricks-and-mortar comp as a reflection of that investment in inventory, and in conjunction with marketing investments that we've made, that you'll see an improvement in the second half. We don't guide comps by region, but we expect to see some nice improvement as we move through the second half.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

We'll take one last question, please.

[Operator]

Thank you. The last question comes from Bob Drbul with Guggenheim Securities. You may ask your question.

[Robert Drbul, Guggenheim Securities LLC]

Hi. Evren, thank you very much and congratulations to you guys.

[Evren Dogan Kopelman, Ralph Lauren Corp.]

Thanks.

[Robert Drbul, Guggenheim Securities LLC]

So I guess if we could spend just a little bit of time on China, I'd love to hear how you guys feel about how the Ralph Lauren brand relationship with the Chinese consumer is and marketing plans there. And specifically, there's a lot of talk around tourism, but trends in Hong Kong, Macau, more tourist-driven markets there. I just wonder if you could just give us some insight into what you're seeing there. Thanks very much.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

Sure. Good morning, Bob. So, listen, we're excited about our progress in China, right. You saw the numbers. They continued to be strong in Q2: Greater China, up 20%; Mainland China, up 40%, consistent with what we delivered in the first quarter. So we have nice momentum, nice momentum there. If you kind of peel the different elements apart, our digital business is growing double digits there. We just launched our digital flagship RalphLauren.cn, so we're excited about that. We just joined TOPLIFE within the JD platform. We're also excited about that, so, in general, good progress on the digital commerce front.

And then, we're continuing to drive our brick-and-mortar presence in the context of the ecosystem we want to build around these big cities, the Shanghais, the Shenzhens, the Beijings and Hong Kongs of this world. We ended the quarter with 68 stores in China. We are on track to open 50 in total for the fiscal year.

And what's exciting and gets to your specific consumer question is what we're seeing in terms of consumer engagement is we're bringing in a good balance between men and women, right. So, you know, globally, our business trends to be more skewed towards men. But in China, actually we've got a good 50%-50% balance between men and women. We're bringing younger consumers, right, so consumers in their 20s and 30s which we feel good about.

And then we're also seeing consumers who are prepared to buy at the high-end of our range from a product standpoint, so one illustration, cashmere, which is one of our higher-priced items, consistently is in the top 10 selling items in China. And as a whole, we're actually seeing the consumer ready to migrate to the higher parts of our portfolio.

From an awareness standpoint, we continue to build awareness. It's always a little tricky to get reliable awareness data in China, but from the latest indications we had is the marketing that we're doing there with influencers weaving the brand into the cultural fabric of China is clearly resonating. And the fact that we had a number of our influencers at the show obviously helped. And we've got Singles' Day coming up, so we'll do a lot of good marketing around that. We're not going to leverage it as a promotional tool. We really focus on it as a brand building tool.

But I would say the response that we're getting from consumers, men and women, across Mainland China and Greater China is actually quite encouraging. And we're building good momentum. And you know what our goal is for the business. We want to hit $0.5 billion in the next five years. And if we continue at this pace, then we'll get to that number and probably a little bit more.

On tourism, actually tourism is a relatively small part of our business, right, so the whole Daegu conversation and so on really doesn't apply much to us. Obviously, it's an area of development for us, but at this point certainly not a vulnerability.

[Patrice Jean Louis Louvet, Ralph Lauren Corp.]

All right, that closes the morning. Listen, thank you to all of you for joining us today. This is clearly an important year for us as we celebrate our 50th anniversary and not many companies get to do that in this industry. And I do want to take this opportunity to congratulate Ralph and the entire team on what we've accomplished so far and the ongoing work that we're all doing to deliver for the future as we write our Next Great Chapter.

We're pleased with our early progress and results as we continue to strengthen our connection with the consumers around the world. We again want to thank Evren for everything that she's done on this part of the business. And I really look forward to you helping us drive Club Monaco to glory. And then, Cori, officially welcome in your new role. This is great succession planning, I think. And we look forward to talking to all of you over the course of the next quarter or at the call the next quarter. So thank you and have a great day.

[Operator]

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.