Ralph Lauren Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Polo Ralph (RL)

Ralph Lauren (NYSE:RL)

Q1 2013 Earnings Call

August 08, 2012 9:00 am ET


James Hurley - Director of Investor Relations

Roger N. Farah - President, Chief Operating Officer and Director

Jackwyn L. Nemerov - Executive Vice President and Director

Robert L. Madore - Interim Chief Financial Officer and Senior Vice President of Finance


Omar Saad - ISI Group Inc., Research Division

Kate McShane - Citigroup Inc, Research Division

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Michael Binetti - UBS Investment Bank, Research Division

Lizabeth Dunn - Macquarie Research

Christian Buss - Crédit Suisse AG, Research Division

David J. Glick - The Buckingham Research Group Incorporated

John D. Kernan - Cowen and Company, LLC, Research Division


Good morning, and thank you for calling the Ralph Lauren's First Quarter Fiscal 2013 Earnings Conference Call. As a reminder, today's call is being recorded. [Operator Instructions] Now for opening remarks and introductions, I will turn the conference over to Mr. James Hurley. Please go ahead, sir.

James Hurley

Good morning, and thank you for joining us on Ralph Lauren's First Quarter Fiscal 2013 Conference Call.

The agenda for this morning's call includes Roger Farah, our President and Chief Operating Officer, who will give you an overview of the quarter and comment on our broader strategic initiatives; Jacki Nemerov, our Executive Vice President, will provide some merchandising highlights; and Bob Madore, our interim Chief Financial Officer, will provide operational and financial details for the first quarter, in addition to reviewing our expectations for fiscal 2013. After that, we will open the call up for your questions, which we ask that you please 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. The principal risks and uncertainties that could cause our results to differ materially from our current expectations are detailed in our SEC filings.

And now, I'll turn the call over to Roger.

Roger N. Farah

Thank you, Jim, and good morning, everyone. We reported better-than-expected first quarter results this morning, delivering 4% revenue growth and diluted EPS that was 7% above the prior year period.

The first quarter sales growth and margin structure were both better than we anticipated, and they demonstrate the tremendous operating discipline of our organization. I'm proud of these results, considering the global retail environment was increasingly challenging during the quarter, particularly for apparel merchandise.

Revenue growth was well balanced across main channels of distribution, and were achieved on top of extraordinary gains in each of the prior 2 periods, 32% in the first quarter of last year and 13% in the first quarter of fiscal '11.

This multiyear growth is a real testament of the diversity of our operating model. Strategic changes, we decided to make in our business, which include the impact of closing 60% of our Greater China distribution network and winding down American Living, combined with unfavorable foreign currency effects, suppressed our consolidated sales growth by approximately 500 basis points in the quarter. Organic growth in the quarter was close to 9%.

Looking at our wholesale segment performance in the quarter. We continue to experience double-digit growth in North America, as we intensified our leadership position in core merchandise categories and in growing distribution of emerging products. Jacki will provide more insight into resilience of our North America wholesale trends later on this call.

In Europe, where retailers and consumers alike are contending with unprecedented economic and political challenges, our first quarter wholesale results primarily reflect our decision to proactively scale back shipments at the specialty channel in order to calibrate inventories to more muted customer demand trends. Our first quarter European wholesale revenues were also negatively impacted by the shift in seasonal merchandise shipments and currency exchange rates.

Retail segment sales were modestly below our initial expectations for the quarter, primarily as a result of challenging traffic trends at our Ralph Lauren stores in Europe and concession shops in Korea and Japan. Volatile equity markets and global economic challenges have clearly had an impact on highly discretionary luxury apparel sales. They have also created reduced stores' traffic in key locations, some of which is also a function of unfavorable exchange rate dynamics.

However, our strategic marketing efforts and focus on world-class customer service, particularly for our most important and loyal customers, have enabled us to mitigate lower traffic levels with improved conversion rates at most of our retail formats worldwide.

As customers have become more cautious and value-conscious with their discretionary spending, our factory stores are providing -- are proving to be extremely resilient worldwide. Our brand and shopping experience is commanding a greater share of the value customer's wallet, as we also continue to see an increase in acceptance of shopping online, where traffic and sales trends to our e-commerce operations worldwide maintained double-digit rates of growth in the quarter.

As you saw on this morning's press release, beginning with a new fiscal year, we have moved to reporting comp store sales growth as a single consolidated metric. With the integration of South Korea last year, we now directly control our distribution at our largest and most strategically important markets.

Given the broad range of retail formats associated with the Ralph Lauren brand that the company operates worldwide and the growing importance of having an omni-channel approach to the customer intelligence and relationship management, we believe the single metric better aligns our discussions with you on how we manage our multichannel approach as a much more integrated and global organization.

The resilience of our gross margin in the first quarter is noteworthy since our retail segments are still cycling through the tail end of the extraordinary spikes in raw material costs that started to affect our margins last year. Lower wholesale shipments to specialty stores throughout Europe put additional pressure on the gross margin, since those accounts tend to be among our most high margin relationships. With inventories in line and lower product costs for the fall, we feel good about our gross margin prospects for the remainder of the year.

Our better-than-expected operating profitability in the quarter was a result of expense leverage in certain large and growing operations that mitigated the impact of the investments we are making in resetting our brand presence in Greater China and our global e-commerce development in customer intelligence and customer relationship management platforms in our systems and infrastructure.

Stronger operating profits were also supported by diligent management expense in the face of a more challenging environment, and included a shift in the timing of certain expenses out of the first quarter into the balance of fiscal '13.

We executed against decisions to align our expenses with the softening global market trends, and that is particularly evident in the resilience of our retail segment profitability in the quarter. This delicate balance between near-term market realities and our commitment to our long-term growth objectives is a defining characteristic of our organization. Historically, it has been a competitive advantage for us in unsettled market conditions.

With over $1 billion in cash and investments, very little debt, well-controlled inventories, our financial condition is very strong. Our cash flows remain robust, allowing us to continue to invest for the long-term growth, while simultaneously returning capital to shareholders by a strong share repurchase program and higher dividends.

As we communicated to you in May, we are planning a year of tale of 2 halves. The first 6 months have profit pressures from raw material cost inflations, incremental investments in our growth initiatives and comparisons to very strong first half results from last year. The second 6 months are projected to see strong growth in operating profits. Our perspective has not changed. And while our new fiscal year is off to a strong start, we are maintaining a cautious view of the global retail environment for the balance of the year. Bob will walk you through some of the specifics of our guidance later, but we are essentially maintaining the full year outlook we provided in May.

It's early in the year and we continue to operate in highly uncertain market conditions around the globe -- around the world. Global financial, economic and political conditions are not only having an impact on the underlying demand trend, but are also resulting in more unfavorable currency dynamics than we initially planned for.

We don't expect to have a true read on the health of the consumer until we're through fall and holiday selling periods. By then, we should also have a better understanding of the political landscape in the U.S. and in China and more insight into how the European Union is dealing with the debt crisis and the implementation of their austerity measures.

In the context of this uncertainty, we want to maintain the flexibility to respond to the market conditions as they evolve.

But we remain committed to staying the course with our investments in our long-term strategic initiative this year, particularly in Asia, for global e-commerce and for customer relations management.

Our first quarter results confirm the quality of our brands and our products. And as Ralph Lauren said in the release today, our products are the lifeblood of our success. We will continue our leadership position in apparel as we create excitement in categories like accessories, footwear and watches. Great products supported by the management teams’ commitment to world-class global execution will help us navigate through difficult times.

Now I'd like to turn the call over to Jacki.

Jackwyn L. Nemerov

Thank you, Roger, and good morning, everyone. The growth we achieved across channels and regions in the first quarter affirms the strong consistent appeal of the Ralph Lauren aesthetic across a large and growing range of merchandise categories. We continue to enjoy a leadership position with more established categories while gaining excellent momentum with emerging ones.

And our reported results only tell part of the story, because sales growth among products that we license to third parties, particularly for Polo and our Lauren brands, were also very strong in the quarter.

Our first quarter sales results were supported by strong marketing and advertising for Lauren at Mother's Day, Polo at Father's Day and children heading to camp for the summer. The Ralph Lauren brand continues to resonate as the perfect gift choice across women, men and our children's category.

Our association with world-class sporting events such as the U.S. and British Open Golf Tournament, Wimbledon and the Olympics, heightened the global exposure of our brand during the quarter. The elevated and iconic presentation of the Ralph Lauren brand through these high visibility partnerships will become even more valuable as we continue to develop our international businesses over the next several years.

Today, I'd like to share with you what's behind our sustained success in the North American wholesale channel, where we've grown our revenues by more than 30% over the last 2 years. This growth is even more noteworthy when you consider the scale of our North American wholesale operations, which exceeded $2 billion in fiscal year '12.

I'm extremely proud of not only the volume, but also the quality of this growth. In addition to the rigor of our sales planning process, we generate extremely high productivity for our core merchandise categories through the disciplined management of our department store distribution, which is, as you know, limited to the best locations in the best doors. We leverage the strength of this foundation to execute high-profile introduction of exciting new merchandise categories such as handbags, footwear, dresses and our newest brand, Denim & Supply.

In the past, you've heard me talk about how design and product development has been important contributors to our market share gains. Another critical ingredient to our success is the tenure and experience of our North American wholesale team. We have an impressive roster of leaders who are constantly raising the bar by driving innovation through compelling strategies and disciplines that not only accentuate the strength of our product, but also drive exceptional profit and growth.

I believe that the passion and the commitment of this team is unparalleled, and the progress we've made over the year truly speaks for itself.

Our success is also a function of the deep, long-standing relationship we have with our key North American wholesale partners. Over the years, we've developed the spirit of collaboration that ensures seamless alignment of priorities and objectives and enables mutual success.

That collaboration has also inspired the creation of compelling new opportunities. Many of our wholesale partners who are in the midst of exciting transformation in how they are managing their growing their businesses, and we are right by their side to support these plans with financial and strategic resources, as well as infrastructure and expertise to ensure their success.

A good example of this is in the area of e-commerce and online marketing, where we have built a dedicated team of experts to fully exploit this rapidly growing channel with each of our partners.

With respect to the first quarter, double-digit growth in our North American wholesale operations was primarily fueled by comp store productivity gains from our men's, women's and children's apparel. Our growth also reflected incremental distribution in Canada for Denim & Supply, Lauren accessories and footwear and Lauren dresses.

The tremendous momentum of Polo in department stores and Black Label in specialty stores contributed to strong performance in the men's category. We had a powerful Father's Day, and it was supported by elevated marketing campaign and the additional halo of our Sports of Summer initiative that drove high interest in our men's product heading into this important holiday.

Our performance in children's was also strong across boys, girls and babies, driven by key items and updated classics.

As many of you know, Lauren is our dominant women's brand in the North American wholesale channel and is the embodiment of the iconic Ralph Lauren lifestyle. The broad appeal of the Lauren's sensibility has allowed the brand to grow in what's been an extremely challenging environment for women's sportswear.

Over the last few years, the Lauren brand has successfully evolved to meet the customer's need for more casual and contemporary product that suits her style and her life. Updated silhouettes in the core sportswear assortment and continued expansion of Lauren Jeans, Lauren Active, Lauren dresses and of course, Lauren accessories and footwear has hit the mark with the customer.

During the first quarter, the focus on color, prints and novelty across all categories of the Lauren portfolio was an important contributor to sales growth across the brand.

Our Mother's Day marketing efforts in-store, in-home and online beautifully brought the product stories to life and emphasized the brand's unique breadth across product classification in a highly impactful way. This was instrumental in driving both gift-giving and self-purchase activity.

Lauren Active and Jeans were particularly strong in the quarter and dresses continued its momentum with double-digits comp growth.

The performance of Lauren footwear was also spectacular with productivity continuing to climb as we introduce more lifestyle sensibilities to the product mix and delivered strong results on trend-right espadrille and sandal styles. Thanks to our success here, we are expanding distribution with our largest accounts.

Distribution is also growing for Lauren handbags and small leather goods. In addition to new points of sale, we are successfully acquiring incremental real estate in our best performing doors. We are especially excited about our new main floor shop at Macy's Herald Square that will be unveiled in September as part of the first phase of the magnificent renovation of that iconic store.

Before I turn the call over to Bob, I do want to call out that we have worked our way through this incredible spike in the cost of cotton that has weighed on our gross margin for the last few seasons. We started to experience some margin relief beginning with summer shipments, and we expect further improvement in the fall season. As we head into spring '13, we will be operating on a more apples-to-apples basis with more normalized cotton prices.

I also want to acknowledge the strong partnership and sophistication of our global sourcing and supply-chain organizations for their remarkable achievements in helping us steer through that challenge with such great skill.

And now, I'd like to turn the call over to Bob for a review of our financial performance in the quarter.

Robert L. Madore

Thank you, Jacki, and good morning, everyone. As Roger mentioned earlier, our consolidated first quarter net revenues rose 4% to $1.6 billion, which was better than we anticipated, primarily as a result of higher wholesale shipments.

Double-digit North American sales growth was mitigated by lower international revenues, primarily as a result of lower European wholesale volumes and the impact our a Greater China store network closures.

Foreign currency effects negatively impacted consolidated sales growth by approximately 2% in the first quarter, which was primarily due to the weakness of the euro. Excluding strategic decisions to terminate certain North American and Asian operations and the impact of foreign currency translation, revenue growth would have been approximately 9% in the quarter.

The gross profit margin of 62.3% was 70 basis points below the record level we achieved in the prior year period, and was in line with our expectations. The decline in gross profit margin was mostly a function of sustained impact of raw materials cost inflation at our retail segment, in addition to overall geographic and wholesale customer mix, primarily in Europe.

Operating expenses rose 3% to $700 million in the quarter. Although the operating expense margin of 43.9% was 60 basis points below the prior year period, which was much better than the outlook we provided in May. The lower operating expense margin was primarily a result of disciplined operational management, particularly at our retail segment, and included a shift in the timing of certain expenses out of the first quarter and into the balance of fiscal 2013.

Operating income of $292 million was 4% greater than the prior year, and the operating margin of 18.3% was 20 basis points below the prior year period, the net result of the lower gross profit margin and operating expense leverage I just discussed.

First quarter net income rose 5% to $193 million and net income per diluted share increased 7% to $2.03. The growth in net income and diluted EPS was primarily a function of our higher operating income, in addition to lower effective tax rate in the first quarter of fiscal 2013.

Diluted earnings per share also benefited from lower average weighted shares outstanding this year.

Turning to some segment-specific highlights for the first quarter. Wholesale revenues rose 3% to $694 million, a result of continued momentum in North America, but it was offset by lower international wholesale revenues, primarily due to lower European wholesale sales and the continued transition of certain former Japanese wholesale distribution to directly operate concessions shops.

As a reminder, the decline in European wholesale sales mostly reflects lower shipments to specialty accounts in Southern Europe, changes in the shipment cadence that we called out last quarter and the net negative impact of foreign currency translation.

Wholesale operating income grew 3% to $156 million in the first quarter and the wholesale operating margin was 22.4%, 10 basis points below the prior year period. Improved profitability in North America was more than offset by a decline in Europe as a result of lower sales and overall customer mix.

Retail segment sales grew 5%, $857 million in the first quarter, supported by the contribution from new stores and incremental e-commerce operations, in addition to 1% comparable store sales growth on a reported basis and 3% in constant currency.

Retail sales growth was partially offset by store closures associated with our Greater China network repositioning efforts.

Sales trends were strongest online and at our factory stores worldwide. Lower tourist travel and restraint among local customers continued to weigh on Ralph Lauren stores in Europe. Double-digit declines in traffic to department stores in Korea and Japan negatively impacted sales at concessions shops during the quarter.

Retail segment operating income of $180 million was 4% greater than the prior year period and the retail operating margin was 21%, 30 basis points below the all-time high achieved in the first quarter last year.

The growth in retail operating income reflects strengths in our international operations and for e-commerce worldwide. While the decline in retail operating margin reflects gross margin pressure from the continued net negative impact from raw materials cost inflation that was partially offset by disciplined operational management.

Licensing royalties of $42 million in the first quarter were 5% greater than the prior year period on higher apparel and fragrance-related royalties that were partially offset by a decline in home product licensing royalties due to assuming direct control over our home textile operations. The higher licensing royalties contributed to increased licensing operating income in the first quarter.

We ended the first quarter with inventories up 8% from the prior year period, primarily in support of our retail-led expansion worldwide. We spent approximately $62 million in capital expenditures during the first quarter for our retail store and wholesale shop development worldwide, in addition to our continued investment in our global systems and infrastructure.

We purchased 2 million shares of our Class A common stock for approximately $300 million during the first quarter and had approximately $277 million remaining under our authorized share repurchase programs at the end of the period.

After funding all of our capital needs and working capital requirements and returning capital to shareholders, we ended the quarter with $1.1 billion in cash and investments, which is a 14% increase from the prior year period.

Now I'd like to review the financial outlook we provided in this morning's press release. For the full year of fiscal '13 period, we continue to expect revenues to increase at mid-single-digit rate.

Strategic changes we decided to make, such as closing a large portion of our Greater China distribution network and winding down American Living, combined with unfavorable foreign currency effects that are expected to persist throughout the year are estimated to suppress our consolidated sales growth by approximately 5% in fiscal 2013.

We continue to expect our full year operating margin to be modestly above fiscal 2012's level, as a recovery in gross profit margin in the balance of the year is largely offset by an increase in operating expense rate to support our investments in our strategic growth initiatives.

The increased expense rate is also reflective of our higher retail mix this year.

Relative to our initial outlook in May, our full year operating margin outlook also includes incremental costs associated with the acceleration of our real estate development and store openings in Greater China, expenses related to the suspension of certain operations in Argentina and higher advertising and marketing expenditures.

The full year tax rate continues to be planned at approximately 33%.

For the second quarter, we expect consolidated net revenues to decline at a mid-single digit rate as a low double-digit decline in wholesale revenues is partially offset by a mid-single digit growth at our retail segment.

Reduced distribution in Greater China and for American Living and unfavorable foreign currency effects are estimated to mitigate consolidated revenue growth by approximately 7% to 8% in the second quarter. As a reminder, we will be comparing against last fall's large initial shipments for the launch of Denim & Supply during the second quarter.

Operating margin for the second quarter of fiscal 2013 is expected to be down approximately 175 to 225 basis points from the prior year period. The decline in operating margin is entirely attributable to an anticipated deleveraging of operating expenses, that is partially offset by an improvement in gross margin.

The increase in the second quarter's operating expense rate is primarily due to lower wholesale revenues and reduced sales in Greater China, where we're still absorbing the cost of our infrastructure and investing for growth and to incremental costs associated with our investments and our strategic initiatives.

At this point, we'd like to open up the call for your questions. Operator, can you assist us with that?

Question-and-Answer Session


[Operator Instructions] And we'll take our first question from Omar Saad with ISI group.

Omar Saad - ISI Group Inc., Research Division

Roger, wanted to see if I could ask you about the retail business. It's a big focus for the company globally. You mentioned -- you had some interesting comments in your prepared remarks about maybe some of the shifts going on and the factory business is really holding up very well and that luxury apparel side in the full price might be a little bit more challenging. As you try to manage the brand kind of across these price points and diverse customer bases, what are the key elements there? Is it the macro factor that is playing the biggest piece? Are there product fashion issues that might be going on affecting as well? How do you think about managing that whole -- that retail business holistically across the channel, the price points, the different sub-brands, et cetera?

Roger N. Farah

Yes. I think it's a good question, Omar, because we obviously have been focusing a lot on retail over the years since you've been following the story, as well as anybody, you notice our ongoing ability to develop a very profitable business model. I think what you're alluding to is some of the channel mix issues that go on between e-commerce or factory stores, the Ralph Lauren stores we own or even the licensed stores that we don't necessarily report as part of the retail comps. I think what's happening is in the first quarter and probably the first half of the year, we're going against some extraordinary comps last year. First quarter last year was plus 19% and double LOI was plus 7%. So we are up against some extraordinary changes. I also think what's happening on a macro basis is we're really dealing with a worldwide customer. We're seeing more and more the high end customer who shops in London and shopping in Paris or Dubai or New York or Beverly Hills or Asia, and so our efforts around a global customer consistency, merchandising consistency, marketing, the same standards for service is a big push for us around the globe. Now in the first quarter, the Ralph Lauren store business was softer than prior trends. I think most of that has been a footfall issue with the higher-end luxury apparel customer was not shopping in Europe or in key markets with the same kind of urgency they've had in the past. I think the accessory businesses, watch, jewelry businesses have held up better perhaps than the apparel customer. The other thing affecting that is the shifting of the tourist business. There is no doubt that Chinese tourists today are the #1 consumer who are traveling around the world and are distorting sales in stores or cities or markets to a much higher degree. We have a very low penetration at the moment with the Chinese customer. I think we talked about it last time, it's less than 2%. And we think, over time, as we build our presence in China and build our brand, we'll begin to see them in some of the other markets. Very interesting to me is the data point, even a smaller business like Club Monaco that today has almost 20 stores in China. The second largest tourist that they're seeing in New York are Chinese. We're in the Ralph Lauren business, where we've closed our distribution and we don't have a big network there, the Chinese customer doesn't make the top 10. For us, the largest tourist groups are Brazilians and Russians and people from the U.K. So it's a very interesting global dynamic playing out across the world landscape. The factory business is strong worldwide, and we feel good about that. Not really through door expansion, it's just through the way we're executing and running that business, and we think that does complement the value customer's need for product at a price. And then, of course, the ongoing overlay of e-commerce continues to be very strong double-digit growth here in the United States. Our business in Europe has almost doubled, given the expansion of countries and markets, and we continue to see growth there. We're very excited with the Club Monaco launch here in the United States and Canada in March and April. We think that's going to have a real strength with the customer. And then, we'll launch in Japan this fall. So it's really multichannel customer today in terms of some of our customers access all 3, and we expect that to continue. The other, again, subject that's not reported in that number is the license market, like the Middle East or Russia, where we've had great strength and continue to have great consumer acceptance, which we think is why those customers when they travel throughout Europe or the United States are fans of the brand. So it's getting to be integrated, complicated world. And I think that our ability to reach all of those customers with consistency is going to help us in the long run.


[Operator Instructions] We'll take our next question from Kate McShane with Citi.

Kate McShane - Citigroup Inc, Research Division

Roger, I was wondering if you could comment at all about inventories at retail and clearance activity -- I'm sorry, inventories at your wholesale accounts and clearance activity in both the U.S. and the European market.

Roger N. Farah

Sure. The inventories within our wholesale channel are very clean. As a matter of fact, Jacki and I were just talking about the August performance, which is strong, really, on the back of new fall receipts. So with a very strong double-digit spring, summer performance we've had, we're in good shape domestically. In the European markets, consistent with what we said earlier in the call, we actually chose not to ship some products into the market that were originally on order, combination of our concerns about their ability to sell through it, as well as some deteriorating credit with some of the customers. So the actual inventory levels in Europe are down, and the inventory in the channel is clearing through, perhaps a couple of weeks slower than this time last year in Europe. Domestically, we're fine.


We'll take our next question from Adrianne Shapira with Goldman Sachs.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Roger, it's impressive that you're maintaining your full year guidance despite the incremental stem that you talked about, and you've always spoken about the year -- as the year of 2 halves. I think we can appreciate the margin opportunity at the back half, but it clearly calls for revenues to accelerate in the back half. So if you could share with us why you and why should we be confident in that acceleration at the back half given some of the softer footfall issues you've talked about with the higher-end consumer impacting retail sales today.

Roger N. Farah

Okay, Adrianne. Well, thank you for putting me on the spot as to whether I'm comfortable. But as you know, we try to be thoughtful in our guidance, we make no guarantees. It really did lay out, as a year that had 2 halves, the first half being impacted by all the things we've talked about. Many of those things begin to become less meaningful in the back half. So particularly in Asia, where we closed a lot of stores and that continued through the year, we do have the beginning of 15 new stores coming online during the fall. So that will begin to mitigate some of that. And the American Living shipments begin to get to be a smaller percent in the back half of the year as well. Obviously, FX is anybody's guess, and our forecast today really just reflects what the currency exchange rates are. So there's no new news there. We happen to think that the comparisons in comps get more favorable in the back half of the year. We've had extraordinary comps in the first half, and then they flattened out in the second half, we think, as customers began to accept the new pricing. We are fundamentally maintaining that pricing as cost of goods come down, so we'll get margin expansion, we hope, beginning next quarter. And we think we've got a great roster of products position for the retail channel, as well as the visibility we have into the wholesale channel at this point, at least through holiday, gives us some confidence in the guidance and the forecast we've given. Our willingness to invest long term, as you said, Adrianne, continues. But what's offsetting some of that is exchange rates are softer than we thought. We are closing our operations temporarily in Argentina that will be a small hit to the original guidance. And we've got an opportunity to take a couple extra great locations in China, which will also hurt the second half a little bit. But given the strong first quarter and given the visibility we have, that's our best thinking at the moment.


We'll take our next question from Michael Binetti with UBS.

Michael Binetti - UBS Investment Bank, Research Division

Roger, maybe I know we've talked a little bit about the global retail outlook today. But maybe if I could focus in on Europe for just a minute, a little more color on what you're seeing in your own stores in Europe. And we heard from you guys in late May, and it seems like things got a little worse than what you were thinking, you would see Roger since then. So maybe some color on whether you think it's stabilized at this point? Or what gets you comfortable with what you're seeing over there right now as far as how you talk to us about the guidance on the retail side today? And then any -- maybe any -- just to follow up that, maybe any help you could give as we look at our models for gross margin outlook for the year beyond what you've given us to help out with the second quarter would be helpful -- in the back half of the year.

Roger N. Farah

Okay. Well, let's talk about Europe. There's a lot of macro issues to deal with, and I'm not going to attempt to go through all of that with you. Our first quarter, when you put retail, wholesale together, on a constant currency basis was plus 3%. And while that's certainly down from where we've run in seasons past and years past, I think it's a very respectable number. We're seeing skittishness by our wholesale partners and orders, future bookings and forward orders. They are operating cautiously as their footfalls and business has been down. So they're trying to increase their turns and therefore, are looking more cautiously at initial orders. I think if business picks up, we'll be able to get some of that business back through replenishment. But net-net, by the end of the year, if we hit our forecast, we're looking to be flat to single digit up in Europe, depending on exchange rate. I think it's going to be lower wholesale businesses and higher retail businesses. And so we'll keep updating you every quarter, but that's our current point of view. The margin, as Jacki touched on and you've heard from others, we have certainly seen return of cotton, which is our primary raw material to pre-spike levels, somewhere in the low-80s, mid-80s per pound, which is a more normalized level. I think we'll begin to see that impact in the second quarter in the balance of the year. We talked in the past about wholesale inventories turning much faster. And therefore, new receipts with lower cost of goods go into the markup on sales, and that's what we're reporting. Markup and margin on sales, not receipts, but it comes through the wholesale distribution faster because of the turning inventory. Comes through more slowly in retail, where you've got on hand that have prior cost of goods, which were higher. And as the new receipts come in and they blend and they work their way through, I think we'll see the retail impact later in the year. So all in all, we're pleased with the retail prices, as I said earlier, we'll maintain. Cost of goods will start to come down. Obviously mix product categories will make that move around a little bit. But we think you'll start seeing that return in the second quarter.


We'll go next to Liz Dunn with Macquarie Capital.

Lizabeth Dunn - Macquarie Research

In terms of the retail commentary, I just kind of want to dive in a little bit to the factory, because I was surprised at your positive comments on factory stores given the traffic drop-off that others have noted there. Is there something that you're doing differently? Or is it just the conversion that you kind of highlighted? And then also, as it relates to the China customer, does that also impact your business in Europe that you don't have as much mind share with that Chinese tourist customer.

Roger N. Farah

Yes. Liz, I think the factory business has held up well, high single digits. That was really achieved on slightly negative footfalls early in the quarter that began to flatten out later in the quarter, and then as slightly positive as we head into the beginning of a new quarter. So we've seen some firming in the foot traffic there. I think our ability to outperform was really a tribute to the higher unit sales, the higher average price of the products, which became a higher unit in dollars sales and higher conversions. So we track rigorously how we convert the footsteps into sales, and we saw an increase both in the ticket pricing and the conversion rates, so that's good news, particularly if the footfall continues to creep up as we work our way into the critical back-to-school and early fall selling. The Chinese customer is, quite frankly, critical at the moment to the global sales of luxury products. Our conversations with many luxury brands is that it can be 25%, 30% or 40% of the European sales. But when you see reports of strong European sales for other luxury brands, 25% to 40% of it is coming from Chinese tourists. So us of the moment that's less than 2%. So until we get our network and our brand presence in China and better educate the customer, I think we're going to continue not to get a high penetration of Chinese in our international markets.


We'll go next to Christian Buss with Crédit Suisse.

Christian Buss - Crédit Suisse AG, Research Division

I was wondering if you could talk a bit about your accessories penetration, where's that gone, and also about how the responses been to new lines in the accessory side.

Jackwyn L. Nemerov

Well, we've introduced our Ralph Lauren Collection handbag business and footwear business over the last couple of years, and have really built on the fashion in that product, the quality in that product and the broader appeal of that product. And we're very pleased with the direction of where we're headed with that accessory and footwear product. And we are really playing that as an important aspect of our own retail stores. So in all the new stores we've built, what you'll notice when you walk in is a great presentation of accessories, which includes handbags, belts, scarfs, a great presentation of footwear from the dressiest style to the most casual, and we've been working very diligently on the growth of those opportunities. We've seen some great penetration in the success of those businesses. But as I said, they're small and they're growing. In our department store business, where we have our Lauren brand and Polo brand, in Lauren, we began in footwear a few years ago, and we're seeing a great penetration and increase in sales. We just came off a marvelous season in our Lauren footwear business. We introduced Lauren handbags just under 2 years ago, and that is really starting to take on some great success, again, a great season and great growth. We've added Lauren handbags and Lauren footwear to Europe as well, and we're pleased with the early results there. Our Polo footwear has really accelerated very successfully, and we are now the #5 brand in men's footwear, which is quite an accomplishment from starting a couple of years ago, sort of not having a footwear business. And we are introducing our Polo men's accessories into our top doors for this fall. And because of, certainly, the power of our Polo brand, we're anticipating some very nice early results there on that product, which our intention is to build on the loyalty of that Polo customer, the introduction of this new category, the positive reaction we've gotten from our customers to the look of that product and the price point that we're introducing it at makes us feel very positive and very excited about what the future of that business can be as well.


We'll go next to David Glick with Buckingham Research Group.

David J. Glick - The Buckingham Research Group Incorporated

Roger, just want to clarify your comments on Europe for your outlook for the year. You said flat to low single digits. Was that on a constant currency or a reported basis? And I was wondering if you could get into a little more detail on your comps in Europe in constant currency in Q1, how you're thinking about that for the balance of the year. And any color on Northern versus Southern Europe will be appreciated.

Roger N. Farah

Okay. So my comments were really based on a constant currency. At this point, I'm not quite sure how to forecast it. We have, like others, seen weaknesses in Europe in the southern tier, not that we have big businesses in Greece, but certainly Italy, which at one point, was our largest country in Europe. Spain, which is also another large country, have seen the greatest impact of their businesses. Italy, almost all specialty store distribution; Spain, almost all department store distribution. The northern countries, whether it's Scandinavia, whether it's England, France, Germany all have performed better, and they continue to show more high potential parts of it. The other part of Europe that I talked about earlier, which we add in, the Middle East and Russia have also been very strong. So it's really a range of performances, depending on where in Europe you want to talk about. We see online growing. We see the retail growing. And I said earlier, we're going to be cautious about wholesale sell-ins. We want to manage the flow of product into the marketplace. We're also going to manage those places that in a specialty channel may have deteriorating credit metrics. So all of that rolls into my comments about viewing Europe for the year as kind of flat to mid-single digits on a comparable currency basis.


We'll go next to John Kernan with Cowen & Company.

John D. Kernan - Cowen and Company, LLC, Research Division

So looks like this year, you expect to finish the year around a little bit above 15% operating margin as you reposition some of your distribution and you continue with the rollout of some of your newer product categories. What's the long term -- what's your long-term view on your operating margin? And is there any reason to believe that there isn't a meaningful long-term operating margin expansion potential as you continue your international rollout?

Roger N. Farah

Okay. Well, I think you've been a student of our business. And other than the spike in the raw materials in the recent past, we've seen tremendous progress in growing our merchandise margins, and we would expect, as we continue to go out over the next couple of years, to see some of that growth rate return. Now the other thing that gives me some confidence about the long-term margin opportunities of the company is our ongoing ability once we fully integrate Asia, is a desire to get some expense leverage. As we spent many years integrating merchandise categories, product categories, regions, we do think we will get some expense leverage. The other piece that we think is exciting for the long-term prospects and margin is many of our new initiatives successfully accomplished should be high-margin businesses, not only the accessory business, but the margins in Asia should be meaningfully higher than the margins in either the United States or Europe. So a lot of the areas we're focusing on, I think, do speak well for the long-term margin opportunities of the company, and we'll see how they play out.

I think at this point, operator, we've hit the time limit. So I thank everybody for their interest and their questions. Appreciate the focus this morning. We're very excited about the back half of the year, and think we're well positioned to navigate some of the short-term turbulence. So thank you very much.


And that does conclude today's conference. Ladies and gentlemen, thank you for your participation. You may now disconnect.

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