Earnings Call Transcript - RL Q2 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ralph Lauren Second Quarter Fiscal Year 2023 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'll now like to turn the conference over to our host, Ms. Corinna Van Ghinst. Please go ahead.

Corinna Van Ghinst, Host

Good morning and thank you for joining Ralph Lauren's second quarter fiscal 2023 conference call. With me today are Patrice Louvet, the company's President and Chief Executive Officer, and Jane Nielsen, Chief Operating Officer and 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. With that, I'll turn the call over to Patrice.

Patrice Louvet, CEO

Thank you, Corinna. Good morning, everyone and thank you for joining today's call. It was great to see so many of you at our Investor Day in September where we laid out our ambition to be the world's leading luxury lifestyle company. We also outlined our company's next phase of growth powered by multiple engines, which we are calling our Next Great Chapter Accelerate plan. We are off to a strong early start with our second quarter performance, which exceeded our expectations on both the top and bottom line, demonstrating the consistency and momentum of our business around the world. At the same time, we continue to drive a culture of operating excellence as ongoing productivity is an important driver to fuel our near and long term growth. This resulted in another quarter of double-digit AUR growth and sales exceeding our plan, even as the broader marketplace became more promotional into the fall, as anticipated. Also, as we had expected from the start of this fiscal year, the global operating environment has remained choppy across many of our key markets. Our solid performance amidst this backdrop is a credit to our team's agility and execution as we focus on delivering what we can control. And while we expect this choppiness to continue in the near term, we're encouraged that our core consumer remains generally resilient despite the macro headlines, reflecting increasing desirability for our brand and the attractive value proposition of our products. As we navigate the broader macro headwinds, we're focused on driving our three strategic pillars of long-term growth. These include first, elevate and energize our lifestyle brand. Second, drive the core and expand for more, and third, win in key cities. With our consumer ecosystem and spanning everything we do is our commitment to deliver positive impact in the world across citizenship and sustainability. Let me take you through a few of our second quarter highlights across our plan. First on our efforts to elevate and energize our Lifestyle brand. As we continue to build our business for the long term, we remain focused on investing in our brand to deliver a differentiated elevated message to our target consumers. Consumers' perception of Ralph Lauren as a luxury brand remained high at 78%, and their perception of our brand's value for money continued to expand both sequentially and versus last year in the second quarter. This is enabling us to both strengthen our existing relationships and recruit new, younger high-value consumers around the world. With the growth in our highest value consumers significantly outpacing our total business. We are leveraging our core brand values and ROI-driven marketing strategy in order to connect authentically with consumers and continue to gain market share. This was evident in the second quarter where we continued to focus our investments on driving brand desirability across a diverse range of activities. First, we celebrated the energy and optimism of sport to our annual sponsorship of the US Open Tennis Championships, which were particularly thrilling this year with record attendance levels and a 50% increase in viewership. It was hard to miss Polo on the court and in the audience from our official ball person uniforms made with recycled plastic to our timeless spectator style showcased by celebrities like Anne Hathaway, Diplo, Angus Cloud, and Jamie Foxx. We were also proud to outfit Serena Williams in Vogue's September issue where the tennis legend announced her retirement from the sport. Our 360-degree campaign for back to school drove strong conversion in our Polo Kids business this fall. Our class of RL video in August followed by our women's Polo ID handbag video in September were our top viewed Instagram reels on our Polo handle of all time. We continue to capture key brand moments that resonate with fashion lovers around the world. 2022 was the year of weddings and we were front and center dressing Hollywood royalty like Jennifer Lopez and Ben Affleck along with NBA superstar, Kevin Love’s wedding to Kate Bock. A few weeks ago we hosted our first-ever fashion show on the West Coast at the Huntington Library in L.A., celebrities and friends of the brand like Lily Collins, John Legend, Ashton Kutcher and Mila Kunis, Jessica Chastain, Diane Keaton and newlyweds JLo and Ben Affleck joined us in celebrating the optimism and joy of California Dreaming, featuring our full luxury lifestyle brand ranging from RRL to Polo Men's, Women's Kids and Home. And as we continue driving our brand leadership deeper into the metaverse, we launched our first collaboration with Fortnite last week in time for holiday. The popular online game has more than 400 million registered accounts with a strong following among 18- to 24-year-olds. The partnership includes a special collection of digital outfits and two special drops of physical product available in our DTC channels and select specialty retailers around the world. Together these activations are attracting younger full-price consumers to our business. We exceeded 50 million social media followers globally this quarter. A high single-digit increase from last year led by Instagram. In our DTC businesses, we added 1.3 million new consumers similar to recent trends and our online search trends grew low double digits from last year in Q2, significantly outpacing our peers across our top markets globally led by Polo shirts and fall apparel such as sweaters and fleece. Moving to our second key initiative, drive the core and expand for more. As we work toward becoming the leading luxury lifestyle company, our products all come back to the idea of inviting consumers to step into the world of Ralph Lauren. Ralph and our design teams are capturing the breadth of styles and end users consumers are looking for today from a more sophisticated take on casual comfort to their modern hybrid approach to where to work and social gatherings. Starting with our core product, which grew mid-teens in the second quarter, supported by all key categories led by sweaters, seasonal core knits, sweatshirts and chinos as we discussed our Investor Day. Our core product comprises about 70% of our assortment and is a key competitive advantage in the marketplace. In times of uncertainty, consumers continue to invest in brands and products they know and trust. Our core also establishes the credentials for driving our high-potential categories, which include Women's Outerwear and our emerging Home business. Together, these high-potential categories grew high teens in the quarter. Women's represents our single largest long-term opportunity for market share gains and category growth. As a company, we are trading her into the brand, including the successful launch of our Polo ID handbag collection. This year we are trading her across by building an offering of essentials like sweaters, sophisticated coats, dresses, and denim that will form the foundation of her wardrobe and expand her lifetime value, and we are trading her up to more elevated products through our hybrid styling as only Ralph can with Women's AUR up 20% in the second quarter. Within Outerwear, another high-potential category, which now represents about 10% of sales, we are establishing our brand as a go-to player for the category. Second quarter highlights included our quilted Beaton and Harper jackets, cotton twill, city windbreaker, and Terra Packable vest. Our Kids Outwear business was led by the launch of our P Layer outerwear system, a versatile collection of functional outer shells and liners constructed of all recycled materials, other product highlights and special releases. This quarter included our US Open collection, which drove our highest sales ever for the event. We also introduced our first US Open Sneaker, which sold out in our stores and our NOLA Collection for women inspired by the culture, climate and beauty of New Orleans and our Polo Active Club collection tailored to next-generation consumers. The digital campaign was brought to life with skateboarder filmmaker Mikey Alfred and his skate group. From our Polo bear sweaters to a return of tailored dressing. Our teams are consistently delivering the styles consumers are craving in this new normal. Switching to our third key initiative win in key cities with consumer ecosystem, we continue to drive our long-term strategy of investing in our key city ecosystems around the world in the second quarter with a focus on elevating and connecting all our consumer touchpoints across every channel. Each of our ecosystems is led by a digital-first mindset representing the best expression of our brand through innovative storytelling, dedicated shop-in-shops and virtual selling experiences. Second quarter sales for our total Ralph Lauren and digital ecosystem, including our directly operated sites, department store.com, pure players and social commerce accelerated to mid-teens growth in constant currency. Our Asia digital ecosystem once again drove the fastest growth globally over a smaller base, up more than 60% in constant currency from last year. Within our own digital sites, sales grew mid-single digits in the second quarter and more than 40% on a two-year stack. We continue to drive an increased penetration of full-price selling through elevated products and investments in AI-powered targeting, and high-quality new consumer acquisition growth was also supported by the continued launch of new sites, including the recent additions of Korea and Australia. Our digital capabilities also provide true endless aisle connectivity to our physical channels. Indeed, our stores remain a critical component of our ecosystems to build our brand and consumer engagement around the world. We opened 29 new stores and concessions in top cities globally this quarter with the vast majority in Asia, particularly the Chinese mainland. Our brand momentum and opportunities in China remains strong with sales up more than 30% performance was balanced across Hong Kong, Taiwan, and the Mainland despite mandatory closures in the period. As you heard at Investor Day, China provides not only the successful blueprint for our elevated ecosystem strategy globally, but it also represents one of several geographic long-term opportunities for our brand. With strong brand momentum, our highest AUR in the world and significant runway for strategic store openings to strengthen our relationship with the Chinese consumer. Looking ahead, the strength we are also seeing across markets like Korea and Australia are just two examples of the diversity of growth drivers that we have around the world. As you heard in September, we remain bullish on our long-term growth opportunities and ability to strategically drive lifetime value across all of our regions. And finally, touching briefly on our enablers. In addition to our strategic priorities, our business continued to be supported by our five business enablers, which we highlighted in September. These include our people and culture, one of our key competitive advantages, best-in-class digital technology and analytics, superior operational capabilities, the powerful balance sheet and leadership in citizenship and sustainability. I won't go through all of these in detail again, but in the second quarter we were particularly proud to be named one of the world's best employers by Forbes. Our people are at the heart of everything we do. They inspire us to be better and to do better. Just a few weeks ago, our teams around the world came together for our first in-person Pink Pony Walk since COVID. We celebrated the Ralph Lauren Foundation's $25 million grant to fund five cancer centers in the US this year, but it was also a moment for us to reflect on our purpose and what we've been through over the past few years as humans as an organization and the important role we play in our communities. In closing, we are highly aware of the macro challenges across each of our geographies. Ralph and I are exceptionally proud of the creativity, agility, and execution our teams continue to demonstrate as we effectively navigate these dynamic times, and while we expect the environment to remain choppy in the near term, what gives us confidence to deliver on our commitments are our powerful authentic brand. Ralph built a brand that stands not just for one product but a lifestyle, a dream to aspire to our multi-pronged strategy with diversified growth across regions, consumer groups, categories and channels, and our fortress foundation. With that, I'll hand it over to Jane to discuss our financial results and I'll join her at the end to answer your questions.

Jane Nielsen, CFO

Thank you, Patrice, and good morning, everyone. Our second quarter results demonstrate solid progress on our NGC accelerate plan, exemplifying our team's execution strength across our multiple strategic drivers and superior operational capabilities in the face of further macro challenges and disruptions around the world. Our top line growth continued with Q2 revenues up 5% on a reported basis and 13% in constant currency ahead of our outlook. This quarter's was once again supported by positive growth in constant currency across all three regions. Operating margin also slightly exceeded our expectations, even with inflationary cost pressures and a more normalized cadence of investments versus last year. We believe our elevated brand focus strategy and targeted investments when combined with our culture of operating discipline and Fortress Foundation enablers put us in a position of strength to continue to drive long-term value creation through uncertain times. Let me take you through our second quarter financial highlights. Total company revenues increased 13% in constant currency above our outlook led by double-digit growth in both Asia and Europe. Ralph Lauren digital ecosystem sales continued to outpace our total company rate, up mid-teens in constant currency on top of a strong compare of nearly 50% last year. This includes mid-single-digit growth within our owned Ralph Lauren and digital sites on top of more than 30% growth last year. We continue to invest in enhanced digital content and storytelling and to expand the breadth of our offering, including the addition of a home shop. In the past year, we are also driving further improvements in the quality of sales with a meaningful increase in full price sales penetration and digital margins still strongly accretive to our overall profitability in the quarter. Total company adjusted gross margin was 64.6% down 270 basis points from last year on a reported basis and 80 basis points in constant currency in line with our outlook. Second quarter AUR was up 18% on top of 15% growth last year. Continued AUR momentum was more than offset by channel mix pressure from stronger than expected wholesale performance and higher product costs, including freight. However, the higher freight spend enabled our improved fall on-time delivery rates and full price selling to deliver revenue outperformance in the quarter. Compared to fiscal 20 pre-pandemic levels, gross margin was 310 basis points higher in the second quarter. Adjusted operating margin was 13.4% on a reported basis and 16% in constant currency representing a 110 basis point decline in constant currency as we normalize spending versus unusually low levels last year during COVID. This was ahead of our outlook driven by strong operating expense discipline and productivity measures. Adjusted operating expenses increased 7% to 51.2% of sales, including marketing expense growth of 18% over last year's lower spend. Marketing was 6.8% of sales in line with our guidance of 6% to 7% for the full year. While we have built increased flexibility across our operating expense structure, we remain committed to investing in our brand, which is driving both near-term top line momentum as well as longer-term brand equity. Moving to segment performance starting with North America. The region's pivot to growth continues with second quarter revenues up 3%. In North America, retail comps were flat on top of a strong 31% COVID reopening compare last year. While we were encouraged by positive comp growth in our full-price stores, this was offset by softer performance in our outlets. As anticipated in our guidance, our outlet AUR up mid-teens reflects our ongoing brand elevation efforts in the channel. However, we continue to see softness in our value-oriented consumers, a subsegment of the channel. In the current environment, we are focused on communicating our strong value proposition to the consumer, which as Patrice mentioned continued to strengthen in Q2. This is supported by our targeted personalized communications. We are managing this channel carefully given ongoing macro headwinds and have assumed increased caution in our fiscal 23 outlook. North America store traffic trends remain below pre-pandemic levels consistent with the broader industry. Although our foreign tourist sales continued to show improvements from last year. Comps in our owned Ralph lauren.com site were down slightly but increased more than 30% on a two-year stack. While we were encouraged by our increased penetration of full-price sales online, this was offset by higher seasonal clearance to keep inventory clean ahead of holiday. In North America, wholesale revenues increased 8% to last year accelerating sequentially from first quarter trends driven by full-price channels. Our strong continued performance reflects our improved brand positioning in the channel with further market share gains in Men's, Women's and Kids versus pre-pandemic levels in key partners. Our sellout grew high single digits from last year on better than expected fall fill rates and enhanced marketing. Our AUR at wholesale also grew high single digits from last year. As we elevated product pulled back promotions and increased targeted communications inventories remain well positioned in the channel versus demand and we have not experienced cancellations to date for either holiday or spring 23. We still expect the channel to be up modestly in the second half of fiscal 23. Despite challenging compares from last year and our more cautious approach to spring 23, inventory buys off price. Sales declined double digits from last year and more than 60% to pre-pandemic levels as we realign this channel to be an excess clearance vehicle. Moving on to Europe. Second quarter revenue was flat on a reported basis and increased 15% in constant currency. Retail comps increased 3% on top of a 27% compare last year. Brick-and-mortar store comps were flat over last year's strong 28% compare, which benefited from the reopening of all markets post-COVID. Total digital ecosystem grew mid-teens in the quarter, including a mid-teen comp in our own digital commerce. While the first half trends were robust supported by improved receipt performance, we remain cautious in the second half of fiscal 23 into fiscal 24, given dynamic macro conditions across the region, Europe wholesale grew 9% on a reported basis and 24% in constant currency driven by stronger fall receipts and fill rates. Our outlook continues to embed a notable deceleration in the second half based on strong compares and macro headwinds broadly across the region. Turning to Asia. Revenue increased 17% on a reported basis and 33% in constant currency. Asia retail comps were up 25% with strong growth in digital commerce along with brick-and-mortar stores. Over the last year's easier compares due to store closures by market every country delivered double-digit growth or higher in the second quarter. This was led by strong continued momentum in Korea, up 26% in constant currency and sales in Japan, which increased 16% as we lapped COVID restrictions in the prior year period. Following last quarters, heavy COVID restrictions in Shanghai, China returned to robust growth increasing more than 30% in Q2 despite COVID related closures in about 35% of our Mainland stores, nearly all of China's stores were reopened by the end of the quarter. Southeast Asia and Australia both grew triple digits in the period in constant currency lapping pandemic lockdowns. In the prior year across our regions, our Q2 performance continued to exemplify the diversity of our growth drivers, not just by geography but across product categories and channels. Moving on to the balance sheet. Our balance sheet continues to be a cornerstone of our fortress foundation, enabling us to balance strategic investments in our brand and business with returning cash to shareholders even through dynamic times. During the second quarter, we returned approximately $220 million to shareholders in the form of our dividend and share repurchases. We ended the period with $1.4 billion in cash and short term investments and $1.1 billion in total debt. Net inventory increased 36% from last year moderating from first quarter trends, but strategically higher to support continued demand for our brand and products earlier receipts and higher goods in transit to mitigate global supply chain delays, increased product costs including freight and cotton, which we will start to overlap in the second half of fiscal 23 and continued elevation of our product mix. We are managing inventories carefully in this dynamic environment. While we still expect inventory growth to remain at similar levels through the holiday, this should become more closely aligned sales by the end of the fiscal year. We believe our inventories are well positioned with 70% of our business comprised of core and replenishment product. As Patrice mentioned, this drives greater consistency in our growth as well as better supply chain planning and visibility and shorter lead times. Looking ahead, our outlook is based on the evolving macro environment including inflationary pressures, disruptions in the global supply chain, COVID-19, foreign currency volatility, and the war in Ukraine. We continue to plan across a range of scenarios and this guidance represents our best assessment of market conditions and resulting consumer impacts. For fiscal 23, we are maintaining our full year outlook in constant currency with revenues expected to increase high single digits or about 8% on a 52-week comparable basis. While the first half revenues outperformed our expectations, this incorporates our more cautious view on second half revenues, given the challenging consumer backdrop in Europe and North America. We now expect foreign currency to negatively impact revenues by approximately 730 basis points driven by the strengthening US dollar. As a reminder, we still expect fiscal 23 growth to also be negatively impacted by about 100 basis points, due to the absence of last year's 53rd week. We now expect operating margins at the low end of our previous range of 14 to 14.5% in constant currency. This reflects a more challenging global macro environment, including our more cautious outlook on second half revenues, geographic mix with a higher sales contribution from Asia this year, and channel mix, including the impact of a US customs delay on select wholesale shipments in Q3 expected to be resolved in the next few months. Foreign currency is now expected to negatively impact operating margin by about 200 basis points. This compares to operating margin of 13.1% on a 52-week basis and 13.4% on a 53-week basis last year, both on a reported basis. Gross margin is still expected to increase 30 to 50 basis points on a constant currency basis. We plan to continue driving stronger AUR and favorable product mix more than offsetting increased freight and material costs. Foreign currency is now expected to negatively impact gross margins by about 170 basis points in fiscal 23. While we still expect input costs to remain structurally higher in the near term, we expect gross margin expansion in the second half of the year as we start to lap higher cost increases. For the third quarter, we expect constant currency revenues to grow in the low to mid-single digit range. Foreign currency is expected to negatively impact revenue growth by approximately 780 basis points. We expect third quarter operating margin in a range of 17.3 to 17.8% in constant currency. At the midpoint, this represents a roughly 160 basis point increase from last year driven by gross margin expansion, as we start to lap higher air freight costs from last year. Foreign currency is expected to negatively impact operating margin by about 180 basis points and gross margin by about 170 basis points in the quarter. We still expect our tax rate in the range of 25 to 26% for the full year and also for the third quarter, and we moderated our CapEx outlook to about $250 to $275 million based on the timing of projects. In closing, we are proud of our team's execution, agility, and progress on our Next Great Chapter: Accelerate plan this quarter even as we navigate a highly dynamic global operating environment, Ralph created an iconic brand that inspires people around the world to dream. These qualities hold as true today as they did 50 years ago. With our brand as our touchstone, we will continue to focus on what we can control and leverage our multiple engines of growth across geographies, product categories, and channels. And with that, let's open up the call for your questions.

Operator, Operator

The first question comes from Michael Binetti with Crédit Suisse Securities.

Michael Binetti, Analyst

One for each. I guess Patrice, you outlined the diversified growth engines that you mentioned at the investor day in September. You spoke to them again today. Just given the current macro that you talked about today, which of these drivers are still the most relevant in your view? And then Jane, so North America operating margin compressed quite a bit relative to pre-COVID levels. Can you speak to where you saw the most pressure? How much is transitory in your opinion and how you're planning that North America margin and holiday in the rest of the year?

Patrice Louvet, CEO

Thank you and good morning, Michael. So clearly the macro pressures are out there, right? Inflation, currency, geopolitical concerns and so on, and you all know them as well as I do, and they're of course top of mind for us. That said, we have a clear game plan and as you mentioned, multiple diversified engines of growth. What I think is really unique for us is the breadth and depth of these growth drivers. It enables agility, so in other words, we have this unique ability to lean harder on some areas of the strategy if others are more challenged, and Q2 is actually a good illustration of that, taking it across the different growth drivers. If you could look at it from the regional side, we were proud that all of our regions grew top line in constant currency and we delivered disproportionate growth, as you heard in Asia where we're seeing the strength of the brand across just about every single individual country, whether that's, outsize growth in Korea, Japan, Australia, Southeast Asia, and we're particularly proud of the continued growth in China. Even with a number of our stores closed with China up 30% this last quarter. If you look at this through the channel lens, we're encouraged that the strength in our full price businesses is more than offsetting the softness that we're seeing from our value-oriented consumer subsegment, which is more prevalent in our outlet business. And on the product side, we can flex the breadth of our portfolio and I think we've demonstrated our ability to dial categories up or down for the consumers as their needs desires change. For instance, in this quarter think more sports coats and dresses and less hoodies. So our ability to be agile in this way is a real competitive advantage in a volatile environment, which served us quite well during COVID. And to this end, we really believe that this is the time to continue to be on offense, recruit new consumers, and continue to take market share. Jane, over to you on North America.

Jane Nielsen, CFO

Okay. So good morning, Michael, and thank you for the question. In Q2, our margins in North America were negatively impacted by a more normalized level of marketing investments compared to last year when we were more cautious given some of the pressures in-store and coming out of COVID. This year really represents a normalization of that spend. So as that spend normalizes in the second half, we would expect that pressure or that leverage pressure from marketing to abate. We also saw more elevated freight expenses in the quarter as we moved to make sure that we could offset receipt delays from global supply chain challenges and have inventory ready for full price selling. We think that that was the right decision. You certainly saw it come through in our AUR this quarter. We're also overlapping some higher labor costs in the year and expect that to abate as well in the second half. So longer term, we see real opportunities in North America, both on the wholesale side and on the DTC side. We're in the earlier phases of our journey in wholesale, so that's encouraging as well as some of the earlier phases in the outlet where we see opportunities in the margin between full price in our outlet. So we're optimistic and expect that to start to play out in the second half. Great, thank you. Next question please.

Operator, Operator

Thank you. The next question comes from Matthew Boss with JP Morgan.

Matthew Boss, Analyst

Great, thanks and congrats on a nice quarter. Thank you. So Patrice, on the current positioning of the Polo brand. What do you see as the global market share opportunity? What have you seen more recently and what have you seen from recent selling trends, maybe direct to consumer, any change in wholesale orders at all? And then just for Jane, what is your level of visibility on outlet in Europe as we think about the moderation that you've embedded in the guide today?

Patrice Louvet, CEO

So Matt, what's exciting about this business candidly is how fragmented the market is, right? So our market share is while we have a sizable business in Polo, Men's, Women's, and Kids. In relative terms, it’s still very small. So we have an incredibly long runway when it comes to market share growth across all three businesses. You will have seen in the more recent share reads that we're continuing to grow share on Men's, we're continuing to grow share on Women's, continuing to grow share on Kids, particularly strong performance last quarter on kids' share growth. And I think as we look around the world at what Polo stands for, the type of products that we have within our lifestyle portfolio and what the consumer is looking for right now, we actually feel that we're really in the sweet spot of consumer demand with the breadth of our range and with the overall positioning across Men's, Women's, and Children's. And I think this is as true in North America as it is across Asia, as you heard me refer to performance earlier as well as in Europe. So I think we're very nicely positioned on Polo and we're going to continue to invest to bring in more consumers, continue to elevate the positioning across that portfolio. When it comes to your question on wholesale orders and Jane and I will tag team on that in the second part listen, there are a few things I would say about our wholesale partnerships right now. First of all, I am really pleased to see how aligned we are strategically with our key wholesale partners, both in North America and around the world. And that's really enabling us to look at things through a similar lens when it comes to growth and value creation. We have seen strong progress this past quarter. You saw North America of 8% strong results in Europe and Asia as well. We are not seeing any pullback on orders or any cancellation of orders around the world with our key wholesale partners. So I would say, Matt, as we, as we said in the guidance, we are not seeing cancellations at this point, but we are more cautious and we took a more cautious stance on our spring buys, given the macro pressures that we're seeing. So while we're very happy with our position in sales, especially in the second quarter, we wanted to be well positioned for the holiday season, overlapping a challenging previous quarter. We have embedded in the guidance, a softer outlook for spring based on those macro pressures. And as we look at in the second part of your question, the visibility that we have in the outlet in Europe, we have seen softer trends and we've incorporated those softer trends into our guidance for EMEA. It's not a one-country, one-region story. I do think that there is variability in the marketplace. This quarter, Germany performed quite well. We saw some more pressures in the UK, as you might expect, given some of the inflation pressures coupled with some political uncertainties. Given the fuel pressures and the outlook we have, we've taken a more moderate view across Europe, but especially in some of the countries like Germany, where we expect gas rationing and fuel prices to be an explicit pressure.

Corinna Van Ghinst, Host

Next question, please.

Operator, Operator

Thank you. The next question comes from Gabby Carbone with Deutsche Bank.

Gabby Carbone, Analyst

Hi, good morning. Congrats on the nice quarter. So my question is on the promotional environment, which is getting more challenging out there, given the high inventory levels across the marketplace. What do you believe is working in Ralph Lauren's favor as you continue to deliver higher AURs? And then just as wondering if you could dig into category performance and where within the business you're seeing the strongest demand. Thank you.

Patrice Louvet, CEO

Of course. Thanks, Gabby. So what we're seeing across the competitive environment, we are seeing an increasingly promotional environment, as was expected. You can see the results as well as we do. There's excess inventory out there and many are looking to liquidate. But our long-term strategy, despite the promotional environment has not changed. We're trying to stay agile and mindful of the competitive environment, but we really have multiple vectors of growth across AUR, and I think that that is really serving us well. Saw that show up in our AUR at plus 18% this quarter. And we're really encouraged underneath the covers that despite our higher AUR, within a more promotional context that we've seen, our value ratings from our consumers continue to increase, both versus pre-pandemic levels and sequentially again this quarter. So for us, that's a key IOR indicator and gives us a lot of confidence. Now that being said, as we have in the past, we build a strategy that has, that is fully aligned with our long-term strategy, but has some flexibility in it. We don't, we are not going to overly react to the promotional environment, but we are going to be strategic about it and know that we need to stay competitive. We feel good about that. We feel good about into the second quarter. We've embedded in our guidance, the confidence that we'll be able to offset inflation with pricing. And you can see that in our implicit gross margin guide. So feeling good and feeling good about the consumer, and especially because it's really based on our multi-year elevation work that we've done as well as the reset work we've done. That's really put us on a healthier base. Increasing desirability and increasing value equation. Those are things that we're driving and we're really pleased to see because that will drive sustained performance. On the product front, Gabby, probably three things I would call out. One is our core is actually doing quite well. It was mid-teens this past quarter, and as we talked about at investor day, our core is 70% of the company, It's actually not surprising that it's doing well because I think at times where consumers are more discerning on where they spend their money, obviously they're going to gravitate towards brands they know and trust and learn to gravitate towards products they know and trust. So strengthen the core. We've seen really nice performance in our high-potential categories, which were up high teens this past quarter in constant currency. The probably the best performer was again, Outerwear where we saw a very strong performance, where we're also very excited to see the progress we're making on Women's across collection Polo Women's and Lauren. And then the last thing I would highlight is the tailored business continues to strengthen and improve. So to my prepared or earlier response to Michael's question, we're seeing more sports coats and less hoodies.

Operator, Operator

The next question comes from Omar Saad with Evercore ISI.

Omar Saad, Analyst

Thanks for taking my question. Great execution this quarter. I wanted to ask you about some of the new consumers, the many new consumers who joined the Ralph Lauren franchise during COVID. I think many of them are younger. How are those consumers performing in this kind of post-COVID era? Are they still kind of behaving with not much price resistance to the brand? I'd also love a quick update on the wholesale channel. Just give us a quick reminder on how you and your wholesale partners are managing inventory planning differently today versus in the past as we're seeing some other retailers and brands out there experiencing some pockets of blow-ups and inventory that you're seeing seeming to be able to avoid. Thanks.

Patrice Louvet, CEO

Good morning, Omar. We're discussing the consumer side with Jane. This past quarter, we added 1.3 million new consumers, and I'm very pleased with the demographic of this new group—primarily younger, higher value, less sensitive to promotions, and more diverse. Our products are receiving consistently positive feedback regarding our price increases. This aligns with Jane's earlier comments about our growing brand desirability and value perception, which are holding steady across different segments, particularly among the younger consumers we're attracting. I anticipate that our partnerships will continue to help us connect with these younger demographics in the areas where they engage with brands. We're also encouraged by our retention rates; while it's great to attract new consumers, it's crucial they remain loyal to our brand to enhance lifetime consumer value. We've seen our retention scores improve significantly this past quarter, which is promising for the future. Regarding inventory planning with our wholesale partners, we've had very productive and transparent conversations that focus on sell-out performance as the main factor for future orders. This strategy is proving successful. Additionally, we've shifted the conversation towards maintaining natural margin growth for both our wholesale partners and ourselves, emphasizing total profitability and integrating this with our average unit retail strategy. We've committed to providing our wholesale partners with timely inventory to support full-price selling. We've utilized air freight for this to ensure they have what consumers need. This quarter, we experienced strong sell-out and AUR performance, resulting from effective collaboration with our wholesale partners. We are well-prepared for the holiday season, with clean and fresh inventories. Although we are slightly above last year's second quarter due to prior supply chain issues, we are still approximately 20% under pre-pandemic levels from FY ‘20, which we believe aligns well with our current strategy. We feel positive about our position.

Operator, Operator

Thank you. The next question comes from Jay Sole with UBS.

Jay Sole, Analyst

Great, thank you so much. I have a two-part question. Patrice, could you elaborate a little bit on the momentum in China that you've seen? Has it continued so far in this quarter and given Singles Day is upon us, is that going to be important for the brand? And just maybe just talk about what some of the key drivers have been in China, and then secondly it seems like the trend in buying back stock has accelerated a little bit from where it was last year, do you expect the trend to continue through the rest of the year? Thank you.

Patrice Louvet, CEO

Very good morning, Jay. We're really proud of the team's execution in China and across the entire APAC region, and we continue to see brand opportunities in China both in the near and long term. What’s working well right now, and has been for a while, is that the teams are integrating the brand into the local culture and translating our core values in a way that resonates with younger Chinese consumers, both men and women. They are adapting global programs to the market and complementing those with local activities and partnerships with influencers. Another aspect is the product offering and the curation the team is doing to ensure our wide range of products includes items that appeal to specific consumers. Notably, our highest average unit retail is in China, which is where we're focusing some of our most elevated products, and we are receiving a positive response from consumers. Connected retail also stands out in China, as it exemplifies our efforts to combine digital and physical stores seamlessly to meet consumer expectations. These have been the key drivers recently and will continue to be as we stay attuned to the local consumer and ensure our presence is highly relevant. Regarding Singles’ Day, for us, it’s primarily a brand-building opportunity rather than a chance to push high sales volumes. We don't aim for high promotional activity, and over time, this strategy has benefited us by focusing on brand exposure, awareness, and desirability. In the lead-up to Singles’ Day, we’ve observed consistent outperformance, which encourages us about our progress in China, viewed within the context of broader growth drivers for the company. On the buyback side, we have become more aggressive in our guidance, suggesting about $450 million to $500 million in buybacks per year. In the first half, we've repurchased around $390 million in shares. We usually take a methodical yet opportunistic approach, and given the stock prices were often below $90, it seemed like an excellent time to repurchase shares. We feel comfortable with our annual guidance and are likely on the higher side of that range, remaining strategic with our buybacks. Thank you. Next question, please.

Operator, Operator

Thank you. The next question comes from Chris Nardone with Bank of America.

Chris Nardone, Analyst

Good morning, Thanks for taking my question. Can you elaborate a little bit on your guidance for gross margin expansion in Q3? Is there any way to provide guardrails around the magnitude on a reported basis? And then also tied to that, can you just discuss how your expectations for markdown activity in your DTC channel has changed compared to when we last spoke at your investor day? Thanks.

Patrice Louvet, CEO

So, our guidance does imply an improvement in gross margin through the second half. Notably in the fourth quarter, you'll in the second half we'll start to lap higher air freight and product cost increases from last year. And while we expect those inflationary factors to still be with us, we'll be able to move into higher gross margin as we overlap some of the more significant increases last year. And as you look at it from a roughly reported basis, I would expect as we called out in the third quarter, that growth that FX would impact us by about 170 basis points. And we're calling that it'll be about similar for the full year. So FX is a meaningful headwind as we move through this year. But you'll start to see us get actual gross margin improvement in the second half, both on a reported and a constant currency basis. And then the second part of your questions.

Chris Nardone, Analyst

Markdowns?

Patrice Louvet, CEO

So as we look at a more promotional environment again, our strategy is not changing. We're on an elevation journey. Our long-term pricing strategy is to match our pricing with inflation as we guided before. We expect inflation headwinds to be meaningful in the second half, but we're also confident that we'll be able to offset those inflation factors. Now that being said, while we won't follow the competition down in any way, we will have built flexibility in our plan to make sure that we continue to offer a compelling value to consumers and be competitive on a total value basis in the marketplace.

Corinna Van Ghinst, Host

Last question, please.

Operator, Operator

Thank you. Our final question comes from John Kernan with Cowen.

John Kernan, Analyst

Excellent. Thanks for squeezing me in. Congrats on all the momentum. Jane, how do we think about the implied operating margin expansion for the fourth quarter and then the timing and sequencing of operating margin expansion as we get out of fiscal '23, as some of the one-time headwinds roll off and freight maybe FX get a little easier? Thank you.

Patrice Louvet, CEO

As we anticipate operating margin expansion in the second half, it primarily relies on the improved gross margin I mentioned earlier. This will be the main factor, along with SG&A leverage. Although we've adopted a cautious approach regarding revenue in the second half, we still expect to achieve SG&A leverage that will contribute to operating margin growth through both gross margin expansion and SG&A leverage. While some revenue challenges have adjusted our outlook to about a 14% constant currency operating income margin, we remain confident in our three-year goal of reaching a mid-teens operating income margin. As for next year, I can't predict foreign exchange trends, which have posed a significant challenge, but we are optimistic about our growth in margin-rich categories, such as Outerwear, and we are well-prepared with our inventory. We're looking forward to next year as we address inflation in the first quarter by renegotiating our freight contracts; the decline in the spot market should provide a boost. Additionally, we plan to have a more even marketing strategy throughout the year, avoiding the fluctuations we saw in the first and second halves previously. We are also observing an improved environment for cotton, so many of the material cost pressures we face now are expected to ease. We typically purchase cotton well in advance, so I expect this to have a positive impact in the second half of fiscal '24. Overall, there are several reasons for cost optimism throughout the year.

Corinna Van Ghinst, Host

All right. Well listen, thank you everyone for joining us today, and we look forward to reconnecting in February to share our third quarter fiscal '23 results, and until then, take care and have a great day.

Operator, Operator

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