Greetings. Welcome to Capri Holdings Limited Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Jennifer Davis, Vice President of Investor Relations. Ms. Davis, you may now begin.

Good morning, everyone, and thank you for joining us on Capri Holdings Limited third quarter fiscal '23 conference call. With me this morning are Chairman and Chief Executive Officer, John Idol; and Chief Financial and Chief Operating Officer, Tom Edwards. Before we begin, let me remind you that certain statements made on today's call may constitute forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ from those we expect. Those risks and uncertainties are described in today's press release and in the Company's SEC filings, which are available on the Company's website. Investors should not assume that these statements made during this call will remain operative at a later time, and the Company undertakes no obligation to update any information discussed on the call. Unless otherwise noted, all financial information on today's call will be presented on a non-GAAP basis. These non-GAAP measures exclude certain costs associated with COVID-19-related charges, the impact of the war in Ukraine, ERP implementation costs, Capri transformation costs, impairment charges, restructuring and other charges. To view the corresponding GAAP measures and related reconciliation, please view the earnings release posted on our website earlier today.

Thank you, Jennifer, and good morning, everyone. Overall, our performance in the third quarter was more challenging than we anticipated. However, many aspects of our business performed well. In particular, we were pleased with the continued growth in our own retail channel across all three of our luxury houses. This is a testament to the strength of our powerful iconic brands: Versace, Jimmy Choo and Michael Kors as well as the success of our strategic initiatives. However, we were disappointed with the performance of our global wholesale revenue in the quarter. Additionally, revenue in Mainland China declined significantly due to the surge in COVID cases as the country reopened. Now turning to third quarter performance in more detail. Revenue decreased 6% on a reported basis and 1% in constant currency. Total company retail sales increased mid-single digits globally in constant currency. New customer acquisition was a key driver of growth as we added more than 12 million new names to our database versus the prior year. This is the largest year-over-year increase in our history. The growth in our own retail channel as well as our large and growing customer database demonstrates the strength and desirability of our brands. However, sales in our wholesale channel declined approximately 20%, driven largely by Michael Kors. Operating margin of 16.9% was below prior year. This reflected the sales mix shift between retail and wholesale, as well as increased marketing expenses to support growth and build longer-term brand equity. As a result, earnings per share of $1.84 were below our expectations. Now looking at third quarter group revenue trends by geography. In the Americas, revenue decreased 4%, with mid-single-digit growth in retail, offset by significant declines in our wholesale channel. In EMEA, revenue decreased 2% on a reported basis, but increased 9% in constant currency. This was driven by strong retail revenue, partially offset by weaker trends in wholesale. In Asia, revenue decreased 20% on a reported basis and 8% in constant currency. This reflects strong results in Japan and Southeast Asia, offset by a nearly 40% decline in Mainland China. Moving to third quarter revenue trends by brand. Starting with Versace. Revenue decreased 1% on a reported basis but increased 11% in constant currency compared to prior year. Excluding Mainland China, revenue increased 21% in constant currency. We were pleased that revenue was better than anticipated and operating margin was in line with our expectations. Turning to product. Starting with accessories which are a key component of our growth strategy, Women's Accessories was the strongest performing category with sales in our retail channel up over 40% versus prior year. We were pleased with the response to our Greca Goddess pillar, which is continuing to gain traction. With our three pillars, La Medusa, Virtus and Greca Goddess, we are making significant progress in our goal to position Versace as a leading luxury leather house. Another component of our growth strategy is to expand footwear. Versace continued to gain authority as a women's luxury footwear brand as we expanded our core offerings, with the introduction of the pinpoint collection, a new range of statement pumps characterized by a curved metal stiletto heel. Men's and women's sneakers also performed well, driven by our Trigreca, Greca and Odessa styles. Moving to brand awareness and consumer engagement. Versace continued to deepen consumer desire through powerful storytelling. The holiday campaign was inspired by Versace's deep roots within the world of theater and the arts. Model Lily McMenamy embodied high Versace drama while highlighting holiday gift offerings. Our marketing initiatives continue to focus on Versace's Italian luxury heritage. This helped contribute to an over 40% increase year-over-year in Versace's global consumer database. Overall, we were pleased with the performance of Versace as we continue to execute our strategic initiatives. Looking forward, we remain confident in the luxury house's long-term growth potential as we reinforce Versace brand codes, significantly grow accessories and footwear as well as renovate our store fleet. Moving to Jimmy Choo. Revenue decreased 6% on a reported basis, but increased 3% in constant currency compared to prior year. Excluding Mainland China, revenue increased 10% in constant currency. While revenue was below our expectations, primarily impacted by China, operating margin was better than anticipated. Turning to product. Starting with accessories, which are a key component of our Grow Strategy. Women's Accessories was the strongest performing category, with sales in our retail channel up high single digits versus prior year. Seasonal updates to our iconic Bon Bon and VARENNE styles performed exceptionally well. Women's footwear sales grew, driven by dress footwear styles as people engaged in social activities, enjoyed special occasions and celebrated the holidays. Sneakers also performed well with positive consumer reaction to our new Diamond Maxi. During the third quarter, Jimmy Choo launched its successful capsule collaboration with Timberland. Sandra Choi partnered with New York Native Designer, Chanel Campbell of Harlem's Fashion Row, to reimagine Timberland's iconic yellow boot. The collection celebrated urban glamour and the eclecticism of New York's dynamic community. This exciting collaboration generated over 50 million impressions across social media as well as strong product sell-throughs. Now turning to brand awareness and consumer engagement. For holiday, our campaign celebrated the playful energy of the party season in London's Claridge's Hotel, where Jimmy Choo designed the 2022 Christmas Tree. The unveiling of the Jimmy Choo Tree was attended by celebrities and friends of the house, including Iris Law, Sienna Miller and Daisy Lowe. Posts by attendees generated approximately 7 million impressions across social media. Our marketing initiatives continue to underpin our focus on glamour. This helped contribute to a 20% year-over-year increase in Jimmy Choo's global consumer database. Overall, we were pleased with the progress at Jimmy Choo as we continue to execute on our strategic initiatives. Looking forward, we remain confident in the luxury house's long-term growth potential as we reinforce Jimmy Choo's brand codes, significantly grow accessories and expand our casual footwear offering. Now turning to Michael Kors. Revenue decreased 7% on a reported basis and 4% in constant currency compared to prior year. We were pleased with the continued growth in our own retail channel with constant currency sales up low single digits despite greater declines in Mainland China. However, we were disappointed with Michael Kors' wholesale, which declined approximately 25% during the quarter. Operating margin was below prior year due to the sales mix shift between retail and wholesale as well as increased marketing expenses in our retail channel. To provide some additional color around wholesale, revenue at POS declined in the mid-teens as sales lag trends in our own retail channel. We had anticipated a sequential improvement at POS during the holiday shopping season, but that did not materialize. Therefore, we shipped less into the channel as we did not want to end up with excess inventory, which will result in additional markdowns. As you know, we have been elevating the Michael Kors brand and product. We believe our elevation strategy is working well, particularly in our own retail channel. We continue to believe that elevating Michael Kors is the right strategy for the brand. Now turning to product. In accessories, sales in our own retail channel increased low single digits globally. Consumers responded positively to core iconic collections, featuring Michael Kors Signature and hardware. We drove newness and excitement in Signature with seasonal updates featuring metallic logo prints. As a result, Signature represented approximately 55% of accessories sales during the quarter. Looking at footwear. We continue to believe we can significantly expand Michael Kors footwear to drive incremental revenue. Footwear sales in our retail channel increased low double digits as we delivered exciting fashion featuring iconic hardware branding elements and signature detailing. Men's remains one of the strongest performing categories in retail, and we remain enthusiastic about our opportunity to expand the accessories collection. Men's third quarter retail sales increased strong double digits globally, led by Signature product. In December, Michael Kors collaborated with Italian luxury sportswear brand, Ellesse, for a second time to create a sporty and glamorous ski capsule collection. The collaboration created energy and excitement, generating approximately 140 million impressions on social media as well as solid sell-throughs. Now turning to brand awareness and consumer engagement. For holiday, our consumer communication embodied Michael Kors Signature glamour and optimism, infused with the joy of the season. Bella Hadid captured the jet-set chic glamour of Michael's designs for the season's festivities. Additionally, in Asia, we amplified the campaign with renowned Chinese model, He Cong. Our marketing initiatives continued to underpin our jet-set storytelling. This helped contribute to a 17% year-over-year increase in Michael Kors global consumer database, demonstrating the strength and desirability of the brand. Overall, we were disappointed with the performance of Michael Kors in the third quarter. Given lower wholesale revenue, we recognize the need to reset our operating expense structure. We are beginning to take measures to better align operating expenses with the change in revenue by channel. Looking forward, we remain focused on our long-term growth initiatives to elevate the Michael Kors brand and reinforce our jet-set codes. We anticipate future growth, driven by our own retail channel, where we can leverage our brand momentum and personalized connections with consumers to drive revenue growth. Now looking ahead to the fourth quarter for Capri Holdings. We expect continued momentum in our own retail channel, driven by each of our brands' strategic initiatives. However, in the wholesale channel, we now anticipate an even greater sequential decline relative to the third quarter. Due to weakness in our wholesale POS performance during the third quarter, which has continued into the fourth quarter, we are further reducing shipments into this channel. Now turning to fiscal '24 for Capri Holdings. We anticipate total revenue and earnings growth in the mid-single digits. In our own retail channel, we anticipate solid growth, driven by our strategic initiatives, clientelling and personalized strategies as well as a recovery in China as the country reopens. In the wholesale channel, we expect revenue to decline in the mid-teens with trends normalizing in the back half of the fiscal year. Looking forward, we remain focused on executing our strategic initiatives to drive sustainable future growth. Our three powerful iconic brands have enduring value and strong brand equity. We remain confident in our ability to achieve our long-term revenue and operating margin targets over time due to the resilience of the luxury industry, the strength of our portfolio and the talented group of employees executing our strategic initiatives. Before turning the call over to Tom, I would like to welcome Cedric Wilmotte as our new Chief Executive Officer of Michael Kors. Cedric has proven himself to be a versatile leader within our luxury fashion group, as President of Michael Kors EMEA for over 13 years, as well as the interim CEO of Versace for the last year and the COO of Versace currently. The Board, Michael and I are confident that Cedric's leadership will help to further accelerate Michael Kors' strategic initiatives and brand momentum. Importantly, Cedric's appointment ensures that we have three experienced and talented CEOs at each of our luxury fashion houses. I am confident that we now have the right management team in place to execute our long-term strategic initiatives.

Thank you, John, and good morning, everyone. Overall, we were disappointed in our performance in the third quarter. While we were pleased with the continued growth in our own retail channel across all three of our luxury houses, revenue in our wholesale channel declined significantly, which resulted in expense deleverage and a lower operating margin. Now turning to third quarter revenue in more detail. Total company revenue of $1.5 billion decreased 6% versus prior year and 1% in constant currency, which was below our expectations. Looking at revenue performance by brand, at Versace, revenue decreased 1% on a reported basis but increased 11% in constant currency compared to prior year. Global retail sales increased in the mid-single digits in constant currency. By geography, total revenue in the Americas decreased 4%. Revenue in EMEA increased 14% on a reported basis and 28% in constant currency. Revenue in Asia decreased 19% on a reported basis and 11% in constant currency, driven by greater declines in Mainland China. For Jimmy Choo, revenue decreased 6% on a reported basis but increased 3% in constant currency compared to prior year. Global retail sales increased low single digits in constant currency. By geography, total revenue in the Americas increased 6%. Revenue in EMEA increased 1% on a reported basis and 14% in constant currency. Revenue in Asia decreased 24% on a reported basis and 13% in constant currency driven by greater declines in Mainland China. At Michael Kors, revenue decreased 7% on a reported basis and 4% in constant currency compared to the prior year, impacted by the decline in wholesale. Looking at Michael Kors revenue by channel, global retail sales increased low single digits in constant currency. This was driven primarily by a double-digit increase in e-commerce sales, with e-commerce penetration increasing 300 basis points versus prior year. However, wholesale revenue declined approximately 25% compared to prior year. Turning to Michael Kors revenue by geography. Sales in the Americas decreased 5% driven by the decline in wholesale. Revenue in EMEA decreased 11% on a reported basis and 1% in constant currency, also driven by a decline in wholesale. Revenue in Asia decreased 18% on a reported basis and 5% in constant currency, driven by greater declines in Mainland China. Now looking at total company margin performance. Gross margin expanded 120 basis points to 66.3%, driven by moderating inbound transportation costs, price increases and channel mix. Operating expense as a percent of revenue was 49.4% compared to 42.8% last year, reflecting several factors primarily driven by the Michael Kors brand. First, the significant decline in wholesale revenue resulted in deleverage as the wholesale channel has a low variable cost structure. Second, as planned, we increased our marketing investments to support brand-building activities across the group. And third, e-commerce sales increased double digits, which resulted in higher variable costs. Due to the operating expense deleverage, total company operating margin declined to 16.9% compared to 22.3% last year and was below our expectations. At Versace, operating margin of 9.6% was in line with our expectations and compared to 12.7% last year. At Jimmy Choo, operating margin of 10.7% was ahead of our expectations and compared to 9% last year. And the Michael Kors operating margin of 22.9% was below our expectations and compared to 28.4% last year. Our tax rate for the quarter was 3% compared to last year's rate of 8.1%, primarily due to the release of a valuation allowance on U.K. deferred tax assets. Now turning to our balance sheet. We ended the quarter with cash of $281 million and debt of $1.54 billion, resulting in net debt of $1.26 billion. As part of our ongoing commitment to return cash to shareholders, we repurchased approximately $300 million worth of shares in the third quarter. Looking at inventory. We ended the quarter with $1.19 billion, a 21% increase over last year. This represents a sequential deceleration compared to the prior quarter. We continue to expect inventory levels at the end of the fourth quarter to be below the prior year. Now turning to guidance. Looking at the fourth quarter, we are more cautious in our revenue outlook in the face of an increasingly uncertain macroeconomic environment. We now anticipate total company revenue of approximately $1.275 billion. This represents a decline of 15% on a reported basis, reflecting a mid-single-digit decline in retail. For wholesale, we had planned the channel down, but we are now planning it down further and forecast an approximate 35% decline. On a 52-week constant currency basis, total company revenue would be down 8%, including an increase in retail revenue in the mid-single digits. For fourth quarter revenue by brand, we forecast Versace revenue of approximately $280 million. This represents a decline of 11% on a reported basis with a low-single digit decline in retail and an approximate 30% decline in wholesale. On a constant currency basis, Versace revenue would be down 7%, including a low single-digit increase in retail revenue. As a reminder, Versace reports on a one-month lag, therefore, the significant decline in Mainland China in December will be included in the fourth quarter results. For Jimmy Choo, we forecast revenue of approximately $130 million. This represents a decline of 16% on a reported basis with a low double-digit decline in retail and an approximate 40% decline in wholesale. On a 52-week constant currency basis, Jimmy Choo revenue would be down 7%, including a low single-digit increase in retail revenue. For Michael Kors, we forecast revenue of approximately $865 million. This represents a decline of 15% on a reported basis with a mid-single digit decline in retail and an approximate 35% decline in wholesale. On a 52-week constant currency basis, Michael Kors revenue would be down 5%, including a mid-single-digit increase in retail revenue. Now looking at operating margins. We anticipate fourth quarter operating margin of approximately 8.5%. This reflects continued gross margin expansion, offset by operating expense deleverage, primarily due to the sales mix shift between retail and wholesale. We expect this across all three brands. For Versace, we now anticipate an operating margin of approximately 10%. For Jimmy Choo, we now expect an operating margin in the negative mid-teens. And for Michael Kors, we now anticipate an operating margin in the mid-teens. Turning to our expectations around certain non-operating items. We forecast net interest expense of approximately $11 million. We expect an income tax benefit with a rate of approximately negative 20%, driven primarily by the resolution of an uncertain foreign tax position as well as anticipated mix of earnings in lower tax jurisdictions. We expect weighted average shares outstanding of approximately 126 million. As a result, we now anticipate diluted earnings per share of approximately $0.90 to $0.95. Now, I would like to take a moment to share high-level thoughts around our preliminary expectations for fiscal '24. We are providing this outlook given the material change in wholesale trends. We currently expect fiscal '24 revenue of approximately $5.8 billion, a 4% increase versus fiscal '23, driven by continued growth in our own retail channels across all brands. We anticipate retail revenue will increase in the low double digits, primarily driven by growth in Asia as China reopens. Excluding Asia, we expect retail revenue to increase in the mid-single-digit range driven by our strategic initiatives. In the wholesale channel, we expect revenue to decline in the mid-teens range. Together with our partners across all three of our brands, we are taking a more cautious approach to planning the business due to the uncertain macroeconomic environment. We now anticipate wholesale penetration will decline from 27% of revenue in fiscal '23 to approximately 23% of revenue in fiscal '24. Now looking at our operating expenses. Because of the anticipated decline in wholesale revenue, we recognize the need to reset our expense structure. We plan to proactively manage expenses while also continuing to make strategic investments, particularly in marketing, to drive long-term growth. Looking at fiscal '24 operating margin. We expect modest expansion to 16.5%, reflecting gross margin expansion, partially offset by expense deleverage. We expect an effective tax rate in the mid-teens as well as higher interest expense, largely offset by lower share count. As a result, we anticipate EPS of approximately $6.40. Now I would like to discuss our expectations regarding the cadence of fiscal '24 revenue and earnings between the first and second half of the year. Looking at revenue, in our own retail channel, we anticipate growth throughout the year. In wholesale, we expect significant declines in the first half, with trends normalizing in the back half of the year, as we anniversary the declines in fiscal '23. Relative to prior year, this will result in lower margins in the first half of fiscal '24, with margin expansion expected in the back half of the year. Looking at our expectations by brand. For Versace, we anticipate revenue of approximately $1.25 billion and an operating margin in the mid-teens range. For Jimmy Choo, we expect revenue of approximately $650 million and an operating margin in the high single-digit range. And for Michael Kors, we anticipate revenue of approximately $3.9 billion and an operating margin in the low 20% range. In conclusion, while we are disappointed with our third quarter results and our fourth quarter guidance, we remain optimistic about the long-term growth potential for Versace, Jimmy Choo and Michael Kors. Our powerful brands have enduring value and proven resilience, reinforcing our confidence in the ability to deliver strong revenue and earnings growth over time.

We will now open the line for questions. Our first question comes from Matthew Boss with JPMorgan. Please go ahead with your question.

Great. So, John, maybe a couple of questions. First, larger picture, could you speak to overall category demand for accessories that you're seeing today, maybe relative to pre-holiday, if there's been any change? And then how best to explain the difference that you're seeing between direct-to-consumer and wholesale as it relates to the overall health of your brand portfolio? And do you believe the reset in revenues for next year appropriately covers you for nearly any scenario from a macro perspective?

Thank you, Matt. We are quite disappointed with our third quarter results, primarily due to the wholesale channel. However, we are encouraged by our retail channel, which demonstrated strength globally, except for China, where we saw declines beyond our expectations due to the reopening. Throughout the fourth quarter, we experienced more store closures in China than at any point during the pandemic, which posed significant challenges. Despite this, we detected an improvement in the business there, particularly in January. We feel optimistic about our retail channel and our ability to engage directly with consumers. This was reflected in our database growth, which reached an all-time high in the company’s history. Our database across all three luxury brands has consistently seen double-digit growth each quarter, highlighting the brands' strength and the positive response from consumers to our strategic initiatives, including marketing and product offerings. We've noted growth in accessories across all our categories, further underscoring the category's strength. Reports from other luxury brands also indicate that the category remains robust. In the wholesale sector, our challenges are more pronounced in North America, while Europe performed better, albeit not to our expectations. Specifically related to Michael Kors, we have been working on elevating the brand through improved marketing and product quality and design. Since we initiated price increases in 2019, pricing has risen on average by almost 25%. During the holiday season, consumers displayed more caution, with strong sales in our own stores through Black Friday, while the North American wholesale channel did not sustain that momentum throughout the year. We initially believed inventory issues were contributing to this lag and took steps to restore our inventory levels in the wholesale channel, but consumer engagement did not meet expectations. It's possible that our pricing increases affected the wholesale channel differently than our own retail operations. We observed a notable difference in performance between stores that had our selling staff present versus those without. Therefore, we plan to increase staffing in the wholesale channel as part of our ongoing investment, particularly seeing positive results in top-tier stores. Despite some challenges, we maintain that the category continues to grow, although we did witness an overall decline in department store sales, particularly in North America, which was disappointing, especially during the holiday season. Looking ahead, we aim to provide clear guidance. We anticipate continued strength in our retail channel, aligned with our observations. The reopening of China is expected to create additional revenue opportunities in our retail operations, and we foresee a small increase in the travel retail channel, especially in Asia. We have prepared for a significant downturn in our fourth quarter and into the first quarter of next year to manage the restocking of the wholesale channel strategically. We anticipate a slightly higher decline in the second quarter, but plan to keep the latter half of the year relatively flat, although it will still reflect a year-on-year decline. We expect wholesale revenues to drop in the mid-teens, and our wholesale partners are being conservative in their planning due to uncertainties about consumer behavior. We are adopting a cautious approach. Lastly, as Tom mentioned in his remarks, we will adjust our investments and spending as needed. The wholesale business has been profitable with low fixed costs, and we are making necessary adjustments within our operations. Our takeaway remains that we have three incredibly strong brands—Versace, Jimmy Choo, and Michael Kors. We are confident in these brands and believe our strategic initiatives are sound. We will remain committed to this vision, which helped us during COVID, as we navigate the current situation while managing a reduced wholesale business that has lower associated costs.

Our next question is from the line of Omar Saad with Evercore ISI. Please proceed with your question.

This is Warren Cheng on the line for Omar. I just wanted to dig in a little bit further on the 4Q sales guidance. It's a pretty big step down, even from the 3Q change. So just to clarify, is that all coming on the wholesale side? Or did you change the outlook on the retail side, too? And then also, just if I look geographically and focusing on China, I think we all understand what happened in December for China. But looking past December, have your expectations for China changed there versus three months ago?

It's Tom here. Thanks for the question. For Q4, we've taken a more cautious outlook due to the uncertain macroeconomic environment and the impact of inflation on consumer confidence. We have observed a significant decrease in wholesale, down 35% compared to last year, and Mainland China also down 35%. In absolute dollar terms, this accounts for almost the entire reduction compared to the prior year for the quarter. We still anticipate retail to grow in the mid-single digits. This reflects a slight adjustment in our outlook for China because we believe there are opportunities next year as they reopen. However, the removal of restrictions has led to a surge in COVID cases, resulting in a near-term decline in traffic and results.

Our next question comes from the line of Ike Boruchow with Wells Fargo. Please proceed with your question.

John and Tom, it's great to hear from you. John, could you clarify a couple of quick questions regarding wholesale? Based on your response to Matt, it seems you are suggesting that wholesale could be down 30% in the first half of next year and flat in the second half. However, you mentioned that Q2 might be worse than Q1. If I understood that correctly, could you explain why? Additionally, regarding the wholesale cost structure, it appears to be somewhat unbalanced due to the declines. How long do you think it will take to align the cost structure so that you feel well-positioned for profitability in that channel moving forward?

Sure, Ike. It's Tom here. I'll take those. So for wholesale, Q1, Q2 next year, so overall, as you mentioned, will be down 15% for the year. We expect declines in the first half as we are anniversary-ing the restocking in fiscal '23, and that's going to be more weighted to the first quarter. So, the first quarter in wholesale will be down more than the second quarter on a year-over-year basis. So hopefully, that answers the first question. And then in terms of aligning costs, as we mentioned, wholesale has a lower variable cost structure. We are working on a number of initiatives to reduce expenses, have embedded those into our guidance. We're recalibrating the rate of spend across all our divisions and reducing non-revenue-generating expenses in corporate, for instance, and also a rigorous evaluation of other expenses not directly linked to consumer engagement and revenue and other areas that are driving the business. That said, we are going to continue to invest, particularly in marketing, but also in areas like e-commerce and digital that we know drive engagement and allow us to use that large database and growing database.

I want to clarify that we are planning for retail sales, not wholesale, with our partners across the wholesale channel in the first and second halves of the calendar year. We anticipate the business to be roughly flat, with potential exceptions like a slight increase for Jimmy Choo. This perspective reflects our outlook on how consumer behavior may evolve in the latter part of the year, particularly with Michael Kors, given the significant decline we observed in that channel previously. It’s worth noting that last year, we did not see such a decline; in 2021, Michael Kors performed very well in the wholesale department store channel. Factors like price increases may have impacted this situation, although we cannot comment on store staffing levels. In our own stores, where our teams are present, we are successfully connecting with consumers. The growth in our customer database, primarily consisting of purchasers, indicates strong interest in all three of our brands. While the changes in the wholesale business may pose challenges for many on this call, we remain confident in the strength of our three houses. We now need to adapt more quickly than we initially planned since we always intended for the wholesale business to constitute about 20% of our total sales. This transition has occurred sooner than expected, but we’ve demonstrated our ability to be agile and move forward effectively. You can expect to see the positive outcomes of our initiatives, including cost rebalancing, materializing in the near future.

Our next question is from the line of Alex Straton with Morgan Stanley. Please proceed with your question.

I wanted to focus on gross margin here. It appears to have held in quite nicely. Perhaps could you just share your observations on the promotional environment in the quarter as well as the assumptions you have embedded in a modest expansion guidance going forward?

Thank you, Alex. I think the better news in our report was our performance at our own retail stores; second, again, the database growth showing the health and the response of the consumer to our brands. I think the gross margin also. We had a number of things that impacted the gross margin positively. Again, we've had this sequential price increase. We told you either two calls ago or last call, we are not going to be taking any more price increases. There's a little bit of it that will flow through in the first half of the year. Then we're stopping the price increases across the group. For the time being, we're going to take a pause. We also took a fairly significant price increases at Jimmy Choo and Versace as well. We think we're in a good place in terms of where our pricing is right now. Part of that is reflecting in the gross margin. Tom will speak to some of the other areas that have also impacted it positively. You'll see two things next year. Again, you'll see a little bit of some of the freight and the benefit. That will start to show up a little bit more in next year. Secondly, there will be a channel mix. As retail becomes a bigger part, that will also show up in the gross margin. But let me have Tom speak to this year and next year.

Sure. I'm happy to give you a little more color on Q3 and it's very similar trends for Q4. As John mentioned, we did see moderating inbound freight costs. We benefited from the price increases that are still ongoing but will stop in the future, and the channel mix with a higher retail versus wholesale. We were not more promotional. But given the better inventory position compared to last year, we did have a more normalized level of promotional or markdown sales. Some additional headwinds included regional mix. As we've been saying over the past several quarters, Asia is a lower percentage of revenue, and it's a higher margin as well as the stronger dollar, which has hurt us through the year on a margin perspective. But as we look at next year, retail will be a larger portion of the business. We expect a rebound in China, which will be a tailwind, and freight as well. This is in addition to the strategic initiatives on our brands, which, over the past several years, have driven significant improvements in gross margin across our brands, all of our brands. And wholesale, as John mentioned, in the first half, it's going to be a headwind because of deleverage with that low variable cost base. But as we normalize in the back half, those other areas will shine through.

I might also add that we feel that FX will probably not be a headwind or a tailwind next year. We're expecting it to more or less normalize. It will still be a headwind in the first two quarters. But then by the time we get to the back half of the year, it should be normalized or just a very minor tailwind. Hopefully, some of that noise will start to come out of the performance numbers. It's been a significant headwind for us this year. Thank you, Alex.

The next question is coming from the line of Brooke Roach with Goldman Sachs.

John, I know you mentioned pricing as a potential explanation of what could be driving additional weakness in wholesale. Along those lines, can you talk about the momentum that you're seeing across your business within various income demographic cohorts or price tiers of your product architecture? Is there any difference in sell-through trends or sell-out trends in your own retail business and outlet versus mainline stores, particularly in North America? Separately, you've had nice growth in your consumer database. Can you talk to the repeat purchase activity that you're seeing from customer cohorts that were acquired over the last few years that may be more price-sensitive?

Thank you, Brooke. What’s interesting about our database and our consumers is that we reviewed this yesterday, and particularly regarding Michael Kors, we are still working with a relatively high-income demographic. This hasn't changed significantly over the past five to seven years, which we consider a positive sign. There was concern about whether lower-income consumers have shifted toward the brand or if we've lost any brand equity with higher-income consumers, but so far, that hasn't been the case. Interestingly, while we have some crossover between e-commerce and our physical stores, it's not as extensive as we expected. The good news is that approximately 60% of our database growth is coming from the e-commerce channel, and it's not detracting from our store customers. We view this as a healthy balance. As Tom mentioned, we significantly increased our marketing efforts across all three of our brands during the quarter, which was a deliberate decision. We were aware that many of our competitors in Europe and North America would also ramp up their spending, so we wanted to ensure our brands stood out. The positive outcome of this is that our databases are growing large enough that some of our direct-to-consumer marketing costs may decrease next year, allowing us to leverage our existing databases. We've seen an uptick in repeat customers, and through our data analytics, we've successfully encouraged lapsed customers to engage with us more frequently. We see a chance to create leverage next year given the size of the databases across all three companies. We plan to enhance our clienteling initiatives over the next two years, and while it may take time to establish this as a competitive advantage, it remains an essential part of our strategy.

The next question is from the line of Paul Lejuez with Citigroup. Please proceed with your question.

Just a couple of quick ones. Curious if you can talk about transactions versus ticket within the DTC business that you saw in the quarter and what you expect going forward. Then free cash flow assumption for F '24 and then just China, the assumption in the first half or second half of '24.

Thank you, Paul. We didn't observe significant changes in transactions or units per transaction, so that wasn't a concern for us. We did experience a slight decrease in ticket size, which was largely due to a shift back to smaller bags. This trend was evident across the group, where we noted an increase in cross-body bags and small leather goods. During the COVID period, we had seen a rise in larger bags as people needed to carry more items. The retail prices of our units remained stable, but the number of transactions dipped slightly. This was mainly due to a notable increase in our small leather goods segment, including cross-body bags, as consumers seemed to enjoy going out and celebrating during the holidays. Unit sales were marginally higher than the retail performance, driven by the consumer's preference for these types of products. I will now hand over the discussion about cash flow to Tom.

Sure. With regard to cash flow, you asked about last year, but just to comment on this year. We're at free cash flow of approximately 450 year-to-date, and our Q3 was even above that. We had an incredibly strong cash flow quarter. We would anticipate next year that we'll have similar cash flows, that has always been a strength of the Company, generating strong free cash flows across our brands. Our balance sheet is extremely strong. We noted in my prepared remarks a net debt of $1.26 billion. Our leverage ratio is very solid and low. We feel very comfortable with the strength of both our balance sheet and our cash flow, and we're using that to redeploy and purchase shares to return cash to shareholders. When we look at our capital allocation priorities, still number one, invest in the business; number two remains returning cash to shareholders, and then paying down debt, which we have done over time and managed very carefully. Regarding China into fiscal '24, we expect it to grow at an outsized rate compared to the overall growth of retail. I think we had mentioned the retail business, we expect to be up double digits driven, first, by Asia, mainly reflecting China and excluding that, up mid-single digits across the remainder of the world.

Our next question is from the line of Simeon Siegel with BMO Capital Markets. Please proceed with your question.

I apologize if I missed it. But John, we'd love to hear your opinion on whether you think the domestic department store weakness is more a broader consumer demand and traffic versus the stores' attempt to reduce their own inventory? So just trying to think through how big of an industry pressure point you think it might be and how long it might last? And then Tom, if I can, how are you thinking about the Michael Kors' EBIT margins versus the pre-pandemic to the earlier point about wholesale having little fixed costs and just any help on thinking through decremental margins on wholesale from the lower revenues.

Simeon, I want to acknowledge that our partners in both North America and Europe have been outstanding. We have collaborated closely throughout the pandemic and as we move past it. In the first half of last year, we faced significant challenges in meeting the inventory demands of department stores. Coming out of 2021, we experienced a very strong holiday season in that channel, which left us with depleted inventories. It wasn't until nearly August of this year that we caught up on retail inventory. Although the inventory reached retail, we did not observe a notable improvement in the channels. We tried additional staffing in the stores, which was beneficial, but we did not see the expected consumer conversion in that channel. It is unclear if this was due to our pricing. The channel underperformed in our category, particularly in accessories. I cannot predict whether this trend will continue, as we have noticed ongoing weakness through January. As a precaution, we have decided against introducing more inventory into the channel to avoid markdowns that might harm our brand. We have worked hard to achieve our current status and are willing to accept inventory declines to protect the brand. We believe we are making progress in elevating Michael Kors and Versace, and I anticipate significant developments for Versace soon. We have scheduled a fashion show on March 10 in California. Our new CEO, Emmanuel Gintzburger, is making remarkable progress alongside Donatella. We expect a noticeable improvement in our product and marketing strategy, and we are very excited about the developments. Jimmy Choo has performed well this past year, particularly during the holiday season. Our partners are concerned about consumer behavior for the upcoming year and have adjusted their expectations conservatively, despite our cautious inventory management. We are fine with that approach because we want to avoid excessive markdowns in our stores. We believe it's crucial to remain committed to our long-term strategy if we want to uphold our luxury brand's integrity. Our team is dedicated to that mission.

With regard to Michael Kors operating margin long term, we continue to believe in the mid-20% range operating margin goal for the Michael Kors brand. Near term, there's definitely a step change in the wholesale revenue. We will adjust our cost structure to address that, and we've already begun to rebalance the cost base. As we look at '24, as I mentioned, in the first half, the wholesale declines will create deleverage. But then the initiatives, the growth in retail, China and Asia becoming a larger portion of the mix, again, as they recover and little freight tailwinds, we believe along with our strategic initiatives will get us back on that path.

I'd like to thank everyone for joining our call this morning. Again, we are very disappointed in our results for the third quarter and our guidance for the fourth quarter. That being said, we believe in the strength of our three luxury houses. We believe that we have a very good plan for fiscal year '24 on a go-forward basis. That will continue to embrace and support the strength of each of these three phenomenal brands, and we believe that we will return to the type of growth that we expect in the future. So, thank you very much for your support, and we look forward to keeping you updated.

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.