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. [Operator Instructions] 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 at capriholdings.com. Now, I would like to turn the call over to Mr. John Idol, Chairman and Chief Executive Officer. John?

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 expense 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…

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…

[Operator Instructions] And our first question comes from the line of Matthew Boss with JPMorgan. Please proceed 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. So obviously, we are very disappointed with our third quarter results, mainly driven by the wholesale channel. We are pleased, as we said in our prepared remarks, with our own retail channel, which showed strength really across the globe with the exception of China, which had further declines than we had anticipated, and that was due to the reopening. And I think we have said that we had more stores shut down at certain points during the fourth quarter in China than we did during -- at any point during the pandemic. So that was quite difficult. And we have seen an uptick in the business there, especially in January. So, we're feeling strong and good about our own retail channel and how we're able to communicate and clientele and work directly with the consumer. And of course, you also saw that in our database growth, where we have the largest growth ever in the Company's history. And we've consistently grown the database at all three of those luxury brands every single quarter in the double-digit range. And I think that speaks to the strengths of the brands, the way the consumer is reacting to our strategic initiatives, and that's everything from the marketing to the actual product itself. And you saw in all three of our categories, we had growth in accessories. And so that really speaks to, I think, the strength of the category. I think you've also seen from many of the other reports that have happened with other luxury houses in the world, the category is strong. In terms of what happened in the wholesale category, and I'd say that's more of a North America issue where Europe performed better, although still not up to our anticipation, we have been -- and this…

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. And for Q4, we've really taken a more cautious outlook due to the increasingly uncertain macroeconomic environment and also, as John mentioned, inflation impacting consumer confidence. So what we've seen there is a big step down in wholesale for -- down 35% versus prior year, and Mainland China down 35%. So in total, if I do that on an absolute dollar basis, that's pretty much the whole reduction versus our prior year for the quarter. We still expect retail to grow mid-single digits. And this is a slight change in our China outlook because we do have opportunity next year, we believe, as they are reopening. However, as they've taken away all the restrictions, the COVID cases had surge that has created, I think, a near-term pullback 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, good to hear from you guys. I guess, John, if you could just clarify two quick questions on wholesale. So I believe, based on your answer to Matt, that you're kind of talking about next year, wholesale being basically down 30% in the first half and flat in the back half. But I think you said Q2 should be worse than Q1. If I heard that right, could you just clarify why that would be? And then just within the wholesale cost structure, obviously, it's a little out of whack because of the declines. How quickly do you think it will take -- how much time do you think it will take to kind of align the cost structure so that you feel like you're in a good position to go forward from a profitability perspective out of that channel?

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. And so we are working on a number of initiatives to reduce expenses, have embedded those into our guidance. And 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.

And Ike, I want to clarify one thing, and I understand why you asked the question. So we are planning at retail, the business down with our partners across the group in the wholesale channel in the first half of calendar year and the back half of calendar year. So this is at retail sales, not wholesale, at retail. So it's POS. We are planning the business roughly flat. And there might be some exceptions to that, whether it's Jimmy Choo planned up slightly. But in terms of impacting the total company, we think that, that's the right way to view how what may happen with the consumer in the back half of the year. And we think that's prudent with Michael Kors, given that there was such a high decline in the channel during the back half of the year. I might add one other thing, too, in terms of color. We did not have that decline last year. So in calendar 2021, we actually had a very strong performance with the Michael Kors brand in the retail -- in the wholesale, in particular, department store channel. So this was -- as I said, this could be caused by some of the price increases that we've seen happen. We can't speak to what staffing levels were in the stores, et cetera. But we know where we put our own people in. We know in our own stores where we have our own teams in place, we are doing, I think, a very good job connecting with the consumer. We also know that when you have database grow the way that we saw -- and by the way, those are predominantly consumers who are actually purchasing from us. So usually, when the database is growing, they have made a purchase from us. So that shows us that there's tremendous interest in all three of these brands. And so again, we feel confident. And I know that it's not going to be easy for many of you on this call and people listening in given the step change in the wholesale business. But again, we continue to look at the strength and the power of these three houses. We're going to have to pivot a little more quickly than we had anticipated, because we always have wanted the wholesale business to get down to around 20% of the Company sales. This just happened a little faster than we would have anticipated. But I think we've shown we can be nimble and really move forward quickly. And so, I think you can expect to see some of the fruits of our initiatives around rebalancing certain costs and areas to happen relatively quickly.

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, first, our performance at our own retail stores; second, again, the database growth showing the health and the response of the consumer to our brands. And 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. And 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. So we think we're in a good place in terms of where our pricing is right now. And part of that is reflecting in the gross margin. Tom will speak to some of the other areas that have also impacted it positively. So I think that 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. And 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. So 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. And 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. And 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. So hopefully, some of that noise will start to come out of the performance numbers. And as you know, 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 talked to the repeat purchase activity that you're seeing from customer cohorts that were acquired over the last few years that may be more priced sensitive?

Thank you, Brooke. Brooke, the overall -- what's very interesting about our database and the consumer and the database, and we've actually reviewed this yesterday, we're still -- and this is also, in particular, to Michael Kors, we're still dealing with a fairly high income demographic in the Michael Kors database. And it hasn't changed a lot over the last five, six, seven years, which we think is a good sign. Where there's been a concern, does a lower income consumer be driven more towards the brand? And did we lose any brand equity with more higher-income consumer? And so far, that has not been the case. What's also interesting is while we do have crossover between the channels, between e-commerce and our stores, the crossover is not as great as we continued to anticipate. So the good news for us is -- and probably 60% of our database growth, and it's pretty consistent across the group, is coming through the e-commerce channel. It's not cannibalizing the store customers. So we think that's a very healthy mix. And you can see, as Tom mentioned, we significantly accelerated our marketing activities across all three of our houses during the quarter. And that was a very distinct decision on our part to do that. We knew that many of our competitors in Europe and North America would also be accelerating their spend. And we thought to be competitive from a mind share standpoint that we had to really make sure that our brands were shining through. And so the good news for that is these databases are getting so sizable that, in certain ways, some of our direct-to-consumer marketing costs may be coming down a little bit next year. And that's because we're going to be able to mine the existing databases.…

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.

Paul, thank you. Paul, we really didn't see a lot of change in transaction or UPTs. So that wasn't an issue for us. We did see a small decline in the ticket, and that was really more of a result of -- we saw a shift to smaller -- to a return to smaller bags. And I would say, we saw that across the group, where there was much more cross bodies, small leather goods. We benefited, during COVID, over a lot of larger bags selling where people were needing to put more things in larger bags. And so, actual retail price of units was not down, but the actual transaction was slightly down, and that was more because of -- we've seen a very -- a double-digit increase in our small leather goods business, and we classify our cross bodies in that category, which really reflected, I think, people enjoying the holidays, going out and parting, dressing up. And so unit sales were slightly higher than actual retail performance, and that's driven by a lean-in by the consumer into that category of product. I'll turn over the 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. So 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, that we're generating strong free cash flows across our brands. And our balance sheet is extremely strong. We noted in my prepared remarks, a net debt of $1.26 billion. And our leverage ratio is very solid and low. So 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. So when we look at our capital allocation priorities, still number one, invest in the business; number two remains returning cash to shareholders and then pay down debt, which we have done over time and managed very carefully. And as regards to 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, number one, I want to say that our partners, both in North America and in Europe, have been terrific partners. So we worked very closely together all through the pandemic and exiting the pandemic. And the first half of this -- of last calendar year, we had tremendous difficulties filling the inventory needs of the department stores. And as I said to you, coming out of calendar 2021, we actually had a very strong holiday season with that channel, and we were depleted in inventories. And so we didn't really get caught up in terms of inventory at retail until almost August of this past year. The inventories got to retail. We did not see any type of a significant step change in the channels. And we were, as I said, very hopeful. And we did run some tests with additional staffing in the stores, which worked well for us. But we just didn't see the conversion with the consumer in that channel. I can't tell specifically whether it was our prices or not. But we just know the channel didn't deliver in our category and obviously, the biggest category being the accessories part of it. I don't know whether this is going to continue or not. We've seen a continuing weakness, as I've said, through January. So we've taken, again, a very prudent step. We do not want to put additional inventory into the channel to cause markdowns, which we think will cause brand erosion. And we've worked too hard to get ourselves to this point. We've said we would suffer the inventory declines if -- and the wholesale shipment declines if that meant preserving the brand, and I think we're going to continue to do that. We know that we're on the right track with elevating Michael…

And Simeon, 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. And 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. Thank you, Simeon.

Best luck for the rest of the year.

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. Thank you.

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