Please stand by. We're about to begin. Good day, welcome to the Michael Kors Holdings Limited third quarter 2017 earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Christina Koliopoulos, Director of Investor Relations. Please go ahead.
Thank you. Good morning, thank you for joining us for our third quarter fiscal 2017 earnings call. Presenting on today's call are John Idol, Chairman and Chief Executive Officer, Joe Parsons, Chief Financial and Chief Operating Officer. Before we begin, let me remind you that certain statements made on this call may constitute forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ from those that 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 the statements made during the call will remain operative at a later time, the company undertakes no obligation to update any information discussed on the call. I will now turn the call over to Michael Kors Chairman and Chief Executive Officer, Mr. John Idol.
Thank you, Christina. Good morning, welcome to Michael Kors's third quarter fiscal 2017 earnings call. For the third quarter of fiscal 2017, total revenue was $1.4 billion. Earnings per share were in line with our expectations at $1.64. We saw solid results in several areas of our business during the quarter. The new fall and holiday handbag introductions performed well, led by the Mercer, Brooklyn, and Sloane Editor collections. All of these new fashion luxury handbag groups were supported by enhanced marketing in both traditional and social media channels, which helped create strong sell-throughs across these launches. We also continued to see strong response to our new Michael Kors Access line of wearable technology, with sales exceeding our expectations for the season. In addition, momentum in our athletic footwear business remains strong, our holiday women's ready-to-wear collection received favorable response.
Our digital flagship in North America continued to deliver double-digit comparable sales growth, while sales in our new digital flagship in Europe exceeded expectations. We also rolled out Custom Kors on our digital flagship in North America, which featured free monogramming services as well as options to curate your own personally styled Sloane Select handbag. All of these initiatives, which were led by Michael and our design team, demonstrate our continued commitment to delivering exciting new luxury fashion products to consumers globally. While we were pleased to see the strong performance in multiple areas of our business, we were disappointed in our North American and European comparable sales, which continued to be impacted by negative traffic trends and currency fluctuations. We also saw average unit retails negatively impacted by the highly promotional environment, as well as the continued fashion trends towards crossbody and small leather goods.
Additionally, the fashion watch category remained challenged, which continued to negatively impact our comparable sales. In the retail segment, global net sales grew 9% during the quarter. Comparable sales decreased 6.9%. In the Americas, retail net sales decreased 1%. Comparable sales decreased in the mid-single digits, which was in line with our expectations, despite the very difficult retail environment. The e-commerce business outperformed expectations with double-digit comparable sales increases. In stores, traffic declined in the high single digits, which was partially offset by an increase in conversion rates. We also saw solid results from the launch of our click and collect offering in 10 stores in North America during the quarter, enabling customers to make their purchases online and pick up the merchandise in one of our retail locations on the same day.
Based on the strong response to click and collect thus far, we plan to roll out this feature across all U.S. locations in this quarter. We believe that further enhancing our omni-channel presence will help us to drive improved comparable sales results in the future. Turning to the international business. In Europe, overall retail net sales were essentially flat during the quarter. In our newly launched digital flagships, sales significantly exceeded expectations. In stores, comparable sales decreased in the mid-teens range as we saw steeper-than-expected declines in store traffic, which we believe was due to the continuation of weak tourism trends, as well as reduced consumer confidence related to Brexit and terrorist attacks in certain markets. In addition, a portion of the decline was attributable to a shift in customer traffic from retail locations to the newly launched digital flagships.
If we were to include e-commerce sales, our European comparable sales results would've been down in the mid-single digits on a reported basis. Essentially flat on a constant currency basis. This is similar to the trend we saw in North America when we launched our e-commerce platform. In Asia, total retail net sales increased almost 300%, largely as a result of revenue from the acquisition of the Greater China and Korea operations. In Japan, retail net sales grew more than 25%, with comparable sales increasing in the mid-single digits. The Greater China business, while not included in the comparable sales base, increased double digits on a constant currency basis. We were also excited to launch our first digital flagship in China in October, with initial performance exceeding expectations.
While the digital landscape remains small for luxury brands in this region, we feel that offering a full view of the Michael Kors brand online enhances our customer engagement and acquisition. Importantly, these results indicate that the Michael Kors brand is strong and growing in Asia. We opened 29 net new stores globally throughout the quarter, including 14 new and expanded men's stores, bringing our total to 35 men's locations, as well as two new flagships in Asia. Michael was on hand for the opening festivities of our flagship store in Seoul, Korea, and helped celebrate Harper's Bazaar Young Korea feature, which showcased looks from our Resort 2017 collection. In Singapore, Michael was joined by Kate Hudson to help celebrate the opening of our Mandarin Gallery store, which at 6,000 sq ft is the largest Michael Kors flagship store in Southeast Asia.
Turning to the wholesale business, net sales declined 18% during the quarter. In the Americas, sales decreased 15% as we continued to strategically reduce sell-in into the department store channel. In addition, beginning this month, we are reducing promotional activity across the retail and wholesale channels, which is expected to result in higher average unit retails as the product positioning will be elevated. While we believe this is the right thing to do for our brand long term, this decision is expected to negatively impact our net sales throughout fiscal 2018, albeit to a smaller degree, and the declines are expected to further moderate in fiscal 2019 as we anniversary the reductions in inventory and reduce promotional activity. As we continue to reduce our inventory position in the wholesale channel, we anticipate this segment will be a smaller portion of our net sales going forward.
In Europe, net sales in the wholesale segment decreased 12% as the headwinds that impacted our retail stores also had a negative effect on sales in the wholesale channel. We also continued to see a shift in sales trends towards products with lower average unit retails, such as crossbodies and small leather goods, and anticipate this trend will continue throughout fiscal 2018. In addition, we anticipate market volatility in this region throughout the calendar year. In the U.K., we continued to experience a decrease in traffic despite the weaker pound sterling. In France and Germany, we are concerned about the upcoming elections, which we believe may impact consumer buying habits. In Asia, wholesale net sales decreased 68%, primarily attributable to the shift of China and South Korean sales to our company-owned retail segment. This decrease will continue until we anniversary the acquisition of our Greater China license.
Turning to our men's segment, we are pleased with the performance of this developing business. We now have more than 250 men's shop-in-shops, and our men's sportswear offerings is resonating with the customer globally. Additionally, we have further expanded our leather goods offering, which drove accelerated growth in this category during the quarter. We remain committed to developing this segment of the men's business. In the licensing segment, revenue declined during the quarter as a result of continued softness in the fashion watch and jewelry categories, and lower revenues in Asia as a result of the recent acquisition of our license operations. This was partially offset by the strong performance of the Access line of wearable technology globally, which exceeded our expectations for the quarter. Given the current size of the Access business, the new collection only partially offset the decline in fashion watches.
Based on this success, we will continue to invest in and expand the wearable technology category with the goal of ultimately becoming the second-largest smartwatch brand globally. We were also pleased with the performance of the fragrance collection in this quarter, especially the positive response to our new Wonderlust fragrance, which led to strong results, particularly during the holiday period. The fragrance category continues to represent a significant growth opportunity for the company. In conclusion, we believe the Michael Kors brand remains strong, but it is clear that we must enact changes to reverse the negative comparable sales trends that we are experiencing in our stores. We are focused on five specific initiatives to improve comparable sales performance in North America and Europe. First, Michael and our design teams have introduced new design elements in accessories to provide a more elevated and layered assortment.
These unique and innovative techniques including artisanal craftsmanship, iconic hardware details, and intricate mixed media leathers that will enhance our glamorous handbag offerings in the $498-$398 category. Additionally, we have five iconic groups consisting of Hamilton, Selma, Savannah, Cynthia, and Mercer handbags that will be shipped this quarter and are strategically priced at $298 for medium sizes and $258-$228 on certain smaller sizes. Second, we will be expanding the presence of our new Jet Set signature accessories in our stores, which will include multiple layers for the fall season. Initial results of our new Jet Set signature deliveries for the spring season have been very strong. This is an iconic element for our brand, and we will capitalize on the current fashion trend for signature accessories. Third, we are increasing the penetration of footwear in our largest volume doors.
As one of the leading fashion footwear companies globally, we intend to capitalize on this strength and increase the presence of this category in key stores. Fourth, we are focusing on our fast-growing dress category as an iconic cornerstone of our women's ready-to-wear. This will be highlighted by our new online dress shop that is scheduled to launch this fall. This category will represent approximately 50% of our ready-to-wear assortments in our stores. Fifth, we will significantly increase our digital marketing spend to fuel our fast-growing e-commerce business globally. We continue to see strong revenue growth from our initiatives in this channel as consumers shift their shopping behavior. With these five initiatives, we expect to drive increased store and site visits, as well as increased average unit retails and deepen our engagement with consumers in our retail channel to improve comparable sales in North America and Europe.
In addition to these initiatives, we remain confident that we have a significant incremental revenue opportunity as we build Asia into a $1 billion business. We also feel strongly that we're on the right track to developing a significant men's business, which could ultimately be $1 billion in revenue. In summary, our increased emphasis on the retail segment, in addition to the expansion of our Asia and men's business, will help us rebalance our revenues and position us for growth in the future. With that, I'll turn it over to Joe to review our financials.
Thank you, John. For the third quarter, total revenue was $1.35 billion compared to $1.40 billion in the prior year quarter. In the retail segment, net sales increased 9.2%, driven primarily by the addition of 193 net new stores since the third quarter of last year, including 143 stores associated with the recent acquisitions of Greater China and South Korea. Comparable sales decreased 6.9%, reflecting a mid-single-digit decrease in North America and a mid-teens decline in Europe, partially offset by a mid-single-digit increase in Asia. E-commerce comparable sales contributed approximately 340 basis points to our performance in the quarter. As John mentioned, North America remained under pressure from declining store traffic and the aggressive promotional environment, which was partially offset by increased conversion rates and strong performance of our digital flagships.
The comparable sales decline in Europe was driven by reduced store traffic and lower average unit retails as a result of a shift in product mix, with a portion of the decline attributable to the launch of our European digital flagships. The North American digital flagships achieved double-digit comparable sales increases in the quarter. While European digital flagships are not yet included in the comparable sales base, had they been included, the European comp would've been down in the mid-single digits on a reported basis and essentially flat on a constant currency basis. In the wholesale segment, net sales declined 17.8% due to lower sales in the women's accessories and apparel businesses. The wholesale business in the Americas region declined in the mid-teens as we remain disciplined with the amount of inventory we ship into that channel.
European net sales decreased in the low teens, while in Asia, the decrease in net sales largely reflects the shift of our Greater China and South Korea businesses to the retail segment during the quarter. In the licensing segment, revenue decreased 22.9%. This was primarily due to the continued softness of the fashion watch and jewelry categories, as well as lower revenues from the geographic licensing arrangement in Asia due to the recent acquisitions of our licensee operations. Gross margin expanded 10 basis points to 59.6% due to a favorable channel mix shift towards the retail segment, as well as an increase in the wholesale gross margin. Gross margin increased 210 basis points in the wholesale segment, primarily due to lower allowances and favorable change in the geographic mix.
Gross margin declined 270 basis points in the retail segment, which was attributable to an increase in promotional activities as compared to last year. Total operating expense grew 9.7% and increased 410 basis points to 34.3% of total revenue. The increase was primarily due to the inclusion of our businesses in Greater China and South Korea, including higher depreciation expense and amortization of the reacquired rights of the intangible asset recognized in connection with the recently acquired businesses, as well as investments in new stores, e-commerce, and omni-channel capabilities, new shop in shops, and infrastructure improvements. Income from operations was $341.9 million, or 25.3% of total revenue as compared to 29.3% of total revenue in the same period last year. Retail operating margin was 21.3% compared to 27.8% in the prior year period. 270 basis points of this decrease was due to the gross margin reduction that I described earlier.
180 basis points was a result of China and South Korea acquisitions, including the amortization of reacquired rights. 190 basis points was related to the continued investments in building our digital flagship platforms, retail store-related costs, and deleverage, in large part related to a mix shift between e-commerce and in-store sales. We expect operating margin for the retail segment to continue to be negatively impacted by the inclusion of the newly acquired international businesses and a mix shift of sales to our e-commerce channel, both of which currently carry a lower operating margin. Wholesale operating margin was 29.6% compared to 27.9% in the prior year period. This was largely the result of the 210 basis point increase in our wholesale gross margin, partially offset by a 40 basis point increase in operating expenses as a percent of revenue.
Licensing operating margin was 54.7% compared to 64.8% in the prior year period. This was primarily due to increased costs associated with advertising as well as increased depreciation expense. Income taxes were $70.4 million in the quarter, and our effective tax rate was 20.6% as compared to 28.0% in the same period last year. The decrease in our effective tax rate was primarily due to the favorable effect of certain global financing activities. Net income was $271.3 million for the third quarter, and diluted earnings per share was $1.64. This compares to net income of $294.6 million, or $1.59 per diluted share in the third quarter of fiscal 2016. Turning to the balance sheet, we generated $521.6 million in operating cash flow, ending the quarter with cash and cash equivalents of $368.8 million. Inventory was relatively flat compared to the prior year as we continued to carefully manage these levels.
We ended the quarter with $147.8 million of debt, which was recorded within short-term debt on our consolidated balance sheet. The debt consisted of borrowings under the company's revolving credit facilities. At the end of the third quarter, the amount available for future borrowings was approximately $852.7 million. In January 2017, the company repaid all the borrowings outstanding under the 2015 Credit Facility. During the quarter, we repurchased approximately 2.1 million shares totaling $100 million under our share repurchase program and have another $250 million of availability remaining in our most recent $1 billion authorization. This most recent share repurchase further demonstrates the company's commitment to returning value to shareholders and our confidence in our long-term growth potential.
Capital expenditures for the quarter totaled $39.1 million and were related to the build-out of new retail shops, as well as investments in our distribution facilities, our corporate offices, digital flagships, and other infrastructure improvements. Looking forward, we expect continued headwinds from challenging retail trends in North America and Europe, as well as our decision to further tighten inventory control and reduce promotional activity. As a result, we have moderated our outlook and now expect fiscal 2017 revenue to be approximately $4.48 billion and comparable sales to decrease in the high single-digit range. We anticipate gross margin to be approximately 59.3%, below our initial expectation, as our lower European sales outlook will result in a less favorable benefit from geographic mix than we initially anticipated. We expect operating expenses as a percent of total revenue to be approximately 39.7%.
These assumptions result in an operating margin of approximately 19.9%, excluding the $11.3 million in one-time transaction costs related to the acquisition of our Greater China licensee. We expect diluted earnings per share to be in the range of $4.09-$4.13 on a GAAP basis, including the $11.3 million in one-time transaction costs, and be $4.15-$4.19 excluding the one-time costs. This assumes a tax rate of approximately 21% and 169.0 million weighted average shares outstanding. For the fourth quarter, we expect total revenue to be $1.035 billion-$1.055 billion, and a low teens decrease in comparable sales. As compared to our prior fourth quarter expectations, we now anticipate retail net sales to be approximately $54 million lower, as we have prudently adjusted our outlook to reflect continued slower sales, as well as revised foreign exchange expectations, somewhat offset by our strong e-commerce results.
We reduced our wholesale segment expectation by approximately $11 million, reflecting a larger than anticipated impact from the new promotional policy and weak trends in Europe. Gross margin is now expected to increase to approximately 58.4%, driven by a favorable geographic and channel mix shift. We plan to continue to invest in our digital flagships, international expansion, and global infrastructure. This would result in an operating expense as a percentage of total revenue of approximately 44.4%, resulting in an operating margin of approximately 14.0%, a decrease of approximately 400 basis points from our prior expectations, with approximately 150 basis points as a result of lower gross margin and 250 basis points as a result of deleverage, as we reduce our retail and wholesale sales. We expect diluted earnings per share to be in the range of $0.68-$0.72.
This assumes a tax rate of approximately 22% and 164.0 million weighted average shares outstanding. For FY 2017, capital expenditures are now expected to approximate $200 million and will focus on ongoing investments in global digital strategies and omni-channel capabilities, global retail expansion, including approximately eight net new stores in the Americas, 25 in Europe and 28 in Asia, 96 wholesale shop-in-shops globally, and the company's global distribution infrastructure, information systems, and corporate facilities. In conclusion, while the current environment is challenging, we continue to focus on our operating priorities in order to drive sales and earnings growth. Looking forward to FY 2018, we anticipate modest top-line growth driven by higher retail net sales as we continue to deliver an innovative luxury product offering, enhance our e-commerce capabilities, further expand our business in Asia, and grow the men's segment.
We anticipate the declines in the wholesale business will moderate as we anniversary the reductions in inventory and reduce promotional activity. We expect licensing revenue to be relatively flat as declines in the fashion watch category subside and the smartwatch sales continue to grow. Taking all this into account and the strategic investments that we are making in the company, we expect operating margin in the high teens and modest earnings per share growth. Consistent with our prior practice, we will provide you with additional detailed guidance when we announce our fourth quarter results in late May. I will now turn the call back to John for closing remarks.
Thank you, Joe. While we face certain challenges in the short term, we continue to believe there is meaningful long-term growth ahead for the company as we focus on maintaining our luxury leadership position while expanding the Michael Kors brand internationally. With that, I will open up the call for questions.
Thank you. If you'd like to ask a question, please signal by pressing *1 on your telephone keypad. Due to time restraints, please limit yourself to only one question. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is *1 to ask a question at this time. We'll take our first question from Omar Saad from Evercore ISI.
Morning. Thanks for all the info, guys. Wanted to first ask about the wholesale business. The rate of decline improved a little bit in the third quarter. Both North America and globally, European as well. How should we think about when that could normalize, start to form a solid base from which you can begin growing again? Again, specifically on wholesale.
Okay. Thank you, Omar, and good morning. I would answer it differently for North America and Europe. In North America, as we have previously said and indicated, our revenue base will decline throughout the entire period of next fiscal year. That's as we reset with our department store partners based upon our new promotional policy, which, as we said in our prepared remarks, starts actually around February 1st. That's in place now. Many of our partners are reducing their inventory with us, and we're reducing it with them as they have operated with a much more aggressive promotional posture. As we said, again, our objective is to reduce promotion, increase average AUR, and position the brand in a more elevated place with our consumer. This is a very aggressive approach.
We don't believe any of our competitors are taking this level of stance as it relates to walking away from the promotional activity. We will have, for periods that we do authorize a Michael Kors event during the year. We think it's going to take the entire fiscal year to work our way through that. As Joe mentioned in his prepared remarks, we see that leveling off in our fiscal 2019. That being said, inside the category, men's as a wholesale component inside the U.S. will grow and should grow rather quickly. We're very pleased with what we've seen so far, in particular on the wholesale side with that business, both in ready-to-wear and in leather. Europe is a separate conversation. Again, many of the department stores are experiencing similar things that you're seeing here in North America.
There's been a slowdown in traffic in many of the cities. We've gone through the reasons of that, whether it was Brexit or whether it was terrorist activities, which have stopped certain people internationally on tourism basis and also locally. There are many places where people are, quite frankly, fearful of going into shopping malls because of incidents. We anticipate that to continue, that level of disruption to continue through, again, the balance of this fiscal year. In addition to that, we're very concerned about upcoming elections and what that might do in certain of the marketplaces. We highlighted in particularly Germany and France, where we have very sizable businesses. Again, we do not see that kind of resetting until, I would say, fiscal 2019 for us. That's why we're really looking at the company in total, Omar, to rebalance our business.
We're going to be much more retail-focused, led by our digital flagships than our retail stores. Also that will be really driven even more heavily by our opportunities that are inside of Asia. Thank you very much for that question.
Thanks, John. That's super helpful. Then could you maybe comment on M&A strategies, especially with some assets up for sale in your categories? Obviously, been doing a great job buying back stock, using the great free cash flow for share repurchases, just want to get a temperature where your head is on potential acquisitions.
Sure. As we've said, in terms of capital allocation, our number one priority is to continue to reduce our share base outstanding. Again, we've said it over multiple calls. While we're disappointed with our financial results, we still think our multiple is low comparative to the total group. We view that, myself and the management team and the board of directors, as our greatest opportunity to create value for the shareholders. We'll continue to be aggressive with our share repurchase program. Secondly, we've said that we will look at potential acquisitions. We are actively looking at a number of different things. If it's right for our company and our management's ability to execute and create value for our shareholders, then we will take advantage of that. We certainly have the capacity to do sizable transactions or smaller transactions.
What we've said to you in the past is that we probably won't do anything small. We think that would be a distraction for us and really not create the kind of value we think the shareholder is looking for from us. Again, actively looking, and we'll see what transpires.
We'll move to the next question from Oliver Chen from Cowen and Company.
Hi, thank you. Good morning. Regarding the average unit retail, could you just help us understand the timing and how the assortment may change in terms of raising AUR over time? As you think about the reality of store traffic and some of the issues there,
What's your long-term view on the Americas store footprint and where it should be right-sized, just in light of digital growing so nicely and thinking about how to prudently engage in omni-channel? Thank you.
Sure. Thank you, Oliver, and good morning. I would answer the first question regarding AUR, again, in two ways. First, what we did, we announced it, I think, on the last call, we're really looking at what the average product is going out the door to the customer at. We believe that the $300 handbag category is a very big opportunity. What we want to do is create value. When she walks in the door, she sees an amazing design, she doesn't have to wait for a coupon or a sale or anything else. She's stimulated by what she's seen. We clearly saw that with our Mercer handbag collection, which was non-promotional the entire fall season and was basically our number 1 selling collection.
She responded to the design, she responded to the fact that it was full price, she also responded to the fact that there was great value there in that collection. What we're doing is we've learned from that, we've said, "Okay, why don't we expand that thought process?" One of the great, exciting collections that we're actually reintroducing in new shapes is Hamilton, which has been one of our best-selling groups for many, many years. We had decided to remove that from our retail channel. We're reintroducing that, again, they were just literally unpacking the boxes on that in some stores recently, we've had excellent initial sales results.
We think that's the right thing to do to create value at the right price, that when she walks in the door, she doesn't have to think about whether something's on sale or not. We believe that's going to have a fairly significant impact on our AUR. Secondly, we are, as I said in my prepared remarks, now that we believe we've reset this 298 and 258 and 228 bases, we're now going to look at our $498 and $398 category and really try and build up that area of opportunity, where we believe, in particular in our own stores, we're capable of being able to sell that at a full price. I also want to point out that the second best-selling product for us, that we actually ran out of during the holiday season, was our Access watches.
Again, totally full price. No sale on that product. When it's the right fashion, the right price for the consumer, we think we're doing quite well with them on that. That's the strategy on AUR, we will be a lot less promotional by a significant amount of days. We're looking to raise that ultimately by approximately 10%. That's our goal to get to, we think we can do that throughout the year. It's not going to happen all on day 1, it will happen throughout the year. Secondly, on the store traffic side, we view our stores in two ways. First off, the majority of our fleet globally is very profitable. There are definitely some unprofitable stores that we will analyze over the next six months and make some decisions on, the majority of the fleet is very nicely profitable.
That being said, we also view our store footprints as an opportunity for us to act as a distribution center in a sense. We talked about click and collect and our omni capabilities. We're learning a lot more about that as we go forward. We also have tests that are upcoming in the spring season on same-day delivery out of a number of locations. We want to make the determination of what does a footprint allow you to do in terms of service. We think service is going to be a critical component of our long-term success as a brand and also as an omni-channel retailer. How do we service her? Where do we provide her that service? At which speed? We all know the people who are setting the standard in that.
We take it very seriously, we think that the store footprints will allow us the capabilities of doing that, as long as they remain profitable. Obviously, if they don't remain profitable, we will look to reduce that footprint. Thank you, Oliver.
I will take the next question from Matthew Boss with JPMorgan.
Thanks. As we think about the EBIT margin profile going forward, high teens now laid out for next year. That's clearly below the two-handle multi-year floor that we talked about in the past. What ultimately, I guess, has changed, do you see high teens as the reasonable long-term resting place, or should we think about it more as a multi-year kind of trough that you expect to bounce off of?
Well, Matt, I'm going to answer, take a first shot at, then I'm going to turn it over to Joe. Next year, we expect the following things to happen. Actually, our operating margins in retail will expand for two reasons. Number one, for geographic mix, and in particular, Asia. Asia is getting more profitable for us each quarter as we're gaining velocity, and we're gaining scale, which is creating leverage. As you know from many of the other global luxury players, Asia sometimes can be the most profitable part of their business. We believe that's going to have a very significant impact on our operating margin performance going forward in retail. We are also getting more profitable in our e-commerce business.
It's still not where we want it to be in terms of against where we are in our retail stores, but it is getting more profitable. We believe that will have a positive impact on us next year in terms of operating margins. We will see operating margins decline slightly in our wholesale business, as we do have some deleverage in terms of the size volume coming down. Also there have been some significant initiatives that have gone on inside of our organization, obviously to reduce costs, given our new revenue outlooks.
While we are disappointed that we are no longer able to, for the moment, say that we can carry a two handle, we do think that we will still be one of the most significantly profitable global luxury brands in the world, and generating significant free cash flow, which will continue to give us the ability to execute on both share repurchase and then acquisition potential. As we've said, even in the future, we might consider dividend, although that's not on the immediate horizon. I think we are comfortable that we do not need to think about a further significant deceleration in the EBIT margins. Joe.
Matt, I don't have much to add to that. We clearly did think it was our obligation, since we were seeing less than two handle for fiscal 2018. We will provide additional guidance, as we said, during our normal guidance cadence when we release fourth quarter.
Thank you.
We'll move to the next question from Randy Konik from Jefferies.
Yeah, thanks a lot. Couple things. One, I guess, John, I wanted to ask, what is the impetus or thought process around acquisitions? I guess my question is why do them when the cap of the company is where it was with the IPO? The stock is significantly cheaper than peers, et cetera. I'm just kind of curious on why even do one, or contemplate one. Secondly, just back on the operating margins. Do we think that we're towards the end of the SG&A dollar investment cycle, and then also CapEx, I think you said $200 million. Can we get further lower from there? Because the free cash flow of the company continues to pile up, and the market multiple on those cash flows keeps going down.
I'm just trying to get a sense of, the market wants to know where these cash flows bottom, where these expenses bottom, et cetera. I'm just kind of thinking through those items and would love your response. Thanks.
Sure. I'll start with the CapEx piece. CapEx is going to continue to be around the level that we're at this year. It may go down a little bit, but not much. We have some additional IT initiatives that are going to go on inside the company. The significant, whether it was our corporate headquarters in New York, whether it was our Venlo operations that we built for distribution in Europe, most of that will be finished. The predominant amount of store openings will be focused in Asia. We're pretty much done with the footprint in North America, pretty much done with the footprint in Europe. There'll be some capital around the men's expansion. We feel very comfortable kind of in that range of where we are today or lower. Slightly lower will be where we will be on a go-forward basis.
In terms of acquisitions, look, I said it to you earlier, our number one capital allocation priority is to repurchase shares. With our multiple being consistently below where our peer group is, and us still being much more profitable than many of them, we think there's a dislocation and the board and the senior management of the team of the company feel that's really the best investment for us to make. I think that will be number one. Number two, again, if we can utilize the management team's expertise and certain other of our capabilities internally to create value for our shareholders, we will look at that. We're not going to do that at the expense of our own corporate initiatives. We believe there is still very significant volume revenue opportunity for the company over the next few years.
We are being impacted by a decision that we've made to kind of get out of the fray of this every kind of few weeks promotional activity. I think that's the right decision for us, but that's going to take a significant amount of revenues away from the company, but I think create much better value for us long term as a brand with the end consumer. That's the right thing for us to do. We'll stay focused on that as our priority, and then look at our share repurchase program. If the right acquisition comes up, we will consider it. If we don't, then we'll pass and stay focused on what we're doing.
Thank you, Randy.
I will take the next question from Erinn Murphy with Piper Jaffray.
Great. Thanks. Good morning. I wanted to focus a little bit on inventory. It seems that it's about 1,200 basis points higher than your implied sales guidance for Q4. Could you just talk a little bit about the complexion of inventory by wholesale versus retail, and then where do you anticipate inventory to end this fiscal year?
Sure. As you know, we're very focused on inventory and controlling inventory. As an international company, and growing differently in different areas, it's a little difficult to guide you. The reason inventory would be up somewhat from what your expectation would be, is because we are continuing to build stores in Asia. We need to ship inventory into those. We're very comfortable with our inventory levels and again, given the complexity of our business, we think we're at the right levels.
Okay. Just following up on Omar's very first question. In North America in Q3, can you break down the sell-through versus sell-in, for that 15% decline in the wholesale channel in North America? Thanks.
Yeah, Erinn, we don't go to that level of detail. Thank you.
We'll move to the next question from Dana Telsey with Telsey Advisory Group.
Hey, everyone. As you think about the Access watch, how large a piece can the Access watch become? Can it become as large as the traditional watch category is? John, how do you see the growth of that handbag category? What did you see, and what's your outlook as we go into the balance of the year? Thank you.
Sure. Thanks, Dana. Dana, we're very excited about what happened with Access watches, and I will tell you that from the minute the watches hit the store, we had something happen that we haven't seen in a long time as it relates to the watch category. We had people kind of lining up for the watches. You may have seen it in some of our stores, and we're still having trouble catching up with the demand that we have both in our own stores and at many of our retail partners. Clearly, this is a category that is here, and is a category that will grow. We're excited about that and both Fossil and ourselves feel that we're at the very beginning of something that could become sizable. I can't tell you whether it's going to ultimately outpace where we were with the total fashion watch business.
The category of fashion watches in total continues to decline, not just us. Many competitors as well are seeing the same thing. Again, both Fossil and in particular Kosta, I believe that the fashion watch business will be completely reshaped as we know it today, and that most watches over the next three to five years will come with some level of technology. We'll be making some exciting announcements in Basel in a few weeks about some additional things that we're doing in the wearable technology space that we think will further enhance our positioning. Just know that, again, Fossil and in particular Kosta and myself are very committed to maintaining our leadership position in the fashion watch business.
As I said in my prepared remarks, we think we will ultimately become the second-largest wearable watch business in the world, clearly the numbers are pointing towards that. If this category grows, this can be important for us. As I said again in the prepared remarks, it did not offset the decline in the total fashion watch business. We were significantly encouraged by the beginning of a trend change that we saw, and look forward to that continuing on. The handbag category, Dana, our kind of intel, we believe the category was about flat in calendar Q4/our Q3. I would say that was in both North America and Europe. We believe the category actually grew in Asia. We are going to have reduced market share. That is absolutely something that we actually want.
By us reducing our wholesale shipments and to some degree, pulling back on the promotional activity in our own stores will reduce our velocity in our own stores. We will have less market share, and we actually think that's a healthy thing for us on a go-forward basis. Our outlook is that the handbag marketplace globally will remain approximately flat, maybe up a point or two. Again, that's in USD. In units, we actually think that the market was up significantly. I'll just give you one number. In North America, in handbags, where we had a single-digit decline in our own stores, we were up 11% in units. That's actually sold units to the customer. Once again, that gives us great comfort that the consumer is absolutely engaging with the Michael Kors brand. Again, all of our consumer research says that.
She's just finding it at a much more attractive price than she's previously been finding it at. We're going to show her value in a different way going forward that we think will keep her engaged. Our objective is to sell significantly less units next fiscal year than we were sold in this fiscal year. Thank you, Dana.
We'll take our next question from Ike from Wells Fargo.
Hi, everyone. This is Nancy Hilliker on for Ike. Just a couple of small questions. When you think about the European retail trends in the fourth quarter, do you expect them to stay consistent with this quarter or decelerate? If you could talk about margin puts and takes within each segment in the fourth quarter as well.
Okay. Thank you very much. The second question, we're not going to have time to do, so I'm only going to answer the first question for you. The European trends, again, I think there was an interesting note that you heard in my prepared remarks, and you heard in Joe's prepared remarks which were that if you added back in our e-commerce business on a constant currency basis, actually our business in Europe was flat. We far exceeded our expectations when we turned on our e-commerce sites and what we refer to as our digital flagships, which we believe had a significant impact on our business in the marketplace. While traffic was down in Europe, it was down in the mid-single digits which was lower than what we had anticipated. Again, we believe a lot of that volume went directly to our own website during the period.
We're going to continue to watch that. We saw the exact same thing happen in North America. The minute we turned on our e-commerce, our comp store sales were impacted pretty dramatically quickly. Again, that's just consumers changing their shopping behavior. As we've seen in many countries, they want to go to the official website. We certainly have had other partners having e-commerce in the territories. Now there is the Michael Kors website, which you are able to see the full range of our product. You're able to engage with many of our social activities and styling tips. As we said in North America, we're launching specialized product offerings under Custom Kors, and we're going to roll that out in Europe as well. There's a lot that's going on on our websites.
We also talked about the fact that our dress shop will launch in the early part of fall, maybe as early as late as spring. We think that this is only going to get bigger. Again, that's why I said in my prepared remarks, we're spending more money to help fuel that. We think Europe, in particular, will see that trend continue. There's a long-winded way of me saying that we think actual store comps will remain down in the same trend, maybe even a little worse than they've been. We'll look at what that total mix is wrapped up with our e-commerce business to see how that's impacting our trends. I think we'll take one last question.
We'll take the next question from Mark Altschwager from Robert W. Baird.
Great. Good morning. Thanks for taking the question. Could you just talk about how you're thinking about full price versus off-price exposure within the North American wholesale channel? Where does that mix sit today, and what would be your goal as the recalibration unfolds? Then along those lines, you talked about AUR strategy and full price. Any sense on what's happening in the outlet channel and how you see AUR progressing there? Thank you.
Yeah. Good morning, Mark. Mark, we don't break out full price versus off price in the various channels. What I can say to you is the following, is that many of our department store partners have been offering promotions. If it's not every two weeks, it's every third week. There's something going on all the time. As I said to you, we're going to really consolidate that down to four times a year. We believe that's going to significantly reduce the amount of off-price business that we're doing. Hence the reason for the significant reduction in the inventory going into the channel. I think that that's something we're going to just have to see how it plays out over time. We are focused on making sure that along with that, we provide great value. That value doesn't only mean $298 or $228.
That value could also be in one of our very successful, our Mercer bag, which the grab bag with the grommets. The consumer saw that at $498 and said, "Wow, this is an amazing design and tremendous amount of workmanship and detail and design that went into that" at what we thought was a very exciting and compelling value for the consumer. We look at those things and really balance them. Again, we're trying to make sure that she sees the Michael Kors as an elevated brand, not something that's on promotion on a regular basis. In the outlet channel, I would say AUR did decline during the quarter and has declined over the last few quarters as the channel has become also extremely promotional. Our competitors are, in many cases, much deeper in discount than we are.
That's becoming something that we've had to really compete with. The good news in that channel is there is less of a traffic issue and so that has helped us balance off the AUR piece. Our conversions are up in that channel as well. Thank you very much. That's going to conclude our call for today. We look forward to updating you on our future guidance in our fourth quarter earnings call. Thank you very much for taking the time to be with us today.
That will conclude today's conference. We appreciate your participation. You may now disconnect.