Urban Outfitters Inc (URBN) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Urban Outfitters Inc. second-quarter FY17 earnings call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce Oona McCullough, Director of Investor Relations. Ms. McCullough, you may begin.

Good afternoon and welcome to the URBN second-quarter FY17 conference call. Earlier this afternoon, the Company issued a press release outlining the financial and operating results for the three- and six-month period ending July 31, 2016.

The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the Company's filings with the Securities and Exchange Commission.

We will begin today's call with Frank Conforti, our Chief Financial Officer, who will provide financial highlights for the quarter. Trish Donnelly, Chief Executive Officer, Urban Outfitters Group, will provide a brief update on the Urban brand. Richard Hayne, our Chief Executive Officer, will then comment on our broader strategic initiatives. Following that, we will be pleased to answer your questions.

We have posted a slide deck with key financial information for the quarter and the year to our corporate website. You can find the link within Investor Relations section under the presentation tab within the financial news and events section. Additionally, the text of today's conference call will be posted to our corporate website at www.urbn.com.

I'll now turn the call over to Frank.

Thank you, Oona, and good afternoon, everyone.

I'll begin my commentary discussing our FY17 record-setting second-quarter results versus the prior comparable quarter. Then I will share some of our thoughts concerning our third quarter and the remainder of FY17.

Total Company, or URBN, sales for the second quarter increased by 3% to a second-quarter record of $891 million. This increase included a 1% retail segment comp, a 4% increase in wholesale segment sales, and a $12 million increase in non-comp sales, including the opening of eight net new stores in the quarter, and sales from the newly acquired Vetri Family restaurants.

Within our retail segment comp, the direct-to-consumer channel continued to outperform stores, posting another double-digit sales gain, driven by an increase in session and conversion rate, which more than offset a decrease in average order value. Negative comp store sales resulted from decreased transactions and average unit selling price, while units per transaction were flat.

By brand, our retail segment comp rate increased by 5% at Urban Outfitters, was flat at Free People, and was down 3% at the Anthropologie Group. Our URBN retail segment comp was the strongest in July, followed by June, with May being the weakest.

Free People wholesale segment sales delivered another solid quarter, as sales rose 4% to $75 million. These results were driven by increased space at select department store doors to support our category expansion, like FP movement and growth in our European accounts.

Now moving on to gross profit, total URBN gross profit for the quarter increased 8% to $343 million. Gross profit rate improved by 179 basis points to 38.5%. The improvement in gross profit rate was primarily driven by improvement in the Urban Outfitters and Anthropologie Group brand maintained margins, with both brands delivering higher initial markups and lower merchandise markdowns versus the previous year. Partially offsetting these improvements was a lower gross profit rate at the Free People brand, primarily driven by lower maintained margins due to higher markdowns to clear slow-moving products.

Total SG&A expenses for the quarter were up 5% to $224 million. Total SG&A as a percentage of sales deleveraged by 48 basis points to 25.2%. This SG&A deleverage was primarily due to an increase in direct marketing and technology-related expenses to support our strong direct-to-consumer growth. Direct store controllable expenses also increased in the quarter in order to support our square-footage growth of 4% in the quarter. Operating income for the quarter increased by 14% to $118 million, with operating profit margin improving by 131 basis points to 13.3%. Our tax rate for the quarter was 35.5% compared to 35.2% in the prior year. Net income in the quarter was $77 million, or $0.66 per diluted share, a new second-quarter EPS record.

Turning to the balance sheet, inventory decreased by 4% to $367 million. The reduction in inventory is due to a 4% reduction in retail segment comp inventory at cost. The reduction of inventory is not necessarily predictive of future sales growth, as we are currently doing a nice job of lowering our weeks of supply and getting faster turns out of our inventory, as shown over previous quarters where our sales comp has outpaced our comp inventory growth.

We ended the quarter with $328 million in cash and marketable securities. During the second quarter, we paid down $25 million of our outstanding revolver, leaving $50 million currently outstanding.

As we enter the third quarter of FY17, it may had be helpful for you to consider the following. We are planning to open a total of approximately 23 net new stores for the year, excluding our food and beverage division. For the third quarter, we are planning 6 new Anthropologie stores, including 1 new Anthropologie store in Europe, 2 new Urban Outfitters stores, and 3 new Free People stores.

For the year, we are planning on opening 3 net new Urban Outfitters stores, including 1 in Europe; 7 net new Anthropologie stores, including 2 in Europe; and 13 net new Free People stores. For the full-year FY17, we are also planning on opening two new Vetri pizzerias and one cafe adjacent to an Anthropologie large-format store.

Now on to gross margin, we believe our third-quarter gross margin rate could improve versus the prior year, with that improvement in rate being slightly lower than the 142 basis points we achieved in the first half of the year. Our third-quarter gross margin improvement could be largely driven by higher maintained margins at the Anthropologie Group and Urban Outfitters brands, which could be partially offset by declining gross profit rate at the Free People brand.

Based on our current plan, we believe SG&A could grow at a low double-digit rate for the third quarter. Please note that we recorded lower incentive-based and share-based compensation in the third quarter of the prior year, which is contributing to the increase in our SG&A growth rate for the third quarter of this year.

For the year, we believe SG&A could grow at a high single digit rate. We believe the growth will be driven by increased investment in marketing and technology expenses, hopefully helping to continue driving our double-digit direct-to-consumer channel sale gains. So our related expenses are also expected to increase in order to support our square-footage growth, which is planned at approximately 5% for FY17.

Capital expenditures for FY17 are planned at approximately $170 million. Total spend for FY17 is primarily driven by new, relocated, and expanded stores and the completion of our new East Coast fulfillment center. Finally, we are still planning our FY17 annual effective tax rate to be approximately 37% for the year and believe our fourth-quarter tax rate will be lower than the annual planned rate.

As a reminder, the foregoing does not constitute a forecast, but is simply a reflection of our current views. The Company disclaims any obligation to update forward-looking statements.

Now it is my pleasure to pass the call over to Trish Donnelly, Global CEO of the Urban Outfitters brand.

Thank you, Frank, and good afternoon, everyone.

The Urban Outfitters global brand had a very exciting second quarter. We delivered record sales volume and drove a 5% retail segment comp on top of the 4% comp increase from the previous year. Both the North American and European businesses contribute to the success, with Europe delivering a solid comp despite the political backdrop in the UK. Strong sales, partnered with improvements in merchandise margins and the team's focus on expense management, allowed us to deliver significant improvements in overall operating margins.

During the quarter, the Urban Outfitters brand was able to achieve near record merchandise margins through tight inventory management and IMU focus, not to mention compelling, trend-right products, creative and easy-to-shop visual presentations in stores, and exceptional imagery with an easy-to-navigate user experience in our direct-to-consumer channel. The brand's strong partnership with our internal production team, led by Chief Sourcing Officer, Barbara Rozsas, resulted in higher initial margins compared to prior years. Our attention to driving and developing a meaningful regular-priced business helped improve the global margins significantly.

Now let me discuss in further detail the various initiatives contributing to the strong top-line growth. The record volume in the quarter was driven by increases in regular price businesses across categories, geographies, and channels. One of our biggest shifts in strategy across all merchandise categories has been our focus on exclusive product and offering our customer product he or she can't get anywhere but Urban Outfitters.

In addition, to our own brand product, which is 100% proprietary and a majority of the total assortment, we worked with key brand partners such as Adidas, Wrangler, and FILA, on special makeup, exclusive styles, and UO collaboration. The ability to work creatively and collaboratively with brands we admire who get Urban Outfitters and get our customer has been really rewarding, and the response by our customers has been tremendous.

We saw impressive growth in our all-important women's apparel and accessories businesses across a variety of categories. At the end of the quarter, over 90% of our women's apparel assortment was available only at Urban Outfitters.

Today, more than ever, product differentiation is critical, not just as a traffic driver to both direct-to-consumer and stores, but more importantly, it's an obligation we have to our core customer. Our customer looks to us for unique products and first to trend, and exclusive product offerings ensure her she won't be wearing something offered anywhere else.

Globally, the brand also saw impressive growth in what we've previously referred to as emerging categories, specifically intimates, home, and beauty. Within intimates, we've had great response to our bras and undies programs, as well as our exclusive bodies and colors in Calvin Klein. We are also seeing really nice traction in our lounge and dorm offerings, and we will continue to build upon the successes we've seen.

In addition to intimates, we're seeing sizeable growth and upside in our home division. This is an important category in the lives of our 18- to 28-year-old core customer, whether they're moving into their dorm room or their first apartment. The small space and on-campus home marketing campaigns and social posts were some of our most engaged in the quarter, averaging six-figure customer likes on Instagram.

Also during the quarter, we launched a home showroom in Space 15 Twenty in Los Angeles, one of our large-format stores. This showroom shopping experience is truly omni-channel, and we'll continue to refine and support this initiative. With the majority of our direct-to-consumer traffic coming through mobile devices, the direct and retail experiences need to be seamless, and URBN is committed to supporting this with the necessary team and resources.

Our third emerging category, beauty, continues to see compounded comp growth and increasing penetration to the total business. Here too, we recognize the importance of exclusivity and first to market, and the beauty team has done a tremendous job curating a brand-right assortment with partners and brands around the world. The unique and different, even in beauty, resonates with our customers, and we'll continue to build out this special offering.

This brings us to a new emerging category, music, which has always been part of Urban Outfitters' DNA and product mix. Today we continue to offer vinyl, turn tables, cassettes, and cassette players, as well as wireless speakers and headphones with collaborators like Bang & Olufsen.

In addition to the product side of the music category, we're also committed to delivering the experience. Digitally, we've been building out our music video series, UL Live. With tens of thousands of subscribers and views, it gives us another platform on which to connect with our customer, while supporting our favorite artist and bands. Our Urban Outfitters music Instagram is growing quickly, with mix tape previews and vinyl giveaways, our most engaged customer interactions.

Finally our men's business. Although still not where we want it to be, the progress around the regular priced business, particularly in the direct-to-consumer channel, is seeing great traction. We see a path to positive growth for the back half of the year, with strong and relevant product assortments, including own brand, branded, collaborations and exclusives, relevant and creative marketing strategies, and easier-to-shop in-store visual merchandising setups.

We've said from the beginning that the men's comp will follow women's, which is how it's actualizing. The leadership in men's design and merchandising, planning, store visuals, and brand marketing has been laser-focused on our customer, on the assortment, and on compelling pricing; we're very excited about where the business is headed.

In addition to our product and experience initiatives, we are in the process of globalizing our team. This change allows us to communicate a seamless global message and a consistent retail and direct-to-consumer experience, while leveraging talent and creative assets across the globe. We are committed to pursuing long-term international growth. And this past quarter we opened a new Urban Outfitters store in Utrecht, Netherlands, bringing our total store count in Europe and the UK to 44. In addition, we opened an Urban Outfitters concession within the Selfridges flagship on Oxford Street late in the quarter, and we're looking forward to seeing success here.

On a global basis, I'm proud to say our brands saw improvements across all channels, in all customer groups this quarter, with new, retained, and reactivated customer counts increasing year over year. Another area where we've seen tremendous customer growth and audience engagement is in social immediate. Our Instagram followers exceeded the 5-million mark during the quarter, increasing 65% over the prior year, and we're now capturing over 200,000 new followers a month. In addition to our national Instagram account, our stores manage their local accounts, which accrued almost 700,000 followers and over 19 million likes in the quarter.

Snapchat is important in our consumers' lives, and we're also seeing fast growth here, with viewership increasing 25% month over month. Urban Outfitters was called out in L2's July Digital IQ Index for specialty retail as quote, the most prolific brand on the Snapchat platform, posting 6 times the index average, with 83% featuring video content, end quote.

This channel has given us yet another relevant way to connect with our customers and engage in two-way conversations. A great example of this occurred during LGBTQ pride month in June, where our Snapchat stories garnered close to 130,000 views.

In the 24 months I've been with Urban Outfitters, I'm proud to say we've made progress. And although there's still a lot to accomplish, there have been a number of positives. The results this past quarter could not have occurred without the exceptional leadership of the Urban Outfitters executive team, and I would like to thank each team member for their hard work, dedication, and passion for the brand. Their focus on our customer and the collaborative culture they've created for their teams and colleagues have allowed the quarter's successes to materialize.

And finally, a very special thank you to Meg, whose partnership is invaluable. Her love of Urban Outfitters and for our customer inspires the teams daily, and her contributions to this quarter's success were critical.

Thank you. I will now pass the call to Dick.

Thanks, Trish, and good afternoon, everyone.

URBN produced record sales and earnings per share in the second quarter, with comparable demand accelerating sequentially. May is typically our biggest month of the quarter, but as we suggested on our May conference call, unseasonably cold weather in the eastern half of North America depressed and delayed apparel purchases. As a result, total retail segment comparable sales in May were negative. Fortunately, the weather shifted in June and sales rebounded strongly. July sales jumped even higher, generating the best comps of the quarter.

Given the weak start to Q2, we're very pleased our final sales numbers show a positive retail segment comp, and we're delighted to report record second-quarter earnings per share. The monthly sales curve was similar across all brands, but overall results varied, so let me say a few words about each brand's performance.

First, the Urban brand: as Trish just reported, Urban produced a terrific quarter. All major product categories posted positive comp sales, except men's, and a number of categories delivered double-digit comps. Urban's European business also experienced strong comp gains, with seemingly little impact on the business from the Brexit vote.

Not only did the total Urban brand produce its best comps in 12 quarters, it also continued to deliver strong regular price sales; managed its leanest quarterly markdown rate as far back as brand records go, improved initial margins; administered height, inventory, and expense controls; and created a flurry of outstanding marketing events and campaigns. All of these factors combined to create record second-quarter sales and one of the most profitable second quarters in the brand's history.

Brand momentum at the end of Q2 was powerful. Therefore, the team believes they will continue to please and excite customers with new fashion and new marketing campaigns in the second half.

My congratulations go to Trish, Meg, and the entire Urban Outfitters team on both sides of the Atlantic, for planning and delivering an exceptional quarter. I'm so proud of what the team has accomplished over the past two years. Urban has now regained its position as the fashion loader for young adults, and I couldn't be more excited for the brand's future.

Turning your attention to Free People, in Q2, the brand posted flat retail segment comps and a mid single-digit increase in wholesale sales. The brand opened five new stores during the quarter and achieved total retail segment revenue growth of 8%. Almost all product categories in the retail segment delivered positive comp sales in the quarter with most of the gains driven by higher promotional activity.

As we discussed on last quarter's call, Free People entered the second quarter with excess retail segment inventory. The brand aggressively cleared this stock during the quarter by taking additional markdowns, which lifted sales but depressed margins.

I'm pleased to report the comparable retail sales inventory at quarters end fell by 8% on a year-over-year basis. Inventory is now more current and weeks of supply more in line with sales. As such, we believe the brands are positioned to deliver lower markdown rates in the second half than those experienced in Q2. Although the brand team has made significant progress in terms of inventory management, their goal is to further reduce the average weeks of supply.

Looking forward, the brand is encouraged by some excellent early fall selling of its newest fashion offering, especially in its direct channel. Regular-priced sales in that channel are running nicely positive, but haven't been strong enough to overcome lower markdown sales and negative store sales, so total retail segment sales are negative. The brand will continue to make adjustments to their assortments based on these early reads, but the team believes that retail segment results, which are up against multi-year positive comparisons, could remain difficult in the back half.

Meanwhile, the Free People wholesale team continued to produce excellent quarterly results in spite of a difficult environment. The headwinds to growth in this channel had been well documented; still, the team delivered a 4% increase in year-over-year sales in the quarter and 9% growth for the first half. This growth was driven by continued success in expanded categories, such as FP Movement, and significant growth in European business, where quarterly sales almost doubled versus the same period last year. The team believes there is significant wholesale growth opportunity remaining in Europe.

Looking ahead, timing issues with the wholesale shipments in the third and fourth quarters last year create easier comparisons for Q3, while Q4 is more difficult. In spite of this, fall and holiday bookings are strong, and the team believes they can return to double-digit growth for the back half of the year.

I thank Meg, Sheila, Dave, and Chrissy and the entire Free People team. Although not their finest financial results, the quarter marked a return to fundamental disciplines that will benefit the brand going forward. Given the enormous creativity housed within the brand, I'm confident that the Free People will continue to delight its customers with fresh fashion and inspiring environments.

I'll take this opportunity also to recognize and congratulation Sheila Harrington on her recent promotion to the role of Brand President, reporting to me. Sheila has been instrumental in growing the brand over her 13-year tenure at Free People, including extremely successful launches of all of the Free People product extensions, from intimates to Movement. Sheila, thank you for your many contributions and congratulations to you.

Next I'll speak to the Anthropologie brand. Although the brand reported a negative 2.5% comp for the quarter, there were numerous bright spots to report. Anthropologie Europe delivered positive comp sales. Again, we saw no change in customer demand from the Brexit vote.

Almost all Anthropologie product categories performed well in the quarter, with six of seven generating double-digit positive comps; only women's apparel was negative. Due to exceptional inventory management, the brand was able to limit markdowns in the apparel category and decrease the total markdown rate on a year-over-year basis by more than 100 basis points. This decrease in markdowns, in combination with very strong IMU improvement, drove significant year-over-year increases in merchandise margins on both a rate and dollar basis. The result, in spite of negative overall comps, Anthropologie generated more operating profits in Q2 this year than in the same period last year.

Obviously, the team's focus is on turning the women's apparel business around, and I believe the brand is making slow but steady progress. Reaction to Anthropologie's apparel assortment on a comp basis improved sequentially in the quarter. Areas of strength included dresses, which registered strong double-digit comp gains, and woven tops, which improved as the season progressed.

The brand believes the apparel assortment will continue to evolve throughout the fall and holiday seasons and feels positive about their assortments in a growing number of apparel classifications. Certainly, re-energizing this category is the brand's number one immediate goal.

Strong performance of the expanded categories, such as home, beauty, Bhldn, and Terrain continues to be a brand highlight. All expanded categories are ahead of plan and are fueling the increases in the direct-to-consumer business and the stellar performance of the two new larger format stores.

Home is the most developed of these categories and continues to surprise on the upside. We're excited to see customer reaction to the September home journal, which will drop in mid-September and have 42% more pages than last year's book.

The brand's beauty assortment is also connecting with the customer, and shows significant sales growth in both stores and online. By the holiday season, more than 130 Anthropologie stores will have a beauty shop-in-shop, up from 70 the prior year.

The two younger brands, Bhldn and Terrain, which became part of the Anthropologie Group over the last few years, have benefited greatly from the ability to cross merchandise and leverage the Anthropologie Group's resources. Both have experienced significant revenue growth and positive comp sales. Bhldn has the potential to top $50 million in revenue this year and is quickly becoming our customer's go-to destination for her special occasion.

The long-term strategic importance of positive customer reaction to these product expansions and extensions, both in store and online, can't be overstated. Nowhere is that reaction more clear than sales generated at the two newly expanded stores in Portland and Newport Beach. Last quarter, we reported on the phenomenal openings each of these larger format stores had. Now, three months later, both stores continued to exceed their sales plan, and importantly, for the quarter, both stores average higher sales per square foot than the average Anthropologie store. I think that's extraordinary.

While one quarter's results do not confirm a trend, should this metrics should continue, the long-term implications for the brand would be profound. Furthermore, the team believes there are many ways to enhance the assortment and experience of these stores and build stores even further.

During the third quarter, Anthropologie plans to open two additional expanded stores, Walnut Creek and King of Prussia. The Palo Alto relocation and expansion is planned to open in the fourth quarter.

My thanks go to David, Meg, and the Anthropologie team for delivering an exceptionally profitable quarter, and I congratulate David and the team for successfully developing the Anthropologie expanded categories and larger format stores.

Before closing, I will briefly comment on trends in the market and summarize our accomplishments this quarter. Over the past several years, the complaint of lack of fashion has become common in the marketplace. I spoke to this subject on our conference call in March of this year. I actually said, I'm not predicting exactly when a change in fashion will occur, but that I saw more fashion excitement in spring than I'd seen in quite a few years. I repeat those comments again as we move into fall, except I believe the change is now upon us and our customers are adapting to new looks and sillhouettes as we speak. As in all such cycles, some customers and brands adopt newness faster than others. But the fact is, there is currently an abundance of exciting fashion happening, and this is very good for our brands, for URBN, and for our industry as a whole.

Now to summarize URBN's accomplishments in the second quarter. During the quarter, we generated record sales, with a 1% increase in retail segment comp sales and a 4% gain in wholesale sales, and achieved these record sales with 4% retail segment comp inventory decrease. We also drove strong direct-to-consumer sales, in part by increasing our marketing spend; grew our year-over-year initial merchandise margins by almost 100 basis points; managed the markdowns for the lowest rate for any quarter in Company history; delivered the highest maintained merchandise margin in recent history; and earned $77 million in the quarter, or a record $0.66 per share.

Finally, in closing, I thank our brand and shared service leaders and our 24,000 associates worldwide for their inspiring dedication, drive, and creativity. I also recognize and thank our many partners around the world, and finally, I thank our shareholders for their continued support. That concludes my prepared remarks.

I now turn the call over for your questions.

Thank you.

(Operator Instructions)

Your first question is from Lindsay Drucker Mann from Goldman Sachs.

Hi, thanks. I wanted to ask about the Anthro margin story. I wanted to ask first of all about why you saw IMU improvement at Anthropologie. And ask if UO is seeing merch margins at it highs, how would you describe Anthro's merch margins relative to the historic range?

Lindsay, before anybody answers, please limit your questions to one so that everybody gets a chance to ask a question, thank you.

Hi, Lindsay, David here.

Like Urban, Anthropologie delivered near record merchandise margins in Q2, despite some of the shifts of product categories that we discussed. That was due to really impressive margin gains, IMU gains that Barbara and team led with design and merchants. And that was due to higher penetration of owned brand products, combined with strong sourcing negotiations and what we've seen in the deflation of raw materials.

Your next question is from Kimberly Greenberger from Morgan Stanley.

Oh, great thank you. What a nice surprise today.

Thanks, Kimberly.

I'm particularly impressed by the level of acceleration, Dick. So my question is, if you could look under the covers and at the drivers of the acceleration in the back half of the second quarter, are there learnings that the organization had there that will help you kick off third quarter? Or as we turn from spring, summer into fall, is it a blank slate? And any comments you have on August with respect to that question would be fabulous, thank you.

Okay Kimberly, thanks very much. I think -- I don't want to have the group take entire credit for this. As I said in my opening statement, there was a weather factor. And I think there was depressed demand in May, and we saw a lot of that demand come back in both June and July, but we did see sequential progress in demand over those three months, and I attribute that to much better planning on the Urban front this year than last year, stronger product assortments in every major classification. And I think Trish was a little reticent to talk about men's, but we're even seeing it in men's now in Urban. So I feel very strongly about Urban.

As you know, we still have work to do, as I mentioned, in the Anthropologie brand in some of the apparel classifications. But we saw nice sequential growth improvements there, as well. And definitely in the home categories and the intimate categories, and basically all their other categories performed very well. And Free People, as I said in my prepared remarks, we've gotten some very nice reads online in the new apparel offerings. Some of the other businesses are softer than we want, and we're making adjustments in those categories. So I think that we've got a lot of momentum going into Q3, particularly in the Urban business.

It's pretty strong, and congratulations to Trish and Meg and their team for really engineering that.

The next question is from Adrian Yih from Wolfe Research.

Good afternoon, congratulations. Well done.

Thanks, Adrian.

Dick, I think this is for you or maybe it's for a number of people. But the fashion trends that you speak of, do you think that they are equally as promising across all three brands, or do you think they are particularly weighted toward UO? And what type of interpretation can each of the brands do with what's happening out there?

Thank you.

Frank says he wants to take that. No. I made my comments on purpose that some brands and some customers adopt at different rates. I think it's particularly -- a fashion change is particularly kind to Urban, but I think that the other brands have lots of fashion as well. And to the degree they may be a little slower in adopting it; I think that they will adopt it. This is fashion change that's happening, and my experience is once it starts to happen, there's not much that stops it.

I do think that Free People has a lot of fashionable items in their apparel area. And as I said, it's only a couple of the other categories that are softer. So I think that both Free People and Urban are in the sweet spot with fashion. Anthro is going to get there; I'm quite confident of it. They just might take an extra couple months.

Your next question is from Paul Lejuez from Citigroup.

Hi thanks. Dick, can you -- you've talked about the traffic challenges out there for some time, just the general pressures and the retail landscape. The new fashion that you're talking about, do you think that's enough to offset the traffic pressures for you? And I'm curious if you think the same about the industry as a whole and how that ties into what you expect for the second half of the year, thanks.

Yes, Paul, thanks for the question. I think that Urban is definitely benefiting from a lot of the initiatives they're doing, not just the good fashion, but the social media work that they're doing and the marketing work they're doing. In July, they actually saw a positive comp store sales in North America and in Europe. They had positive comp store sales, so yes, I think it can make the difference.

I do believe that we shouldn't get too negative on stores. I think that there's no questions there are too many stores in North America, and we start to see some of those stores going away, some of the -- Our competitors are closing stores at a reasonable rate, and, of course, there was just a Macy's announcement of closing stores. So I think that you will continue to see a lot of stores close and go away. And I think that's a positive thing for the industry and a positive thing for all of the people, including the ones that are closing the stores.

But I don't think it's a problem with stores, per se. I think the store concept is still valid. What I see happening over time is just fewer stores, but probably the stores larger and delivering more of a unique experience, which complement their direct-to-the-consumer business. And I think that that will be the winning combination.

Also, if you don't mind me taking a second to talk about proprietary product, which is a question that you asked last quarter and gave me a lot of reason to think about it. Like Trish said, this proprietary product, I think is one of the -- going to be one of the main drivers of differentiation in the marketplace going forward.

As Trish said, almost 90% of the women's product was proprietary in Q2. With Free People wholesale and Free People retail it's 100%, and somewhere around 90%. And at Anthropologie, the women's apparel is somewhere around 80% proprietary. Our goal is to really have this proprietary product across all categories not just in apparel. Currently, apparel is the highest penetration of proprietary product, but other categories like accessories and intimates, which are much less, are trending up. And we believe that over time, they will maybe not exceed apparel but approach apparel. So our goal is to offer these experiences in stores; that it's impossible for customers to get any other place than one of our brands.

The next question is from Janet Kloppenburg from JJK Research.

Hi, everyone, and congratulations, a really nice job.

Thanks, Janet.

Just on Anthropologie, I think you said it, Dick, but that the apparel trends were accelerating. Are you optimistic that this can improve in the third quarter? And just tied to that, are the inventory levels at Anthropologie balanced and where they should be after being light at the end of the first quarter? Thank you.

Yes, Janet, I'm going to let David answer that question.

Hi, Janet. Yes, it's true, throughout the quarter, there were opportunities for us to have different inventory levels that may have had impacted some of our apparel demand. But mostly the inventor level opportunity was in how we distorted the product and the opportunities in learning and where the customer is moving more forward. As Dick alluded to earlier, all of URBN will be focusing on how to be faster speed to market, use more predictive tools in our resources, and over time, lower inventories in total for the organization.

As it relates to Anthropologie and the sequential growth, we did see that in Q2; however, when we look at the balance of the year, I wanted to remember that about six months ago, we launched with Meg and Barb, an overhaul of Anthropologie's vision for archetypes, our process, speed to market. The teams have changed, and that's about six months ago.

And we expect fall and holiday to be similar to Q2 where the Company will look similar to Q2's results, and expanded product categories will outpace apparel's growth, yet still see opportunities to show improved merchandise margin over the prior year. That's even with apparel being soft for the balance of the year relative to comps.

The next question is from Lorraine Hutchinson from Banc of America.

Thank you. I just wanted to follow-up on inventory. I know you just touched on it for Anthro, but inventory seemed lean across the chain this quarter. Did the strong reaction to the initial fall items tempt you at all to invest more heavily in inventory, especially as there is newness in fashion for the back half?

Okay, Lorraine. The decrease in inventory is planned, and we are planning to decrease inventory further. But we don't think that that should impact sales negatively; we actually think it will impact sales positively, because our other goal is to be able to replenish those things that are selling well faster.

So to that end, Barbara and her team in sourcing have implemented a lot of initiatives that are going to allow us to speed up the time that it takes us to replenish. And as we get faster and faster, I think you will see inventory decrease even further. But hopefully sales will go up, because we'll have the right product in the right place at the right time.

The next question is from Simeon Siegel from Nomura Securities.

Thanks, good afternoon, and congratulations. With the top-line acceleration throughout the quarter, can you just share any color on August trends? And then just with UO and Anthropologie reaching near the record margins, can you just talk to where you'd expect those concept's operating margins to round out this year and maybe how you think about the ongoing opportunity to push beyond the peaks after the next couple quarters?

Thanks.

Okay, Simeon. I think from a macro level, so URBN level, we think that the sales are going to be relatively consistent, or are relatively consistent August to date with the total Q2 results. Remember we're on a calendar basis, so the early August comparisons are up against an extra weekend last year, which causes us about probably 1%, 1.5% difference. So we're down slightly to the Q2 results. But overall, we think we're about even when you factor in the extra weekend.

The next question is from Brian Tunick from Royal Bank of Canada.

Yes, hi this is Kate Fitzsimmons on for Brian. Thanks for taking our question.

Just on gross margin, Frank, you indicated that you expect the gross margin to be up in 3Q but maybe moderating slightly from the second quarter. Can you just talk about behind some of your assumptions within that? And specifically, how should we think about merch margins across the brands, and also delivery and fulfillment expense within gross margin? Remember last year that was a headwind in 3Q.

Thank you very much.

Yes, Kate, this is Frank.

So you're correct in that we do believe that we can right now deliver improved gross profit margin in the third quarter. We delivered about 142 basis points of improved gross profit margin for the first half of the year. We think Q3 could come in around 100 basis points. This obviously assumes that the Urban Outfitters brand continues with the strong momentum that they have right now, that Anthropologie posts similar performance to what they delivered in the second quarter, and Free People delivered sequential improvement in their markdown rate in the third quarter from where they landed the second quarter due to inventory being in a better position.

But by line item, the improved MMU would be through improved initial markup at both the Anthropologie and Urban Outfitters brand, and potentially lower markdowns at all three of our brands for the third quarter.

The next question is from Marni Shapiro from the Retail Tracker.

Hello. Congratulations.

Thanks, Marni.

So I'm just curious if you could dig a little bit into the customer that's coming into or back into the stores at Urban and Anthropologie. But even what you're seeing at Free People. Is this being driven by new shoppers, or is it your shoppers that were coming in and they're buying more? Any color there would be great.

I'm going to ask Trish and David, and if Sheila wants to talk about it, she can talk about it too. So Trish?

Thanks.

Hi Marni, what we're seeing is definitely still our core customer, our 18- to 28-year-old core customer. And what we're seeing, and I mentioned it in the script, is in all buckets of customer, new and reactivated, we're seeing really nice growth both in North America and Europe. So to answer your question, really just getting that core 18- to 28-year-old customer back in the brands.

Marni, for Anthropologie Group, we're seeing stability in the customer file and the type of people coming in, though obviously the product category shifts, we do see some differences. So we do hear of customers coming in who are new to the brand because they may be passionate about home, the beauty assortment being a little different, also watching what's happening with the primary apparel-only shoppers, we look at it.

But we also know as we get into Q3 that the Anthropologie customer really starts to shop aggressively after the kids have gone into school. So we'll be looking after the kids go back to school to get ready for fall.

The next question is from Anna Andreeva from Oppenheimer.

Great, thanks, and congratulations on a great quarter.

Thank you.

My question was on the fourth quarter. With new fashion trends emerging and the green chutes you're seeing across brands, barring the environment, could we expect both Urban and Anthropologie to comp positively in the fourth quarter?

And also just a follow-up on gross margins. You spoke to Q3 expansion, inventories very well managed. What kind of expansion should we expect for the fourth quarter? Thanks.

I'll take the first part of it, Anna. And I don't want to be rude but we can't speculate about comps in the fourth quarter. Trends right now would suggest it's possible, but we don't know for sure and we can't speculate.

And this is Frank. I'll reiterate that. Certainly, I think there is the opportunity for the fourth quarter, but if our trends were to continue. But as you know, this is retail and that just feels like it's a long way out right now.

The next question is from Omar Saad from Evercore ISI.

Thank you. Thanks, good afternoon. Great quarter.

Thank you.

Was wondering on Anthropologie, the success you are having in many of the non-apparel categories, I know you're optimistic about apparel improving. But the larger format stores, there's new larger format real estate that's probably coming open and maybe some mall anchor space. Have you thought about really pushing that angle for the brand and perhaps accelerating the format?

Hi Omar. Yes, we couldn't be more pleased with the start we've had with the large format concept that we launched during the URBN 2020 vision session. It's all focused around the customer and her appetite for the brand, and like all of the URBN brands product category expansions, it's been -- it's a wonderful opportunity for us.

It's only been three months, but she certainly seems to be enjoying the experience and the product offer. And we're still working through and learning how to operate and maximize in an opportunity. As Dick said, we believe with what's going on in the digital environment that it's more important that our offer be -- not only will our offer be compelling, but the in-store experience will be compelling. And we think these are very experiential, including what Dave Deals' team is adding in terms of dining and all of the product categories and their new service selling model.

We're opening, hopefully, three more this year. We've slated loosely four to five the following year. And if these results were to continue, we'd hope to see would this also activates the broader assortments online, which will blur both.

So we're again, very early in the stages in terms of time and the categories have lots of upside. But like you intimated, we think this is a very healthy sign from our customer acknowledgment of the strategy.

The next question is from Ike Boruchow from Wells Fargo.

Hi everyone, let me add my congratulations on a great quarter. You mentioned the one category at Anthro that was negative is women's apparel. Can you just remind us what percent of the business that represents? And then just curious which product categories within apparel you have the most confidence in that can show improvement in the back half and which might take a little bit longer?

It's David here again and regarding Anthropologie apparel again. As we look at it, we see we're six months into working through this. We've seen the terrific work that Meg and the leaders have done at Free People and Urban.

So we're really -- we believe we're headed down the right path with the new approach. The teams are starting to work together well and we're starting to understand the archetypes and the potential and learning how to react. And with that confidence, the merchants and planners will start to feel better about those investments. Dick alluded to we've had double-digit successes in dresses. We too are excited about the fashion changes and think Anthropologie's customer will adapt to the fashion moves at a different way and a different pace than the other two brand customer sets.

But we are seeing some really interesting movement in denim, wovens continue to show some nice highlights, and we're seeing just a lot of interesting read. That being said, we are expecting and anticipate it to continue to lag the performance of the expanded categories for fall, holiday time period, but continue to learn each season.

The next question is from Dana Telsey from Telsey Advisory Group.

Good afternoon, everyone, and nice to see the progress.

If you think about the changes in Anthro, do any of the success factors of Urban Outfitters, whether it's the exclusive product offerings or the working with brand partners, would any of those be an opportunity for Anthro?

Okay, Dana, I'll take the question. I think absolutely there's learnings that are applicable. They might not be as direct as what we see happening at Urban, but I think the idea of collaborations with different designers, different artisans and artists are absolutely applicable for the Anthropologie customer. And as we get into home, I think that that gives even more opportunity. So I would expect you to see the same thing at all three brands. I think what Urban has done is really very powerful and the customer, obviously, is reacting extremely well.

The next question is from Neely Tamminga from Piper Jaffrey.

Hi Trish, we really do like what we're seeing and what these exclusives from the national brands. I'm thinking specifically here of some of the social media splash on Adidas. How should we be thinking about -- are you going to be pulsing more of them more frequently or -- and/or are you looking to actually increase some of the depths of inventory into each one of these exclusive launches or collaborations?

Thank you.

Hi, Neely, thanks so much. I'm really glad you're liking what you're seeing.

Yes, as we find partners that are like-minded and make sense, and we know there are brands that will resonate with our customer, we'll for sure pursue those as great partners. There's no specific number of or there's no specific -- it's a far more organic process. In terms of the depth, to your point, where we are seeing success, yes, we are going back and managing that inventory appropriately.

What we do see, Neely, is a lot of brands now coming to us and wanting to partner, because they see the credibility that it has given some of our partners. So I think that yes, we'll continue to do this, we'll continue to expand it but we'll be extremely selective in who we do it with.

The next question is from Richard Jaffe from Stifel.

Thanks very much. And my congratulations as well. A quick question about Europe and the Anthropologie business. It was a slow start for Anthropologie overseas and it looks like it's really picking up pace. Wondering if it's matching the performance of Urban, and if so, is its trajectory going to accelerate? What's the outlook for Anthropologie? Thank you.

Hi Richard. Anthropologie Europe did have, did see some improvement. I wouldn't say it was at the pace of what Trish and team experienced in Europe this past quarter.

That being said, as we discussed on the March call, we think all of URBN has tremendous growth potential, Europe, Asia, and beyond. We announced during that time that we were going to hire a leader. In our last call, we announced Stefan Labahn, who has now joined us, is going to be heading up the international strategy and strategic growth and working with the brand leaders to find those opportunities, not only for Anthropologie but others.

Also want to take a moment, while I have you, to follow-up in the other prong of my new role, which was URBN digital growth and wanted to let you know we're very happy to announce the promotion of Dave Hayne, who will be the new Chief Digital Officer for URBN, taking some of the experiences and great track record he had in working with Meg and Sheila and team at building Free People's digital growth and working with the brands to carve out that strategy as we move ahead, along with international.

If I might add, Richard, all three brands saw strength in Europe this past quarter. Urban had very good retail segment comp sales, as did Anthropologie, but not to forget Free People. The Free People wholesale division almost doubled their sales in Europe, so almost counterintuitive because of all the political noise that was coming out of Europe, but Europe right now is performing very well.

Our last question comes from John Morris from BMO Capital Markets.

Good, my congratulations as well. And, Dick, I think, if you want to continue with that thought, that was actually going to be my question in terms of what you attribute -- the very impressive performance in Europe given that we've heard a lot of retailers having had a pretty challenging quarter there. And I'm wondering what you attribute that strength and resilience to -- of the brands overseas, as it may apply to what's to come ahead.

Okay, John. The only thing I can attribute to is product and some team changes at Urban. At Urban, we've brought on some new members of the team, and they are performing extremely well and we're very pleased with them. At Anthropologie, there have not been a lot of changes to the team, so I can't attribute it to that.

But I think again and again, it's always about product and execution, and I think we did a much better job executing this year, and the product is better. With -- and that, I believe, is our last question. And I thank everybody for being on the call and hope to talk to you next quarter. Thank you.

This concludes today's conference call. You may now disconnect.