Urban Outfitters Inc (URBN) 2019 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Urban Outfitters Inc.

Third Quarter Fiscal 2019 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 Third Quarter Fiscal 2019 Conference Call.

Earlier this afternoon, the company issued a press release, outlining the financial and operating results for the 3- and 9-month period ending October 31, 2018.

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.

Sheila Harrington, Free People brand President, will provide you with an update on the Free People brand.

Richard Hayne, our Chief Executive Officer, will then comment on our broader strategic initiatives.

Following that, we will be pleased to address your questions.

As usual, the text of today's conference call will be posted to our corporate website at www.urbn.com.

I will now turn the call over to Frank.

Thank you, Oona, and good afternoon, everyone.

I will start my prepared commentary, discussing our recently completed fiscal 2019 third quarter results versus the prior comparable quarter.

Then I will share some of our thoughts concerning the remainder of fiscal year 2019.

Total company, or URBN sales, for the third quarter increased by 9% versus the prior year.

The increase in sales resulted from a strong 8% URBN Retail segment comp, 12% growth in URBN Wholesale sales and a $10 million increase in noncomp sales.

Foreign currency translation had little impact on sales or profit for the quarter.

Within our URBN Retail segment comp, both the digital and store channels delivered positive comps during the quarter.

Digital continued to lead the way, posting double-digit sales increases at each of our brands, driven by increases in sessions, average order value and conversion rate.

For the store channel, it is now the third quarter in a row that our store comps have been positive at each of our brands.

Positive comp store sales resulted from increased average unit selling price and increased units per transaction.

Store traffic for the quarter was down approximately 1% versus the prior comparable quarter.

This traffic decrease was driven by lower traffic in the EU, while North America traffic was flat for the quarter.

By brand, our Retail segment comp grew by 12% at Free People, 8% at Anthropologie Group and 7% at Urban Outfitters.

This performance marks the fifth straight quarter each of our brands posted positive Retail segment comps.

Our URBN Retail segment comp was positive in all months, with August coming in the strongest, followed by September and October, which were comparable to each other.

During the quarter, we opened 7 new locations, including 2 Urban Outfitters stores, 2 Anthropologie stores and 3 food and beverage locations.

We also closed 2 stores in the quarter, one at Free People and one at Anthropologie.

Our URBN Wholesale segment sales grew 12% versus the prior year.

This growth was largely due to an 8% sales increase at Free People.

Free People's growth was driven by their domestic business in department stores and digital businesses.

These increases resulted from the growth in several categories, including women's apparel, intimates and Free People Movement.

The remainder of the Wholesale segment sales growth was due to the recently launched Anthropologie home business as well as the Urban Outfitters BDG launch.

During the quarter, Urban Outfitters launched wholesale of their BDG brand with partners in the U.S. and the EU.

While each of these brand initiatives are small today, we believe both provide for meaningful growth opportunities over the next several years.

Now moving on to URBN gross profit for the quarter.

Gross profit increased 13% to $338 million, while our gross margin rate improved by 134 basis points to 34.7%.

The rate improvement was driven by lower markdowns at all 3 brands and leverage in-store occupancy expense due to the strong Retail segment comp.

Total SG&A expenses for the quarter were up 7% to $241 million.

Total SG&A as a percentage of sales leveraged by 40 basis points to 24.8%.

The growth in SG&A expenses was primarily due to increased payroll to support the positive store comps, increased bonus and equity expenses earned as a result of strong company performance, and marketing expenses, helping to fuel the strong Retail segment sales increase.

Operating income for the quarter increased by 32% to $96 million, with operating profit margin improving by 174 basis points to 9.9% of net sales.

Our effective tax rate for the quarter was 20.4% versus 37.4% in the third quarter last year.

The significant favorability in the tax rate versus the prior year is primarily due to the lower federal statutory rate resulting from tax reform enacted late last year.

Additionally, please note that this quarter's effective tax rate was favorably impacted by certain discrete items.

Net income for the quarter grew by 72% to $78 million or $0.70 per diluted share.

Now turning to the balance sheet.

Inventory increased by less than 1% to $452 million, with Retail segment comp inventory essentially flat for the quarter.

We ended the quarter with $602 million in cash and marketable securities and have 0 drawn down on our asset-backed line of credit facility.

Capital expenditures were $34 million for the quarter and we are planning for approximately $120 million in total capital expenditures for fiscal year 2019.

The capital spend for fiscal 2019 is primarily driven by new, relocated and expanded stores, followed by investments in our home office space and technology.

Lastly, we repurchased 1.5 million shares for $58 million during the quarter.

This leaves 16.4 million shares remaining on our current repurchase authorization.

As we enter the final quarter of fiscal year 2019, it may be helpful for you to consider the following.

I will start with sales.

Given our current sales trend, at this point in time, we believe our Retail segment sales comp could follow along our 2-year comp stack, consistent with how our business has performed for the first 3 quarters this year.

Now moving on to gross margin.

We believe URBN gross margin rate for the fourth quarter could improve by a rate similar to the improvement achieved in the third quarter.

This improvement could be driven by higher initial markups, lower merchandise markdowns and leverage in store occupancy expense as a result of strong sales comp and prior year impairment charges.

Please note, we are speaking to improvement versus our reported numbers for last year, not our adjusted numbers to exclude impairment charges.

Based on our current plan and sales performance, we believe, SG&A could grow at approximately 5% for the quarter.

The growth in SG&A could primarily relate to increased incentive-based compensation as a result of URBN's strong current year performance, digital marketing investments and increased store payroll to drive and support our sales growth.

Our annual effective tax rate is planned to be approximately 25% for the fourth quarter and 23% for the full fiscal year 2019.

We are planning to open 4 new stores for the quarter, while closing 8 stores.

For further detail on store changes by brand, please see our investor metric sheet posted to urbn.com.

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 Sheila Harrington, our Free People brand President.

Thank you, Frank, and good afternoon.

I'm proud to report the Free People brand delivered a record third quarter with total sales growth of 12%.

Both the Retail and Wholesale segments experienced strong growth.

Retail wholesale revenues grew by 8%, driven by strength in department stores.

Retail segment sales increased by 15% in total and 12% on a comparable basis.

The brand delivered double-digit comp increases in the digital and store channels.

Comparable store growth was driven by increases in traffic, conversion and units per transaction in both the digital and store channels.

This marks the eighth consecutive quarter of positive Retail segment growth.

While sales were strong across all categories and channels, our bottoms division had a particularly strong performance, driving over 50% of the total apparel growth for the brand.

The design and merchant teams executed a compelling assortment, which is well received by our customers.

Within the bottoms category, the brand launched Kirby, a new fit to better service a greater range of the Free People customers.

The Kirby fit was introduced in our denim collection through our digital channel.

The customer response has been amazing.

Since the Kirby launch, 60% of our new denim customers have purchased this fit.

These results have exceeded our expectations and confirm the opportunity to better service both our loyal and future Free People customers.

We will continue to grow this fit in the spring by expanding color and style count in the digital channel as well as expand distribution into select wholesale accounts and retail locations.

During the quarter, we continue to focus on the growth of Free People Movement, and our more recently launched wellness and beauty categories.

Within these categories, the Free People brand has a unique opportunity to create product specific to the customers' lifestyle, and we believe offers a strong growth opportunity for the brand.

These 3 categories represented almost 20% of the total brand's growth for the quarter.

Let me start with wellness and beauty.

I am pleased to announce the brand launched our first own brand all-natural fragrance collection.

The product speaks to the brand values of clean beauty, an underserviced space in the market.

Our customers' response was stronger than anticipated and we look forward to continuing to develop and provide additional unique products for our customer within this category.

Now moving to our Movement category.

Movement produced exceptional growth across all 3 channels in the quarter.

We expanded our wholesale distribution through 8 new Movement shop-in-shops within Nordstrom as well as expanding specialty accounts, including boutique fitness studios.

Within the digital channel, Movement nearly doubled its revenues versus the prior year.

We now offer a Movement assortment in 35 Free People doors.

Throughout the year and the quarter, our store teams have been hosting local events with community-based studios and instructors to help create an experience that goes beyond just the purchase transaction.

These events, one of which was hosted by Cleo Wade, helped to create over 11 million social impressions and our 82% increase in Movement customer versus the prior year.

Free People Movement wellness and beauty categories will continue to be a priority focus for the brand.

We are excited about the momentum and the future opportunity these categories have and are making talent investments to ensure this potential is realized.

Turning to our international business, which continues to be a strategic focus for the brand.

Just last week, we opened our first retail location in Europe with a store located in the 9 Little Streets of Amsterdam.

Although still very early, we're excited about how well this store and the brand have been received.

We will open our second European location in London late in the fourth quarter.

Additionally, we are excited to enter Israel in early 2019 with Free People's first franchise location in Tel Aviv.

We are pleased with our international success to date and enthusiastic about the significant opportunity to grow each of our channels in the years to come.

I'm extremely proud of the team for the results they've produced in the first 3 quarters of the year and I'm excited about where Free People brand is going.

I would like to thank Meg, Krissy and the entire Free People team for an outstanding quarter.

Thank you.

I now turn the call over to Dick.

Thanks, Sheila.

Excellent comp sales.

You also ended Q3 with clean inventories and one of the lowest markdown rates in URBN history.

Congratulations on the superb quarter.

My thanks to you, Meg, Krissy and the entire Free People team for a job extremely well done.

Let me now turn to an analysis of total company third quarter results.

In the last few conference calls, I have spoken about factors which have created powerful tailwinds for our business, namely a vigorous U.S. economy, record consumer confidence, ultra-low unemployment and a changing fashion silhouette.

These factors have helped us generate record results.

I'm pleased to report the tailwinds continue to blow.

And in Q3, we produced yet another record quarter.

URBN brand teams delivered an 8% Retail segment comp on a plus 1% last year, and earnings jumped 72% over the prior year period.

Sales, earnings and earnings per share all set new URBN third quarter records.

As was true in the first half, strong demand for apparel and accessories drove much of these record-setting results.

Both Retail segment channels registered positive comps in both North America and Europe, and digital comps continue to grow at a double-digit pace at all 3 brands.

For the quarter, store traffic came in flat in North America and down single digits in Europe and conversion was essentially flat.

However, higher AUR and a slight increase in UPT offset traffic issues and generated positive store comps.

Retail segment inventories at all brands were well controlled, and total comp inventory at cost was flat to last year at quarter's end.

Tighter inventories and faster turns help to improve markdown rates at all brands and boost merchandise margins.

Now Sheila spoke to the Free People performance in some detail, so I will now address third quarter results at the other 2 brands, starting with Anthropologie.

Anthro achieved an 8% increase in Retail segment comp sales on top of a 2% gain last year, and all product categories produced positive comps.

This comp improvement was powered by a strong double-digit increase in the digital channel, combined with a positive store comp.

The store success came from increases in UPTs and AUR, which combined to drive better average order value.

The digital channel benefited from improvement in all metrics.

On our call last quarter, we told you that the performance of Anthro's internally designed apparel had improved throughout the first half of the year.

As a result, the merchants increased the penetration of internal product.

So in the third quarter, the apparel assortment was more equally balanced between internal and market product.

More internal product lifted IMU, which we believe should continue to positively impact Q4 as well.

The Q3 apparel assortment also performed better than last year.

So the need to take markdowns was reduced, and together with better IMU produced solid gains in merchandise margins.

This, along with tight expense control, enable the brand to deliver much improved operating margins.

The brand has now produced better year-over-year operating margins in each of the first 3 quarters of FY '19.

But we believe Anthropologie has opportunity for additional margin recapture going forward by continuing to improve IMU with a higher penetration internal product and achieving better markdown rates.

Turning to Anthro's international business, comps in Europe outpaced those in North America in both channels.

Higher conversion and better traffic produced nice single-digit comp store gains.

In the digital channel, the European group generated powerful double-digit comps by increasing sessions, AOV, UPTs and conversion.

All product categories participated in this success.

Beyond Europe, Anthropologie entered 2 new digital markets during the quarter.

China on Tmall Global platform and Israel through Terminal X are partners in online platform.

Early reads in both markets are positive and give us confidence to pursue further expansion in fiscal 2020.

Anthropologie's wholesale business also enjoyed continued growth in Q3, primarily by expanding distribution at Nordstrom.

In addition to the Anthro Home product carried on nordstrom.com, the brand now has 19 dedicated home category shop-in-shops in Nordstrom locations and a select home assortment in an additional 60 doors.

In Europe, Anthro Home wholesale is currently distributed through John Lewis, but going forward, the brand plans to expand distribution points by forming strategic partnerships with additional European retailers and expanding the number of doors with each partner.

In all channels, all geographies and all categories, the Anthropologie team orchestrated an excellent quarter.

My congratulations to Hillary, Andrew, Meg and the entire Anthropologie team on a job well done.

I look forward to your continued success in Q4 and beyond.

Now please turn your attention to the Urban Outfitters brand, where total Retail segment comps in the third quarter grew by 7% on top of flat comps last year.

Like the other 2 brands, apparel and accessories led the increase, but all categories produced positive comps, including the home category.

Home sales had been soft for almost a year, but turned nicely positive in Q3.

Furniture and decorative accessories fared especially well as did the fun and games assortment, which features novelties and gifts.

For the Urban brand, this latter product group sells particularly well at holiday time.

So third quarter success bodes well for holiday sales.

The brand delivered positive comps in both digital and store channels in both North America and Europe.

Flat store traffic in North America and soft traffic in Europe were both offset by higher AUR, which was helped by less need to take markdowns.

The brand opened 2 new stores during the quarter, one in North America and one in Europe and helped to open its third franchise store in Israel.

Urban's global digital business saw double-digit growth driven by increases in sessions and average order value.

One recent example of this success is the brand's results from Singles' Day on Tmall Global.

Singles' Day is the biggest one-day sales event in the world.

And this year, the Urban brand achieved the #1 apparel brand on Tmall Global.

As you may know, global is Tmall's smaller platform for brands that don't carry inventory in country.

We're told Tmall Classic, their larger platform, generates approximately 10x greater customer demand than Global.

Thus, we plan to launch all 3 brands on Tmall Classic next year.

The Urban brand is enjoying strong worldwide brand recognition and acceptance, be it in Europe, Israel or China.

During the third quarter, the number of global Urban brand customers increased at a double-digit rate and the UO Rewards loyalty program now tops 9 million members.

In Q3, the Urban brand launched its BDG wholesale collection through nordstrom.com domestically and Zalando in Europe.

The collection offers core denim and woven bottoms rounded out with a tight assortment of knit tops and jackets.

Partner sell-throughs from both geographies have been very encouraging and the brand expects to significantly expand distribution next year.

While total brand IMU was fractionally lower than the previous year period, merchandise margins meaningfully improved due to a much higher mix of regular priced sales.

In fact, the Urban brand delivered its lowest quarterly markdown rate in its history and total brand expenses leveraged nicely as well.

Better merchandise margins and a lower expense rate allowed much of the third quarter sales gains to flow to the bottom line and create a double-digit improvement in the brand's operating margins.

My congratulations and thanks to Trish, Meg and the Urban teams on both sides of the Atlantic for producing an outstanding quarter.

In conclusion, each brand delivered an excellent quarter and impressive 9-month results.

Our teams have much to be proud of, besides driving excellent sales growth, they kept their inventories clean and lean, manage markdowns well and control expenses.

As a result, profitability is up sharply, but is it sustainable?

With this question in mind, allow me to revisit our commentary on this subject 18 months ago and reiterate why we see amazing opportunity in front of us.

As we discussed then, there are 4 major areas that can drive top line growth.

The digital channel remains our largest opportunity.

Over the past decade, URBN digital has delivered consistent double-digit growth.

Much of the gain resulted from increasing our offering, expanding our geographic reach, improving convenience, enhancing the experience and elevating our marketing efforts.

We still have many improvements and additions to make in each of these levers.

Our digital penetration is now approximately 40% of Retail segment sales.

If the digital channel continues to grow at even a low double-digit rate and stores produce a slightly negative to slightly positive comp, then our total Retail segment comp would be in the mid-single digit range.

We believe this is a likely scenario for comp sales growth going forward.

We also have massive international growth opportunity.

URBN's international sales penetration remains in the teams.

Given the power of our brands and the recent performance in Europe and other markets, like China and Israel, we intend to accelerate our rate of growth.

In Europe, we plan to open 10 to 20 new stores across all brands in each of the next 2 years, with the current base of 61 stores we plan for our European store count to exceed 100 in 3 years.

As we open stores, we expect the European digital business to achieve strong growth as well.

Our entrance into the APAC market has been through China.

The Urban and Free People brands have been experimenting with this market for the past several years by having a presence on the Tmall Global digital platform and fulfilling orders from the U.S. Given the success I discussed earlier, we plan to establish a larger presence by mid-next year.

To do this, we will switch to the much larger Tmall Classic platform, hold inventory in-country and fulfill orders through a third-party service provider in China.

In addition, we plan to sign leases for several stores opened in calendar year 2020.

In the Mideast, based on our current success in Israel, where our franchisee now operates 3 Urban stores, we have recently signed an additional franchise agreement to open stores in other Middle Eastern markets.

We expect to have more than 10 stores in total across all brands in operation by the end of 2020.

Another growth driver has been our Wholesale business.

Over the past 5 years, Wholesale has consistently grown revenues at a double-digit rate.

This was achieved by offering great product and adding categories like intimates, shoes and more recently Movement and denim.

This year both Anthropologie and Urban brands began offering segments of their assortments to selected retailers and e-tailers.

We believe the wholesale channel can continue its double-digit growth by expanding the core Free People offering geographically and building the account structure for Movement, Anthro home, and the Urban brand's BDG collection.

Finally, we have 2 smaller concepts, Terrain and BHLDN.

We believe both could exceed $150 million in sales and grow faster than our core brands.

In closing, I believe all brands in the URBN portfolio are resonating powerfully with their chosen customer.

The macro environment is favorable.

We have numerous growth vehicles to drive our top line and our teams are executing masterfully.

I believe URBN's future has never been brighter.

I thank our brand and shared service leaders; the merchant, creative and operating teams; and our 24,000 associates worldwide for their hard work, dedication and creativity.

You've produced a truly excellent quarter.

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.

Thank you, and now for your questions.

(Operator Instructions) Our first question comes from Kimberly Greenberger with Morgan Stanley.

Okay.

Great.

Frank, I just want to make sure I understood what you said before I get to my question.

I think you said September and October comps were similar and I just wanted to make sure I heard that correctly, and whether or not October represented actually a more difficult comparison than September.

Yes, Kimberly.

This is Frank and you did understand that correctly.

September and October were both comparable.

August was our strongest, but then September and October came in pretty consistent.

And yes, October was a more difficult comparison on a 2-year stack.

And our next question comes from Matthew Boss of JPMorgan.

Great.

On same-store sales, I guess, can you touch on top line trends you've seen in November and maybe just some of the drivers as you break down the mid-single digits sustainable as we think about next year and beyond?

Sure, Matthew.

What we've seen so far in November is right in line with our plan of mid-single digit comps.

Digital remains very strong.

We have seen a slight decrease in traffic in our store and a slight decrease in the store comp from what we saw in September and October.

However, again, if you look at it on a 2-year stack, both traffic and store comps are right in line with where they were.

And our next question comes from Adrienne Yih with Wolfe Research.

Dick, I was wondering if you could talk about inventory.

Are you seeing any earlier inventory coming in?

Any port delays as people try to get in before kind of these looming tariffs issue?

And then on the merchandise margin opportunity for, I guess, if you can talk a little bit about 2019, Frank?

Can you talk about at each of the brands where we have sort of the rank order of merch margin opportunity?

Okay, Adrienne.

As far as inventory is concerned, we saw a little backup in October, when people try to get stuff in before the tariffs took effect.

Since then, everything has sort of straightened out and we don't see any right now.

Our inventories are in excellent shape, as I think I reported in my prepared remarks.

Total retail comp inventory on a cost basis was down slightly and that, we're very happy, drove a plus 8% Retail segment comp.

And in the Free People wholesale area, we did clear through a little bit of inventory that we had to get rid of from the prior year.

That's all behind us now.

And the wholesale inventory on a unit basis at the end of Q3 was actually down about 20% on a year-over-year basis.

So we're very pleased with where our inventories are right now.

We're pleased with how we're prepared for Q4, and we'll see how the customers react.

Adrienne, this is Frank.

To answer your question as far as the opportunity for margin flow through next year, I think the biggest opportunity exists within Anthropologie, within their markdown rate.

And it's not that Anthropologie hasn't made significant strides this year, which they have, and the team certainly has done a great job from an execution standpoint, but I do think Anthropologie leads the way with markdown rate opportunity next year.

And our next question is a follow-up from Kimberly Greenberger with Morgan Stanley.

Sorry, Dick, my question was actually on inventory and the supply chain.

I wanted to know if the speed that you have developed in your supply chain is actually allowing you to run with leaner inventory levels without holding back your comp performance?

And if you can just remind us, in any given quarter, how much inventory in the following quarter do you have open to buy at this point?

Kimberly, I -- there's no question that speed to market has helped us not only staying lean on the inventory side, but being more on target with the inventory that we do bring in.

Of course, the closer you can get, the more accurate you can be, because you have more information to make the call.

As far as how far out we are, about 50% of our inventory is between 10 and 12 weeks out.

So it's not 1 month, but it's about 2 months.

And our next question comes from Brian Tunick with RBC Capital Market.

Great.

I was curious, Dick, maybe your view of where we are in this fashion cycle, maybe by brand.

Like, where do you think we are, whether it's an inning or from an uptake perspective between the different brands?

And then maybe Frank could talk about maybe a normalized SG&A growth rate given all the great growth initiatives, Dick, you just highlighted.

Sure.

I think the -- in terms of fashion, I think, we're still very early stages of this fashion change.

I think all brands, as you can tell by their sales, has done a reasonably good job, and I would say a very good job of anticipating what that change means for their customer and giving their customer what they want.

I don't see any -- Sheila went into the fact that we are in a bottom cycle and what it meant in terms of the growth for the Free People brand, I don't think there's any question by what that bottom cycle is going to continue in Q4 and into 2019.

As a matter of fact, I would expect it to continue for a few years.

So I think that's kind of where we are and we're excited about the fashion and about the fashion going forward.

Brian, this is Frank.

And I can promise you that the number of growth initiatives is pretty consistent with what we've always had here on our plate and trying to drive it as a company, and Dick certainly leads the way for the organization there.

As we always try and plan for leveraging our operating expenses as we did last year and certainly it looks like we are on pace to do really nicely this year, it is what our thoughts are for next year.

But that being said, we're in the heart of our budget season right now and still working on finalizing our plans and I'm just not comfortable giving out a final number yet.

But I promise I will have some more commentary on this when we talk again in ICR in January.

(Operator Instructions) Our next question comes from Lorraine Hutchinson, Bank of America.

Just following up on the fashion cycle, where is the penetration of bottoms right now versus history?

And do you see that as a comp driver for each of the brands over the next couple of years?

Well, I think, typically tops to bottoms ratio is anywhere from 2:1, 3:1, and we are much closer to the 2:1 segment, which would indicate that bottoms are more popular than tops on a relative basis.

That's not on a price basis, that's a unit basis.

So I think that I don't expect that to change in the near future.

There's no question over time it would start to drift back to a more normalized 3:1.

When you get above 3:1, then you know you're in a top cycle.

But we're nowhere near that now, and I don't anticipate that for a long time.

And our next question comes from Paul Lejuez with Citi.

Just curious about delivery expense, how that look this quarter as a rate to sales and how that compared to previous quarters, also what you expect in future quarters given the e-comm business continuing to grow.

And also, Frank, just early thoughts on how should we be thinking about CapEx next year?

Yes, this is Frank, happy to.

So as it relates to delivery expense, we did experience some minor deleverage this quarter on a year-over-year basis, and that was all due to the increase in penetration of the digital channel.

That being said, I would tell you that this is probably the least amount of delivery expense deleverage we've seen in -- for several years now as several of our operational efficiency initiatives have really taken hold here and we're really starting to mitigate the rate of deleverage, which is -- honestly, which has been fantastic to see.

That being said, as we look forward to the fourth quarter, I will tell you that we do anticipate the delivery expense potentially deleveraging in a slightly higher rate in the fourth quarter than it did for the course of the year, and honestly that just relates to the fact that there's just risk of upcharges from carriers as it relates to forecasting in volume coming through as everyone tries to rush to get that last order underneath the tree for the customer.

As it relates to CapEx, we haven't finalized our plans there yet for next year, but we are looking at some expansion of our distribution facilities.

So it wouldn't surprise me if our CapEx did uptick next year versus what we're planning for this year.

Again, I'll have more on that when we talk in January, but we are looking at having to expand our distribution facilities within Europe, and that's a nice thing because it's due to the growth that we've experienced in Europe and hopefully some efficiency that we can get out of a new facility down the road as well as potentially a furniture facility here domestically.

And again, that's also a good thing as it's due to the strong growth that we've experienced in furniture.

And our next question comes from Janet Kloppenburg with JJK Research.

Frank, first is a point of clarification, people are confused -- and then I'll follow with my question.

Just the gross margin rate was supposed to be using to compare against is 32.3%; that's what I'm using.

So you're saying that to clarify that gross margin could be up as much in the third quarter -- as much in the fourth as the third compared to 32.3%.

If you could clarify that?

And my question is on gross margin, looking at the fourth quarter and into '19, I think there's some favorable trends on own brands growing as a penetration, maybe you could talk about -- or Dick -- you could talk about the opportunity there and how much the growth of national brands that Urban Outfitters may constrain that opportunity?

Janet, this is Frank.

So I'm going to try and take my time here as best as I can possibly do as there's a lot of moving pieces.

So what you're referencing at 32.3% is backing out the impairment charge that we incurred last year, which is roughly $1 million.

If you were to reference that number, our forecast based on margin improvement would be less.

It'd be in that 30 to 50 basis points range, and what would be driving would be potentially and what we were hoping for is lower markdown rates, with Anthropologie leading the way there; potential IMU improvements driven by all 3 brands; as well as store occupancy leverage.

What I will tell you is that we're hopeful that this is a conservative plan.

I think with the holiday environment out there, we want to be conservative as you never know exactly how promotional the holiday is going to be.

As I did mention earlier, delivering logistics, I think, we're hoping that we have a conservative plan there.

But we always run the risk of running deleverage at a higher rate due to the potential carrier upcharges, again, related to things like capacity volume and forecasting accuracy.

And lastly, I will say that there still is some impairment risk in the fourth quarter this year, while not nearly as much as we had to record last year in the fourth quarter, but depending on exactly how holiday performs for certain stores that are on the watchlist.

There is some risk around new-store impairment in the fourth quarter as well.

And again, I am hoping that this is all conservative, but it is where we're planning the business right now based on where we sit.

And, Janet, this is Trish.

I'm going to answer your question about brand penetration in the Urban brand.

As you know, national brands has been a really important part of our mix since inception.

And if you look at penetration in women's, for example, which is our biggest division, it's a small minority.

It's certainly not material when you look at the penetration from own brand, particularly in women.

And going forward, we don't really see any big shift in penetration for branded product in women.

And our next question comes from Simeon Siegel with Nomura Instinet.

Frank, just to that point, just to clarify, so you said "conservative" a bunch of times.

So recognizing that, just any help thinking through next year as gross margin or just the opportunity there, just given that moderation, you have the sales strength, clean inventory, IMU.

So any help thinking through the go-forward gross margins, and then I think you mentioned the impairment, any way to quantify the range of what that might be that's baked into Q4?

Yes, so thanks, Simeon, and I hope it was -- it is a conservative plan.

All I can say is on the impairment, there are couple stores that are on the watchlist and it will depend on how holiday sales come.

But the number would be, we believe, hopefully meaningfully less than the $11 million that we incurred last year.

And then as it relates to fiscal '20, I think, for us, we just want to get through holiday right now, and then we'll have more to talk about related to the opportunities and the initiatives that we have on fiscal '20.

But I will reiterate, I think, that the biggest opportunity that is in front of us is to recapture further markdown rate opportunity at the Anthropologie brand, while that brand has made significant strides this year and great progress, there is definitely still opportunity for them to get back to where the brand historically runs when it's performing this well on a top line basis.

And our next question comes from Mark Altschwager with Robert W. Baird.

Frank, could you update us on what you're seeing from a rent and occupancy perspective and your ability to drive some savings on that line, especially given your comment on the watchlist stores?

And then separately, just following up on the inventory topic, obviously nice progress there, just bigger picture, give us a sense of where you think inventory turns can progress to over time?

Mark, this is Frank.

So as it relates to rent and occupancy, I think, right now the way we look at next year and most likely the year after that is on a cost basis, we believe that our rent and occupancy is going to remain flat.

I think we remain incredibly disciplined as it relates to renewals as you've seen with an uptick in our closures last year and this year to where if we can't get deals to pencil, we are willing to walk away from locations where we can't get -- go and get those concessions.

And being able to keep the occupancy dollars flat gives us that opportunity, that if the store comps are flatter or even slightly negative and the digital business continues to perform where it does to flow through some margin and some dollars flow through there.

Mark, this is Dick.

I just wanted to add to that, that we are seeing reasonable rent reductions in deals that we're doing in Europe and ones going forward.

So I think there is a deflation in rent expense in Europe.

And our next question comes from Dana Telsey with Telsey Advisory Group.

It seems like with this strength in sales and the merchandise margin improvement, there is some initiatives on product that seem to be taking hold, whether it be the internally designed apparel at Anthro, it sounds like beauty and wellness also being very impactful, Movement, and then BDG going wholesale.

As you see these drivers, are these the drivers for next year that drive merchandise margin top line?

What are we -- what am I missing and what could the sales lift in margin -- merchandise margins be as a result of these categories or others you see coming in?

Dana, I don't think that these are the initiatives that are driving margins.

Many of the initiatives that you discussed actually have slightly lower margins.

Where we've seen the improvement in margins is around our traditional core competency, which is women's apparel.

And having a more accurate call on the fashion, which has led to better sell-throughs and fewer markdowns.

What's allowed us to do that?

I would say that there are number of factors that have done it.

First of all, demand.

Because the economy is better and the fashions change, the demand for women's apparel and men's apparel as well has gone up the brand.

And then secondly, the brands have developed their speed-to-market capabilities that we just discussed, that gives them a shot at being more accurate, and I think that they have indeed become more accurate.

The third is we have a couple folks, a number of the brand merchants who are -- who were reasonably new to the brands, and they now have years of -- 1 more year of experience under their belt and better understand the customer and better understand the brand proposition that we offer the customer.

So the experience has helped.

And as we look forward to FY 2020, I would say that not only do we have an opportunity to continue to have a slightly better IMU and slightly better markdown rate, as Frank has gone over, but we also have, I believe, an opportunity to very gently and I want to emphasize gently raise some prices.

And I think that will help drive AUR and drive top line as well.

(Operator Instructions) Our next question comes from Janine Stichter with Jefferies.

Just want to follow up on some of the comments you made on the home category of Urban Outfitters, especially the novelty gifting category.

Can you just remind us how big that is overall and then give us a sense of how much bigger it is in the fourth quarter?

And then also if I'm remembering correctly, I think that was kind of a source of markdown pressure in holiday last year.

So if you could just help us frame up the opportunity now that category is back on track and how you're thinking about that as a driver for holiday?

Janine, it's Trish.

And yes, you are remembering correctly.

It was -- it was definitely an opportunity.

The team has spent a lot of time really getting into the customer's head and thinking customer first.

And it's -- while it's important to determine all year around, fourth quarter is really where we see an outsized penetration.

I'm sorry I can't share with you exactly what that penetration is, but it's significant and it's a great conversion in UPT driver in stores.

And yes, we're really excited about what's in stores right now.

And our next question comes from Ike Boruchow with Wells Fargo.

Frank, just on the gross margin, so up around 30, 40 basis points in the quarter, I understand the compares are different.

I guess my question is, is it, relative to the rest of the year, is it more a function of maybe less maintained margin and store leverage or is it more a function of just more delivery deleverage because of the holiday and some of the things you kind of mentioned earlier in the call?

Just kind of curious the puts and takes within the gross margin line.

Yes, Ike.

This is Frank.

And I think it's a combination of multiple things.

One is, I would say, the business did move into a nice positive comp territory at this time last year.

And both Urban Outfitters and Free People brands are up against, I would say, a more difficult comparison as it relates to their margin improvement as they did start to have nice margin improvement last year as well as the Anthropologie also started to have margin improvement last year.

So some of that markdown rate opportunity now at each of the brands is a little bit smaller, especially at the Urban and Free People brands.

In addition to that, yes, we do believe that there is potentially some more pressure on delivering logistics in the fourth quarter as there begins -- just a continue to be a rush in order to get product to the consumer.

And our next question comes from Susan Anderson with B. Riley FBR.

I was wondering if you could talk about, as you accelerate the international business, I guess, where you think the penetration could go in terms of total sales for the next 3 to 5 years.

And then maybe to -- if you could just remind us in terms of margins, where they're at versus U.S. business?

Okay, Susan.

This is Dick.

We think that there's an awful lot of opportunity in international.

As a matter of fact, I was just reading article today, that said -- projects that in 2019, China will become the largest purchaser of apparel in the world surpassing the United States.

Now of course, they also have 3x as many people, so on a per capita basis, they are not better, but it just shows the incredible opportunity that exists just in one country.

We think we have opportunity around the world.

In Europe, we hope to add 10 to 20 European stores per year for the next 2 years and get to over 100 in 3 years.

In the Middle East, we have recently signed a second franchise agreement to open stores in other Middle Eastern countries and we're also opening -- continuing to open more stores in all of the brands in Israel.

So there will be growth there as well.

And as I said, in China, once we can get inventory into the country and fulfill and distribute that inventory in-country, then we can switch over from Tmall Global to Tmall Classic, which should give us anywhere, we believe, from 5 to 10x bump from what we're currently going.

And then we have the opportunity also to start to open stores, which is our goal for not '19, but for calendar year '20.

And our next question comes from Laura Champine with Loop Capital.

Wanted to ask about cash uses, just because you're sitting on a lot of cash even entering the fourth quarter, and the buyback is just at these levels not going to be a significant use.

Are the international expansion goals that you have for next year going to use much in the way of this cash?

Or, what's the plan for that stacks among your balance sheet?

So this is Frank.

And I will say that we continue to remain committed to returning cash to the shareholder.

But I think we'll continue to follow our historical strategy of being opportunistic when it comes to repurchasing when we believe it is most appropriate given our cash needs and external market conditions.

I want to remind everyone, I think in fiscal '18, we repurchased 8 million shares for $157 million and then we just did repurchase 1.5 million shares for $58 million most recently in the third quarter.

And we currently have 16.5 million shares or 16.4 million shares remaining on our current repurchase authorization.

So it is something that we will -- we continue to do, but we will continue to remain opportunistic as to how we deploy that cash.

And our question comes from Edward Yruma with KeyBanc Capital Markets.

You guys have had some very nice success in the wholesale, I think particularly at Nordstrom.

I guess, some of these are probably locations where you don't have physical stores, but when you do, are you seeing any cannibalization?

How is it change in kind of sales in those markets?

Ed, were you talking about the Anthropologie Home wholesale, the Free People wholesale or all of the above?

All of the above.

Well, I'll ask Andrew to talk about that in terms of Anthropologie Home, and then Sheila to talk about it in terms of Free People.

Yes.

So we haven't seen any cannibalization actually since we launch Anthropologie Home in Nordstrom.

And the Nordstrom locations are in similar locations to our Anthro stores, because one of our goals is to acquire new customers, so that really seems to be what's happening.

We are very confident in next year to actually we can double ourselves with Nordstrom still without even thinking about cannibalization with the Anthropologie customers.

So it's a win-win for us.

It's sales growth and noncannibalization of our core offer.

This is Sheila.

I would reiterate the same thing for Free People.

Ever since the beginning, when we were launching wholesale and retail stores in similar locations, as long as we're with the right partner, we see a win for the total brand and that continues to happen in all cases.

Yes, if I can just add my 2 cents to that, what we've seen many times when we open a Free People store in a mall that actually has another one of our wholesale outlets, whether it's Nordstrom, Macy's or whomever, actually the sales of our partner in those malls go up and Free People does quite good business on top of it.

So it's really just an expansion of the brand.

And that concludes our question-and-answer session for today's call.

I will now turn the call back over to Mr. Richard Hayne for closing comments.

Thank you so much everyone for joining us on the call.

We look forward to getting back together with you in 2019.

Thanks.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes today's program and you may all disconnect.

Everyone, have a wonderful day.