Urban Outfitters Inc (URBN) 2005 Q3 法說會逐字稿

The following discussions may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Please note that the actual financial results of the company for the periods being discussed may differ materially from the financial results projected or implied in the forward-looking statements.

Additional information concerning factors that could cause actual financial results to differ materially from projected results is contained in the company's annual report on form 10-K and in other documents filed by the company with the Securities and Exchange Commission.

The company disclaims any intent or obligation to update forward-looking statements.

No recording or rebroadcast of this call is permitted without the company's express written permission.

At this time, I would like to turn the program over to Richard Hayne.

Go ahead, please.

Good morning, everybody.

Dick Hayne, here, Chief Executive Officer and Chairman of the company.

Welcome to the Urban Outfitters conference call.

Today, we will review our third quarter earnings release.

Assisting me in that call -- in this call -- is John Kyees, our Chief Financial Officer;

Ted Marlow, President of the Urban Outfitters brand;

Glen Senk, our President of the Anthropologie brand, Freeman Zausner, our Chief Administrator Officer;

Glen Bodzy, our General Counsel; and Bob Ross, our Controller.

Earlier this morning, we issued a press release outlining our financial and operating results for the quarter and the nine months ended October 31, 2004.

I will now examine those quarterly results in more detail, and discuss the company's current business trends.

After that, our team will join me in answering your questions.

Please note that the earnings release and the text of today's call will be available at the company's corporate website, urbanoutfittersinc -- all one word --com.

My colleagues and I are very pleased to report yet another record shattering quarter.

During the three-month period just ended, we generated more sales and created more profits than any other quarter in our history.

A review of the quarter's highlights show that quarterly net sales topped $200 million for the first time in our history, and grew by more than 52% over the prior year's period.

All brands enjoyed strong consumer response of their merchandising initiative,s and total comparable store sales jumped by 18%.

Against last year's quarter, direct to consumer sales rose by 85 percent, wholesale sales advanced by 58 percent, gross profit margins expanded by 235 basis points, and SG&A expenses leveraged by 111 basis points.

The operating margin for the quarter reached 20% of net revenues.

Earnings per diluted share shot up 14 cents to 31 cents, versus 17 cents from last year.

The Free People brand successfully launched a commerce-enabled website, and the company opened six new stores during the period -- three Urban Outfitters and three Anthropologie.

These exceptional results demonstrate the strength of the emotional bond our brands have developed with our customers and the validity of our strategy to create and promote multichannel brands, and the ability of our teams to execute operationally.

The magnitude of these achievements is revealed by a detailed analysis of the results.

First, a look at the four elements that drove our dramatic 52% growth in sales: First, there were 36 new stores in operation by the end of the period against a base of 98 comp stores in operation during the same period last year.

This 37% increase accounted for $37.8 million in new and noncomparable store sales during the quarter.

These sales were responsible for more than half of our total third quarter sales gains.

From the beginning of our current fiscal year through the date of this release, we have opened 21 new stores -- 11 Urban Outfitters and 10 Anthropologie.

We plan to open at least five more new stores by the ends of the fiscal year.

This includes one new Free People store.

The second factor driving the sales increase was an 18% increase in comparable store sales.

This strong performance was achieved following an equally strong 17% comp store sales gain in the same quarter last year.

Looking at comparable store sales performance by month, increases ranged from mid-teens to low 20s, with October being the best of the three months.

Comps were also strong across all geographic regions, and by brand they rose by 22, 49 and 15%, respectively, at Anthropologie, Free People and Urban Outfitters.

Overall, these comp gains were driven by a 10% jump in the number of transactions, a 4% rise in average unit retail price and a 3% gain in the average number of items sold per transaction.

The third factor pushing sales higher was an 85% spike in direct to consumer sales.

Increases in catalog circulation of 16 and 88% at Anthropologie and Urban Outfitters, respectively, helped to fuel that gain, as did a 28% gain in total response rate.

During the quarter, Free People successfully launched its commerce-enabled website.

Viewership and sales at this site are running well ahead of our plan.

Total unique visits to all of the brands' websites during the quarter surged ahead by 94% versus the same period of last year.

The final factor driving the cost line of was a 58% gain in Free People wholesale sales.

Once again, better product and better buying led to higher demand and improved ship to billed ratio.

Pushing the top line higher by 52% was one, but not only, made the major accomplishment of the quarter.

Over the past three years, we have concentrated on growing sales and operating margins simultaneously, and we have had tremendous success in both areas.

Third quarter operating margin two years ago was 11.9% net sales.

Last year, it stood at 16.5%; and this year we produced an exceptional 20% operating margin, a gain of 820 basis points over the two-year period.

As in the past quarter, the factors driving this improvement continue to be better initial merchandise margins, significant leverage of store occupancy costs due primarily to strong gains in comparable store sales, plus tight control over merchandising and selling expenses.

During the quarter, these factors more than offset an increase in the order fulfillment costs at the direct to consumer business.

Total inventories as of October 31st grew own a year over year basis by $40.7 million.

The majority of this increase was required to stock new stores.

On a comparable store basis, inventories increased by 22% in terms of dollars, and 12% in terms of units.

This compares to last year when total inventory decreased by 1% in terms of dollars and 4% in terms of units, even as gains in comparable store sales last year exceeded 20%.

As a result, inventory turnover during the holiday season last year was dangerously fast.

This year, we planned for and received holiday season merchandise slightly earlier, and overall we are very comfortable with the current stock levels and our weeks of supply on hand.

Growing sales by 52% and coupling that feat with a 346 basis point gain in operating margins would suggest a surge in net income, and our third quarter did not disappoint.

Net income jumped by 85% over the comparable quarter last year.

Third quarter earnings per diluted share rose from 17 cents last year to 31 cents this year.

All channels of distribution were solidly profitable; and when measured against a percent of net sales, all three brands posted double-digit earnings.

Looking at a summary of our major achievements in the third quarter, our company grew sales by 52%, and for the first time in the company's history, achieved quarterly sales above $200 million.

We continued to deliver solid store-level productivity gains, increasing comparable store sales by 18%.

We achieved a quarterly operating margin of 20% of net sales for the first time since the company went public in 1993.

We grew earnings from 17 to 31 cents per diluted share.

We opened six new stores, and we successfully launched the Free People commerce-enabled website.

We have often repeated our strongly held belief that the company's competitive advantage is the ability of the brand teams to deliver a shopping experience that is both differentiated and emotionally compelling.

This year's exceptional third quarter results profoundly reinforce that belief.

We also often repeat our belief that all of our brands are in an early stage of growth.

We believe that our opportunity to grow the number of stores and expand the direct to consumer business for each of our brands, and enlarge the Free People wholesale business, is more than sufficient to fuel our growth goals for many years to come.

Our goal is to continue to grow revenues at a compound annual rate of 25% or more, and to grow net income at a rate faster than that.

To accomplish this goal, we must first grow the number of store units by at least 20% per annum, which means we would like to open between 28 and 30 new stores next year.

Our real estate, construction and store opening teams are confident that this is very achievable.

We want to grow the direct to consumer business.

With the direct business now approaching $80 million in annual sales, we believe the sales growth on a percentage basis will begin to moderate from the torrid pace of the past two years.

However, we are confident that this business will continue to significantly exceed our overall top line growth plan of 25%.

To achieve this, we intend to grow catalog distribution next year, and Anthropologie and Urban Outfitters by 17 and 25%, respectively, more fully exploit the marketing potentials across all channels within each brand, and to continue to add web-only products into each brand's mix.

We also intend to grow the wholesale business.

The repositioning of the Free People brand is on track and is working extremely well.

A number of our larger customers have reported that Free People is one of their most profitable, young contemporary ventures.

As a result, the wholesale team has made considerable progress in negotiating for more shop within shop locations with these larger customers.

As the shops are phased in over the next year, wholesale sales should respond positively.

For spring 2005, advanced bookings are currently very significantly ahead of last year's bookings at the same time.

And lastly, we want to grow our comparable store sales.

Our plan, as always, is to grow comps at an annual rate of 3 to 4%.

Obviously, we have greatly exceeded this plan for some time.

We will continue to develop merchandising and marketing initiatives designed to increase our store productivity.

However, as our year over year comparisons become more and more difficult, we expect our comp store results to moderate.

Our current sales trends, on the other hand, continue to significantly exceed our plans, and we remain optimistic about our prospects for the important holiday selling season.

In conclusion, we are extremely pleased with our record third quarter results.

We have three very powerful brands, all with significant opportunities for expansion.

And we have a solid long-term plan to develop these brands and meat our stated growth objectives.

We are confident that we can continue to deliver the growth and continue to deliver solid financial results in the future.

And that concludes my prepared remarks.

And I'd like to now open the it up for questions.

At this time, if you'd like to ask a question, you may do so by pressing the star and one on your touch-tone phone.

To withdraw a question, please press the pound key.

Once again, to ask a question, please press the star and one your touch-tone phone.

Okay, we'll go ahead and take our first question with Jeff Black from Lehman Brothers.

Go ahead, please.

Hey, good morning.

Congrats on that great quarter.

Thank you very much.

Could you give us a little color on the distribution capacity you have now in the system with the expansion of the direct sales and when we can see more online?

I will give that to John.

He's in charge of that.

Yeah, actually, we've run several stress tests on our distribution center -- on the direct fulfillment portion of it -- over the last three months.

The most recent one was a week ago Tuesday, where we for the first time in our history shipped 10,000 orders in a single day.

We think the peak levels during holiday will be around 12.

We are very comfortable we can achieve that, because actually the 10,000 was done on a reduced shift, and we had to scratch to get enough orders to be able to do it.

So we are very comfortable with the productivity.

It's more than tripled since earlier this summer in terms of the flow through in that building.

So we think holiday is prepared, and actually the distribution center is looking forward to the holiday volume.

Okay, and John, just to follow up on catalogs, you know, we've been dropping a lot more catalogs.

What's the track for Q4 versus last year in terms of catalog drop, and what might we see in first quarter versus the first quarter of this year?

Great question.

You know, fourth quarter, we're really projecting still pretty aggressive growth in catalogs, both from the Urban and Anthropologie side, well into the double-digit growth numbers.

If I could just say, Jeff, the Anthropologie is projecting a 21% increase in catalog growth in the fourth quarter.

And Urban's actually projecting a much larger number than that, and it's because they are increasing their catalog drop, I believe, taking it out of early spring and putting it into the fourth quarter, so in January.

But when you -- there will be a significant increase in Urban, and a 21% increase in Anthropologie.

For next year, Anthropologie is projecting a 17% increase and Urban is somewhere around 25%.

Okay.

Great.

Thank you very much.

Good luck.

Thank you.

Thank you.

We will take our next question from Christina de Marval with Sidoti.

Go ahead, please.

Good morning, and let me add my congratulations.

An outstanding quarter all around.

Thank you.

I guess first for you, Dick, just to split hairs a little bit, could you clarify your comments about sales guidance?

You said that you expect sales trends to moderate from -- can you clarify if it was the third quarter performance or the October, November-type trend, which seems to be above the third quarter average.

Well, I think as most people know, our comps continue to get a little tougher in terms of comparison on a year over year basis.

They were 17% in the third quarter of last year.

I think that goes up to 21% in the fourth quarter.

And then into the 30s in the first quarter of next year.

And my only point was that as the bar is raised and we have to go against those comparisons, I would expect our actual performance to moderate.

I think that this would be a natural assumption of most people, and I just want to reinforce that.

We certainly don't plan to be down, but the -- on a planning basis, as you know, we started the year planning for a 3 to 4% comp increase.

Over the last five years, we have delivered somewhere around 8% -- so double what we planned.

We expect at some point our comp store sales will be back down in that range.

I don't know when it will happen, but I just don't want everyone out there anticipating that, you know, on and on and on into the future we are going to be delivering high teens, low 20s, or even 30% comp store increases.

Having said that, our current trends would indicate that we are still significantly ahead of our 3 to 4% plan.

Okay.

That sounds very reasonable.

And since you bring up the first quarter, is there anything in terms of planning the spring business where you see potential areas of opportunity that might not be obviously apparent looking at just how strong it was last year?

Well, I think we have a number of merchandising and marketing initiatives on the marketing side -- certainly not the least is the drop of catalogs --

Right.

-- which has been a powerful force behind the -- not just the growth in direct, but the growth in the retail side as well.

There is a very synergistic effect with this multi-channel strategy.

And that's what we have discovered, and we certainly want to continue to increase the penetration of that effect.

On the other side, of course, the merchants -- Ted, Glen and their teams -- are hard at work, you know, figuring out and then trying to meet the demands of the specific categories and classifications and/or concepts that we believe our customers will respond to.

We see a lot of change in fashion, and we think that that's extraordinarily positive for us.

Our worst enemy is the stagnant fashion look.

So we have identified some of those fashion changes and we're acting very aggressively to deliver those changed fashions for fourth and first quarter.

Sounds encouraging.

And then, just if I may, for John, just wondering if you could help me out with a couple of housekeeping questions.

First, with respect to the inventory, can you comment on the change in inventory, and the carry over inventory more than 90 days old?

Actually, our carry over inventory greater than 90 is pretty comparable to last year, so it hasn't really grown at all.

We we're -- we feel like the inventory levels that we started in the fourth quarter with are appropriate ,given our objectives for the fourth quarter, and given the fact that a year ago we were down 1% on comp store inventory.

So we started last fourth quarter very lean, and this year we don't want to -- we did not make that mistake again.

So the inventory is fresh, and there was some early fall, early holiday deliveries in October.

Okay.

We believe that last year, when you looked at comps that went from 2% up to 21%, for most of the second half , particularly, we were playing catch up.

And we were almost frantic in here trying to order merchandise and get it in, because it was going out the door so much faster than we had originally planned or expected.

And this year, with a nice solid comp history behind us, you know, we feel much more confident about going into the first third quarter and then now fourth quarter, with a more appropriate level of inventory.

And we think that that's going to bear fruit in the fourth quarter.

Okay.

And just finally, on the Free People e-commerce site -- which looks great, by the way -- is that -- the revenue from that in the direct -- lumped in the direct channel, or is that in the wholesale?

It's in the direct now, as you can well imagine.

Free People is a relatively minor part of it right now, so it doesn't really show up, and that's why I didn't report the number.

It is, I think, going to have a profound effect on the brand over time.

We see continuing to develop this multichannel strategy.

We think it's very powerful, and we think Free People on the retail side and the wholesale side will benefit greatly by the e-commerce.

Okay, thanks very much.

Sure.

Thank you.

Thank you.

We will take our next question from Janet Kloppenburg with JJK Research.

Go ahead, please.

Hi, Dick, hi John, congratulations.

Thank you, Janet.

Dick, I totally understand about the inventory moving higher.

I mean, you obviously have been chasing goods.

Do you think that you will continue to run at these kind of levels through the next few quarters as you play catch up to weaker inventory levels, or lean inventory levels of the year prior?

Well, as you'll recall, we went into the year basically flat on inventory --

Right.

-- and we were looking at 30% comps in the first quarter.

Right.

We were still really playing catch up at that point.

So I would anticipate the coming out of the fourth quarter still ahead.

But you know, we don't believe it's going to grow.

You know, certainly this should start to moderate and we'd come back into an equilibrium.

Okay.

So I think we would want definitely to have more inventory than last year at year's end.

And what's going on in the home business?

I know you've made some changes there, and you know, it looks -- the assortments look a lot stronger.

How was the performance in third quarter and how do you look at it -- how are you feeling about it for this holiday season?

I think it becomes a bigger percentage of the business in the fourth quarter, doesn't it?

Right, it does.

I think there's a little divergence here by brand.

I will speak for to the brand presidents, and then they can jump in and tell me if I'm right or wrong.

But Anthropologie is having very good success right now.

Their home business is up double digits, and they are quite pleased with it, although they know there's still work to be done, and anticipate a good holiday season.

Urban's still, I think, in an execution basis not doing what they need to do.

We intend to remedy some of that, and we think that there's still a lot of room to grow at the Urban side of the home.

Okay, so do you think that those trends will prevail through the fourth quarter as well?

I don't see any reason to believe that they wouldn't.

Okay.

And then I heard you say something you about you see a lot of fashion change for the spring -- and I know you don't want to talk about details for competitive reasons.

But at both brands, will we see a major shift in the look, you know, we've become familiar with in the stores?

I think I will let the brand presidents speak to that.

Thank you.

At 57, I'm not the fashion maven.

Janet, it's Glen.

We've discussed this already.

I think the store looks very different today than it did three or four months ago.

And I expect it will look different again, you know, in January and February.

Will color still be important, or will it become more muted?

Yeah, I mean, we don't comment on specifics.

I think that color is always important.

I mean, it's a question which color.

But you know, for at least for Anthropologie, color is always important.

Thanks, is Ted there?

Yes, Janet.

Hi, Ted.

In the Urban business, [INAUDIBLE] inventory, I think you would see that it's -- I don't know if you've -- [INAUDIBLE] store has just completed deliveries for holiday and we are in the process of wrapping up our holiday prototype at this point.

But the mood of what we were saying was that merchandise on the floor for back to school, it was a bit of a different mood than what we were saying for holiday, and we intends to change that again as we flow into the month of December and then up to January for spring business.

So we'll just see a change as we move forward?

Well, obviously there are items that are very important in our mix for the late November, December, time period from a fashion standpoint, that certainly are not as appropriate as you go into spring selling season.

So the mood of the floor will change pretty dramatically.

Okay, and I was just wondering if you guys could talk a little bit about the mix of private label to branded businesses and more you're looking -- what the trend is right now, and what it will move to?

I don't think there's any significant change there.

I mean, there are minor variations if you were to look on a micro level buy class, but --

I was just thinking, Dick, that if the PL was going up, that that would help the gross margin move higher next year.

That was my thought.

Okay, I don't think it's going to change significantly.

Our initiatives in terms of buying new is much more related to sourcing and negotiation skills in terms of dealing with our vendors.

I think there's a lot of opportunity, certainly to be had with the elimination of quota and what that is going to do.

So I think there are a number of things that we believe could be beneficial for us in the IMU category, but I wouldn't see the mix of private label being one of those big drivers.

Okay, thank you so much.

My pleasure.

Thank you.

We'll take our next question from Kimberly Greenberger with Smith Barney.

Go ahead, please.

Thank you.

Good morning and congratulations on another terrific quarter.

Thank you, Kimberly.

You know, it seems like every time we turn around you guys are blowing through your three-year operating margin goals.

Scary, huh?

I was just wondering, you know, you gave us a list of, you know, sort of six or seven items that you were looking at at the beginning of this year for an opportunity to increase your operating margin by about 250 basis points, increased IMU reduced markdowns and leveraging some, you know, work on your new stores.

What in that lift, you know, did you not actually achieve this year, given the stellar margin performance that we've seen?

Well, Kimberly, I don't think that we have completed any of the items on that lift right now.

If you take a look at some of the things that we've talked to you about, like planning allocation, we are doing in the next week or two live testing of that, and then we will be up and going in the early spring and phase it in over probably a nine-month period.

We want to be extraordinarily cautious about the phase in of this package.

We think it's going to reap a lot of rewards when we finally get it in and up; but we have been told many, many, many horror stories about the phase in, so we are going to be extraordinarily cautious and conservative, as we always are.

In the product development management package that we've talked to you about over time, the software is installed.

We're up and going in a couple of classifications in Anthropologie, testing that out to make sure that there's nothing that's going to blow up in our face there.

We are intend to have that phased out into more classifications in spring, and then probably fully implemented by maybe fall of next year.

The construction management program that we've talked to you about, we have installed it.

We are training in it and we are testing the systems -- and, again, we are life on that live on tha,t but it's still about halfway through to its completion.

A couple of the other ones that we've discussed, business analysis software, we are just implementing that and point-of-sale, we just started installing the new hardware; and that will take probably also a half a year to three quarters of a year to get in.

So I would say that of the initiatives that we've talked about, we are well on our way to implementing most if not all of those initiatives.

Some that we hadn't even talked about as early as a year and a half ago, like warehouse management systems, that is also an initiative that we will hopefully phase in over the next year, year and a half.

But most of the things that we talked to you about in terms of systems really are not giving us the benefit yet that we expect to get out of it.

Most of what we -- most of the benefits we have derived are along the lines of the items that I went over -- IMU and some of the store-related leveraging.

So I think that there's still some benefits to come.

Great, Dick.

Thank you.

And then just a couple of questions on 4Q, and also specifically on October.

As you look at this third quarter, and October in particular, the comp on a normal retail calendar basis, would it have been, you know, largely similar to the one that you reported?

Secondarily, it sounded like October was the best month within 3Q.

And I think as I recall that was your more difficult comparison.

And I think November -- if I'm recalling properly -- also was a more difficult comparison than December.

So just looking, you know, obviously not for pinpoint numbers, but you know, directionally, a little bit of color on those, if you could.

Yeah, that's a great question.

October, since we are on a calendar month rather than a retail month, we did benefit in October with the addition of an extra Saturday.

So that usually has anywhere from 1 to 3% comp difference associated with it.

So take that into consideration.

But October was the strongest month of the three.

And I said the range was mid -teens to low 20s, and October was the best month, so I guess you can figure out what it is.

As we go forward, we really are coming up against a very strong November.

And then a little less in December, and then a very powerful January.

So that's what we're up against.

And as I said, we are continuing to exceed our plan.

So that, I think, gives as much color as I feel comfortable doing.

Thanks so much, Dick.

That's helpful.

Okay.

And then, lastly, for your two brand presidents, any holiday initiatives that you have going on this year that you feel comfortable discussing, or any strategies or categories that you think are going to be particularly robust this year?

I'm sorry, Kimberly, you said holiday what?

Any holiday initiatives.

Oh, initiatives, okay.

I think -- Kimberly, it's Glen -- I think that at Anthropologie, I think the -- we did a good job with the gift book.

I think the reaction to it has been excellent.

I think that the store's group outdid themselves with the windows and the visual merchandising and display work, and I think there's a very strong gift message in the store.

And I'm just very -- I mean, that's been the strategy and I think we did a good job executing it.

And you know, although it's a much smaller business, same holds true for Free People.

I think that we've got -- really manipulated the calendar quite a bit, both at wholesale and retail, and I think we've got the right product, both in our wholesale accounts and our retail stores, and we've done an equally good job with execution.

Kimberly, Ted.

In regard to the Urban business, I would just start on the same adjectives that Glen did in regard to the direct work and the outreach marketing for the holiday time period.

We're putting a second drop in place on our holiday gift book, which this is going in home right now.

There will be a second drop as we get into the month of December.

We changed size and paper on that book, and we really love the quality and feel of it.

Additionally, we will put a little bit of a small preview section on spring in the second drop, which goes in December, which will also be a bit of a preview of the look of new items for the direct customer for the spring season.

We also will be flowing -- we also will be dropping our initial book on spring a little bit earlier in the month of January, and the feel of that from a fashion standpoint will definitely be in line with where we're going for spring, and we think reinforce the business to be done in the month of January.

Within the stores, we put a little bit more time and attention into our approach to gift giving this year.

And one thing -- although I didn't discuss -- I guess a bit of a sell-side initiative, is I feel really good about what we've got going on in packaging and collateral material to compliment the assortment of products, and we've gone through a bit of the [INAUDIBLE] and discussion on sales initiatives of the stores on approach to gift giving this holiday season.

This is something we did not do last year, and we feel like that that will be a further INAUDIBLE] to do business as we get into the hardcore gift giving time period.

In regard to the assortment, there are also are items in the assortment that the stores take further advantage of the idea around gift giving, and we're optimistic that will pay off for us.

Great.

Thank you.

Thank you.

We will take our next question from the site of Richard Baum with Credit Suisse First.

Go ahead, please.

Good morning, everybody.

Congratulations on the blow out.

Thanks, Richard.

A question on Free People, Dick.

You know, obviously, it seems like this concept is starting to gain a lot of traction, both wholesale and retail.

You haven't really, you know, talked about when you would be ready to roll it out.

And I guess the question would be, you know, what do you think the potential is for it, when do you think you'd be ready to comment on it, both on the whole -- particularly on the retail store roll-out, and then also on the "shop in shops" concept within the department stores.

How many of those do you have now, and how many do you think are you potentially targeting to have?

Well, I'm going to let Glen talk about the "shop in shop" and the wholesale.

But I want to talk about the retail stores for a second.

We'll probably open somewhere between four, five and possibly six Free People stores next year.

I think one of the strongest concepts that Urban Outfitters has going for it and has developed this over time is the organic way in which we develop our businesses.

We feel very, very strongly that we know we can make mistakes, and we know we are going to make mistakes, and we also know that we're not smart enough to know where those mistakes are going to be made.

And we feel that, you know, when a business is young and in a very, very early stage, like the Free People retail, it's very good for us to go cautiously and develop it cautiously over time, and allow the customers to tell us what we're doing right and allow the customers to tell us what we're doing wrong, learn from that and tweak it so we have a pretty -- pretty solidly set.

We are extraordinarily pleased with the customer response to the Free People store.

It's probably going to do somewhere in the neighborhood of 700, and maybe even more than that per square foot on a selling basis in the current year.

But we believe that there is a lot of room to continue to develop that so its even more productive.

And so we want to learn, though, some thing about the customer, and we want to learn some things about potential types of locations.

Right now, our only stores are in a clothes mall.

We intend over the next year to test some other venues and see what the feedback is.

So I just want to tell you that we're going to develop it -- we're going to develop it cautiously like everything else we've done -- and I think that long-term, that's the best way to grow a business.

Now as to "shops in shops", Mr. Senk I know has been very active in malls with that endeavor, and he'll fill you in on it.

Richard, the principal places where we have shops within shops are Bloomingdale's and Marshall Fields; and basically, in addition to those two, we kind of have two other major accounts -- Macy's West and Nordstrom -- and then we -- as you know, we sell some 1200 specialty accounts.

The "shop within shops" were probably up about 24 "shop within shops" now.

Bloomingdale's has actually just came back to us and told thus that they would like to increase our real estate and kind of level of visual merchandising in their four best venues, including 59th Street and Sojo.

I was on the West Coast the last -- a couple of weeks ago, and met with Pete Nordstrom and his merchandising group.

And as Dick mentioned earlier, we were one of their best contemporary vendors of spring, and they are very, very -- you know, feeling very positive about the potential for growth within the brand.

So I just think that, you know, we're not -- we really don't -- as we've said in earlier conference calls -- want to expand distribution.

We want to expand our presence within our current accounts and our quality of execution within our current accounts, and I think that we can grow the business quite well by doing that.

It's kind of the flip side, Glen, given the success that you're experiencing in Free People -- and I know it did start as a wholesale concept.

Any thoughts to doing wholesale with Anthropologie, because it is, you know, in large part private label?

It's actually -- remember, it's about at the same private label penetration that Urban has -- about 50% -- and absolutely no, you know, wholesale thoughts whatsoever.

And then just one comment.

I just take issue, Dick, with one thing that you said.

Okay.

And that's --

Feel free.

When you said that you make mistakes from time to time.

Many of them.

Yeah, I can't remember the last one that you made.

We can remember. [LAUGHTER] You are not here --

Calendar 2000.

You're not here to see my bloody shirts with scars all over my back, Richard.

I think that the thing is is that if you look at the growth of Anthropologie, it's very instructive.

You know, Anthropologie's first year store was 1992, and second store was, I think, 1994.

And we grew it slowly, and I can tell you, and Glen will tell you also -- because he's full of scar tissue as well -- that we've made an extraordinary number of mistakes.

And just to bring one to the for, not to dwell on anything, is the introduction of men's into the mix.

Bad idea.

Wrong.

And had we basically quote, unquote rolled it out and opened 50 or 100 stores within a couple year period, we probably would have really made some major, major mistakes.

I think that the strength of our concepts by and large is that we take our time and we get it -- we try to get it right.

But it's by no means that we don't make a lot of mistakes.

We're actually proud of the mistakes because it shows that we're experimenting.

I guess it's the hair and the tortoise.

I guess that's a good lesson for everyone.

Right.

Keep on winning.

Thank you.

Thank you.

We'll take our next question from Liz Pierce with Sanders Morris & Harris.

Go ahead.

Good morning and congratulations.

I will just add that you guys wear your scar tissue pretty well.

That's why we are always fully clothed. [LAUGHTER]

Hey, I wanted to just expands a little bit on -- I guess for you guys have been a little bit on Free People and what you think that's really capturing the customer that she's not getting elsewhere -- if there's any way you could articulate it a little bit more for me?

Okay, I'm going to let Glen take that, Liz, because I know he was involved in a -- in some customer sessions not too long ago.

I think, you know, Dick's vision, Liz, of the three brands is brilliant.

I think that the best way for -- you know, for me to understand it, maybe for the rest of the group to understand it, is really to the talk about life stages.

And you know, as Dick and Ted earlier talked about the Urban customers not being in the -- you know, the mating phase, we also talk about the Anthropologie customer being in the nesting phase.

And we know that the majority of Anthropologie customers are either married or in committed relationships -- I mean, 80% of them.

More than 50% of them have kids -- and this has a direct impact on the way that they dress and live their lives.

And you know, you've heard Dick and Ted call the Urban customer the "upscale homeless" and he or she absolutely is that.

I think the Free People customers just spot in between those two target groups.

Again, there's a little of lead with Urban, there's a little bit of lead with Anthropologie -- but I would, you know, technically refer to the customer as the true, young contemporary customer And you know, she is -- I certainly know the Anthropologie customer well -- she is more fashion forward than Anthropologie, she is -- you know, spends more of a percentage of her income on clothing, I think she's willing to take more risks.

The Anthropologie customer does a lot of investment spending.

When she buys something, she expects it to wear it more than one season.

I think the Free People customer is, you know, a little bit more influenced by trends.

You know, and on top of all of that there's a -- there is kind of a DNA to the brand that dates back to the beginning, and you know, their very influenced by the design director, Meg [INAUDIBLE], as many of you know.

And then there's a Bohemian element that is really a strong part of who Free People is, whereas Anthropologie, I would say, is more of a feminine element.

So you know, it tends to be -- there's a hand contrasted nature to the product, there's a Bohemian nature to it.

It's a little bit -- you know, I wouldn't say it's sexy, but if I had to put it on a scale, I would say it's sexier than Anthropologie.

It -- you know, the customer is largely a single woman.

They've got, you know, a higher income than the Urban customer, but lower household income than the Anthropologie customer.

And it -- it -- I can just tell you we have focus groups now, I spent a lot of time in our wholesale accounts, and you know, a lot of time looking at the product, and it's substantively different than either of the two brands.

And it is pretty neat.

I mean, if you speak to -- you know, and I know a lot of you have gone to the trade shows -- if you speak to some of our better accounts, you know, be it the folks at Bloomingdale's or Nordstrom, I think they'll tell you that there's really not anyone else doing what we're doing.

All right, thanks, that's really helpful.

Excuse me.

And then I just have -- I suppose, Dick, I'l throw this out based on what you said to Kimberly's question, which I think is probably foremost on most of our minds.

So are we now talking about a new goal for operating margins beginning with a Q?

Well, we -- I think last time we spoke at a conference and, probably two or three times before that, had sort of ratcheted up our expectations to get somewhere close to 20 in an annual basis.

And I think that we still have some room to grow there.

As I said earlier, I think that we don't see any reason why we are quote, unquote tapped out, in terms of how high we can go; but you know, I think at this time, I don't want to go beyond that.

But I think what we can say is that what we said before, which is 200 basis points above the -- you know, 17.5 that we've done in getting this 19.5 to 20 is a very good goal; and if we can achieve that, we will be very satisfied.

Okay.

Great.

And then quickly for John, just housekeeping, do you have the ending square footage for each division?

Yes, I do.

For Urban, the selling square feet were 688,807; for Anthropologie, 476,518,and for Free People 1,535.

Great.

And best of luck for Q4, guys.

Thank you.

Thank you.

We will take our next call from Joe Teklits with Wachovia Securities.

Thanks and hi, everybody.

Hey, Joe, how are you?

Good.

Dick, I've got a question for you about your stated net income growth.

You say 25% square footage growth, and net income growth that is above that, so I'm curious why 25% and why not 15 or 20 or 30.

And then on top of that, just curious how long this has officially been your goal.

I know I've heard a couple times -- and then also, how long -- or how far out does it stretch?

Okay, what I said was that we want to grow on our new business store units by 20 at least -- 20% on an annual basis.

Okay.

And we believe that, combined with an average comp increase that is somewhere around 3 or 4%, combined with a direct business that is growing faster, combined with a wholesale business that is growing faster, should get our top line revenue somewhere around 25% or higher.

Okay?

And our goal has always been to grow our bottom line faster than we're growing our top line.

That is to say, we continually find ways to be slightly more productive than we were in the prior year or the prior quarter.

So that's our goal, and it's really not changed.

I mean, if we take a look at our compounds annual growth rate from inception, it's in the mid 20s.

If you take a look at it from when we went public in 1993, it's in the mid 20s.

If you look at it over the last five years, it's in the mid 20s.

You know, so the last year and a half -- last year -- has been a little bit of an anomaly, and that is pretty far above the mid 20 level.

But I think that what we're very comfortable in is the idea that we will grow in the mid 20s on a compounded annual basis for a number of years.

Now, can I tell you it's going to be another 20 years?

I don't know.

I probably won't be here, Joe -- but the others in this room may be, and God bless them.

But in the next three or four or five years, I would anticipate being able to do that, and that is our goal.

And so the foundation of it is just the 20% unit growth, and you're building that kind of bottoms up -- you're basically looking at each concept and just basically saying how much growth is left ahead, and that's how you're getting that 20%?

Well, we know we can open more stores, if we so chose.

But we think that there's a reason when you look over time that we have achieved mid 20s.

And again, I go back to the notion of doing this organically.

So it must be that there's something in me, or something in the water in Philadelphia, that says that the mid 20s is the right place to be.

And so we build it up and say, we know we have a lot of opportunity to open stores, we know we have a lot of opportunity to develop a direct business, and we have demonstrated an ability to deliver mid single to high single-digit comp store gains on a year over year basis, average.

So when you combine all that, that's how you get up to 25%.

Mm-hm.

Okay, good luck.

That's all.

Thanks.

Thank you.

Thank you.

We'll take our next question from Holly Guthrie with Morgan Keegan.

Go ahead, please.

Thanks.

Just kind of a follow-up to Joe's question.

I guess looking at your comp projections, those three to four, Dick, they've been in that area for a long time -- as long as I can remember --and some years it's better, some years it's worse.

But I guess right now what we're looking at is, you know, stronger unit growth.

And we're looking at what I think is better management in inventories than ever I -- than I can ever remember.

So I'm just trying to understand how you get to that three to four.

You know, if you look at comps on a two or three-year time frame and you look at improvement in inventories, as well as an increase in circulation, which I know I know it clearly probably drives some sales to the stores, but if you could talk about why you still feel that three or four is the right number?

Well, Holly, I think as we said a number of times, we start off with three to four because we are very conservative people and we want to control our expense line.

So we budget -- as a matter of fact, that's what we're doing, you know, this month -- we're putting together our budgets for next year -- and we budget for the 3 to 4% growth, so that we can get a very good handle on our expenses.

We have told you that we have just about doubled -- as a matter of fact, we have doubled on average over the last five, six years, the actual performance.

In other words, we've come in at 7 or 8.

We realize there's a difference there.

And we feel it's prudent in terms of a budgeting process to budget for 3 to 4%.

Now just so happens in the year coming up, yeah, we are up against some mighty stiff comp stores from the prior year.

Time will tell; and I'm not trying to suggest that we can't once again beat our three to four plan.

I think what I'm trying to get across and communicate to everyone is that we would not be totally disappointed if our comp store sales were to come down, because what we're doing is trying to build this business on a long-term basis.

We're trying to build and say that we are going to try to deliver 25% growth on average year over year, and have our income grow a little bit faster.

If I could fast forward for five years, and we would have accomplished just that, I would be awfully happy, and I think that the shareholders who would be with us for five years would be awful happy as well.

And that's why most of the people in the room are shareholders and most of the people are satisfied.

Thank you.

Yup.

Thank you.

We will take our next question from Lauren Levitan with SG Cowen.

Go ahead, please.

Thanks.

Good morning.

Good morning, how are you?

Well, thank you.

Good.

I know in the past you have all talked about some of the initiatives you've got underway to make sure that you aren't facing any strain -- and all the changes in the fulfillment center, for example, have been in place to make sure you don't run off the track since you're running so fast.

Can you maybe give us a report card on other initiatives, other elements of the infrastructure, maybe store initiatives, to ensure that people are moving through quickly and being serviced quickly enough, particularly as you're get to go such high volumes in some stores?

And then related to that, I'm wondering if there are any stores that you would look to needing to be either expanded or altered to accommodate the much higher levels of sales that you're doing in some of those stores?

Thanks.

Sure, Lauren.

There are a number of stores that we would love to expand.

We do have a number of constraints called landlords that would prohibit us from doing that.

But there are also initiatives that are ongoing to help develop an ability to have these high volume stores be more productive -- and I will let Glen and Ted talk about that.

Yes, Lauren, this is Ted.

In regard to the Urban business, one of our initiatives for this year was exactly that.

It was a high volume store initiative.

Two of our larger stores were really the ones that we went after initially, needless to say.

We put a little extra capital into those stores in reconfiguring fitting rooms, and as well check-out processes in those stores; and at this point, it is paying off nicely and they are able to achieve record volumes.

We're expanding some of the work that we did in those stores into a tier just below the volume that they are achieving for work this next year, and we would have further productivity gains there.

Secondarily, there are some high productivity stores where we have been able to pick up additional space, and we are doing a bit of renovation as well as capturing additional space in those stores, and we are looking at more stores on the roster for that opportunity.

Thirdly, there are some stores where we just cannot expand, that we are looking for location in the same market to -- since we do have a strong following within the market -- to expand our presence in the market and take advantage -- and maybe take a little volume off one store.

I wouldn't go so far as to use the word cannibalize, because I do think the productivity will remain extremely strong in the markets where we are doing that in existing stores.

The other thing that I would just [INAUDIBLE], we just complete ad survey within the Urban business in all types of stores -- that being enclosed mall stores, street stores, Promenade lifestyle center stores.

About 1200 people were involved in that, and there are findings that we're going through right now coming out of that survey that we will take action on in regard to sales and services within the stores as we go forward to this next year.

But we got some really good information, and we like what they had to say about us, but they also told us some things we could work on.

Lauren, it's Glen.

I mean, Ted and I and our respective store directors, you know, spend a fair amount of time with each other discussing test practices, and following them through the brands, if they're brand appropriate.

So we're working on a lot of the same things.

Anthropologie this year is, you know, through the first nine months, is on a run rate of $800 a foot.

So we've been dealing with these productivity issues for some time.

We -- the two pressure points in the store are obviously the cash rack and the dressing room.

And we have spent a lot of time addressing both of those issues.

If you go to some of our newer stores, you'll see very different dressing room designs in where we've been able to, in our stores that are, you know, $1000-plus a foot, we've gone back and retrofitted those dressing rooms.

We -- in our very high volume stores, we have retrofitted the cash rack.

You heard Dick say earlier that we're about to launch a new POS system, which we expect to -- you know, one of the benefits of that will be improved efficiency.

We're also doing things like testing a change in our security system in some of our stores.

You know, if you stand in our stores, actually the single biggest impediment to the transaction time at the cash rack is taking the security devices off the garment.

So we're looking for ways to change that.

We also -- you know, we've been talking about a CRM system for some time now.

That's something that we expect to begin to implement probably in the third and fourth quarter of next year, and really, you know, roll-out fully in calendar 2006.

I think that will have a big impact on efficiency.

But we -- you know, you heard us saying earlier in the conference call that in February we did kind of December levels of business, and -- but in both of our brands, you know, there's not a month that goes by where we don't have record sales months.

And I'm not talking about record for the month, I'm talking about record for the -- you know, for history of the store.

So it's something that we're looking at on a continual basis.

Great.

Thank you.

I do have another question for you, Dick.

Could you comment on long-term planning for the building cash balances and what types of cash levels you think long-term you think are appropriate on the balance sheet, and what other uses you might have for them?

Thanks.

Sure.

First the good news, and that is the cash balances are increasing.

And because we are profitable -- and very profitable.

We review the cash balances on a quarterly basis with the Board of Directors and we review on a benchmark basis with our cash balances relative to our competitors' cash balances, and when we do that review, we are somewhere at mid-point -- meaning that we don't have the most cash and we don't have the least cash -- and so right now we're very comfortable where we are.

We are very happy that it is building; and at some point ,we might have to do something different, and once the board decides that, we would absolutely make an announcement.

Great.

Thanks very much, and good luck for holiday.

Thank you.

We'll take our next question from Christine Chen with Pacific Growth Equities.

Congratulations on another great quarter.

Thanks, Christine.

I have a couple of questions for you.

One, if you could just remind me of the timing of your holiday floors that [INAUDIBLE] into stores this year versus the timing last year?

Is there any difference in the concept?

Yeah, floor sets.

Ted and Glen, you want to talk about that?

The -- this is Ted -- regarding the Urban business.

The physical floor sets, we were just a couple of days earlier.

We did a better job, however, I think in the flow of new products for that floor set and being in position as we take that to then the field of actually setting the product that we are looking to drive volume with as we go into holiday.

I think we did a better job on that this year than last.

As you know, our business we pretty much rebuild the interiors of the store when we go through a floor set.

We are just at this point, I'd say, about the 60% complete phase.

We're on schedule.

We will be fully set for strong business once Thanksgiving week is here.

Okay.

Thank you.

Christine, it's Glen.

The Anthropologie customers, I think, tend to buy a little earlier than the Free People customer, the Urban customer.

So we tend to set holiday up earlier.

So we begin to receive some early holiday products as early as the middle of September.

And the products for the most part, with the exception of kind of refreshment components, is fully received by the end of October.

And similarly, the large scale physical set up is completed by the end of October.

But I'm one who kind of, you know, is allergic to hearing Christmas music or seeing Christmas before Thanksgiving, so we kind of try to have the miracle of Christmas happen, you know, Thanksgiving night, where you will see the -- those kind of strong Christmas elements suddenly appear for the Friday after Thanksgiving.

But the large scale installation is -- pretty consistently always happens the last week in October.

Okay, and then on the West Coast port issue, has that affected deliveries for you guys; and if so, how have you adjusted for that?

No, it hasn't affected it at all.

We have avoided for a couple years now Long Beach, and we will continue to avoid it.

Good plan.

And then if you could just update -- give us an update on a potential new DC -- I think you had mentioned that a couple calls back, and I know that the DC. is fine for this current holiday quarter -- but just going forward, what's the status of that?

We're still in negotiations.

There's nothing new to report there, and when there is, we'll certainly make an announcement.

Okay.

Thank you very much.

Once again, at this time, if you would like to ask a question, please press star and one on your touch-tone phone.

We will take our next question from Adrienne Tennant with Wedbush Morgan.

Go ahead, please.

Awesome.

I was worrying.

I'm sure you're getting sick of all the kudos, so I'll add on my congratulations.

Well, we never get sick of that, Adrienne.

I think -- you know, most of my questions have been answered.

The only one I have is a housekeeping one for John.

Very often, you guys break down the gross margin component in terms of leverage, like the IMU, and then last time it was the decrease in markdown -- if you could do that.

And then if you can just give me a quick update on the mall stores, how many Urban mall stores do you have now, and are they still performing above in terms of productivity?

Thank you so much.

Okay.

The gross margin, the pieces of that were 90 basis points on mark up, 159 basis points on occupancy, markdowns were negative 35 basis points, and freight offset that with 21 positive basis points.

The freight was slightly up?

Yes, 21.

Okay.

What was the second part of your question?

Just the Urban mall stores, how many do you have now and what's the plan for '05 in terms of those 28 to 30 stores, and then the productivity?

Yes, Adrienne.

Current count on enclosed mall stores is 14.

We just opened the 14th unit this past week, which was Thousand Oaks in California.

We have one more enclosed mall to open this year.

That's at Queens Center, and then we have two life style projects that are yet to open this year.

These will all be open by Thanksgiving.

In mid-next year, in [INAUDIBLE] streets versus lifestyle or promenade and enclosed, honestly at this point, the breakdown is pretty darn even.

A third, a third, a third.

And then in regard to the productivity, they are certainly coming in line with our proforma expectations.

One thing that we have found is the shopping frequency -- just coming off these survey results in stores that we surveyed in -- shopping frequency in the mall stores is greater than the other two formats; and that being said, what we found in our own business that on average, we get about a little over ten visits a year.

So we are still very optimistic about the potential of that piece of our strategy.

Okay.

And then if I recall correctly, in the early part of December, there were two back to back weakened storms in -- I think in the first two weeks of December.

Do you -- I mean, do you have any plans or how do you look at that in terms of the impact on the Urban stores, because so many of them are outdoors?

Well, we got in touch with the Big Guy, and we said no storms this year.

Well, there aren't supposed to be any, so that's the good thing. [INAUDIBLE] positive.

I guess given the fact we're up against a 21% comp for the quarter, we basically thank God.

Okay.

Great job, you guys, and good luck for the fourth quarter.

Thanks.

Bye bye.

Once again, if you'd like to ask a question, please press the star and one on your touch-tone phone.

We'll take our next question from Mary Briscol with Standard & Poor's.

Go ahead, please.

Good morning --or good afternoon.

We've passed the magic moment, huh?

That's right, congratulations.

Thank you very much.

You're welcome.

Maybe -- I was hoping that maybe you could break down what's going on with your catalog?

Can you give us some metrics on the productivity per catalog, that kind of thing.

Well, it's a very difficult thing to separate -- it's a very difficult thing to separate the catalog from e-commerce, because most of the people who receive the catalog and once they order, they order via the web.

And we don't track necessarily all the people who are buying through the web and are they're buying because have they received the catalog.

It's tough for us to tell.

But I think that the metrics are that the response rate at the Urban catalog is slightly higher than the response rate at Anthropologie, and would you expect that because the Anthropologie average order size is almost twice as much as the Urban average order size.

So what else would you like to know about it?

Well, can you tell us what the average order size is and how it compares to the average order in the mall or you know, a normal shopping transaction in a store?

Basically, even though we do have variations by month, by season, you can count on catalog order being about twice what the store transaction is.

But we don't release that information.

Okay, well, thanks a lot.

Thank you.

Thank you.

And we'll take our next question from Liz Pierce.

Go ahead, please.

Sorry, I'll pick up the phone.

Dick, did you give a break out in the store openings by quarter next year, or just kind of how we should model it?

No, I did not do that.

We would expect to have a few in the first quarter, most of them in the second and third quarter, and then back to a -- you know, a reasonable number in the fourth quarter; but you know, I think that the vast majority of them will be open in the second and third quarter next year.

And then just between the two, is it split, did you say?

Yeah, it's going to be very close to split.

Okay.

You know, we're anticipating 28 to 30; and in general, we're looking somewhere in the neighborhood of you know, 50/50 break.

If it falls one way or the other by a store, too, it doesn't really matter.

Okay, and then can I just clarify, Ted, something that you -- did you say that you had a couple lifestyle projects that should be open by Thanksgiving?

Well, they're not -- I wouldn't put them on the enclosed mall side of the equation.

One is in Crocker Park which is suburban Cleveland.

It's not enclosed.

It's drive up lifestyle.

The other is in Pittsburgh, which is a similar situation, but a bit more street -oriented as opposed to suburban lifestyle.

Okay, and then circling back, I don't know if, Dick, you want to address this or John, inventory targets for how we should be thinking about inventory for next year, given your kind of low single-digit comp guidance?

Well, the way we planned inventory is slightly different than the way with plan comps.

Inventory really is -- we do it on an ongoing week over week basis in terms of weeks of supply.

So it's on a natural basis rather than a twelve-month projected basis.

So you know, we would look to maintain the same kinds of weeks of supply that we are comfortable with.

Again, it's sort of an organic thing, where we get to the 10 to 12 weeks of --and, yes, we're always looking for ways of maybe to speed that up very slightly.

But again, that's what we're comfortable with.

And that's what the customer seems to respond to.

So kind of continuing at the same level, the same run rate we're at now?

Well, within the 12 weeks of supply, yes.

Okay, okay.

Great.

Thanks, guys.

Yup.

Thank you.

It appears that there are no further questions, so I'll turn the program back over to the host.

Well, I thank everybody for attending, and hope to see you in three months.