Urban Outfitters Inc (URBN) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Urban Outfitters third-quarter FY16 earnings call.

(Operator Instructions)

As a reminder, this conference 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 FY16 conference call.

Earlier this afternoon, the Company had issued a press release outlining the financial and operating results for the three- and nine-month period ending October 31, 2015.

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 third quarter.

Trish Donnelly, President, Urban Outfitters North America will provide a brief update on the Urban Outfitters brand in North America.

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.urbanoufittersinc.com.

I'll now turn the call over to Frank.

Thank you, Oona, and good afternoon everyone.

I will start my prepared commentary discussing our recently completed FY16 third-quarter results versus the prior comparable quarter.

Then I will share our thoughts concerning the fourth quarter.

Total Company, or URBN, sales for the quarter increased by 1% to a third-quarter record of $825 million.

This sales increase included a 1% retail segment comp, a $9 million increase in non-comp sales, including the opening of 10 net new stores which more than offset a 5% decline in wholesale sales.

Additionally, please note that our sales growth was negatively impacted by approximately 130 basis points of currency translation.

Our wholesale segment sales were negatively affected by transition delays at our new distribution facility in Gap, Pennsylvania.

These delays resulted in approximately $9 million of third-quarter shipments being delayed into the fourth quarter.

Had we have been able to fulfill these orders during the third quarter, our wholesale sales growth would have been approximately 9%.

As we enter into the fourth quarter we continue to see strong demand in both department and specialty stores, and based on several measures put into place we do not anticipate further sales misses due to delayed shipments.

Within our retail segment comp the direct-to-consumer channel continued to out-perform stores, posting double-digit sales increases driven by increases in session, average order value, and session conversion.

Negative comp store sales resulted from decreased transactions and units per transaction partially offset by higher average unit selling prices.

The negative transaction could have been affected by traffic which was down at our comp stores during the quarter, although we did benefit from an increase in conversion rate.

By brand, our retail segment comp rate increased by 3% and 1% at Free People and Urban Outfitters while the Anthropologie Group was flat for the quarter.

Our retail segment comp was positive in September, flat in August, and negative in October.

When thinking about the months in the quarter, please keep in mind that the Labor Day holiday weekend shifted from August last year to September this year so if you were to look at the months combined to try and account for the holiday shift, the net result of the two months together was a positive retail segment comp for the period.

Total URBN gross profit for the quarter was up 2% versus the prior comparable quarter to $288 million.

Gross profit rate improved by 11 basis points to 34.9%.

The improvement in gross profit rate was driven by almost 150 basis points of improvement in URBN's maintained margin due to significant improvement in the Urban Outfitters brand mark-down rate, which was partially offset by lower maintained margins at the Anthropologie and Free People retail segment.

URBN maintained margin improvement was partially offset by approximately 100 basis points of deleverage and delivery and fulfillment center expenses primarily related to the ongoing Gap, PA fulfillment center transition and the increased penetration of direct consumer sales.

Approximately half of the deleverage in delivery and fulfillment center expenses previously noted, related to the transition of the South Carolina fulfillment center to Gap, Pennsylvania.

After the direct-to-consumer transition to the new facility in the second quarter went well, this deleverage in third quarter which was primarily related to the wholesale segment transition, was more than we had originally anticipated.

We believe this deleverage will continue into the fourth quarter.

Additionally, we estimated that currency translation negatively affected our gross profit rate by just under 50 basis points in the quarter.

Total SG&A expenses for the quarter were up less than 1% to $208 million.

Total SG&A as a percentage of sales leveraged by 23 basis points to 25.2%.

This SG&A leverage was primarily due to lower incentive-based and share-based compensation expense as well as currency translation benefits which were partially offset by an increase in technology-related expenses used to support our direct-to-consumer channel investments.

Operating income for the quarter increased by 5% to $80 million with operating profit margin leveraging by 34 basis points to 9.7%.

Net income for the quarter was $52 million or $0.42 per diluted share.

Turning to the balance sheet, inventory decreased by 5% to $442 million.

The reduction in inventory is due to a 9% reduction in retail segment comp inventory at cost, partially offset by increases in wholesale inventory and non-comparable store inventory.

The decrease in retail segment comp inventory is due to improved inventory planning and control as the business continues to work towards managing to a lower week to supply.

We ended the quarter with $273 million in cash and marketable securities.

During the third quarter, the Company repurchased and retired 3.6 million common shares for approximately $112 million.

We have 11.6 million shares remaining on the most recent Board of Directors share repurchase authorization.

Year to date we have repurchased 10.7 million common shares for approximately $366 million.

As we look forward to the fourth quarter of FY16, it may be helpful for you to consider the following: First, I wanted to briefly comment on our current quarter-to-date sales trend.

As noted above, October was the weakest sales comp in the third quarter and this negative trend has worsened into the first half of November.

As of quarter to date, this negative trend is consistent across each of our brands and most prevalent in stores.

We are planning to open approximately 8 stores during the fourth quarter, totaling 28 net new stores for the year.

For the fourth quarter by brand, we are planning approximately six new Anthropologie stores globally including one new European store and two new Free People stores in North America.

URBN's gross margin rate for the fourth quarter could decrease versus the prior year.

This decrease could be driven by deleverage related to our fulfillment center transition, store occupancy deleverage related to negative store comps and lower maintained margins at the Anthropologie Free People brands.

This deleverage could also be driven by the current negative sales growth rate.

This deleverage could occur despite year-over-year improvement in the Urban Outfitters brand maintained margin due to continued progress in regular-priced sales and overall lower levels of mark-down sales.

Based on our current plans, we believe SG&A could grow at a mid single-digit range for the fourth quarter.

This increase would be driven by direct-to-consumer channel investments related to marketing and technology.

Capital expenditures for FY16 remain planned at approximately $145 million, driven primarily by new stores and the completion of our new East Coast fulfillment center.

Finally our FY16 annual effective tax rate is planned to be approximately 36%.

As a reminder, the foregoing does not constitute a forecast but is simply a reflection of our current views.

The Company disclaims any obligation to update forward-looking statements.

Now it is my pleasure to pass the call over to Trish Donnelly, President of the Urban Outfitters Brand in North America.

Thank you, Frank, and good afternoon, everyone.

We are incredibly proud of the progress the UO brand has made this past quarter.

The team's focus on assortment planning and allocation; on creating compelling trend-right products; on delivering unique shopping environments; and improved four-wall productivity; and on communicating our brand messaging through creative imagery and social engagement, has given us solid quarterly results and a successful and stable foundation from which to continue to build.

Starting with assortment planning and allocation, the team's laser focus and discipline around inventory control and management has resulted in significantly improved mark-down rates and historically fast inventory turns.

The collaboration between planners and merchants has been exemplary.

The teams work together to edit redundant styles and offerings while funding emerging businesses based on current trends.

This balance and focus has resulted in positive rate price comps in both retail and direct and the businesses into which we've intentionally restored it are seeing very exciting double-digit full-price comp results.

We came into this year knowing we had a lot of work to do around IMU.

Although it is still a work in progress with great focus, discipline, and collaborative efforts with Barbara Rozsas, our Chief Sourcing Officer, and her team we are proud to report our IMU for the quarter showed nice improvement versus last year.

Our design and merchant teams have worked closely with Barb's group on increasing our internal design penetration which has also proven beneficial to improved IMU.

In addition, the design team is executing more in-house drape which allow us to get samples right the first time, resulting in faster production turnaround and speed to stores.

The last time we spoke, I talked about our focus on driving four-wall productivity and the initiation of a detailed review of all store floor plans to assign appropriate square footage by product category.

We are well into this complex project and although it is still a work in progress, we've seen some excellent results in large format stores, specifically Herald Square as well as our mall proto store in King of Prussia.

We are taking our learnings here and continue to rollout what's working to rest of stores.

Most recently successful examples of this has been in our dresses, intimates, and beauty category where the margin contribution within our four walls has dictated greater square footage needs, so we are distorting these areas accordingly on each store's floor plan.

As a Company we recognize the importance of this exercise in making our stores as productive as possible.

Now turning to product.

Last year, Meg Hayne, Chief Creative Officer for URBN, initiated a trend to concept process for the UO brand.

By promoting strong creative talent already within the brand and hiring outside talent where we needed additional support and expertise, her process resulted in an effective framework which gave clearer focus to the design teams and to the actual product assortment.

We are now able to cover a broad number of sensibilities and end uses that still evoke a strong UO branding statement.

We have now increased our attention to the men's division where we know we've got tremendous opportunities to please our core customer.

We will build upon successes for staying and expand product categories where we see growth and opportunity.

In addition to the initiatives and progress already noted, we are still incredibly committed to delivering unique and exciting store environments for our core customer.

As in the past, our display artists in the field continue to build compelling art layers and fixturing for the stores in which to highlight product.

We saw great results with these fixture builds which has helped define our floor sets and shop-in-shops, making it easier and more appealing for customers to shop each defined area.

Successful examples of this include our back-to-school and fall shops in dresses, beauty, intimates, and music and photography.

These categories saw some of our highest comp growth rates for the quarter.

Even though our four-wall focus is on efficiency and return on invested square footage, we haven't lost sight of the importance of the visual display and creativity that is unique to each individual UO store.

In celebration of our artists in the field we posted images on hash tag UO display on Instagram and given the thousands of instances in which the hash tag has been used and the thousands of likes we're seeing when we rebrand via our local and national accounts our customers have a clear appreciation for the creative talents of the UO display team.

In addition to unique visual merchandising within our four walls, we are also highly focused on the direct channel and saw year-over-year increases in conversion across all of our experiences: desktop, tablet, mobile web, and our UO app.

As the majority of our direct customers experience our brand through mobile, we activated our beacon program in all stores this past quarter.

Engagement here is growing, with 65% of customers receiving beacon messages choosing to interact.

Also in the quarter we launched scan and shop in the UO app, allowing customers to shop the styles in our dress book simply by holding their phone up to the catalog page while in store.

In addition, with music being so important to our core customer, we've launched UO music within the app featuring our favorite play list and our UO mix tape.

And in our Herald Square store to enhance and add to the more experiential shopping experience, we've opened our first UO cafe which is fast becoming a popular breakfast, lunch, and dinner spot.

From a brand marketing standpoint, our web imagery continues to drive and support the impressive direct-to-consumer comp increase we saw in Q3.

As this imagery has resonated with customers on our website and our app and in our digital marketing channels, we've begun using the imagery in stores to support our product initiative, shop-in-shops and distortion category.

This omni-channel visual approach led by Sue Otto, our Chief Creative Officer, helped link the online and offline shopping experience and sends consistent cross-channel messaging.

Sue and her team have made it clearer for the customer to see what we're standing for and what we're excited about for the season with a more singular cross-channel brand marketing point of view.

Given the excitement around our brand imagery, we are also exploring printed piece opportunities, specifically our recent holiday dress book and our men's journal which launched at the end of Q3.

We will continue to explore this direct mail journal and zing concept as we move into spring.

Our social media team continues to drive engagement throughout the quarter with particularly strong increases in Instagram and Pinterest, up 76% and 52%, respectively over last year.

Our Instagram following of almost 4 million users was highly interactive this past quarter with our posts averaging close to 100,000 likes.

Particularly exciting is that we saw engagement at this high level across all categories: women's, mens, apartment, music, electronics, beauty, and intimates.

Some of our newer more successful social campaigns this past quarter included: hash tag UO on campus; our all-store listening event; previewing Lana Del Ray's newest album which became the number one trending topic in the US during the hash tag launch; our marketing campaigns around product collaborations with Calvin Klein, Fila, and Adidas; and our Dreamers and Doers events in stores which celebrate artisans in local markets by providing space within our stores and marketing support to show their work.

Because our customer is very interested and highly engaged in these types of social interactions, we'll continue to build on this opportunity and we're excited about our future initiatives.

In Q3, we experienced double-digit growth in our active customer count, with increases in new customers and retained customers as well as customers coming back.

While we've made notable progress over the last year in the areas of inventory management, product offering, four-wall productivity and brand marketing, we continue to see significant growth and efficiency opportunities within the business.

We still have a lot of work to do.

I'd like to sincerely thank the Urban Outfitters team for the quarterly results and I appreciate your time on the call today.

Thank you.

Thank you, Trish, and good afternoon, everyone.

The Urban team has made excellent progress in re-energizing its brand over the last two years and that progress continues in this year's third quarter.

As Trish explained, the team made a decision to pull back on promotional activities, while improving the fashion and quality of the offerings.

The strategy worked.

Although top-line growth in the third quarter was just 1%, the improvement in regular-priced selling grew healthy double-digit increases in gross profit dollars.

The brand game also improved in creative messaging with better imagery and more robust social engagement.

Many on today's call should have received a copy of the Urban holiday book.

This is but one example of the improved marketing.

I hope you'll agree with me that it's an extremely compelling catalog.

As Trish said, similar books will be distributed next year as the team believes this will help drive digital sales and store traffic.

After two years of rebuilding the brand, it is now positioned for growth.

We believe there is considerable opportunity to enter new markets, expand the direct-to-consumer channel and build more projects like Space 2420 in Austin, Texas.

I'll talk more about that exciting project in a few minutes.

I congratulate and thank Trish, Meg, and the entire Urban branded team for a job well done.

Before I turn your attention to the other brands, let me say a few words about the macro climate in which we currently operate.

The fall season has been disappointing from a traffic and sales perspective.

Combined North American store traffic for the quarter versus the same period last year was down 6% while conversion was up 12 basis points.

Meanwhile, combined North American direct traffic, or specials, grew by 4% and conversion was up 20 basis points.

However even though direct sessions were up on a quarter-over-quarter basis, the rate of increase dropped from Q2.

The effect of this drop in traffic has been uneven across the categories we offer.

In general, sales of apparel and accessories have been slower, while home, intimates, shoes, and beauty have been more robust.

I believe our customers' current lack of enthusiasm for the apparel and accessory categories is primarily due to a lack of fashion business.

We currently have a number of new fashion bright spots in our apparel offering, but whether or not these trends become more mainstream is uncertain.

Having been in this situation before, my experience tells me the best course of action is to keep inventories lean, continue to experiment and know that new trends will emerge soon.

Now I'll address the other brands, beginning with Anthropologie.

For Anthro, Q3 was very similar to Q2.

A number of important classes, like sweaters and dresses, offered assortments less compelling than the prior-year period and those classes depressed overall sales gains.

The team continues to make adjustments in the assortment and offering additional promotions where necessary to move slower-selling inventory.

The effective inventory management has helped to mitigate the mark-down pressure and as of October 31, apparel inventory this year stood 4% below last year on a comparable basis.

Even though some assortments were off the mark, the Anthropologie Group also produced a number of successes.

Categories and businesses such as home, beauty, shoes, BHLDN and Terrain all delivered fairly strong quarter-over-quarter sales gains.

For example, online sales of home product in the quarter were exceptionally strong.

They were driven by expanded and compelling product along with the mailing of home-only journals.

The Anthro customer also responded positively to the new beauty offering.

After strong results from testing this product online and in several stores, the brand recently completed a roll-out of beauty shops within 70 existing stores.

Early results are very encouraging and speak to a much larger potential for the beauty and the brand.

These and other product expansions helped to drive double-digit increases in Anthropologie's direct-to-consumer sales in the quarter.

The growth of online sessions and increased traffic coming from the site via natural search suggested Anthropologie's customer engagement remains very powerful.

The success of expansion categories online has also increased our excitement about launching larger format stores that can offer more expanded product.

Four larger stores are scheduled to open FY17.

Anthropologie was not alone with the success we've achieved by offering expanded categories.

Free People benefited as well.

Recently Free People opened two new larger format stores, one each in Denver and Dallas.

Each was a relocation of an existing store within the same mall and each more than doubled the selling space previously available.

The additional enabled the brand to offer wider selections from the Free People expansion category, including large branded footwear and [neater shops] in both locations.

Denver featured an area devoted to the newly-launched FE Movement activewear.

And Dallas greeted customers at the door with a holiday party dress assortment.

All of this newer product complimented the established ready-to-wear and accessory offerings.

I'm pleased to report that those stores registered sales significantly greater than their opening day plan.

And the Denver store easily set an [industry-leading] opening day sales record despite stiff competition from the sister store in Dallas.

Both stores have continued to produce strong sales so the customer clearly likes the larger offering, and thus the brand will continue to open more stores of this size going forward.

Three months ago in our investor call I suggested it would be difficult to maintain, let alone improve, the extremely high level of sales productivity the Free People brand achieved in their existing retail stores.

My concern proved to be correct.

Comp store productivity declined in Q3 versus the prior-year period.

Important seasonal classes like sweaters, jackets, and cold weather accessories failed to beat their comparable sales.

We have now realigned our expectations for future comp store sales growth and believe that future sales increases at the Free People brand will come mostly from square footage growth.

As with Anthropologie, Free People's success with expansion categories, most of which aren't available in the smaller format stores, did continue to drive double-digit sales increases online.

This was achieved despite softness in international direct sales during the quarter due to the strength of the US dollar.

The brand did, however, manage to record better online sales from UK and China, because of a more invested market.

Before I discuss the wholesale channel performance, I want to comment on our new Gap fulfillment center issues that Frank referred to in his early commentary.

After a relatively painless transition to the Gap facility, or DTC channel in late summer, the wholesale inventory was moved into the Gap center in September.

This turned out to be a bigger job than expected and resulted in a delay in filling wholesale orders in late September and early October.

Consequently, wholesale order fulfillment in October, one of the peak wholesale shipping months, was more back-end loaded than normal.

The compressed order flow was more than the new store could handle.

Processing volume combined with systems problems and insufficient staff training resulted in some October wholesale orders being shipped in the first few days of November.

Today we believe the software/hardware problems have been largely fixed.

We've hired additional staff and implemented a more rigorous training program.

Virtually all of the direct orders are now being shipped within 24-48 hours from our fulfillment centers on both the East and West Coasts, and wholesale shipments are up-to-date from both our Trenton and Gap facilities.

Based on corrective measures we've taken over the past month, I believe we are positioned to fulfill all of our orders on a timely basis in the fourth quarter.

As for the performance of the wholesale channel in Q3, had it not been for the transition issues, I believe that division would likely have posted double-digit sales increases.

Furthermore, based on orders in house, I believe it will return to a double-digit sales increase in Q4.

Now let me discuss this morning's announcement.

For several years we've been talking about expanding categories in order to please our customers more and capture more of their spending.

We have consistently repeated that new categories can be products or services, as long as they fit within the lifestyle of the customer.

In recent years, casual dining has been one of the fastest growth categories and our involvement in the foodservice business through our successful cafes in two training locations and in the Urban Outfitters location on Herald Square has taught us the potential synergies that can exist between retail and food operations.

This morning we announced an agreement to acquire substantially all of the Vetri Family group of restaurants which includes its award-winning Pizzeria Vetri.

Most recently Food and Wine Magazine named Pizzeria Vetri the best pizza restaurant in America.

With casual dining growing rapidly and pizza one of the most popular foods in the country, we believe there's tremendous opportunity to expand the Pizzeria Vetri concept.

We feel fortunate to have Marc Vetri, a James Beard award winning chef, with his business partner Jeff Benjamin and their caliber of teams working in partnership with URBN development and shared service teams to realize this growth opportunity.

Currently, the Vetri Group operates 2 pizza restaurants in Philadelphia and is scheduled to open 3 more in the next 12 months.

We believe future can be standalone restaurants or part of a larger retail complex.

A big attraction of this concept is the enormous depth of its appeal.

Very young to very old, everyone loves great pizza.

Last week the Urban brand launched its new Space 2420 project in Austin across from the University of Texas campus.

This project includes an expanded Urban Outfitters store and several food and beverage concepts, including Pizzeria Vetri and Michael Symon's Burger Joint.

The store and the restaurants are clustered around an open air courtyard that offers restaurant seating and a stage for special events and concerts.

So in addition to a large Urban store, we've assembled award winning pizza and burgers serving beer and other beverages and offering live music.

And this is all directly across the street from 60,000-plus UT students.

We believe the project has a high probability of success.

The Vetri pizza concept is not limited however to pairing only with Urban brand.

In early 2017, we plan to open a project in Devon, Pennsylvania which is a high-end suburb of Philadelphia.

This project will include a larger format Anthropologie stores, a Terrain Garden Center outdoor store, a Glass House cafe, a Pizzeria Vetri and one of the Vetri Group's higher-end restaurants.

We're excited to add foodservice to our brand portfolio and believe the Vetri Family group of restaurants compliments our brand nicely.

Having known Marc for many years and having worked with him on numerous charitable projects, I know our organizations and cultures fit together easily.

Marc and Jeff will partner with Dave Ziel, our Chief Development Officer who currently runs our URBN food and beverage division, in leading this exciting opportunity for our Company.

Finally a special thanks to all of the home office folks who volunteered to help work in the new fulfillment center at the end of October.

And of course, I thank all of our 23,000 associates worldwide for their inspiring dedication, drive and creativity.

I recognize and thank our many partners around the world and also our shareholders for their continued support.

That concludes my prepared remarks.

I'll now turn the call over for your questions.

(Operator Instructions)

Our first question is from Kimberly Greenberger of Morgan Stanley.

Great, thank you so much.

Good evening.

I think we're all trying to figure out what's going on in the external environment and you talked about that a little bit tonight on the call.

You have obviously a lot more data as you look at your store businesses and your different concepts and performance by category.

Maybe you could help us with your early diagnosis.

Obviously this is a dynamic situation, but your early diagnosis is some of the things that are causing business to be a little softer or store traffic to be a little softer.

Was there something that changed materially in October and November here to date that would suggest that there could be maybe something beyond the weather happening in your Business?

Hi, Kimberly, thanks for the question.

I don't necessarily think there's anything that happened in October, as you say, beyond the weather.

Of course, weather is always factor and we have had significant decreases in some of our weather-related classes.

But as you know, having been associated with the Urban brand for many, many years now, we never, ever blame the weather for anything.

So I want to discount that.

We have seen lower traffic, as I said in my prepared remarks, if you could hear them.

We've had lower traffic throughout the quarter and the traffic got a little bit worse in October.

I think that, from our analysis, the primary thing driving that is lack of newness and fashion.

I think the current fashion look is getting a little long in the tooth and I wouldn't be surprised if we start to see some signs of it changing a little bit more radically than it has, let's say, over the last four or five years.

We do think that we do see a number of areas in our business that we're excited about with the new fashion.

But it's pretty early to start saying that it's a trend because there are items here, there are items there.

What we have seen outside of the apparel and accessory areas, and why I don't believe that it is the lack of traffic is, let's say, a precursor of a recessionary environment, is we see real strengthen a number of our categories.

I mentioned the home category in Anthropologie, which has been really off the charts.

So they've done a great job of providing more product and with the journals that they've issued I think the customer is responding very well to that.

Across most, or all three, of the concepts we've seen intimates and we've seen beauty respond very well.

There are a number of categories that are doing very well, so I don't think the customer is without money.

I think she's without fashion newness.

Great thanks, Dick.

Thanks, Kimberly.

Thank you, the next question is from Lorraine Hutchinson of Banc of America.

Thank you.

I just wanted to focus on SG&A for a minute.

Were there incentive comp reversals in this quarter?

And what's the reason for the re-acceleration in the SG&A dollar growth rate in 4Q?

Then following up on that, are there cuts you can make for 2016 or FY17 if sales trends don't pick back up?

Lorraine, this is Frank, I'll take that question.

Yes, the third quarter benefited from, first and foremost, strong control at the brands related to variable spending, specifically direct store controllables.

The comps there were negative.

The brands managed to payroll appropriately.

Secondly, there was a benefit in the quarter due to lower incentive-based, as well as share-based, compensation.

The Company is no longer on pace to hit where we originally hoped to land for the year.

There were some appropriate reversals there.

That is why you see the growth rate come back up a bit into the fourth quarter, although we originally were planning for the fourth quarter to be in the high single-digit range.

Right now we have revised that down into the mid single-digit range.

Again, that spend will be focused primarily on technology and marketing initiatives to continue to support the growth that we're continuing to see in the direct-to-consumer channel.

As it relates to FY17, we'll have a little bit more commentary on that when we get on our next call.

Thank you.

The next question is from Paul Lejuez of Citigroup.

Thanks.

I'm curious what AUR increases are you seeing at the Urban Outfitters brand?

And same question on the Anthro and Free People side in terms of the decrease.

And how long do you assume that these trends will continue?

Is there a point that you can see in the future where we should expect the AUR starting a little bit higher at all three brands?

Thanks.

Hi Paul, it's Trish.

I'll take that question for the Urban brand.

In terms of AUR increases, we're not seeing anything material.

We are able to get better IMUs through some strategies and also by focusing on internal design products and working closely with production.

But in the Urban brand we're not seeing any material AUR increases.

Paul, it's David.

I'd have to echo Trish's comments.

AUR has been relatively steady.

We're seeing a great response from our -- a solid response -- from our existing core customers and working on seeing the traffic decreases coming mostly from new customer trends.

As Dick indicated, the appetite doesn't seem -- and the product's right, as we're seeing at home.

She's willing to buy larger-ticket items from us at a greater pace than she has in the past.

The next question is from Adrienne Yih of Wolfe Research.

Good afternoon and, Trish, congratulations on the successes at UO.

The bill of book looks fantastic, so good luck there.

Dick, I guess my question -- I have two quick questions.

One is can you talk about the differences in the uptake, if there are emerging trends at UO and the successes fall to date or season to date versus the 35-year-old customer perhaps at Anthro.

Are these trends less in her wheelhouse, in the Anthro wheelhouse?

Maybe that's for David actually.

Then on the wholesale channel, do you think it's all this notion of the Company-specific Gap, Pennsylvania move?

Or do you think it has something to do with what Macy's and Nordstrom and the department stores are saying about over-inventory and a slowing in their channel?

Thank you.

Okay, let me take the last part of your one question first.

As far as wholesale is concerned, it has absolutely nothing to do with our customers.

I've had conversations with the wholesale folks as recently as Thursday of last week and they assured me that all of our partners are still enthusiastic about the Free People brand and are enthusiastic about receiving the product.

It had everything to do with exactly what I said, which was a combination of some errors on our part in not accurately projecting the quantity of merchandise we were going to have to ship, having a few -- more than a few, actually -- system bugs, both hardware and software, and then as I said inadequate training.

So those three things combined to cause some real problems.

I believe that the majority of those problems are now behind us and I believe that we will be shipping wholesale product and our direct-to-consumer product on time through our various fulfillment and distribution centers.

Now I think I'll ask Trish to take the first part of your question and, David, you'll take the other part of that one question.

Hey, Adrienne, thanks for the kind words about the look book.

We're really excited about it as well.

In terms of emerging trends, we're seeing great growth particularly in dresses and skirts, in addition to the emerging businesses we talked -- I talked about -- in the commentary, such as intimates and beauty.

So I think I'll defer to David on the second part of your question about how that relates to Anthro.

Hi there.

When we look at Anthro's comparables against LLY positive comps in the apparel space, as Dick said, when we look at it there's no news of a macro fashion side where we've had some early reads on new fashion proportions.

They tended to be short-lived; we'd get a week or two bite, so probably our earliest and fastest adaptors.

The proportion still seems to be big over little for us.

The categories that are checking and when we look at the items they reinforce that.

We are seeing some movement in long over slim better proportions.

But again, that being said, there's sufficient traffic and brand engagement where, had we executed better and had a little more appeal in styling, we think we could have still had better results than we actually delivered.

We have looked at our approach to design our lead times, as Dick has talked about, across all of URBN and like where we're headed for spring of next year in terms of being even more nimble and leaner and working with Meg on the same approach of concept to customer.

So we're hoping that will yield better results.

Thank you, our next question is from Lindsay Drucker Mann of Goldman Sachs.

Thanks, good evening, everyone.

I just wanted to see, as you think about the deceleration comp trend that we've observed and you talked about specifically in the quarter across successive months, is the key factor that surprised you the deterioration in traffic trends?

Was that the big comp lever that disappointed you?

And can you square the comp shortfall with how down your inventories are in the quarter?

Would you have expected, if comps had gone to plan, inventory to be down even further than what they ultimately materialized?

Or were you able to cut orders back or is there another timing issue there?

Thank you.

Okay, Lindsay I'll try to answer that.

I think that traffic definitely was the biggest surprise; however as I say that, we have been experiencing lower traffic in stores now for a number of quarters.

It just happened to be a little bit more intense in this quarter and it also manifests itself in the direct business, which we really haven't seen before.

So I would say the traffic was a bit of a surprise.

As far as inventories are concerned, I think we really have a very good group of people now in each brand controlling the inventories and they've reacted extremely quickly to the business.

That's the way we did it many years ago, and it's the way I like to do it, so that we react to the current business and going forward so we don't get caught with excess inventory.

I think you're right, had the sales materialized to where we had planned them to materialize, we may have been a little bit lighter in inventory.

But I think the teams did a great job in cutting back when they saw the trend.

Thank you, our next question is from Janet Kloppenburg of JJK Research.

Hi, everybody.

Hi, Janet.

I had a clarification question.

It sounds like the Urban Outfitters business, women's is performing well.

Trish, you've done a great job there, Trish, Meg, the whole team.

I was wondering if you saw the same slowdown there and if, Dick, you're worried about the fashion trends to that customer.

But it feels like you've actually performed better there than most.

So I'd like you to talk about the woman's outlook or the trend in woman's at Urban Outfitters and the slowdown occurred to the same magnitude there.

And secondly, Frank I'm a little unclear on the gross margins for the fourth quarter.

You say they may be down which I understand relates to top line.

But is there also some one-time impact coming there from the Gap, Pennsylvania issue, the DC issues in Gap, Pennsylvania?

And can you give us the magnitude of what you're thinking in terms of the one-time fulfillment issues?

Thank you.

Okay, Janet, I'm going to start off and then ask Trish to come in and then Frank.

I think that Urban Outfitters women's did reasonably well during the quarter.

I would congratulate Trish and the women's team and Meg for really giving the customer what I think is extremely good product.

When I go into the stores and I take a look at the product and compare it to two or three years ago, I think it is spectacularly better.

Now having said that, overall sales were up 1%.

So I think that while the women's apparel had much better full price, it shows that it wasn't enough to offset the mark-down group of product.

I think that, again, traffic is an important element of this and we're fighting against the wind, as it were, as when it comes to the offering.

I think that there's still opportunity for the Urban brand to do better in some classifications.

But overall, I give the Urban brand in women's a solid A for their efforts and their offering.

I do think traffic affected Urban, as well as the other two brands, I just think that Urban had a better fashion presentation.

Trish, do you want to add anything to that?

Sure, hi, Janet.

As Dick said, our focus in women's is really on right price and delivering compelling trend-right products at better quality at really good prices.

And we saw that pay off in a number of categories.

As Dick also said, there's some categories that we're still working on and we'll continue to do that through the quarter.

Overall, happy with where we were for Q3, understanding we have a lot more work to do go forward.

Hi, Janet, this is Frank.

First, let me just say, obviously, based on the current sales trend, it's very hard to predict where the fourth-quarter gross profit margin is going to come in.

We certainly think that it is appropriate to be planning the quarter conservatively right now.

You are correct; there are some one-time items hitting the fourth quarter that will affect us in a similar way to the third quarter.

Those being the fulfillment center transition, which we do anticipate deleverage in the fourth quarter similar to that of what happened in the third quarter, as well as currency translation negatively affecting us in the fourth quarter similar to what hurt us in the third quarter, as well.

Thank you, our next question is from Dana Telsey of Telsey Advisory Group.

Good afternoon, everyone.

As you've spoken about the other categories beyond apparel and accessories that are working, what do you see, or what do you envision as the percentage of the store that is allocated to those categories go forward?

What the percentage of sales should be in the future?

And how does this impact gross margin long term?

Is there a new normalized gross margin that we should be looking towards?

Thank you.

Okay, Dana.

I think that one of the things that the Urban brand had a lot of success with this quarter was putting the right penetration of the product into the store and rearranging the store so that it is grouped around product categories as opposed to product categories being hashed throughout the store.

That has helped us a lot.

When you think about, and say, what is the right penetration of these various product categories, the answer is the right penetration is what the customer deems it to be.

Our job is to figure out what the customer wants and what is the percentage of a certain product category that she wants, and then give it to her.

So I don't think there's any necessary long-term effect on gross margin because I believe, as I said before, when the fashion changes or as the fashion changes, I would fully expect apparel and accessories to come back and whatever margins it has, it will have.

Meanwhile, the other categories may carry a higher or a lower margin.

So I don't think there's any particular long-term effect of margin on these other categories.

I would say the one exception to that is probably the home area.

Home traditionally has a lower initial margin.

But oddly enough, it usually has a very similar maintained margin because the mark-downs are typically much less.

That shouldn't really have much effect on gross margins.

Thank you.

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

Brian, I believe you disconnected yourself.

Can you requeue?

Press star then 1 on your touch-tone phone.

Your line is open.

All right, super, thanks.

Frank, just when you thought you were at the end of the IMU questions, now you'll start hearing questions about cheese prices.

(laughter) But my question really was on the Anthro margins this quarter.

Lots of worry there about where gross margins will normalize.

Can you talk about where does the third quarter shake out versus your plans?

And David talks about how either changing the open to buy, or lead times.

Today is different versus previous cycles for the Company.

Thanks very much.

Sure, Brian, this is Frank.

I'll answer as much as I can, and then certainly David is open to add in, as well.

So the Anthropologie margins for the third quarter were down from what we had originally planned.

With that being said, due to how well the brand has managed inventory, not just this quarter, but over the last several years and how quickly they react, that deleverage in margin was not as significant as what we've seen many years ago that would have driven the Anthropologie to a much lower level of profitability.

Following on Frank's comments, we look for those early reads and adjust.

We are working on trying, as Dick had talked about, our go-to-market strategies and working with Barbara Rozsas and our supply chain partners to shrink that even closer, we're under way.

I would say most of that gain is we're going to start to see in next fiscal year.

And this year was when we got our early reads and indication, we work with our vendor partners to reduce orders and so we cut back.

But we are excited about the nimbleness.

We have for three-plus years now, I believe, worked on speeding our turn.

This year turn will probably be slightly flat; we're not expecting to see a faster turn.

But we do believe there's plenty of opportunity to lower inventories go forward without sacrificing rate price.

And, Brian, this is Frank too, just to jump in and provide a little more clarity.

When I was speaking of plan, I was talking about what we would have budgeted originally for this year.

As it relates to the third quarter and the last time we spoke, Anthropologie's margin actually came in very consistent with what we expected.

Thank you, our next question is from Marni Shapiro of The Retail Tracker.

Hello.

If we could get a quick update on your international business?

A big picture question, it feels as if Meg has the magic touch here.

As she flits around waving her magic wand, Meg, she's done some impressive things as she partners with each of the groups.

She's one person obviously.

So can you help us understand short of Meg coming back and helping Anthro, how should we think about the Company as far as, are there new people working at Anthro?

Has there been turnover or has it changed and Free People?

And over time how does that look?

Marni, I would never speak for my wife, so I'm going to ask Meg to answer that question.

Hi, Marni.

Thanks for the compliment, and it's been nice talking to you throughout this time.

We worked really hard at every brand to develop talent that's needed to be able to do the job.

When I came over to Urban, there was a lot of creative talent within that brand and we just gave them a stronger voice.

And we also hired some people externally towards that.

I feel very confident with the creative talent in the brands and working with Trish and she recognizes how that creativity is important and supports all of our initiatives.

And with Anthropologie, there are several very creative people there too.

I promoted someone that's working directly under me that's managing design and concept that's been with the brand, I think, for over ten years.

We're building a team there as well and working with the image team, who we had someone that worked for Anthropologie and left and came back.

So I feel pretty confident with all of the people underneath me working for these brands with the creative talent.

And then we're just working and supporting the process and procedure.

As David has said and Trish has said, the trend the customers incredibly important in getting that right process in place and making sure the people in place have the strong voice to be able to carry through the original vision.

I know I'm busy flitting around from place to place but our goal is to always put creative talent in each brand to be able to do the job that's needed to be done.

Thank you.

Our next question is from an Anna Andreeva of Oppenheimer.

Great, thanks so much, good afternoon and thanks for taking our question.

A question to Frank, looking at the spread between sales and comp, it narrowed pretty significantly during the quarter, even after we adjust for delayed shipments.

Is there anything to call out from a new-store productivity performance during the quarter?

And should we expect that spread to return to more normalized levels in the fourth quarter?

And just to double check on the fulfillment issues, should we expect those to be contained to the fourth quarter or could they continue into 2016?

Thanks.

Yes, Anna, this is Frank.

That spread has actually been declining a bit over the last several quarters.

I do think there is opportunity for it to recover a little bit in the fourth quarter, but certainly the spread will be down from where we've been historically.

I would say that our new-store productivity, although we are building a lower number of stores, as we always talked about, the Anthropologie and Urban Outfitters brand in North America being capped internally by our own doing; around 200, 250 stores.

We're getting closer to that cap so you're seeing a lower number of new stores that separates that spread.

That's part of the effect that you're seeing there.

Additionally, please remember that the spread is also being negatively affected by foreign exchange.

We had about 130 basis points of negative effect on sales related to FX in the third quarter.

I do anticipate that to be fairly similar in the fourth quarter and then we'll start to anniversary that as we move into next year.

And Anna, to discuss again the fulfillment center issues, I do believe that we have taken a lot of corrective actions.

I can't promise that we have discovered each and every one of the bugs in the hardware and software.

But we believe that we certainly have the ones that we know about fixed.

I believe that we have -- I know we have hired extra people.

That's why Frank has suggested that the deleveraging might occur in the fourth quarter, as well.

I know that we have instituted a much more vigorous training program.

So with all those things combined, we're pretty confident that we have this under control, and I don't expect to see any additional problems in the fourth quarter.

Thank you our last question comes from Simeon Siegel of Nomura Securities.

Great, thanks.

Just two quick ones.

Frank, just one thing about your expenses, do you know what percent are variable versus fixed?

And sorry if I missed it, but given the acquisition announcement and the buybacks, any thoughts or updated thoughts on capital allocation strategies at this point?

Thanks.

Sure, Simeon.

The reason we don't typically give out our percent of variable versus fixed is because the direct-to-consumer channel continues to increase at varying rates from quarter to quarter, but continues to out-pace the store growth.

That number actually changes from quarter to quarter, so essentially as soon as I would give it out it would be different the following quarter and it's just difficult.

I don't want the modeling to be relied on a number that's continually moving.

As it relates to capital allocation, consistent with each quarter next week we have our Board meeting.

Certainly, share buyback and capital allocation will be a topic of our conversation and we will then act accordingly.

Thank you all very much for joining, and I look forward to talking with you in three months.

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

This concludes the program.

You may now disconnect.

Have a wonderful day.