Urban Outfitters, Inc. (URBN) Q3 2017 Earnings Report, Transcript and Summary

Welcome to the Urban Outfitters Inc. Third Quarter FY '17 Earnings Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I'd now like to introduce Oona McCullough, Director of Investor Relations. Miss McCullough, you may begin.

Good afternoon and welcome to the URBN third quarter FY '17 conference call. Earlier this afternoon, the Company issued a press release outlining the financial and operating results for the three- and nine-month period ending October 31, 2016. The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the Company's filings with the Securities and Exchange Commission. We will begin today's call with Frank Conforti, our Chief Financial Officer, who will provide financial highlights for the third quarter. Sheila Herrington, President, Free People Brand, will provide a brief update on the Free People brand. Richard Hayne, our Chief Executive Officer will then comment on our broader strategic initiatives. Following that, we will be pleased to address your questions. As usual, the text of today's conference call will be posted to our corporate website at www.urbn.com. I'll now turn the call over to Frank.

Thank you, Oona and good afternoon, everyone. I'll begin my commentary discussing our FY '17 third quarter results versus the prior comparable quarter. Then I will share some of our thoughts concerning our fourth quarter. Total Company or URBN, sales for the third quarter increased by 5% to a third quarter record of $862 million. This sales increase included a 1% retail segment comp, a 30% increase in wholesale segment sales and a $12 million increase in non-comp sales, including the opening of 12 net new stores in the quarter and sales from the newly acquired Vetri Family Restaurants. Please keep in mind that the third quarter last year was negatively impacted by approximately $9 million of wholesale shipments that slipped into the fourth quarter due to delays at our recently opened east coast fulfillment center. Additionally, please note that foreign currency translation negatively impacted our sales growth by approximately 120 basis points in the quarter. Within our retail segment comp, the direct-to-consumer channel continued to outperform stores, posting another double-digit sales gain, driven by an increase in sessions and conversion rate which more than offset a decrease in average order value. Negative comp store sales resulted from decreased average unit selling price and a slight decrease in transactions, both of which were partially offset by an increase in units per transaction. By brand, our retail segment comp rate increased by 5.2% at Urban Outfitters, while Free People and Anthropologie were down 1.5% and 2.7% respectively. Our URBN retail segment comp was strongest in September, followed by October, with August being the weakest. Free People wholesale segment sales delivered another solid quarter as sales rose 30% to $77.5 million. As noted earlier, the quarter year-on-year sales growth rate benefited from approximately $9 million of shipments moving out of last year's third quarter into last year's fourth quarter. If you were to adjust last year's number for these shipments, our wholesale segment growth would have been 13% in this year's third quarter. These results were driven by increased space at select department stores to support our category expansions like Shoes and FP Movement. Now moving on to gross profit, total URBN gross profit for the quarter increased 4% to $300 million. Gross profit rate declined by 15 basis points to 34.8%. The reduction in gross profit rate was primarily due to increased penetration of the direct-to-consumer channel resulting in increased customer delivery and overall logistics expense rates. Within gross profit, maintained margin for the quarter was relatively flat versus last year with initial markup or IMU, coming in lower on a year-over-year basis and markdowns coming in favorable on a year-over-year basis, essentially offsetting each other. IMU was lower due to the increased penetration of the wholesale segment sales at Free People which carries a lower IMU versus our retail segment. IMU in our retail segment increased due to improvements at each of our brands. Markdowns were favorable due to lower markdowns at the Urban Outfitters brand which was partially offset by higher markdowns at the Anthropologie and Free People brands. Despite well controlled inventory, Anthropologie was not able to hold their markdowns flat this quarter due to their challenging women's apparel performance. Total SG&A expenses for the quarter were up 10.5% to $230 million. Total SG&A as a percentage of sales deleveraged by 143 basis points to 26.6%. This SG&A deleverage was partially due to one-time legal settlements which accounted for approximately 20% of our year-over-year growth or almost 50 basis points of deleverage. The remaining increase in SG&A primarily related to an increase in direct store controllable expenses. A large portion of these expenses were due to the several large format Anthropologie stores recently opened, were opened in the quarter. While we're extremely pleased with the top-line performance of these stores, we have invested a considerable amount to ensure the hiring, training and overall execution of these stores were second to none. Many of these expenses, pre-opening and initial staffing levels, we believe we can reduce and leverage in the upcoming year through improved control and planning based on our current year's learnings. Operating income for the quarter decreased by 12% to $70 million with operating profit margin declining by 158 basis points to 8.2%. Our tax rate for the quarter was 33.5% compared to 35.3% in the prior year. The improvement in the quarterly tax rate was due to the ratio of foreign taxable losses to global taxable profits in the year. Net income for the quarter was $47 million or $0.40 per diluted share. Turning to the balance sheet, inventory increased by 3% to $454 million. The increase in inventory is primarily due to an increase in non-comp inventory to support our new and expanded stores. Our retail segment inventory comp was up 1% at cost with both Anthropologie and Free People well controlled and appropriately negative. Urban Outfitters inventory ended just slightly higher than where we would have liked it to have been. We ended the quarter with $265 million in cash and marketable securities. During the quarter, we repurchased and retired 1 million common shares for $35 million, leaving 6 million shares remaining on the most recent Board of Directors authorization. Additionally during the quarter, we paid down the remaining $50 million on our outstanding revolver, completing full repayment of the $150 million this fiscal year. As we enter the fourth quarter of FY '17, it may be helpful for you to consider the following. We're planning to open a total approximately 23 net new stores for the year, excluding our food and beverage division. For the fourth quarter, we're planning four net new stores, including one new Urban Outfitters store in North America, one new Anthropologie store in the UK, two Anthropologie closures in North America due to lease expiration and four new Free People stores and one closure due to lease expiration. The planned fourth quarter openings would result in the following store changes for the year, three net new urban outfitter stores, including one in Europe; seven net new Anthropologie stores, including two in Europe; and 13 net new Free People stores. For FY '17, we also opened two new Vetri pizzerias and one cafe adjacent to an Anthropologie large format store. Now on to gross margin, we believe our fourth quarter gross margin rate could decrease versus the prior year primarily due to higher markdowns. These markdowns could be driven by higher markdowns at Anthropologie related to their women's apparel performance and slightly higher markdowns at Urban Outfitters related to marginally higher inventory. Based on our current plan, we believe SG&A could grow at a mid single-digit rate for the fourth quarter. This increase would be largely driven by increased store-related expenses to support our non-comp store based growth. Capital expenditures for FY '17 are planned at approximately $160 million. Total spend for FY '17 is primarily driven by new, relocated and expanded and the completion of our new east coast fulfillment center. Finally, we're still planning our FY '17 annual effective tax rate to be 36% for the year and believe our fourth quarter tax rate will be lower than our annual planned rate. As a reminder, the foregoing does not constitute a forecast but is simply a reflection of our current views. The Company disclaims any obligation to update forward-looking statements. Now it is my pleasure to pass the call over to Sheila Herrington, President of the Free People brand.

Thank you, Frank and good afternoon. Today, I will discuss a few highlights from Free People's third quarter performance and then review the progress the brand has made on our strategic growth initiatives. In total, the Free People brand grew revenues by 16% this past quarter. The brand's strongest growth came from our wholesale business segment which delivered a 30% increase. When normalized for last year's operational challenges in our distribution center, the growth was still a strong 13% increase. This growth was driven by strength in our core apparel collection, increased business with online partnerships, along with the growth in expanded categories including movement, intimates and shoes, both domestic and in Europe. A double-digit increase in forward bookings makes us feel confident in the health of our wholesale business. I'd like to congratulate Chrissy Meehan-Mashinsky as well an entire wholesale team in leading this brand expansion. Free People's retail segment sales grew by 6% in the quarter, through the opening of three new stores, partially offset by a negative 1.5% comp. During the quarter, August was our weakest comp, reflecting a difficult seasonal transition. As we cleared through the product and began flowing newer fashion into stores and our direct-to-consumer channel, our business showed significant improvement, with both September and October delivering positive retail segment comps. While the store showed improvement as the quarter progressed, the direct-to-consumer channel lead the way with double-digit regular priced comps fueling a positive direct-to-consumer comp for the quarter. The customer clearly has reacted positively to our women's apparel fall fashion online and we believe this momentum can continue into the fourth quarter. We reacted to those reads by taking appropriate markdowns and are flowing in increased levels of product freshness through the holiday season. Now we would like to discuss our progress on our long term strategic growth initiatives. We remain focused on improving our website overall shopping experience. We have launched a new web platform for our direct-to-consumer channel in the first quarter of this year and have seen the benefits of this initiative. The site's load time is faster, we have streamlined our check out process and enhanced our search capabilities, to name a few of the benefits of which we believe have helped to improve our website conversion. Additionally, in September, we have launched the iOS shopping app in both the UK and China. Over 15,000 users have downloaded the app in China and sales through the app already represent 45% of demand within this region. With our customers' growing affinity for our mobile devices, we believe these types of investments are critical to our future success. While technology is considerably a part of the shopping experience, Free People's delivery of creativity and inspirational imagery has always been a cornerstone to our success. The social team has continued to raise the level of engaging content including videos, photographic imagery and collaborations. This resulted in over 3 million Instagram followers, a 30% increase over last year. Finally and extremely important for our long term growth, is the progress the brand has made in our new and expanded categories. The brand launched beauty and wellness online in July with a carefully curated assortment focused on natural cruelty-free products, including makeup, skin care and supplements. Early customer reads have been positive. Movement in beauty collectively accounted for 20% of the growth in the direct-to-consumer channel during the third quarter. Additionally, our expanded categories are featured in our larger retail store locations. We opened three larger format locations in the quarter, two of which are new locations, Honolulu and Charlotte and one of which was the relocation and expansion of our store in King of Prussia Mall. The King of Prussia store now houses all expanded categories including beauty in just over 6,000 selling square feet. The store has become a true brand-defining destination incorporating the touch and spirit of Free People. In closing, I'm proud of the team's ability to react quickly and create positive momentum as the quarter progressed. This is a testament to their creativity and nimbleness. I would like to thank the entire Free People team for their inspiration and dedication. Additionally, a sincere thank you to Meg Hayne for her passion, encouragement and the relentless pursuit of the excellence for the brand. While the brand has grown significantly over the past several years, we believe there's more opportunity ahead. I'll now turn the call over to Dick.

Thank you and good afternoon, everyone. Sheila, congratulations to you, Meg and the Free People team on the terrific progress you made with your apparel assortment. Your design and merchant teams did an excellent job of interpreting the fashion trends. Had it not been for a difficult seasonal transition in August, Free People comp sales would have been nicely positive in Q3. I believe the improved fashion coupled with better inventory control should allow the Free People brand to enjoy a positive holiday season. Good work, Sheila and thanks for your leadership. Now let me turn to a discussion around two of the retail topics I find most interesting, the shift in channel demand and the shift in fashion silhouette and discuss how these changes have impacted our brands in the third quarter. The divergence in demand by channel that we've witnessed over the past few years continued in Q3 this year. In general, the digital channel outperformed, stores lagged and wholesale delivered strong growth. In the store channel, fiscal shopping visits as reported by industry groups continued to be down on a year-over-year basis. Overall traffic fell by mid single-digits in Q3 for the second consecutive year. With several notable exceptions, our brands' comp store sales echoed this traffic pattern and were negative in almost all regions by all store types, mall, lifestyle centers and freestanding. Lower comp store sales at the Anthropologie and Free People brand in Q3 were driven primarily by fewer transactions and lower AUR. There were, however, a few bright spots in store channel performance. The Urban brand produced positive store comps in North America and Europe and the Anthropologie brand registered positive comps in Europe and the recently opened larger format stores continued to exceed expectations and deliver sales per square foot greater than the Anthro average. That said, URBN store comps were negative in Q3. The direct-to-consumer channel, on the other hand, delivered strong double-digit sales growth in the quarter. Both traffic measured in sessions and total number of orders received grew at double-digit rates and total conversion improved as well. Within the digital world, customers continued to migrate from desktop to mobile as preferred method of interaction. Mobile devices now account for almost 2/3 of total Company digital sessions. The strength in the digital channel more than offset the weakness in stores with total retail segment comp sales increasing by 1% in the third quarter. The disparity in channel results demonstrates that the consumers' affinity for digital shopping continues to grow. Her expectations around functionality and service levels in this channel are also growing. This is why we continue to make significant investments in personnel and technology that will expand our online assortments, enhance and personalize the digital experience, give us more insight into customer preferences and permit us to deliver orders faster and more reliably. Improving our capabilities in the digital channel is one of our strategic priorities. The third channel is wholesale. In Q3, the Free People wholesale business reported a 30% spike in sales but, as Frank and Sheila both explained earlier, this year's results benefited from shipping delays last year. Adjusting for this anomaly, wholesale still produced solid gains across all customer types, specialty store, department store and e-commerce retailers. During the quarter, we also saw a shift in fashion silhouette, that I've alluded to on prior calls, begin to strengthen. This emerging trend which seems to have its roots in Europe, is not impacting all brands equally. Predictably, younger, more fashion-forward customers are adopting these new looks more readily. So in Q3, the Urban and Free People brands benefited from the shift while the Anthropologie brand did not. In the fashion industry, times of rapid change, like we see when silhouettes shift, offer the greatest opportunities but also pose the greatest risks. Now let me turn your attention to the Anthropologie brand where third quarter top-line results were very similar to Q2. Total retail segment comp sales landed at negative 3% in the quarter, with weakness in stores more than offsetting the growth in direct-to-consumer sales. The comp shortfall was driven entirely by the apparel category. All other product categories and sub-brands delivered positive retail segment comps. The expanded categories of home, beauty, Beholden and Terrain performed particularly well. We expected to see more progress in the apparel category, but customer response to fall assortments was lackluster. This led to higher markdowns versus the prior-year period even though inventories which ended down 3%, were tightly controlled. While we could see modest comp sales improvement in Q4 over Q3 rate, we believe apparel sales on a year-over-year basis will likely remain difficult and weigh on total Anthropologie comps and margins for the holiday seasons. Transition in fashion silhouette are never linear or easy to predict. As a customer becomes more comfortable with a different silhouette and our merchants become comfortable presenting her with more newness, we expect better results. I believe we will begin to see improvement in customer reaction to the apparel offerings with our 2017 spring/summer deliveries. Despite the apparel issues, we remain confident the emotional bonds between the brand and our customers remain strong. She is responding enthusiastically to all of our expanded categories, especially our newly expanded home assortment. Reaction to the 200-page home journal mailed to customers in September exceeded plans significantly, so the home team is expanding the assortment further and plans to mail another home journal in spring. Other expansion categories experienced double-digit comp sales as well. During the third quarter, Beholden opened two new shop-in-shop locations and launched the series of omni-channel marketing initiatives which resulted in strong store and digital sales gains. The beauty category expanded into 65 additional stores during the quarter and the Terrain brand continued to benefit from inclusion into the Anthropologie group. During the quarter, Terrain launched several cross marketing initiatives and opened its first shop-in-shop in the new Walnut Creek Anthropologie store. And in early November, Terrain launched 10 holiday trim shop-in-shops in core Anthropologie stores. In Q3, Anthropologie opened two additional larger-format locations, Walnut Creek, California and King of Russia, Pennsylvania. To date, sales at these stores are running nicely ahead of projections which strengthens our confidence in the brand, the strategy of opening larger stores and the strategy of expanding product categories. The largest stores have also helped to build expanded category demand in the digital channel. This past weekend, the brand opened another larger-format store in the Stanford Shopping Center in Palo Alto. Besides an expanded assortment of home products, shoes, accessories and beauty products, the Palo Alto store also offers a full assortment of Beholden wedding gowns and occasion dresses and Terrain outdoor living products and decor. The store also provides customers with the Terrain cafe for casual dining. Customer reaction has been fantastic, with weekend sales coming in 33% above plan. During the quarter, Anthropologie was the second of our brands to migrate to our new digital platform. This platform allows for improved response times, a better cart and check out experience and vastly improved user visibility across all screen sizes. After being installed for one month, the brand has seeing a 40% improvement in user load time and a double-digit increase in conversion. The Urban brand plans to migrate to this platform early next year. I want to congratulate David, Meg and the Anthropologie, Beholden and Terrain teams for their successes in growing the expanded categories, in launching the larger-format stores and in producing strong digital channel growth. These important achievements continue to strengthen an already powerful brand. Turning now to Urban Outfitter results in Q3, the brand delivered a terrific quarter. Total retail segment comp sales grew by over 5%, driven by a double-digit increase in direct-to-consumer sales and positive store comps in both North America and Europe. Impressively, all product categories delivered strong regular priced comps in the period. A year ago, I referred to the stable foundation the brand had rebuilt from which they could grow. I'm pleased to report they are now delivering this growth, doing so by creating compelling trend-right product through internal designs and third-party collaborations, by producing differentiated and engaging shopping environments both in stores and online, by elevating creative imagery and social engagement and by executing exceptional marketing campaigns. Looking at results by category, women's apparel and accessories were both strong, the expanded categories, intimates, beauty, home decor and tech, all continued to excel and for the first time in eight quarters, men's apparel delivered a positive comp as well. Furthermore, the brand grew its male customer base by 17% on a year-over-year basis. The Urban brand also realized improved IMU and lower markdowns versus the prior year which drove 200 basis points of improvement in merchandise margins on top of impressive increases last year. In the last two quarters, the Urban brand has delivered an historic low markdown rate. While we may see a slight uptick in the fourth quarter, we believe markdown rates could improve even more as we execute initiatives to increase inventory turns and decrease weeks of supply. This year, the Urban store teams have further refined the shop-in-shop concepts first introduced in August 2015. These concept shops allow for larger assortments of expanded category products and more accurately align product demand by category with space allocation. The stores look and feel dramatically different and now provide a clear, engaging shopping experience. The customer has responded to these changes. During quarter in spite of negative store traffic on a macro level, the brand experienced higher store traffic counts and positive comps across all regions for the first time in 13 quarters. Meanwhile, third quarter metrics in the direct-to-consumer channel remained strongly positive with sessions, sales and number of orders all showing double-digit increases and customer frequency up as well. Our customer file continues to grow with double-digit increases in new, retained and reactivated customers. Across both channels, the teams created compelling brand marketing messages. Our social media team continued to drive significant engaging with particularly strong year-over-year increases in Instagram and Pinterest which were up 60% and 44% respectively. The brand now enjoys more than 6 million Instagram followers and many are highly interactive. The marketing team worked on many notable social campaigns in the quarter, with the Justin Bieber launch registering as our brand's largest social reach to date. Euro launched an exclusive product collaboration with Bieber for his Purpose tour in August. This was a timed launch in stores and online, first in London, then in New York City and then in Los Angeles. Long lines formed at Urban stores globally to purchase Purpose tour paraphernalia. Customers were highly engaged on social and registered 237 million Twitter impressions for this event and the exclusive product co-lab received impressive coverage from influencers' digital and print outlets. In summary, the Urban brand is enjoying considerable success. The brand is once again the destination for their core customer. It's in stores, online and via social media. The customer is engaged with the brand like never before. Congratulations to Trish, Meg and their teams on both sides of the Atlantic for orchestrating this remarkable achievement. Before I turn the call over for your questions, I want to recognize and thank our 26,000 associates worldwide, including our teams in North America and Europe. I thank our wholesale partners, domestic and international and our many vendors and suppliers. Lastly, I extend my thanks to our many shareholders for their continued support. I'm grateful for the opportunity to lead the URBN community. Thank you. I will now turn the call over to your questions.

[Operator Instructions]. Your first question is from Adrienne Yih from Wolfe Research.

Dick, I was wondering if you could and thank you for the color on the silhouette shift, but I was wondering if you can take us back to the 2008 to 2009 time period when it actually went to the upside down triangle. How big a shift is this? Are we going fully back to kind of tight on top, bigger on bottom? And at that point, you had stepped into it quickly and aggressively and so do you think that the business is trailing the trend like not in it effectively enough or kind of timing it and measuring it appropriately? Thank you.

I actually think that it was 2006, 2007 if I recall correctly, but you might be right. I think that we're in another shift that is similar. It's going to take awhile. Probably takes three to four years to actually get through and as I said, the ups and downs in that period can be reasonably severe. So I think that each of the brands has a different customer segment that will adapt to the shift at different times and at different levels. It's always a difficult thing to judge how much of the old and how much of the new based on how many customers you have that are more advanced and how many you have that are less advanced. But the overall point that I'm trying to make, A, besides the fact that there is a shift going on and in progress, is that, in the long term, it's incredibly positive for fashion retailers.

The next question is from Kimberly Greenberger from Morgan Stanley.

Sorry. Dick, I wanted to ask about also the progress in the fashion shift. Would you characterize Free People and Urban Outfitters as largely being through the fashion shift or is that shift for those brands still in progress, but there's just sort of more visible traction with that consumer? And has there been any sign at all on the Anthropologie side that customers are starting to wear the new silhouette? I'm just wondering, tactically speaking, how you think about navigating through the shift over the next four to six quarters at each brand. Thank you so much.

Well, Kimberly, I'll take a shot at it to begin with, but then I'll turn it over to my wife who knows much more about fashion than I. I think that we're not through at any of the three brands and I think that Urban is seeing, I guess Urban, I would characterize Urban in Europe as being the furthest along, but I don't think even they are, I would guess, even 50% of the way there and I think we're still progressing on the way. I think that you will see, as each quarter goes on, you'll see more and more toward that shift and your final question which has Anthropologie seen some of the shift? I think we're beginning to see that. So David, why don't you, after Meg talks, could you talk about how you see that in Anthropologie?

I really don't have much to add. It is come and going, there's a fine balance between keeping up with what we know and moving on to what we don't know and each brand has seen some light in the new ideas and new styles, so that's really exciting, but they are still holding on to sort of what we know. So it's really a good balance, but really excited with the new ideas that she is liking and where that can go because there's so much opportunity in that direction. Thank you.

For the Anthro customer, we've absolutely seen some movement in what she likes in terms of style and profile and proportion. In particular, we saw her adapt the increase or the rise, in wastes very quickly which allows her to wear -- and then we saw a real separation in the proportion of tops, in particular, up and out, a great deal of sleeve interest was embraced, but also still there was plenty of customers who shifted instead of big over little, was sort of long over lean.

The next question is from Paul Lejuez from Citi.

We talked about the higher penetration of e-com hurting gross margin a bit. That's been a dynamic for some time. Just wondering if anything has changed, you stepped up there and if there's anything that you can do to limit some of that pressure as DTC continues to grow as a percent of sales. Thanks.

This is Frank and you're right. That dynamic on DTC has been going on for some time and I think as it continues to increase in penetration, you'll continue to see delivery expense and logistics expense to leverage relative to the total of URBN. Where there's an incremental offset though is relative to the increased penetration, you do see reduced -- and leverage relative to store property, so as DTC increases, it does deleverage delivery expense and logistics expense but it does then provide for some offset opportunity in store property. Obviously, store comps need to hold their own as well. But we've actually experienced quarters where the store comps were negative and just slightly negative and, due to the increase in DTC penetration, we were able to see a benefit and leverage out store occupancy because of the benefit we get from the growth in that channel.

The next question is from Lindsay Drucker Mann from Goldman Sachs.

I wanted to follow up on your remark on gross margin. I guess this is for Frank or maybe for Dick. You talked about the 4Q outlook for gross margins could be down because of markdowns, but do you have any comment on IMUs or maybe the benefit from lapping the distribution center, the GAAP distribution center, that opened that was a source of expense? And, Dick, you alluded to these inventory initiatives that you have in store for UO that could accelerate turn even more and reduce markdown. I wanted understand maybe the timeline, specifically, what those could be and the timeline for implementation. Thank you.

Lindsay, this is Frank. Let me see if I can take your question relative to the fourth quarter. As it relates to IMU, we actually are looking for that, right now, planning for that line item to provide for some opportunity, some leverage, as well as potential relative to distribution. Although, right now, we're focused on our service levels there right now and we aren't getting, we aren't currently recapturing the deleverage that we experienced last year relative to our distribution center. But relative to IMU, we're looking for some improvement there. Unfortunately, right now, based on the current plan, we do believe that markdowns could cause the fourth quarter gross profit margin to be down similar to what we saw, similar to the decrease of what we saw in the third quarter and that's going to be, could be largely driven by increased markdown rate at the Anthropologie brand based on their current performance at women's apparel division.

Lindsay, this is Dick talking. About the inventory initiatives, we're trying to do two different things, one is have faster turnover, meaning that the velocity of the turn is greater and then we're trying to reduce the weeks of supply. Both of those, we believe, in the long term, will allow us to have lower markdowns and better fashion, more appropriate fashion. In order to do that, we need to have slightly faster speed to market and that's some of the initiatives that we're working on currently and making some decent progress on that, so I think that we can hopefully look for lower inventories and faster weeks of supply over the next year.

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

Two questions, one, on the Anthropologie larger-format stores, just curious are you measuring it from a sales productivity perspective of where you need to get leverage? Are you measuring it from how big do you grow the DTC business in the area? Or are you testing it from a category distortion perspective? And then, on the UO division, a lot of people have been commenting how big Calvin Klein and Tommy Hilfiger and Adidas look and I guess Nautica is now coming in the store. So do you have a goal of what you think third-party versus private label should look like as we head into next year or where it's been versus previous cycles? Thanks very much.

This is David. Regarding the Anthropologie expanded format stores, what we did long ago was to, as we got to know our customer and saw her real strong relationship and appetite for additional product categories, we expanded the assortment and then we expanded the offering online and then we realized that certain categories needed the physical presence and the marketplace to transact. A great example would be home, testing your first beauty product, any number of things. When we're measuring these, we're looking for total productivity over the long term, being able to see our share in the market from a customer grow, regardless of the specific channel she chooses to transact. We don't want to predict that. That being said, early on, we have seen, as Dick alluded to earlier and Frank did as well, the really strong early performance from the stores we've opened to date running well ahead of pro forma on the top line and we're watching the sales productivity, given how short a time period it is, sales productivity per product category and then trying to draw linkages to what's going on with digital. That being said, the multiple purchase behavior over the year takes quite a while to begin to see those trends from a macro perspective.

In terms of branded and the Urban Outfitters brand, you mentioned CK, Tommy Hilfiger and a few others. It's really important to understand that these are really the vast minority of the assortment and I think, even within these brands, the other thing that's a differentiator for Urban Outfitters is the fact that the majority of what we're carrying in Calvin Klein, Tommy Hilfiger and all the other brands, is exclusive product. So it's only available at Urban Outfitters. So I'm glad it's resonating and you're seeing it, but it is important to know that it's really the minority of the assortment.

And, Brian, I think that it's important to understand that the customer dictates. To the degree the customer likes the branded product, we will carry a little bit more branded product. To the degree they don't, we won't. So we do what the customer likes.

The next question is from Omar Saad from Evercore ISI.

I wanted to ask a follow-up question on the, your comments around the gross margin pressure in the Anthropologie apparel business. Is that related to this kind of allusive, mysterious fashion shift being too far ahead of the curve on the apparel side with the Anthropologie customer or is it related to other issues?

Omar, it's David. Yes, as we look at it, we would say it's sort of a combination of factors. As the customer is dialing into, as we're dialing into where the customer is on the curve would be one component of it. The second would be, as Anthropologie embarked on embracing a sort of a newer way of working and building our apparel right on the heals of the tremendous success at Free People and Urban, we're still learning how to work together more seamlessly, align around big ideas, execute well following the process and we're trying to make progress each quarter. With that being said and given the general, I don't know if uncertainty, but sort of where we're in this phase of the curve, we're making certain to enter spring lean in apparel, in particular, so that we can read and react, as Dick and Frank alluded to, thinking about ways that we can speed our turn and reduce markdowns for spring.

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

It sounds like a lot of good news coming out of the UO brand. I was just curious as to what happened with inventory, why that's elevated and if there are any specific categories where you expect the higher levels of markdowns.

So if you remember from Frank's commentary, he referred to the inventory overage as slight and marginal and Dick also referred to it as a slight uptick, so I don't want to lose sight of the headline being the great work the team has done around the plus 5% comp for the quarter. We did chase a little bit aggressively in Q3 and now we're seeing that in Q4, but it's certainly not material and it is something that we're going to deal with and will be clean for spring. That's the goal. If you look at the overage to last year, again, it's slight. But if you look at the inventory overage against a three-year average, we're still way under historic, where we've been historically. So we're dealing with it and look forward to Q4.

Just to reiterate and, obviously, agree with Trish. You're talking about inventory comps for the retail segment, the Urban Outfitters brand being just at a plus 6% and their current trend where they finished the third quarter at a plus 5%. So and if you actually look at it rounding, they are within 100 basis points there. So pretty tight and pretty well controlled. I think some of that slight markdown risk in the fourth quarter is equally due to inventories as well as it's due to near record margins last year. So and you know, we don't see that risk as being a significant material one right now. Thank you.

The next question is from Janet Kloppenburg from JJK Research.

Couple of questions, David, on the Anthropologie apparel assortments, it sounds like you have confidence that the business will strengthen in the first quarter or let's say, the spring season and I'm just wondering if there's some -- but you're still locking for gross margins to be pressured in the fourth quarter which means maybe it's not figured out. So what I'm wondering is are there green chutes that are giving you some evidence that what you've invested in for the spring season will help turn the business? And, Dick, I was just wondering, given the robust strength of the direct channel, if that's making you rethink your square footage expansion programs across all brands? Thank you.

As we look at the spring/summer season with Anthropologie businesses and, like many, as you move from spring to fall or holiday to spring, there's always a question about how the businesses are going to perform. We've been impressed with our customers' engagement with the brand, customer counts across all three sections, measurements are up, the large formats are doing well, digital has continued to grow at a double-digit pace. So a lot of very good finds. As it relates to apparel, we really don't want to predict how she's going to respond to it yet. We'd planned to enter leaner than we have before, leaner than we did with fall and holiday so that we can react to the trend. We're working, learning to also work together more cohesively as a team to make sure we're trying to put forward our best stories to learn from. But, ultimately, she will guide us.

I don't think that, first of all, you know we have one of the leanest store fleets in the industry and I don't think there's any way we can consider ourselves over stored and we've been extremely cautious about opening more stores in recent years. As far as the Anthropologie large-format stores are concerned, I think it's being proven that it was a very good idea. The extra and extended categories are performing extremely well. So I don't really don't think it's a problem with stores per se. I think the real problem is there are just too many stores in North America and I think what you'll see day in and day out are reports of people either reducing their store count or going out of business altogether which I believe, over the long term, will reduce the store count and bring the supply and demand back in line. With that, I guess the answer to your question is I think we're doing things just about right. We're opening a few stores and it's very selective. We're very diligent in making sure the pro formas work and when we go into re-up and we have to sign a new lease, we're being diligent about the, perhaps, downward pressure on sales and looking for rents that are either a little bit lower or very close to what still would be making money. So I think we're right on track there and I look forward, in two or three or even four years, when I think you're going to see significantly fewer stores across the country and the supply of apparel product decrease.

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

It's very important, the Purpose Tour. So I want to move off of the shift that has everybody so up in arms and just focus on your DTC business a little bit. You clearly, a highlight here in where your customer is shopping and you could see in the stores where some of the returns are the one of a kind rack. So I'm curious if you're having success moving customers into what I call bricks and clicks and then if you are having success at the store level in moving returns out without having markdown pressure or even pressure on the staff and the store and how to manage it, how that all kind of works out.

Yes, we're seeing a lot of returns from DTC coming into the stores and we're clearing some of those returns through the pick back and ship. But we're also doing some other things like, in a lot of the stores, we have a rack called last chance, where we take onesies, as we call them, that are usually returns from DTC and put them on a rack and mark them down. So we have markdown pressure there, but I don't think it's really out of control. We haven't experienced big problems with that, so I don't think it's going to be a big issue even as the penetration of direct continues to grow. We already have that in Free People where the penetration is the highest of the three brands and have been able to manage through it.

Marni, this is Frank. I just want to add on to that as well. The reality is if the customer wants to return a DTC purchase to the store, there actually oftentimes can be an incremental benefit for us because not only does it drive traffic, it gives her another opportunity to experience and interact with the brand and, oftentimes, we're able to convert her.

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

Dick, as you talk about summer 2017, I believe, at which we should begin to see the rebound on the apparel assortment, how do you see that coming along? What should we be watching for as we go through the next six or seven months? And then, as you think about Anthro and the increased investment in Anthro with the category extensions, how do you balance category extensions with adjusting and enhancing the apparel? One investment before the other? How do you think about the connection? Thank you.

Dana, first, I'm going to say that I said spring/summer and I have seen some of the advanced fashion from spring/summer and I'm pretty excited about it. So I'm pretty confident that the consumer will be excited about it. David, do you want to take a shot at that?

Absolutely. Dana, to your first question, we, well generally, when we looked forward at the line and Dick was referring to, as we saw presentation from our own brand team that put together continued to push the merchants and their thinking about proportions and silhouettes, really nice combinations of fabrics and prints. The stories are coming together and more distinct. We think we have the creative team lined, as Meg talked about, our concept to customer and working on our storytelling and we think with the merchants' eye starting to see and adjust, that we'll be able to buy and adapt more confidently. Is it late spring? Is it summer? Is it transfer fall? We're not certain. Again, she will let us know. To your question on the expended categories, it really is an exciting one and a thrilling place to be because when you work at URBN, we're thinking about growth and always thinking about our customer and we have made -- Dick and Frank have been tremendously supportive of helping us begin to expand, they offer like they have with all brands in order to meet at the lifestyle and life stage potentials of each brand. So we're looking at these the vagaries and trends in fashion as knowing that the brand remains incredibly strong. Like we've said, customer metrics are super strong. She's just buying less apparel and apparel at a lower price and, as that cycle turns back and you combine and then we come out of the apparel cycle in positive shape and you add to it the power of the other expanded categories, we think it could really become a very nice inflection point when you think about the strength of the in-store experience and then what we're investing in in digital as well. So we're excited to see apparel regain momentum in the future as we look at it over the cycle of the coming seasons.

The next question is from Oliver Chen from Cowen and Co.

Richard, as you articulate thoughts around digital capabilities, how would you prioritize the nearer term things you're looking to implement or edit or change and longer term digital capabilities? As we see it, Amazon is well positioned to be the number one apparel seller next year and a lot of customers start their journey here and you obviously have such great consideration expertise and fashion credibility in a store experience which is highly differentiated. But if you could articulate how you'll draw out your competitive advantages in that context as you guys have great understanding of what your customer is seeing holistically. Thanks.

Now, I could take a stab at that, but I'm going to ask an expert here to do it, Dave Hayne.

I think what we're very excited about is the helping to reestablish the creative execution that the brands bring to the table through the stores and looking at the opportunity to personalize the experience through the digital platform, so personalization is going to be a very big priority for us in the upcoming year. We also think customer service is going to be a key focus for us and we need to improve the delivery experience that we have for customers and make sure that she has a positive experience with us and continues to come back.

I would say one other thing is the communications and that goes to both personalization and delivery and having the customer be able to understand where she is in the process of her purchase is something that we want to accomplish probably next year.

The next question is from Simeon Siegel from Nomura.

Can you guys talk about any update to the international business? Frank, I think you mentioned foreign taxable losses impacting the tax rate. Just any thoughts on sales and profitability of international, thanks.

So, I'll just answer real quickly as it relates to the tax rate and then certainly let David speak a little more to international if he would like to, but as it relates to foreign taxable losses, we actually are seeing some benefits now due to foreign taxable income. The European business, quite frankly, at all three brands right now is performing well and, in many cases, especially in the stores leading the way. So we're seeing some incremental profits there versus where we've been in previous years and that's translating to a benefit in our existing tax rate.

Simeon, David here. We had mentioned several quarters ago the emphasis we're putting on going forward of exploring how to bring the brands even more strongly to the international markets combined with Dave Hayne's focus on direct-to-consumer. Stefan has been working with the brand leaders, Trish and Sheila and then Dave Hayne to develop our plans to take the brands, again, even more broadly. We're in the midst of reviewing the strategy and understanding the operational needs and the investment there, but it looks to be very promising and quite material in terms of the size of the opportunity and we're just right in the midst of reviewing that strategy now.

Our last question comes from Matthew Boss from JPMorgan.

So on holiday, what are you seeing from holiday levels or from inventory levels more broadly across the mall? And then just any comments on top-line trends by concept in November I think would be helpful, just how you guys see Q4 playing out as a whole.

Matthew, this is Dick. I don't go to the mall all that often, so I can't talk to other people's inventory levels. But what I will tell you is, from our point of view, we're excited about this holiday. I think it's going to be equally promotional to holidays passed, but for those who have the right product including the right apparel product, I think Christmas will be very good this year. And I think it's certainly going to be better than last year, so I'm optimistic about the holiday and fourth quarter and, as I said earlier, it's about 60% of our sales are going to come in the next four and a half weeks, so we will know then. It's tough to project right now. Our current trend would suggest that we're slightly ahead of our Q3 run rate and I'd rather be ahead than behind, but the next four and a half weeks are going to tell the story. Thank you.

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

That's all I have. Thank you very much and, everybody, have a nice Thanksgiving.

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