Good day, ladies and gentlemen, and welcome to the Urban Outfitters, Inc. third quarter fiscal 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would like to introduce Oona McCullough, Director of Investor Relations. Ms. McCullough, you may begin.
Good afternoon, and welcome to the URBN third quarter fiscal 2018 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 31st, 2017. The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the company's filings with the Securities and Exchange Commission. We will begin today's call with Frank Conforti, our Chief Financial Officer, who will provide financial highlights for the quarter. Sheila Harrington, President, Free People brand, David McCreight, President of URBN and CEO of the Anthropologie Group, and Trish Donnelly, Global CEO, Urban Outfitters Group, will provide an update on their respective brands.
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 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 will start my prepared commentary discussing our recently completed fiscal year 2018 third quarter results versus the prior comparable quarter. Then I will share some of our thoughts concerning the fourth quarter of fiscal year 2018. Total company or URBN sales for the third quarter of fiscal 2018 increased 4% versus the prior year. The increase in sales resulted from a 1% URBN retail segment comp, a 9% increase in Free People wholesale sales, and a $14 million increase in non-comp sales. URBN retail segment comp for the quarter, adjusted for the impact of the hurricanes, was 2%. Within our URBN retail segment comp, the direct-to-consumer channel continued to outperform our store channel, driven by increases in sessions and conversion rate, which more than offset a small decrease in average order value.
Negative comp store sales resulted from declines in transactions, average unit selling price, and units per transaction. Store traffic for the quarter was up, with strong growth in our European market. By brand, our retail segment adjusted comp rate was positive at all three brands, with increases of 5% at Free People, 2% at Anthropologie, and 1% at Urban Outfitters. These comps have been adjusted for the two hurricanes experienced in the quarter. The adjustment represents approximately two-thirds of a point at each of our brands. Our URBN retail segment comp improved sequentially throughout the quarter, with both September and October being comp positive months. During the third quarter, we opened 4 new store locations, 2 Anthropologie locations in North America and 2 Free People locations in North America. Moving on to the wholesale segment.
The Free People wholesale segment sales increase of 9% for the quarter was driven by domestic and international growth in department stores, specialty stores, and direct to consumer. We believe Free People wholesale has the opportunity to continue to grow domestically through category expansion and internationally within all categories. We are planning similar growth in the fourth quarter of 2018. Additionally, we delivered our first Anthropologie Home wholesale order in the U.K. We believe Anthropologie wholesale of the home category has strong opportunities to grow with key partners in Europe as well as in North America, and we're excited to have completed their launch into this new channel of distribution for the brand. Moving on to URBN gross profit for the quarter. Gross profit decreased 1% to $298 million versus the prior comparable quarter. Gross profit rate declined by 142 basis points to 33.4%.
The decline in gross profit rate was primarily driven by deleverage in delivery and logistics expense due to increased penetration of the direct-to-consumer channel, higher international penetration, and increased furniture penetration. Total SG&A expenses for the quarter were down 2% to $225 million versus the prior comparable quarter. Total SG&A as a percentage of sales leveraged by 143 basis points to 25.2%. The leverage in SG&A rate was primarily due to savings associated with our store organization project and lower share-based compensation expense. These reductions were partially offset by increased investments in marketing expenditures to drive sales. Operating income for the quarter increased by 4% to $73 million, with operating profit margin flat at 8.2%. Our effective tax rate for the quarter came in at 37.4% versus 33.5% in Q3 last year.
The variance in quarterly rates is primarily due to the ratio of certain foreign profits and losses to global tax profits in those periods. Net income for the quarter was $45 million, or $0.41 per diluted share. Now turning to the balance sheet. URBN inventory was down 1% versus the prior year to $450 million. Retail segment comp inventory decreased by 1% at cost. We ended the quarter with $369 million in cash and marketable securities and have zero drawn down on our asset-backed line of credit facilities. During the quarter, the company repurchased and retired 3 million common shares for $66 million. This brings our fiscal year 2018 buyback totals to 8 million shares for $157 million. Capital expenditures came in at $20 million for the quarter, $63 million year to date, and we are planning for $90 million in total CapEx for fiscal year 2018.
The capital spend for fiscal 2018 is primarily driven by new, relocated, and expanded stores, followed by investments in the direct-to-consumer related technology. As we enter the fourth quarter of fiscal year 2018, it may be helpful for you to consider the following. We are planning on opening one net new store during the fourth quarter. This will result in 19 new stores opened for the year and eight store closures. For brand level store information, please see our financial metrics sheet posted to our urbn.com website. We believe that gross margin rate for the fourth quarter could decline on a year-over-year basis, primarily due to deleverage in delivery and logistics expense, primarily due to the increased penetration of the direct-to-consumer channel.
We believe the decline in gross margin rate could be lower than what we saw in the third quarter due to store occupancy leverage and lower markdowns if our positive sales performance continues throughout the quarter. Additionally, we believe gross profit dollars could increase on a year-over-year basis if sales growth from the third quarter continue to improve throughout the fourth quarter. Please keep in mind the holiday selling period has been difficult to predict over the last several years. This is only our current view. Based on our current plan, we believe SG&A could increase by approximately 4% for the fourth quarter. This increase could relate primarily to increased digital marketing investments to drive stronger top-line sales growth.
As we believe the brand's product offerings are improving, we believe there is an opportunity to increase our marketing investments to hopefully help drive an improving sales growth rate in the fourth quarter. Finally, our fourth quarter effective tax rate is planned to be approximately 32.3%, which would result in our annual effective tax rate at 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. It is my pleasure to pass the call over to Sheila Harrington, Free People Brand President.
Thank you, Frank, and good afternoon. I am thrilled to report the Free People brand delivered 8% sales growth in the third quarter. This top-line sales growth was coupled with expanded margins, leading to stronger growth in operating income for the brand. By channel, wholesale delivered 9% growth, driven by strong increases in specialty accounts. I would like to thank Kristie and her team for their continued strong performance. The retail segment increased by 7% in total, with a 5% adjusted retail segment comp, Free People's strongest retail segment comp this year. The retail segment comp benefited from strong double-digit increase in digital. This marks the fourth consecutive quarter the brand achieved a positive retail segment comp and reflects even more distortion by channel, with over 50% of our retail segment revenue now coming from digital.
Due to our recent re-platform and centralized digital team, we are excited by the new opportunities to continue to evolve our online experience. Additionally, during the quarter, we opened two new stores and ended the quarter with 132 doors. The brand is well positioned to continue to learn and react to our omni-channel opportunity as customer behavior continues to evolve. In both the retail segment and wholesale, the brand continued to experience strong total and regular price growth in apparel, particularly in our bottoms classification. Also worth noting, our intimates and shoe business showed strong growth within wholesale and tremendous improvement in the retail segment compared to the trend earlier this year. In September, the brand creative teams partnered with Vogue to develop the Coat Check video marketing campaign, combining strong product imagery and cleverness associated with both brands.
This collaboration was the first of its kind for the brand, we are committed to continue to find new and creative ways to speak with our customer and reach new customers. While we were pleased with the current results, the progress achieved on our long-term initiatives is even more exciting. First amongst these is the expansion of FP Movement, which represented over 11% of the brand's growth for the quarter. FP Movement grew 36% on a year-over-year basis. The growth is supported by 21 physical locations, 19 within existing Free People stores, and two freestanding pop-up shops. In comp stores with an FP Movement assortment, the category delivered double-digit increases, and the total store comp exceeded the fleet average by over 300 basis points, reflecting the healthy development of this concept.
We continue to invest in the initiatives to boost FP brand awareness, such as a collaboration with strong partners like Well+Good. We believe FP Movement has continued opportunity to help the brand grow and will continue to invest. Moving on to international expansion. Free People delivered 26% growth in the brand's international business, driven by both wholesale and digital. Wholesale experienced strong growth in Europe with existing accounts, as well as a new partnership with a French distributor. In the fourth quarter, the teams have secured additional partnerships in both Spain and Italy, we expect these to benefit sales next year. International digital growth was driven by strength in Europe and China. In Europe, the brand began fulfilling orders to our U.K. customers from our Rushden fulfillment center for the first time. This will enable us to shorten delivery times and provide better communication to our local customers.
We do expect this will further enhance the customer's experience and loyalty to the brand over time. I'm extremely proud of the team's results and the current momentum entering the fourth quarter, as well as the progress we have made on our longer-term strategic initiatives. We are optimistic that the strength of the brand experienced in the third quarter will continue throughout the fourth quarter, remain aware of the unpredictability of the holiday season over the last several years. I would like to thank Meg and the entire Free People team for a great quarter. Thank you, I will now turn the call over to David McCreight.
Thank you, Sheila, and good evening, everyone. I'm pleased to provide you with an update on our progress within the Anthropologie Group. As we mentioned on our last call in August, we were seeing early signs of improvement in North America in our fall product reads. I am happy to report that during the quarter, we did indeed see a change in our business trajectory. The Anthro Group retail segment comp sales improved in the third quarter to a +2% comp, a 600 basis points improvement from Q2's -4% comp. The trend improvement in North America was broadly based across expanded categories and apparel divisions in both selling channels. Importantly, comp sales quality also improved with regular price comps outplacing markdowns. The direct-to-consumer channel had another strong quarter of double-digit growth.
Momentum in this channel was driven by improved digital marketing effectiveness, a broader assortment that we continue to expand, and creative assets that increasingly market the lifestyle experience. The Anthro loyalty member passed free shipping, significantly increased new sign-ups, and overall digital customer counts, also lifting average transaction value with more units in our basket. We continue to invest in our digital shopping brand experience and the data analytics that power best-in-class digital merchants. Last August, we mentioned seeing traffic in our North American stores stabilizing. Store sales did indeed improve across the quarter, with the majority of our stores delivering a positive comp in the month of October. This was the first full quarter with our new field structure. The structure was designed to improve back-of-house and scheduling efficiencies while protecting the customer's experience and delivering more consistent merchandising messages.
We continue to evolve the omni-channel shopping experience through buy online and pickup in-store, as well as mobile ordering of items in-store that are not in stock. With new efficiencies and the aid of technology, Anthropologie continues to provide one of the more unique and compelling retail shopping experiences, and this is never more proudly on display than in the holiday season. From a product perspective, our expanded categories continued their strong comp growth rate in Q3, led by home decor as well as women's accessories and beauty. Anthropologie Home delivered their first wholesale assortment in the U.K., where it far exceeded expectations. While we have become accustomed to Andrew's successes in home decor, the exciting news within Anthro Group's Q3 comp growth was the change in our apparel trajectory.
As we have spoken of previously, the majority of our revenue decline in recent periods was due to the execution of apparel. In a short period of time, Hillary and the apparel team focused the offer on the separates trend that echoes much of what is happening across the fashion industry. They also concentrated on delivering more color, pattern, and special details with a touch of hand for which Anthro is known. In addition to the improved sales trajectory, feedback from listening posts in the field, social channel chatter, and online commentary indicate that customers and associates are increasingly enthusiastic about our offer. This revenue momentum has continued into November, when combined with a shift in fashion, could create conditions for a promising holiday season.
Turning to product margins, Q3 merchandise margin rates were flat to last year and were comprised of a reduction in markdowns offset by lower initial margins due to both lower penetration of own brand apparel and category sales mix. We anticipate higher market penetration in apparel to continue into Q4 and early spring as the newer merchant and design teams gain a better understanding of how to interpret the new fashion trends for our customer. However, we expect own brand apparel penetration to begin rebuilding by early summer of next year. With apparel showing new signs of health and continued momentum in the expanded categories, we can begin leveraging product strength to fuel strategic digital and international expansion initiatives and re-accelerate Anthropologie's growth. In advance of the busy holiday season, I would like to thank the many Anthropologie brand fans and associates working tirelessly to delight her every day.
Thank you, I would now like to turn the call over to Trish Donnelly.
Thank you, David, Good afternoon, everyone. 14 weeks ago, on our last earnings call, I delivered the news that the Urban Outfitters brand had posted a negative 8% global comparable sales rate for the quarter. I recognized product misses, particularly in our women's category, as well as some styling and brand marketing issues which had not resonated with our core customer. I also noted that we implemented a new speed to customer model during the quarter. This new model was designed to shorten our product lead times in order to get the right product in the right place at the right time. The creation, rollout, and implementation of the speed to customer model during the quarter was distracting and disruptive to the business, another factor in the top-line softness we saw in Q2. What a difference 14 weeks make.
I am proud to report Urban Outfitters' positive 1% adjusted comparable sales achievement for the third quarter. In a short time, with our new business model as the foundation, the team was able to react to shifts in trends and categories to dramatically swing the business nine comp points in one quarter. Of course, a business can't shift so drastically on a new business architecture alone. The design and the merchant teams are once again creating relevant products that our customers' loving, Our brand marketing team is supporting the business with compelling and creative campaigns. For Q3, Urban Outfitters delivered positive comp performance in both the women's and men's apparel categories globally. Apparel is having a very exciting moment given the shifts in proportion, resurgence in prints, and strong cycle in bottom. Customer reaction to newness and emerging ideas is strong, almost every sensibility is showing product opportunity.
Early signs point to this trend continuing in both women's and men's as we move through Q4. In Q3, the total global business saw a 24% increase in new customers over last year, with new men's customers outpacing the total. Our UO Rewards membership picked up 60%, and engagement continues to grow. Direct-to-consumer demand posted strong comparable sales in both North America and Europe, with both geographies seeing impressive year-over-year conversion rates. Although the retail store channel in North America remained negative in the quarter, it did show very nice comparable sales improvement versus the second quarter performance. The stores in Europe continued to drive high single-digit increases in traffic comps and positive sales comps to last year. Social engagement was another highlight this past quarter. Our global Instagram following was just shy of 8 million, and our 95 Instagram stories had over 30 million views.
One of our most successful campaigns of the quarter was our What Do You Champion partnership with the Champion brand, where we featured five up-and-coming celebrities and musicians. We saw more than half a million social engagements tied to the video and 2.3 million views. We also partnered with the ride-sharing app, Lyft, to provide free rides to UO home shoppers during the critical back-to-school shopping period. This partnership received 1.1 million organic Twitter impressions. Finally, within UO Community Cares, we partnered with girl group Fifth Harmony on VH1's Save the Music Foundation. According to ListenFirst Media Use Tracker, the tweet announcing the UO x Fifth Harmony collaboration was deemed the number 1 post on Twitter during the campaign window. The improvement in the business from Q2 to Q3 was exceptional.
The nine-point comp swing would not have happened without the incredible talent, energy, and commitment of the UO leadership team, as well as the entire field team, home office organization, and shared services partners. Meg and I would particularly like to recognize Sue, Gabby, Lauren, Colby, and Keith on the North America side of the business, and Emma and Claire on the European side. We truly value you and your team's impressive contributions, your passionate work ethic, and your love for our customer. Thank you. I will now turn the call over to Dick.
Thank you, Trish, and good afternoon, everyone. Congratulations to our brand leaders, to Meg, and to their teams for delivering exceptional improvement in third-quarter comp sales. When I spoke on this call three months ago, I voiced my disappointment in our second quarter results and stated the sales shortfall came primarily from our lack of execution rather than macro headwinds. I expressed confidence there was sufficient fashion newness to drive positive comp sales. Today, I'm pleased to report all brands executed well in Q3. They exceeded the expectations I had when entering the quarter, with each delivering positive retail segment comps and, in North America, sequential month-over-month comp sales improvement. In addition to the retail segment, Free People Wholesale produced another fabulous quarter. Two major trends drove the improvement, one old and one new.
The first was the continuing strength of our digital results, where each brand produced an excellent double-digit sales increase. Digital penetration grew by over 400 basis points in the quarter and eclipsed our previous high recorded in Q4 last year. October digital sales were especially robust. Each brand produced a year-over-year increase in excess of 20%. As we enter the holiday season this year, we are planning for digital penetration to grow even further. It should be noted that during the quarter, we also saw improvement in North American store traffic and less negative comp store sales than in the previous quarter. In Europe, both store traffic and sales remained strongly positive on a comp basis. The second and emerging trend across all brands was a revival in customer interest in fashion apparel. Quite simply, fashion is back, and it's selling.
Demand for apparel, driven partially by the shift in silhouette that I've alluded to in previous commentaries, finally gained traction in North America during the quarter. Regular price sales of women's apparel was positive at each brand, led by Urban Outfitters, with the European group's sales being especially powerful. As Trish noted in her commentary, our merchants were able to read and react to the demand because of improvements we've made in our speed-to-customer capabilities. I believe these competencies, which we are still refining and implementing, will become increasingly important as the customer demands more newness and fashion trends have quicker adoption rates and shorter life cycles because of social media use.
Based on the positive response to our current fashion offerings, combined with our improved ability to execute looks more quickly, I'm optimistic that our merchants will be able to deliver compelling fashion through the holiday season and well into next year. We're excited by the top-line potential created by the confluence of these two trends. To capitalize on this potential, all brands will invest more in digital marketing during the holiday period when online traffic peaks. Our primary goal, of course, is to drive sales, but the spend will also target customer acquisition and retention. While the ascent of digital within the omni-channel retail world can drive increased sales, as it did in URBN in Q3, it can also have a negative impact on our financial model, including causing store occupancy deleverage, increased variable expenses in delivery and marketing, and significantly higher investments in technology.
These additional expenditures are necessary to drive sales and grow share but can result in operating margin erosion. The question then is what can be done to offset some of these additional costs. In the short term, I believe our biggest opportunity is to reduce markdowns. Our speed-to-customer initiative, coupled with tight inventory control and adoption of new demand and allocation forecasting tools, could afford us the opportunity to reduce total markdowns by several hundred basis points. Furthermore, now that demand for apparel is trending higher, we also have an opportunity to produce better retail segment comps, which would help leverage all fixed and semi-fixed costs. Longer term, as our brands continue to expand internationally through a combination of owner-operated joint venture, franchise, and wholesale operations, I believe we will have the opportunity to leverage larger product buys to negotiate better cost prices, which should allow for increased IMU.
I also believe over time, we will see North American store rents adjust to the new omni-channel realities, after which comp store occupancy costs should begin to stabilize. If executed well, these short- and longer-term opportunities could help offset the additional expenses listed earlier. I believe our brands and our company are very well-positioned to adapt to the changing retail environment and succeed in the marketplace. We have no debt. We have expanded cautiously, and today, each brand operates a conservatively sized fleet of stores in North America. Our digital penetration is high and growing quickly. We operate three powerful brands, each of which possesses a proven ability to create unique, compelling products and experiences. Most importantly, I believe we have some of the best talent in the industry. Before I close, I do want to say a few words about the holiday season.
We all know this time of year has become highly promotional and somewhat unpredictable. We have no reason to believe this year will be different from a macro perspective. Having said that, we also know our three brands gained significant momentum as the third quarter progressed, and this momentum has continued in November to date. We believe our brands are better positioned for holiday this versus last year with fresher inventory, more giftable items, a plan to spend more on marketing, and the benefit of renewed consumer interest in apparel. As I write these words, our outlook for URBN in Q4 remains cautiously optimistic. In closing, I thank David, Trish, Sheila, Meg, our shared service leaders, and our 24,000 associates worldwide for their inspiring dedication, drive, and creativity. I also recognize and thank our many partners around the world. Finally, I thank our shareholders for their continued support.
That concludes my prepared remarks. I now turn the call over for your questions.
Thank you. If you have a question at this time, please press * one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Please limit your questions to one per caller. Your first question comes from the line of Adrienne Yih of Wolfe Research. Please go ahead. Your line is open.
Oh, thank you. Good afternoon and congratulations, everyone.
Thank you.
You're welcome. Dick, your comment on what you had just said about the deleverage phenomenon from brick and mortar as you move to online in the DTC. Can you talk more about the gross margin pressure? It used to be that you ran gross margin pressure and then the operating margin, the operating profit, I guess the profit dollars and the rate were actually accretive to overall margins. What would have to happen? What level of store traffic or comp would you need to get to basically break even on that fixed cost component? Thank you.
Hi, Adrienne. This is Frank.
Hey, Frank.
I'll be happy to take that. I'll tell you that this is something that we look at, quite frankly, on a pretty regular basis right now. It's hard for us to give specifics on the model because we are experiencing so much change as it relates to the penetration of stores and direct-to- consumer. Right now, our penetration is moving to our highest growth channels and segments around digital and wholesale, obviously, this can clearly have a positive impact on our top-line growth rate. The pace of the change right now to the digital channel has been pretty dramatic. As seen in the quarter, our penetration to the digital channel grew by over 400 basis points just in this quarter, and we would anticipate that to be pretty consistent, if not even accelerate in the upcoming fourth quarter.
The difficulty, though, as it relates to the overall financial model, is knowing exactly where the penetration lands and, even more importantly, the composition of how we get there. There's a very different financial impact depending on where stores and DTC are and how they make up the composition of the growth rate that's driven at any given point in time. What we do know is that we can improve our operating profit dollars as we continue to grow the business. Committing to an exact rate right now is something that's very hard to do. I think that the short-term opportunity for us, if you think about next year, I'll talk a little bit more about the longer-term opportunity, quite frankly, is just markdowns.
I think both Anthropologie first and then Urban Outfitters have nice opportunity to improve their profit margins and their gross margins in their business, just getting back to where they've historically run their businesses at averages and some of which from a markdown best. That doesn't take into account some of the initiatives that we're working on where we believe we can actually move past some of those historical benchmarks. As it relates to the longer term, Dick did mention several initiatives that we have in place and several opportunities and levers that we have in place to improve our overall profit margin. One is markdown reduction. There's several things that we're doing around markdowns, specifically around the Speed to Customer initiative that Urban has certainly led the way on.
Things that we're doing around data analytics to be smarter about how informed we are about our buy as well as the allocation of our buy. There are things that we're doing around increasing the volume of purchases through just the business that's growing, where we can get to IMU improvement, and there's other opportunities within the business as well. I know it's a rather long-winded answer because it's a question that we know is on everybody's mind as it relates to the model. I think the important point is we do think we can flow through bottom-line operating profit dollars as time goes on. The near term, the biggest opportunity is markdowns at both Anthropologie and then followed by Urban Outfitters. Over the longer term, I think it will depend just exactly where the composition of stores and DTC lands.
There are several initiatives and I think opportunity levers that we have that we believe that we can flow through better to the bottom line.
Your next question comes from the line of Kimberly Greenberger of Morgan Stanley. Please go ahead. Your line is open.
Great. Thank you. Wow, what a different three months make. I wanted to ask about gross margin, if I could. Frank, if you could help us understand the order of magnitude of each of the three contributing factors in the gross margin decline, that would be helpful. Then, Dick, I think you said full price comps were up, and I wasn't sure if that was all brands. I'm just trying to understand within the gross margin how merchandise margin is performing and AUR, I think you said was down. It doesn't sound like that is driven by markdowns, perhaps mix. If you could just speak to the various moving pieces in gross margin, that would be great.
Hi, Kimberly, this is Frank. I'll take as many of those as I can work through and remember. As it relates to the third quarter margin, quite frankly, the lion's share of the deleverage that occurred was all due to delivery and logistics, and that was largely driven by the increased penetration of the direct-to-consumer channel. I think what you're referencing is essentially why did margin not perform better due to the fact that we did perform better from a top-line perspective than we had anticipated coming into the quarter. The truth of the matter there is we didn't get the leverage that we could have from a markdown's perspective, and that was due to two things. One, we had to go deeper in markdowns for product that was not working.
Don't think of this as a breadth issue, the number of units we marked down in the quarter was actually lower, but the depth that we had to go to on those units in order to get them to move and get them out of the assortment was bigger than what we had anticipated. In addition to that, there was two categories hurting the Urban Outfitters brand a bit in the quarter, which we did anticipate coming in. One was shoes, and one was women's accessories. Both had higher markdown rates in the quarter and drove some challenges there on the markdown rate for Urban Outfitters brand within the quarter.
Your next question comes from the line of Paul Lejuez of Citi. Please go ahead. Your line is open.
Hey, guys. Thanks. Frank, any initial thoughts on CapEx for next year after a bit of a lower CapEx number this year? Dick, just curious, as you think about the mix of e-com and stores, what penetration do you have in your mind where you might see EBIT margin more consistently up on a year-over-year basis? I guess any early thoughts as we should think about next year's EBIT margin. Thanks.
Paul, as it relates to CapEx, there's really nothing large around the corner for next year that we see. We currently anticipate that we would think we would see an acceleration in CapEx. We don't have our final numbers and our budget completely put together yet, but I'd imagine it'd be relatively in line with what we see this year. I think as it relates to EBIT margin, as I mentioned earlier, I do think the biggest opportunity for the near term is for first Anthropologie and then next Urban Outfitters to recover back to where they've been from a markdown rate perspective. If they're able to do so, they're certainly able to help offset some of the channel shift, de-leverage points around delivery and occupancy, and flow through some EBIT dollars to the bottom line.
Paul, this is Dick. I think it was four years ago, I predicted that direct penetration would reach about 50% within five years. I think I'm going to be off by about a year. I think that that's probably the point where we start to see some leverage. I don't know if it'll go beyond 50%. I can't really speak to that. I know that stores are still very important. I know that the direct channel and the omni-channel combination is what's driving the customer. I do believe that we will get to the 50% in the next couple of years. I do believe that we will see the improvement in op income as a result.
Your next question comes from the line of Lorraine Hutchinson of Bank of America. Please go ahead. Your line is open.
Thank you. Good afternoon. Last year, you were a bit caught off guard by the increase in penetration of DTC during the quarter. As you think about planning inventory for the holiday season, have you contemplated an accelerating penetration increase in DTC?
Hi, Lorraine, this is Frank again. I would tell you two things. One, we have certainly contemplated an increase in DTC penetration for the quarter. Two, I will tell you each of the brands have further rolled out a shared inventory concept, whereas we're holding back inventory in our distribution center from stores off the initial size of what we used to initially allocate and reallocating later. If the demand, even if we were off from a forecast perspective and it shifts between the two channels differently than we originally planned it, we do have the opportunity now through shared inventory and a replenishment strategy to react in a more fluid and real-time perspective than we did going into the quarter last year.
Your next question comes from the line of Lindsay Drucker Mann of Goldman Sachs. Please go ahead. Your line is open.
Thanks. Good evening. I was curious as you guys think about SG&A, this year was a nice SG&A savings year due to some efficiency programs you put in place. Historically, the company has grown SG&A at a faster rate. It sounds like you're excited about investing in marketing and other top-line driving initiatives. Can you give us just a general framework to think about SG&A dollar growth for the medium term?
Hi, Lindsay, this is Frank. I'll tell you, as it relates to SG&A for next year, I think we'll give a little bit more of an update as we get through the quarter. Obviously, as you mentioned, we are testing some increased marketing spend here in the fourth quarter, which wasn't originally in our plan. We certainly think that it's very prudent to do so given some of the improvements that each of the brands have seen in the assortment and the overall improvement that we think we've seen in how the consumer is behaving. That being said, it is just a test, and the types of investments that we're making, this is not a capital spend, it's not leases, and it's not people.
This is one of the benefits of marketing spend is that it can be measured on a very short-term basis, and you can react in a pretty quick manner as to whether or not it's being successful or not. I think we're going to take some of the learnings from that test in the fourth quarter, and that will help to inform next year relative to SG&A. I think generally speaking, we would look to keep that in line and then hopefully leverage that from a sales perspective.
Your next question comes from the line of Janet Kloppenburg of JJK Research. Please go ahead. Your line is open.
Hi, everyone. Congratulations on the great results.
Thank you, Janet.
Dick, I had a question about your promotional strategy and your value messaging. Clearly, I don't think that you promoted more than you expected to in the quarter, but I felt that your messaging on value was stronger than it's been in a while, with what looked like a lot of planned category promotions, particularly over the weekends. I was wondering if you could talk a little bit about your strategy there and what you think the customer wants in order to drive traffic through both channels. Thanks so much.
Okay, Janet. After I answer what I have to say, I'm going to turn it over to Trish because, I think some of what you're talking about was at the Urban brand. I think what we're seeing in general is the customer is still very interested in value, and that value can be created by fashion, and we have plenty of that going on right now, and it can also be created by price, and a combination of the two. We don't think that, as Frank talked about before, that she's solely interested in price because our markdowns, as Frank said, are needed extra markdown in order to move. Where we see a lot of resonance with our customer is when we are promoting, and giving good, sharp prices for value items and fashion items.
I'm going to turn it over to Trish and let her talk about that a little more.
Hi, Janet. Thank you, actually, for noticing that. We are so much more strategic about our promotional strategy, and our value messaging than we may have been in the past. Just further to what Dick said, value messaging, it's not just discounting. It's finding great items at a great price. We're really, really happy with our pant assortment, and we've got a great $39 pant. We're proud to talk about it. It's a great value price. Just being able to communicate those kinds of things more clearly to our customer has really helped the turnaround this past quarter. Thanks.
Your next question comes from the line of Matthew Boss of JPMorgan. Please go ahead. Your line is open.
Thanks. Frank, as we think multi-year gross margins stand 500 basis points below 2013, I guess, how much of this do you believe was company-specific execution versus how much of it was structural industry headwinds? I guess what I'm really trying to do is size up the recapture opportunity at each of your brands.
Hi, Matt. Yep. This is Frank. As I said, I think for the near term, certainly the biggest opportunity is around execution of the brands. I'll start with Anthropologie from a markdown rate and then to a lesser extent, the Urban Outfitters brand. I think they both have healthy margin recapture opportunity next year as it relates to improving the execution of their assortment, which hopefully translate and should translate to lower markdown rates and overall operating profit. Over the longer term and what we experienced over the last several years, we would anticipate to experience over the next several years as well, there'll still continue to be the model shift that we're working through. We're going to actively manage the risks and opportunities there to try and add as much to the bottom line as we possibly can.
Your next question comes from the line of Brian Tunick of RBC Capital. Please go ahead. Your line is open.
Great. Thanks. I'll add my congrats as well to everyone.
Thanks, Brian.
Sure. Maybe Frank, do you want to maybe talk about what kind of maybe MMU expectation you have in your fourth quarter guidance, versus the MMU in the third quarter, just in light of your comments on the improving trends in the business, but also understanding the holiday promotional space. Just curious what your MMU view is in Q4 versus Q3, and maybe Trish can talk about on the speed to customer initiatives, maybe what categories she thinks still have the biggest opportunity or sort of what, as we look in the early part of next year, she's looking to buy. Thanks very much.
Hi, Brian. This is Frank. As it relates to the fourth quarter, I think right now, based on our current view, we do believe our margin rate could deleverage about half of what we saw in the third quarter, and that's based on where sales trends are right now. That deleverage would be driven largely by delivery and logistics expense. The reason we think that we can show that improvement, one is due to store occupancy leverage, as the sales hopefully continue to be strong as well as due to a lower markdown rate in the fourth quarter if product continues to perform where it is. Whereas in the third quarter, we saw MMU essentially flat or flat-ish. We do, right now based on our current view, are looking at the opportunity to have improved MMU due to a lower markdown rate in the fourth quarter.
I'll just throw out the holiday caveat, though, that please just keep in mind right now that the holiday has been less than predictable over the last several years. Obviously there are a lot of really important days and weeks ahead of us. Based on our current view and our current trend right now, we do believe that we can show MMU improvement in the fourth quarter, and that would be due to lower markdown rates.
Brian. Hi, it's Trish. In terms of the speed to customer model, we had been placing the majority of our receipts on a longer lead time. The new model has completely shifted that. We still see enormous opportunity even within women's apparel. This is still a very new concept. It's still very much a work in progress. Even in women's apparel, there's a lot more opportunity. We're on the same sort of cadence with men's apparel. We haven't touched so many of the other product categories where we see this as an opportunity. I think we have some really nice upside here.
Your next question comes from the line of Ike Boruchow of Wells Fargo. Please go ahead. Your line is open.
Hi. Let me add my congrats as well. Great quarter. Just on the women's bottoms business, can you maybe give more detail around what you're calling the resurgence there? I think it's the first time in a long time you've called out bottoms this optimistically. Curious if you could share what kind of opportunity there could be, if in fact there is a shift back to fashion bottoms again after what feels like a few years' hiatus.
This is Dick. I think there's a lot of opportunity across almost all categories. I guess I would say the exception might be dresses, even though we see the onesies selling very well. I think that separates is what's really happening in the business right now. That's, again, at the expense of some of the dresses, the one piece dressing that was selling. Those separates mean bottoms are selling. There's a lot of different styles and a lot of different fabrications within the bottom category that are performing extremely well. I would expect since this is an area that she doesn't have many in her closet, that should perform for a number of quarters. I think it's a distinct change in silhouette. Trish called it proportion. It's basically the same thing.
My experience over many years in this business is when a change of silhouette or proportion happens, it usually holds for anywhere between 5 and 10 years. I think we have a lot of quarters in front of us.
Thank you.
Your next question comes from the line of Simeon Siegel of Nomura Instinet. Please go ahead. Your line is open.
Thanks. Good afternoon, guys, and congrats on the progress. Can you talk about the international growth opportunity and maybe touch on the international margins? What are the gross and EBIT discrepancies between international and domestic, and how do you view the mix shift impact going forward there? Thanks.
Simeon, we have a lot of opportunity internationally. This is one of our big objectives, over the next year, two years, three years. We think we have, in Europe alone, at least 50% more stores that we can open and operate by ourselves. At the same time, we're trying to enter into franchise agreements. We've already entered into one, which is an agreement with a group in Israel to open stores in Israel, and I think the first store is slated to be open next May or June. We also are working with several other franchise groups, in the Mid East and other places to enter into agreements for those areas as well. We're also discussing entering into joint ventures in some areas.
It's basically all of the above, and I want to include wholesale in that because one of the big pushes in growing the wholesale channel is international. When you take a look at our sales breakdown, North America accounts for over 85% of our sales, and obviously you don't have to get on the Internet to find out that it doesn't account for 85% of the demand potential. We think we have enormous opportunity to grow internationally, and we are doing so.
Your next question comes from the line of Edward Yruma of KeyBanc Capital Markets. Please go ahead. Your line is open.
Hey, thanks for taking the question. Dick, you were kind of early in identifying opportunities around real estate. You indicated you were kind of making sure that lease terms were short, and that you were starting to see rent renewals get more favorable terms. I know you've cited that as a longer term margin driver, but where are you in those discussions, and has there been a change in the landlord community over the past six months? Thank you.
Edward. I think there has been change in the landlord community. I wouldn't say necessarily over the last six months, but certainly over the last year and a half. We see a lot more cooperation from our landlords, a lot more willingness to negotiate. They understand that the world is changing, and they understand that they have to change. We are seeing anywhere from percentage rent deals, all the way up to and including no increases when we go back for renewals. There's a lot of space in between there, I realize. That is sort of the range of what we are seeing with our landlords currently. In some cases, what we see is an ability to relocate and go with a different landlord in some of our areas, and get much better deals.
We are pursuing all of the avenues above because one of our longer term objectives is to bring down our store occupancy rate. Thanks.
Your next question comes from the line of Omar Saad of Evercore ISI. Please go ahead. Your line is open.
Thank you. It's great to see all three brands trending in the right direction at the same time. I wanted to ask you about social media. It seems like you guys are doing some pretty interesting things on platforms like Instagram. I know you can see products there now and get directly linked if you want to buy them. How long have you guys been doing that, and what are you learning in that channel, and what are you learning from that function as people can discover your products there now and get direct to buy from there? Is that proving to be a meaningful new dynamic? Thanks.
Hi, Omar. It's Trish. It's something that we're testing. We're in very early days. It's promising. We know, particularly for the Urban brand, our customer lives on social media, so that presence is really critical. Don't have a lot of detail I can give you around it other than, yes, we're finding it meaningful and yes, we'll continue to test new strategies.
Hi, Omar. This is Dick. I think what we're seeing is that it's really not driving a lot of sales just yet, but I think this is very early days, and I would expect this to be a major strategy going forward.
Your next question comes from the line of Marni Shapiro of The Retail Tracker. Please go ahead. Your line is open.
Hey, everybody. Congratulations. Your stores and your social media have been outstanding. Dick, you alluded to the fact that the omni-channel customer is your best customer. I'd just like to zero in on that a little bit. Can you talk about the penetration and the use of in-store pickup at Urban and Anthropologie? Is your customer using it, and what kind of attachment rate are you seeing to these orders? Just along those lines, what % of your customers are returning online purchases to stores? Because I view that as an opportunity as well.
Yeah. Marni, I don't think that we are fully exploiting the opportunity of pickup in store. We have to do several other things. We're making some improvements to site that will allow better use of that particular facet. I think that right now, I'd say that we are probably in the first or second inning of this, but we believe that long-term, that omni-channel experience is the one that she's going to trend toward, and that's the one that she's going to want to pursue. I don't have the exact specifics. We can get back to you on those, the numbers that you asked for. I think overall, I'd say it's something that we believe in strongly and that we are pursuing, probably with some IT enhancements next year.
Your next question comes from the line of Dana Telsey of the Telsey Advisory Group. Please go ahead. Your line is open.
Good afternoon, everyone. Congratulations on the improvement.
Thanks.
As you talked about in the second quarter, with the adjustment in the operating model across concept, design, planning, merchandising, and marketing.
Hello?
Can you hear me? Hello?
You're going in and out, Dana.
Can you hear me better now?
Yes.
Oh, perfect. With the operating model adjustments that you made to Urban in the second quarter, where are you in that progress to Anthro, how do you see it the same or different on sales and margin impacts on Anthro? Thank you.
Dana, this is Frank. I'm assuming you're talking about our Speed to Customer initiative that we're rolling out and that Urban Outfitters is currently working on. They're doing that within women's apparel primarily right now, we believe we certainly have the opportunity to do it in other categories. We do have the opportunity to roll that out to Anthropologie in the future as well. Right now, the Urban Outfitters brand has been leading the charge on our Speed to Customer initiative.
Your last question comes from the line of Mark Altschwager of Baird. Please go ahead. Your line is open.
Good afternoon. Thanks for taking the question. On the inventory side, just in the context of the improved demand backdrop, how are you feeling about your position there? Do you have the flexibility needed to chase into some of the trending categories? Any areas where you feel constrained? Where would you expect to end the year for inventory? Thank you.
Hi, Mark. This is Frank. We feel like inventory right now is managed pretty well heading into the fourth quarter. We don't think that it will be an inhibitor from the opportunity that we have to accelerate our sales growth if the consumer so cooperates. We do believe that it's well controlled. It's more current than it has been. We've been seeing that nice improvement on a year-over-year basis in managing our inventory and keeping it more current than it has been on a year-over-year basis. We do believe we have enough inventory to support an even healthier growth rate in the fourth quarter.
Okay. I think that concludes the questions. Now, this is a first for me because nobody on the call asked about November trends to date. I'm going to take the opportunity to just talk about them. I want everyone to know that so far in November, our total retail segment comps are running ahead of Q3 rate. I also think it's noteworthy, and you'll be interested to know that we're also seeing a meaningful improvement in store traffic and in store sales from their Q3 trend. Again, I give all the disclaimers that Frank talked about around holiday. I think it's fair to say that the brand teams are feeling pretty optimistic, and I believe the chances are good that this will turn out to be a strong holiday.
Thank you very much for joining the call, and I look forward to talking with you in three months from now, and I wish you all a happy Thanksgiving.
This concludes today's conference call. You may now disconnect.