Good day, ladies and gentlemen, welcome to the Urban Outfitters third quarter fiscal 2013 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. Please do not queue for the Q&A portion of this call until announced. Anyone doing so prematurely will be deleted from the queue. If anyone should require assistance during the call, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to introduce Oona McCullough, Director of Investor Relations. Ms. McCullough, you may begin.
Good afternoon, welcome to the URBN third quarter fiscal 2013 conference call. Earlier this afternoon, the company issued a press release outlining the financial and operating results for the three-month period ending October 31st, 2012. 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. Meg Hayne, President, Free People Brand, will provide a brief update on the Free People Brand. Richard Hayne, our Chief Executive Officer, will 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, along with detailed management commentary, will be posted to our corporate website at www.urbanoutfittersinc.com. I'll now turn the call over to Frank.
Thank you, Oona, good afternoon, everyone. We are pleased to announce another quarter of record results for Urban Outfitters. We are proud of these results and especially happy with the progress we've made year-to-date. We entered the year with a clear plan, now we are seeing the benefits of executing that plan. Each quarter, we have delivered an acceleration of the sales growth rate versus the prior comparable quarter. In addition, we delivered significant improvement in gross profit margin and operating profit margin rate versus the prior comparable quarter. Before I discuss the specific financial results in detail, let me remind you that URBN quarterly financial periods are based on calendar months, not a 4-5-4 retail calendar. This means that Hurricane Sandy, which hit the Northeastern U.S. on October 28th, impacted the last four days of the third quarter.
In total, 106 of our stores were affected by Hurricane Sandy, and while we suffered little permanent damage to our stores, there were many store closures. These ranged from a few hours to more than a week. Additionally, we believe our direct-to-consumer channel was negatively impacted by customer power outages in the Northeast, including a portion of New York City. We believe the effects of Hurricane Sandy reduced our retail segment comparable net sales growth rate by approximately one percentage point in the third quarter and will have a measurable but lesser impact on our fourth quarter results. URBN carries business interruption insurance, which should cover a portion of these losses. However, the third quarter results does not include a provision for an insurance reimbursement. Turning now to the financial results. Total company net sales for the quarter increased by 14% to a third quarter record of $693 million.
This increase was driven by a strong direct-to-consumer growth rate of 36% and an $18 million increase in non-comparable net store sales, which includes 11 new stores opened during the quarter. Total company comparable retail segment net sales, which includes net sales from our stores and direct-to-consumer channel, increased by 8%. This includes increases at Free People, Urban Outfitters, and Anthropologie of 24%, 7%, and 6%, respectively. Total company comparable store net sales declined by 1%, driven by a 2% decrease in the average unit selling price and a 3% decrease in units per transaction, each of which was partially offset by a 4% increase in transactions. I believe it is important to note that if it were not for direct-to-consumer returns at the stores, which we currently charge against store sales, our comparable store net sales would have been low single digit positive.
I will address this further toward the end of my comments. Free People wholesale net sales increased 9% to a quarterly record of $41 million. This increase was partially offset by a small amount of net sales related to Leifsdottir, which was transitioned to the Anthropologie brand in the previous year. Gross profit for the quarter increased by 21% to $261 million. Gross profit rate improved 222 basis points to 37.6%. The increase in gross profit rate was primarily due to a reduction in merchandise markdowns. Total selling, general, and administrative expenses for the quarter increased by 17 percentage points to 24.1%. The increase in rate is primarily due to higher incentive-based compensation in the current quarter. Operating income for the quarter increased by 27% to $94 million, with an operating profit margin of 7%. Net income was $60 million, or $0.40 per diluted share.
Turning to the balance sheet. Total inventories at the end of the quarter increased by $28 million to $395 million, an 8% increase versus the prior comparable quarter. The growth in total inventories is primarily related to the acquisition of inventory to stock new and non-comparable stores and to support the significant growth in the direct-to-consumer channel. Comparable retail segment inventories were flat, and comparable store inventories were -6%. Lastly, we ended the quarter with $456 million in cash and marketable securities. As we look forward to the final quarter of FY 2013, it may be helpful for you to consider the following. For FY 2013, we are planning to open approximately 49 new stores, with approximately 10 new stores expected to open in the fourth quarter.
By brand, we are planning approximately 18 new Urban Outfitters stores globally, 15 new Free People stores, 14 new Anthropologie stores, and one new store each for Terrain and BHLDN. We are planning for continued year-over-year margin rate improvement with a goal of producing 200 to 250 basis points of improvement for fiscal year 2013 versus fiscal year 2012. As previously discussed, we believe our margin rate improvement opportunity is greater in the fourth quarter than in the third quarter based on last year's fourth quarter results. We continue to focus on effectively managing our selling, general, and administrative expenses but remain committed to investing in our business to drive long-term growth. This means increased spending, partially driven by the opening of our new West Coast fulfillment center, increased marketing and customer acquisition efforts, and further investments in technology systems and people.
Given our investments, we expect total selling, general, and administrative expenses to increase in the high teens in the fourth quarter. Capital expenditures for fiscal year 2013 are planned at $190 million to $210 million, driven primarily by new stores, the expansion of our home office, and the completion of our new fulfillment center in Reno, Nevada. Finally, our fiscal year 2013 annual effective tax rate is planned to be approximately 36%. As a reminder, the foregoing does not constitute a forecast, but is simply a reflection of our current views. The company disclaims any obligation to update forward-looking statements. Before I pass the call on to Meg Hayne, our Free People brand president, I want to alert you to a planned change in how we will report URBN comparable net sales beginning with the first quarter of fiscal year 2014.
Starting in fiscal year 2014, we will no longer report URBN comparable store or direct-to-consumer net sales rates. We will continue to report comparable retail segment net sales, which combines our stores and direct-to-consumer channel. This change reflects the changes we see in consumer behavior and our growing ability to present each brand as an omni-channel experience. With the growth of mobile and online sales that can occur anywhere, including inside one of our stores, combined with our offer to customers to return products to any store or to the fulfillment center, the line between store sales and direct-to-consumer sales has become increasingly blurred.
For example, we know that if direct-to-consumer returns into stores were posted against direct-to-consumer net sales, instead of our current practice of posting them against the store to which they were returned, third quarter comp store net sales would have been low single digit positive and all brands would have shown a positive store comp net sales for the quarter. As we continue to erase the boundaries between these channels in order to please our customers, the change in reporting provides our investors with a better understanding of our business. Therefore, we have decided to report the omni-net sales number, which is the most clear and accurate picture of our business. As always, our overriding objective is to do what is best for the customer. Thank you for your time. I will now turn the call over to Meg Hayne, our Free People brand president.
Thank you, Frank, and good afternoon. This quarter has been an exciting one for the Free People brand. We executed many initiatives that I am proud to share with you. Let me start with wholesale. In Q3, the wholesale business posted their best quarter ever with record sales and our highest shipping month in history. Overall, quarterly sales exceeded last year by 9%. Customer reaction to the product has been excellent, with a number of our wholesale accounts reporting plus 20% sell-throughs on a weekly basis. During the quarter, our brand launched a new relationship with Nordstrom, in which Free People built a lifestyle branded shop filled with exclusive product, fixtures and displays, and staffed with trained, brand-appropriate sales associates. We opened our first 800 square foot shop-in-shop in their flagship store in Seattle.
The sales lift from this shop has been dramatic, and we expect to expand this concept into other Nordstrom stores. The success of the Free People product at retail has translated into strong future bookings as well. Orders for future deliveries at the end of the quarter were running ahead of that date last year, and orders booked at the October MAGIC show in Las Vegas were the highest in the company's history. As the Free People brand recognition grows, we are also seeing more and bigger orders from international customers, including a newly opened account in Mexico. In order to facilitate this trend toward global distribution, Free People signed an agreement with World Company Inc. in October, which should help us gain more recognition and sales in the Japanese market. At first, World will focus on increasing wholesale distribution in Japan with current and new accounts.
As we gain a better understanding of the Japanese culture and customer preferences, we hope to launch shop-in-shops soon after. Now let me turn to our direct-to-consumer channel. The direct team produced an exceptional quarter. In September, the direct channel recorded the highest sales volume of any month in our eight-year history. That is, until October surpassed it one month later. The September and October catalogs were two of our best to date, both generating more sales, more social media likes, love, and buzz than any previous catalog. We are particularly pleased with the creative effort that went into our September catalog. Its success can be attributed to a combination of season-right product, a clever concept, strong brand-appropriate styling, and beautiful photography. As a result, traffic at freepeople.com reached new highs in early September as our catalogs hit home. Our international direct business continues to grow as well.
Total international orders for the quarter jumped by 66%, with Australia leading the group with growth of 155%. Furthermore, we are happy to report we successfully launched freepeople.co.uk. This should establish a base for Free People to expand through Europe. Turning to stores, our goal for fiscal 2013 was to open 15 new stores, including our first international stores. We reached that goal by opening five additional stores in Q3, and two of those stores were in Canada, one in Toronto and one in Calgary. Our entrance into the Canadian market has exceeded our expectations, and customer feedback has been exceptional. In total, Free People now operates 77 stores. As we have added more product and more product categories and assortments, we continue to experiment with the proper size for a Free People store.
Next year, we expect to open several slightly larger stores and to relocate and/or expand several of our existing smaller stores. This is part of our ongoing focus to drive top-line growth and profitability in all of our channels of distribution. Of all the initiatives we set out to accomplish in fiscal 2013, none was more important than creating and offering fashion-appropriate product, and I believe this has been our greatest success. Our third quarter product offering was significantly improved over last year. Trending categories fueled the fall season. We had many strong key items, fashion leaders, layering pieces, and attitude builders. The customer told us at every point of contact, through sales, through feedback to the sales associates, and through social media, we had what she wanted, and she liked the way we presented it.
This is our mission and ongoing commitment. To build a dynamic lifestyle brand that pleases our customers through product and through image and makes her confident in her wardrobe and her life. I will now turn the call over to Dick.
Thanks, Meg. Good afternoon, everyone. Free People delivered a great quarter. Congratulations to you, Megan, the entire Free People team. The Free People brand was not alone. Both the Urban Outfitters and Anthropologie brands produced strong third quarter results as well. Overall, it was the best third quarter in the company's history. We built on positive trends established in the two preceding quarters. Total sales, retail segment comp sales, gross margin dollars and rate, as well as operating profit and margin all improved in the third quarter compared to the prior year. All brands continued to deliver on three of the four major goals we established at the beginning of the year. The number one goal was to make steady improvement in productivity by offering more compelling products and by employing more effective marketing techniques. In the third quarter, we successfully accomplished both.
The product offered at each brand improved in the third quarter. Regular price selling accelerated and the corresponding need to use markdowns to clear less desirable merchandise fell by over 200 basis points. This was driven by improvement at all brands, but especially at Anthropologie, where regular price selling improved across all product categories. As a result, productivity increased for the quarter, with total retail comp sales rising by 8%, Free People wholesale sales increasing by 9%, and retail comp sales improving at each brand. The effectiveness of our marketing efforts grew significantly during the quarter as well. The creative execution of all the brands' catalogs and websites improved, as did the in-store visual presentations. The third quarter total web-based marketing spend almost doubled on a year-over-year basis, while the marketing spend on catalog operations decreased by 3%.
Total company marketing expense rose by 21% compared to last year's third quarter. The result of reallocating and increasing our marketing budget was a 32% increase in total web traffic, a 200% jump in sales coming from mobile devices, a 50% increase in sales coming from social media sites, and a 36% growth in total direct-to-consumer sales. The Anthropologie brand launched its website redesign on October 1st, and customer response has been positive, with conversion rate, average order value, and sales growth all improving. During the quarter, we also invested in additional personnel to help us create future gains and drive future sales. Bob McEldowney joined the company as Global Head of the Direct to Consumer Business for the Anthropologie brand, and David Norton joined our shared service executive team as Chief Analytics Officer. The second goal was to open new channels of distribution and acquire more customers.
Again, we succeeded. During the quarter, as Meg mentioned, the Free People brand signed an exclusive agreement with World Inc. to distribute Free People wholesale product in Japan. The brand also launched freepeople.co.uk and entered into the Canadian retail market by opening two new successful stores. Domestically, Free People opened two additional stores during the quarter and drove a 40% increase in visitors at freepeople.com. This year, Urban Outfitters Europe opened three new stores in Germany. Not only are those stores generating strong sales, but they are helping to drive demand at our fast-growing German website, urbanoutfitters.de, which saw an 88% surge in demand during the quarter. Domestically, the Urban brand opened two additional stores in the quarter, and the urbanoutfitters.com website attracted 25% more buyers compared to the same period last year.
Finally, the Anthropologie brand opened four new stores in the U.S. during the quarter, and as I mentioned, successfully relaunched its website. In total, the brands opened 11 new stores in the quarter, bringing the year-to-date total as of October 31st to 39, and total direct-to-consumer businesses attracted 32% more visitors versus the same quarter last year. The third goal was to expand product offering, especially in the direct-to-consumer channel. Web-exclusive product of each brand continued to grow during the quarter and now accounts for 37% of the direct-to-consumer business. This is almost twice the penetration versus the same quarter last year. The growth in web-exclusive product is one important reason the direct-to-consumer business accounts for an increasing share of total sales each quarter. The final goal, which was not met, was to launch or acquire new concepts.
We concentrated less on this goal so that the brand teams could focus exclusively on improving results within the existing concepts. Finally, even though it was not a goal discussed externally at the beginning of the year, let me share the powerful results produced by the company's Pick, Pack, and Ship initiative, launched toward the end of the second quarter. If you recall, this initiative allows us to fill customer demand from any of our points of inventory supply, including each fulfillment center and all of our stores. During the third quarter, $23 million of direct consumer-initiated demand was filled from the stores. Without this initiative, we estimate that one-half of that demand would have been lost due to out-of-stock positions in our fulfillment centers. In addition, this initiative has helped us to lower markdowns and enable the brands to plan their inventory with tighter weeks of supply.
Clearly, however, the biggest benefit of pick, pack, and ship is our ability to better serve our customers. In summary, we are pleased with the progress made during the third quarter and throughout the year. We announced at the beginning of the year, we were focused on steady improvement in the metrics that measure our business. Our teams have delivered just that. In the third quarter, better product, increased product offerings, better and more efficient marketing, additional new stores, and careful control of inventories and expenses have resulted in increased sales, improved gross profit margins, and higher profits. I am proud of our brand leaders and their teams for delivering these record results. Going forward, we are mindful of the challenges we face in the competitive retail landscape, we have demonstrated that our concept of building compelling brands that focus on the customer's lifestyles can produce superior results.
We will not waver from that concept. We have built brands that resonate deeply with our customers. Our strategy to grow these brands is clear, we have strong teams in place to execute this strategy. That is our formula for success. I thank our entire senior team, including our brand leaders and heads of our shared services and all of our 20,000 coworkers worldwide for their hard work, their dedication, and their inspiration. I also thank our shareholders for their continued support. That concludes my prepared remarks. At this time, we will open the call to your questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your questions have been answered and you wish to remove yourself from the queue, please press the pound key. Again, if you have a question at this time, please press star then one. Our first question comes from Kimberly Greenberger from Morgan Stanley.
Great. Thank you so much, congratulations on some very nice acceleration in the business. Dick, my question's on e-commerce, you've shown some really nice acceleration, particularly in e-commerce sales throughout the year, a big sort of step function up here in the third quarter. Is it possible to understand the drivers there? Is it improved execution on the product side, or is it in fact this cross-channel inventory management? Just looking at longer term, what are the keys, what are the sort of various legs of the stool that you think
Urban Outfitters Inc. needs to deliver to get to that 50% revenue goal.
First, thanks, Kimberly, for your kind words. We have concentrated, as you know, over the last year and a half on the direct-to-consumer channel and saw it as one of our main growth engines. Just the mere fact of concentrating on it and paying attention to it and staffing it has contributed significantly to our growth. Besides that, we have done a number of things to enhance the marketing of the websites, I would say that's happened in all three brands and probably has happened the most at Free People brand and at Urban Outfitters. I think going forward, we see the items that are going to continue to drive the sales in web as one, an increase in the product categories that we are offering and the increased number of SKUs that we're offering, what we call Web X product.
Then secondly, the increased and enhanced marketing. Those are the two main factors. Anybody want to add to that here? No? Okay, next.
Thank you. Our next question comes from Adrienne Tennant from Janney Capital Markets.
Good afternoon, everybody, let me add my congratulations. The year-to-date progress has been very measured and sequential.
Thank you.
Kudos there. Dick, I guess my question is, the business model is changing so much. I was looking at the total sales in the third quarter relative to the second quarter. They were up, call it $16.5 million, yet the gross margin was essentially similar to the second quarter, and I think that has to do with the DTC mix. I'm wondering if you can just help us understand, is the gross margin in DTC lower than stores, but the operating margin is materially better? As we model out on this 50/50 in the five-year timeframe, should we be thinking that that 40% margin that was stores only should be a little bit lower than that go forward? Thank you.
Yeah, Adrienne Tennant, I'm going to ask Frank to handle that. I will just say up front, I do not believe that that's what's driving the gross profit margin difference. Frank?
Adrienne, thank you for your question. Yes, the DTC channel does have slightly favorable gross profit margins versus the stores because it doesn't have the store property expense, as you know, and it does have slightly higher SG&A expense due to the marketing load that's put onto the direct-to-consumer channel. Overall, it is a favorable operating income profit rate versus the stores. As it relates to overall profit margin, our improvement this year is primarily related to markdowns, that's across both channels. Our gross profit margin year-over-year on a quarterly basis is due to improved markdowns at all of the brands, and this is primarily due to better product, more compelling product.
Thank you.
Thank you. Our next question comes from Lorraine Hutchinson from Bank of America, Merrill Lynch.
Thank you. Good afternoon. Just wanted to focus on Anthropologie for a moment and get your thoughts on what changed the most in the third quarter. Was it some of the new product from the new merchants? Was it the new pricing strategy that you've implemented? What can we expect to see on the fourth quarter progress?
David, you want to handle that?
Sure. Hi, Lorraine. Like we talked earlier, we've been focused at Anthropologie about making improvement quarter by quarter. That does combine many of the attributes you just discussed. Better products, better inventory controls, as well as stronger marketing activity that Dick had mentioned earlier. All of those yielded to, again, solid top-line growth as well as solid positive reg price comps, which is one of our big metrics that we talked about this year, was not chasing the amount of just top-line sales, but really driving towards full price sales. The other thing has been the customer engagement we've seen from the wonderful experience we've had with our field teams in the stores and then some of the progress we're making in direct-to-consumer.
Thank you. Our next question comes from Neely Tamminga from Piper Jaffray.
Great. Good afternoon. Let me also add my congrats to you guys.
Thanks, Neely.
Yeah, you bet. I want to ask a couple more questions on the whole West Coast fulfillment center. Could you give us a sense again, remind us where you guys are in that process and kind of flipping the switch on that center and when you might see some benefits kind of roll through the P&L? Just walk us through that. I just have a real quick housekeeping question for Frank. The compensation accruals that you referred to in Q3, does that consider and contemplate Q4 outperformance as well? I know some companies can accrue a couple quarters at a time. Just wondering how it is for your P&L. Thanks.
Okay. I'll ask Calvin Hollinger to take the question about the fulfillment center.
Hi, Neely. This is Calvin. We opened up the Reno West Coast fulfillment center mid-September, so we've been up about two months. Roughly 30% of our total online demand comes from the West Coast. At the moment, as we ramp up the volume, we are still having less than
Roughly about 15% is being fulfilled from the West Coast. It's still early days, the benefit we are seeing is we're seeing next-day delivery to our six westernmost states. Faster, more cost-effective delivery. Over the next couple of months, we'll ramp up the volume to get closer to the 30% being fulfilled from the West Coast.
Frank?
Neely, your question on compensation is, our accrual as of the end of the quarter is based on where we expect the annual results to be as of year-end.
All right. Next question, please.
Thank you. Our next question comes from Janet Kloppenburg from JJK Research.
Hi, everybody. Congratulations on a great quarter. Nice job.
Thank you, Janet.
Very nice. I was wondering if Richard or Frank could talk a little bit about the thought process on the ramp in sales for the fourth quarter. I think your inventories are much leaner than they were a year ago, I'm guessing that your clearance activity will be more subdued than it was in the prior year. I think you gave us an idea on margins, Frank, but I was wondering how you wanted us to be thinking about the top-line trends in the fourth quarter. I wondered about inventory content as well. I wondered if maybe some of that loss of sales from markdowns could be made up for by higher full price sell-through rates. Thanks.
Okay, Janet. I'll take the first crack and have Frank-
Thank you
come in. You've been in this business long enough to know that it's very dangerous to forecast what sales are going to be, specifically and especially around the holiday season. Like we said in our release today, the trend in November continues to be very similar to that which we saw in October. If that indeed plays out and that trend continues, we'd expect sales to be up. Again, we certainly don't know for sure. I've certainly seen a number of holiday periods where the trend changes radically come Black Friday. We'll know an awful lot more in about a week. Frank, do you want to add anything to that?
Yeah. Hi, Janet. How are you? Just to your comment on inventory, we don't think that our sales will be constrained by our inventory position right now. We believe last year, inventory was higher than where it should have been, and that's what you're seeing in the inventory comp. We don't think sales will be constrained in the fourth quarter. You are absolutely correct as we do anticipate being less promotional in the fourth quarter on a year-over-year basis, and that is built into our plans to hopefully improve overall gross profit margin by between 200 and 250 basis points on an annual basis. Thank you.
Thank you. Our next question comes from Anya Andreeva from FBR Capital Markets.
Great. Thanks so much. Good afternoon.
Hello.
Frank, I think you had mentioned there could be some impact from Sandy to the fourth quarter. I was hoping you guys could help us quantify that. Looking at the third quarter performance, if you could give us the monthly comp cadence, just trying to understand what September, the best month, or was it August? Then on the gross margin line, what was the drag to gross margin from the online exclusive products? I think you had some negative impact in the second quarter. Just hoping to get that for the third quarter as well.
Okay. Well, we'll try to answer at least one of your questions. Remember, please limit it to one. Frank?
Thank you very much for your question. As it relates to the sales comp, which I believe we put in the management commentary, I believe September was our best month in the quarter, followed by August, and then followed by October.
If I may, remember we are on calendar months and not 4-5-4, so there's an extra weekend in September.
Correct. In addition to that, as it relates to Sandy, we do believe Sandy could have affected our total retail segment comp by up to 1 percentage comp point in the quarter. We do believe that it could have an effect in the fourth quarter as well, but a lesser effect on the overall fourth quarter. Thank you.
Thanks, Anya.
Thank you. Our next question comes from Brian Tunick from JP Morgan.
Thanks. I'll add my congrats as well on the progress.
Thanks, Brian.
I guess sort of for Frank, first thing on the SG&A growth rate, I think you're saying mid-high teens here for the back half. Trying to think how we should be thinking about from a broad expense spending plans for next year. Do you have any catch up that you need to do in the first half, do you still need a positive low single-digit comp in the stores to get leverage? Maybe the brand precedence, it feels like certainly at the Urban division, there seems to be more promotions going on the private label side. Curious, are you using the BDG or some of the other private labels to participate more in the promotional aspect rather than do markdowns like last year? Curious on that thought process, what you're using the private label planning for.
Let's start with that question first. Ted, do you want to address that?
Yes. Brian, we had very nice improvement in regard to our markdown performance in the quarter. In fact, over the last three weeks, we have not annualized promotions that were done last year. In regard to when there is promotion in the business, there is a good chance that that can be on private branded product, being as that is the majority of the product in our mix. There's a very conscious approach and effort involved in the business at this point, going forward through the balance of the year, really, to not annualize much of the promotion which was in the business last year and to realize the margin improvement that goes along with that. I'm confident we'll deliver on that.
Frank?
Hi, Brian. As it relates to SG&A, we're in the current process right now of pulling together our plans for next year and our budget. I think it's a little premature for me to comment on growth rates. We will speak to you a little bit and give you a little bit more color on our next conference call.
Thank you.
Thank you. Our next question comes from Erika Maschmeyer from Robert W. Baird.
Thank you, I'll also add my congratulations.
Thank you.
Last quarter, you talked about how you had learned from Q1, and you mentioned that as you entered Q3, you'd be going into more of a blank slate from a fashion trend perspective, given the change in the seasons. Obviously, you did very nicely. Could you talk about your ability to chase in Q4 based on what you saw work in Q3, how much open to buy you have, how much national brands might factor into that process? Thank you.
Okay, Erika. I think that we did do a nice job of transitioning into the fall season, and we do have some good learnings, as they say in the business. I think that opposed to last year, we see the classification, let's say, of sweaters performing much nicer. Unfortunately for us, sweaters is one of those things that has the longest lead time, and so it doesn't do you a lot of good when you learn about it in September or October, because you can't really get back into it until next year. I think that, yes, we have learnings. We did a good job of transitioning, and it certainly will be of benefit as we go into the fourth quarter. I don't think it's as quite a great a benefit as we saw it going from first to second quarter.
Thank you. Our next question comes from Marni Shapiro from Retail Tracker.
Hey, guys. Congratulations. Great quarter and best of for holiday.
Thanks, Marni.
I was curious if you could talk a little bit about the traffic trends at the stores, in particular at Anthropologie. A couple things. Is she shopping the mall locations as well as non-mall locations? When she's in the store, do you get a sense that she's shopping the entire store, from apparel to home to accessories, or has her shopping pattern changed at all at Anthro?
Okay, Marni, I'm going to ask David to take that.
Hi, Marni. As you know, we don't have traffic counters in the North American stores. Our feedback from our field associates and team members there has really not identified any material changes in traffic patterns or shopping behavior, certainly mall versus street locations or lifestyle. When you look at the Q3 performance, our performance was stronger in accessories and apparel than it was home for the quarter. Our early indications in the holiday on home are, we're off to a strong start on the home. Nothing more really to report on that.
Excellent. Thanks, guys.
Thanks, Marni.
Thank you. Our next question comes from Paul Lejuez from Nomura.
Hey, thanks, guys. You mentioned earlier that EBIT margins were stronger online versus the stores. Just wondering, how did the margins look at retail and direct on a year-over-year basis? Were both up, or was the improvement driven by one versus the other? Just wondering how you expect that to trend over time. Thanks.
Frank, you want to handle that?
Hi, Paul. Thank you for your question. Yes, both channels were up on a year-over-year basis in the quarter. That was primarily driven by improvement in markdowns. Thank you.
How about over time, Frank? What do you expect?
Over time, I guess it would depend on what period you're talking about. Certainly as it relates to the fourth quarter, we are still planning for improved markdowns on a year-over-year basis.
Thank you. Our next question comes from Evren Kopelman from Wells Fargo.
Good afternoon. I wanted to ask about the pick, pack, and ship. If you can talk about maybe some of the initial learnings. What were some of the surprises that you've seen? Do you think the benefits can accelerate as you learn more about it and, I guess, can use it better? Thank you.
Certainly one learning we had was that the stores needed some additional payroll in order to handle the pick, pack, and ship function. We probably at first underestimated that and have since caught up and added the payroll that they need. There's a certain organization in the store that's necessary. There was a little bit of confusion at the very first when we initially launched. There are also some metrics that we use to determine where and when the pick, pack, and ship will be accomplished. We had to sort of tweak that for a while as well. We're pretty confident now that we
We have a better system in the stores. We have all the supplies that they need, so they're all ready for the fourth quarter. We think it's going to be even more meaningful in the fourth quarter than it was in the third.
Thank you. Our next question comes from Betty Chen from Wedbush.
Thank you. Congratulations on the great progress.
Thanks, Betty.
I was wondering if, Frank, you can remind us, in terms of gross margin last year, I think we saw that hurt by several different factors. Certainly markdowns was one of them. Could you just remind us of the decrease we saw last year? How much of it was markdowns versus occupancy versus potential higher input costs? Then, the opportunity as we go into Q4 this year, given the reiteration of the full-year gross margin target that you laid out. Thank you.
Thank you, Betty. The lion's share of the deleverage last year was driven by markdowns. Conversely, then the greatest opportunity for us is markdowns. We've entered the fourth quarter with higher inventories than we should have had, and the product wasn't received as well as it could have been. Our greatest opportunity is markdowns heading into the fourth quarter, and we still feel comfortable with where we're planning the year at 200 to 250 basis points of improvement on a year-over-year basis.
Betty, we're entering the fourth quarter in a much stronger position in terms of sales, regular price merchandise, and specifically with inventory. Our inventory is down from the prior year, and that's a very positive sign. We think we can still make improvements in the future. All the folks around the table are smiling because they know that's one of my strong pursuits. I think for the fourth quarter, unless some trend dramatically change, we should see a nice improvement in our gross profit margin.
Thank you. Our next question comes from Oliver Chen from Citigroup.
Hi, from Citigroup. Thanks, guys. Congratulations. Regarding Anthropologie and the pricing architecture going forward, how do you feel about the mix of good, better, best? A follow-up from an overarching perspective, what are your thoughts on the state of the SKU breadth of the product by chain versus balancing conservative inventory planning?
Okay. You want to take the Anthropologie question?
Yes. For Anthropologie, one of our hindsights from last Q3 was exactly that. We had not followed our attribution history and plan, and we had not really priced the product with the same perceived value. This year, as we talked about earlier, our strategy, our plan, our tactics for Q3 was to get better and more in line. I'd say we did an okay job at that. We mathematically delivered that, but I think it's something, a constant pursuit of all great merchants is figuring out how to make sure the price perceived value. We had opportunities to possibly raise prices on certain items, and I see as we look back at the quarter, we have opportunities where we missed some of the perceived value. All in all, I think we did a much better job this Q3 than we did last Q3.
We expect to see the same type of improvement for Q4 in terms of the perceived value.
Oliver, I think if I can understand your question, it was what is the impact of the Web-exclusive product on our inventories. Certainly, the Web-exclusive product, we continue to add, and we will continue to add more Web-exclusive product as long as the customer says that she wants it. So we are mindful that we do not want to get over-sold, and we do not want to balloon inventory just to have some immediate sales. We are very strict about our discipline of making sure that the inventory is productive.
Thank you. Our next question comes from Sharon Zackfia from William Blair & Company.
Hi, good afternoon. I was hoping to get some feedback on kind of a longer-term question as you're growing the e-commerce business. I'm wondering if that's impacting kind of the ultimate number of stores you actually expect to build for Anthropologie or Urban. If you could give us some thought process on how the sales build occurs in 2013 and 2014. I assume we're going to continue to see maybe square footage decelerate a little bit further, but a longer-term thought process on that, I think, would be worthwhile.
Well, Sharon, we continue to open stores and will continue to open stores as long as we believe that there are store locations that have the kind of demand that will support the store. The stores still are very profitable, and we don't have any intention of giving up stores. We don't think right now that the web business has displaced potential locations. We do not see that happening. We think they actually work very well together, and we see more than anything, there being a sort of what we refer to as the omni-channel effect, which is the two blending very nice and very seamlessly, allowing the women to shop wherever they want, whenever they want, and however they want. That's our goal, and it implies a continuing opening of stores.
We've always talked about both with the Urban Outfitters and with the Anthropologie brands, that somewhere between 200 and 250 in North America would be our max point. There's nothing right now to us that would suggest that that's changed.
Thank you. Our next question comes from Dana Telsey from Telsey Advisory.
Good afternoon, everyone, and congratulations on the progress.
Thanks.
Can you give a little bit more color on international, what you've been seeing there, how trends there have been similar or different than what you're seeing here in the U.S.? Also just on category-wise, accessories, tops, bottoms, what you've been seeing at Urban and Anthro and how those are performing. Thank you.
Okay, Dana, I'm going to ask Ted to handle the first question because Urban has the biggest penetration internationally.
Sure. Hello, Dana. The Urban business in the European market, of course, the market, a great deal of press in regard to the overall macroeconomic challenges. However, what we've seen in our business is performance pretty much in line within the store group to plan on a comp store basis. We, as you know, opened eight stores last year. Our stores tend to ramp a little slower in the European market than they do in North America. The performance on the new stores is in some cases exceeding expectation, very strong performances out of our new stores in Germany and some of the more challenged smaller markets coming up a little short of where we need to be. The overarching positive in the business is the reception and growth in direct-to-consumer, which is outdistancing our plans in the market.
As well as it pertains to product mix, we've seen good improvement in performance in our apparel businesses as we've come through the year. They started off the year with a bit of a challenge in first quarter, have improved consistently as we came through the year and experienced a good third quarter as well.
Dana, I would say the only difference between the two brands really is that Anthropologie has had more success with accessories in the accessory area than Urban Outfitters has. Both brands have shown actually, Free People as well, had very good response to the women's apparel business and at Urban Outfitters with the men's apparel as well.
Thank you. Our next question comes from Jeff Black from Avondale Partners.
Hey, congrats on a nice quarter.
Thanks, Jeff.
Dick, looking past the very easy compare we have in front of us. On the gross margin, where are we on historical levels in terms of markdowns? It seems like there's still some issues to clear product. I'm just wondering what the opportunity is. Is there an opportunity with certain segments of the assortment? When I look at 3Q, what I'm getting at is inventory is low, product is a lot better. I would think 3Q is a pretty good proxy for 1Q and 2Q of next year. What's the overall opportunity after we get the 250 basis points as you guys see it in terms of your margin recovery? Thanks.
Well, Jeff, I guess as a retailer, I'm an eternal optimist, I believe that we have amazing opportunities in front of us to improve our IMU, to improve or decrease the markdowns, and therefore, to increase pretty significantly our gross profit margin. In addition to that, I think we have lots of opportunity to continue to increase sales. I think that while we're very pleased with the progress we've made to date, we're certainly by no means satisfied. We see the opportunity. We know it's there, and we intend to harvest some of that opportunity in this coming year.
Thank you. Our next question comes from Barbara Wyckoff from CLSA.
Hi, everybody. Nice progress.
Thank you, Barbara.
Hi. I have a question for Ted and one also for David. Ted, how many stores do you need in Europe to have enough scale to achieve similar operating margins to the United States? I'll come back to David.
Well, the business produced double-digit bottom-line operating income with 20 stores. In regard to the scale of business, we're pretty well there. It's the investment we continue to make in the overall macro business and pegging that to the growth rate that we expect to see on a year-on-year basis is what we're involved in at this point.
Barbara, as you know, in the Europe continent and in U.K., occupancy costs run higher than they do in the States. We believe that will always be a bogey. We also believe that the growth of the direct-to-consumer business will help offset that. We see right now the European direct-to-consumer business is really the fastest-growing for both Urban and for Anthropologie. Now that Free People has launched there, we believe that'll be fast-growing as well. That is really our strategy in terms of making the overall European business a very profitable one.
Thank you. Our next question comes from Liz Dunn from Macquarie Capital.
Hi. Thank you for taking my question.
I was curious about free shipping. I see this announcement today about free shipping in Europe. I was wondering, and I know you've been sort of running free shipping over $100 for much of the quarter at Anthropologie, I was wondering where you stand on free shipping and if you think eventually you'll need to go to free shipping across both brands without a price break point, and whether or not that changes the profit equation at all.
Each brand has a slightly different approach to free shipping. I'll ask all three brands that are around the table to weigh in on this. David, do you want to go first, Anthropologie?
Sure. We know that shipping is a very visible and sensitive part of the value proposition for our customers. However, in Q3, we actually offered free shipping for half of the number of days that we did the prior year in Q3. We plan to be very careful and use it as a lever where appropriate for the business. We continue to test our way into understanding how it changes purchase behavior. We're looking at in many different aspects of the business. We try to engineer the business in the future to be able to withstand, but offer free shipping without hurting operating margins, but that would be in years to come.
Ted.
Very similar thought process in that we do not have plans to go to free shipping on a day-in day-out basis. We've utilized it in regard to certain time periods when we feel the customer is very much in the mood for shopping. We come back and put together our marketing calendar accordingly, free shipping is often part of that offer. No plans to go to it on a regular basis.
Dave, do you want to talk about Free People?
Yeah, sure. I will just mirror what has been said already. Free People just decided to go full time to free shipping over $100 for our customers. It's something that we had been hearing from customers. It's something that we saw an opportunity to satisfy them with. So far, we're happy with the results. We will be measuring the results over the next few quarters and probably will not decide to go to free shipping permanently for everything, but we'll continue with the tier model that we have.
Thank you.
Thank you. Our next question comes from Laura Champine from Canaccord.
Hi, it's Laura Champine.
Hi, Laura.
How you doing? The question's on the momentum in the direct business, which, of course, has taken a step function up in growth this quarter. Looks like most of the things that are driving that with increased marketing expense and so forth are actually sustainable. How sustainable do you think 30% plus growth is in DTC? Just so I understand, Frank, what you said about the change in reporting, you're gonna pull separate segment reporting for direct, so it'll be tough for us to see when you get to that 50% penetration goal. Am I right on that?
I promise you, if and when we get there, Gig will let us all know. We do think that growth is sustainable at the direct. I can't tell you it's gonna be at 30% or 20% or I can't predict or forecast what the percentage will be, we feel very strongly that we are in our infancy when it comes to direct-to-consumer business. If you'll allow me, since I guess I'm the chief historian here, we've only been in this business now for 12 years, and it is phenomenal that in that 12-year time, we can have almost one-quarter of our sales be in the penetration through the direct-to-consumer channel. There are so many technological advances happening, like mobile, where we see just an astronomical growth rate. I don't see a limit to this. I don't see an end to this.
I can't tell you exactly what the growth rate will be. Besides that, our council, who's sitting right next to me, wouldn't allow me even if I could. We do expect it to continue to grow. With that, I think all the questions have been answered. Thank you very much for joining the call, and we'll see you again in a few months.
Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.