Notes from Urban Outfitters' Q2 2013 Earnings Call

Wednesday, August 29, 2012


Note: I'll be back later today with a September 2012 catalogue preview!

Just over a week ago the corporate leadership team from Urban Outfitters shared its quarterly earnings results with investors. What did CEO Richard Hayne and Anthropologie Group CEO David W. McCreight have to say about our dear Anthropologie? Let's dig into the call transcript and find out!


Here are the overall company results for Q2 fiscal. Total company net sales for the quarter increased by 11% to a second quarter record of $676 million, with Anthropologie representing $281.8 million of that total. There was a robust Direct-to-Consumer growth rate of 22% and a $26 million increase in non-comparable net store sales, which includes 14 new stores overall opened during the quarter. Six of those were new Anthropologie locations. Total company comparable retail segment net sales, which includes net sales from the Direct-to-Consumer channel, increased by 4%. This includes increases of 12% and 6% at Free People and Urban Outfitters, respectively, while Anthropologie was flat for the quarter. Total company's comparable store net sales declined by 1% driven by a 4% decrease in the average unit selling price and a 1% decrease in units per transaction, each of which were partially offset by a 4% increase in transactions.

Direct-to-Consumer net sales increased by 22% to $138 million with penetration-to-total net sales accelerating 190 basis points to 20%. These results were largely driven by a 31% increase in website traffic to over 42 million customer visits.

The great news here is that Urban Outfitters had a great quarter overall, beating both in-house and market expectations. This news is great relief to me! I was starting to get concerned that the company's overall results would be dragged down as they continue working on Anthropologie. In some respects the company was hurt by Anthro's stale performance, but the other tentpoles picked it up. As Anthropologie has often been the brightest star, pulling the other names up by its tail, I think this is only fair. Urban's stock hit a 52-week high last week which is still far below the highs it reached in 2010 but is still encouraging. Analysts have mostly changed their "hold" or weak sells on URBN stock back to buy recommendations, which is great news for Urban Outfitters.

For consumers like you and me the good news is that the average unit selling price is also down. So a dress that may have sold for $200 in the last comparable quarter may be $190 this quarter. That may not sound like a big difference but over hundreds of thousands of units sold it is quite a gap. Luckily there were more customer purchase transactions over the quarter to help offset the price differences.

CEO Richard Hayne highlighted some milestones from the quarter, one of which I'm sure the community has feedback on:
I'll go over 3 major initiatives. First, we successfully launched our of pick, pack and ship capability. This gives us the ability to fulfill an online or in-store order from any store or fulfillment location in the United States based on inventory availability, proximity or a number of other factors. This functionality has a number of very important benefits, including enabling our brands to sell web-exclusive items that had been returned to the stores without first returning them to the fulfillment center. It also allows us to ship orders that are out of stock in the fulfillment center but in stock in the store. And finally, it allows the brands to better manage the disposal of their in-store markdowns. We have successfully tested this function toward the end of the second quarter and have slowly included more stores and more product categories. Based on the analysis of our early results, we estimate that this initiative should account for many millions of dollars in additional sales across all brands in the second half of this year.

The second initiative helping to accelerate the Direct-to-Consumer growth is our company-wide effort to focus on customer acquisition. This includes increasing the marketing spend at each brand. Historically, we have managed our marketing and related customer acquisition costs based on the conversion rate and the immediate revenue generated. We are now able to utilize our internal consumer database to calculate an approximate lifetime value of new customers and thus, we can more accurately adjust the cost to the benefits of acquisition. Using these new tools, we increased total web-based marketing expenditures by 21% in the second quarter, and we plan to accelerate the rate of increase in the second half of the year. Some of this increase in Web-based marketing is offset by a decrease in our catalog marketing expenses.

Finally, during the second quarter we successfully continued to expand our web-exclusive product offering. As an example, last year during the second quarter, we offered approximately 750 dress styles online across all of our brands. This year, we increased that offering by approximately 50% and saw an excellent return. We believe we can continue to enlarge the assortment in dresses and many other categories as well.
How's that pick/pack/ship working out? Well, if the EA community is any kind of barometer, the ability to fulfill online orders from stores has a long way to go before it can be considered a success. I've no doubt that the operations team worked very hard on getting this long-requested service into place. It's been 4 years since I last fully launched an ERP system but I still remember days slogging through the warehouse trying to figure out why the damn UPS labels wouldn't print out right, or why the picklists were offset by one column even though they looked fine in the database, or why certain products constantly had phantom inventory. So I'm sympathetic to all of the behind-the-scenes work that went into this.

Problem is, the feature has way too high of an error rate right now. Anthropologie deleted what seemed like over 100 customer complaints about cancelled orders/wrong items from its Facebook page. Every post on EA has people reporting issues with orders. It's clear that this service was launched before it went through a full user acceptance testing, and that's sad. Used to be that the golden rule was less than a 1% error rate on orders. I can't imagine Anthropologie is hitting that target right now.

It may have helped to note that this service is still in beta. Not every store is able to fulfill online orders right now; not every online item is connected to store inventory. But even had that beta tag been in place, why not make sure it's fully vetted before launching it? Anthropologie is doing more harm to its reputation by making its customers the unwilling quality assurance team, the testers. Had Anthropologie reached out to, say, 1000 of their most active customers and asked them to participate in a pilot program for this pick/pack/ship service I'll bet they could have ironed out 90% or more of the kinks. Instead, they're creating unnecessary frustration and driving people away. I will be very interested to see how this affects their next quarter.

The second initiative scares the crap out of me. Urban Outfitters has joined the ranks of most commerce companies in using Big Data to assess and calculate a lifetime value for its customer base. What does this mean? Much as each person has a credit score based on the number of credit cards you have, the debts you owe, and your record of payments, there are now companies out there creating customer scores based on the stores you shop at, the things you own, where you live, your income, etc. So a person who makes $100K a year, shops at Neiman Marcus and drives a Lexus will likely have a higher score than a person who makes $50K, shops at Old Navy and drives a Ford Fusion. These customer scores also evaluate how you've grown. For example, right after college I was living in Southwest Connecticut and mostly shopping at Bed, Bath & Beyond, Stop & Shop (that's a Northeast grocery chain), LOFT, and occasionally J.Crew or Anthropologie. Now I live in NYC, have triple the buying power I used to, shop at Pottery Barn and its ilk, buy my groceries at Whole Foods (Whole Paycheck to some), and shop mainly at Anthropologie with splashes of J.Crew, Madewell, Barney's Co-Op and Bergdorf Goodman. Think my customer score has risen? I'll bet it has.

The scary thing (to me at least) is that unlike your credit score these customer scores are not federally regulated. The marketing team of retailers will tell you they use these scores to create promotions tailored specifically to your purchasing desires and history. But that's just pure marketing bullshit. The much more likely scenario is that top customers will receive special incentives and that customers with more purchasing power will be prioritized over customers with less purchasing power. Here's an example: I'm a J.Crew cardholder, and in the years when I spent over $7500 with them I've gotten access to a VIP call line, special catalogues and invites to after-hours events. This year I've barely cleared $1000 with them and all of that has mysteriously vanished. It's fine -- I'm using the power of my wallet to tell J.Crew that I love them but their quality needs to improve. Similarly, I also have a Saks card. When I first opened the card I made a bunch of designer purchases. All of a sudden I was getting invites to parties at the store every week, getting calls from SAs in different departments -- one even invited me out for coffee -- and receiving special discount cards in the mail, provided I spend at least $750 of course. I've barely used the card in the last 8 months though and  those calls have stopped, the invites are gone and I'm just customer x. Again, I don't mind as I don't want to spend the money. But I am sad to lose out on my special perks. This is how retail has always been and will continue to refine in the future.

And finally, Mr. Hayne touched on the proliferation of online-only items. Many of these items show up in the NYC Anthropologies anyway -- I wonder how that skews the results. These items wouldn't bother me so much if the fit was consistent. Since fit is not reliable however it bothers me that we effectively have to pay shipping to try these items on. Not to mention the tall tax -- tall items are still online only even as petites get trunk shows and store boutiques and yes I am a bitter kitten over it.

One of the analysts asked about the online exclusives.


Betty Y. Chen - Wedbush Securities Inc., Research Division
Dick, I was wondering if you can talk a little bit more about the web exclusive. It looks like the team is having a lot of success on that front. Can you remind us what mix of the merchandise is now considered exclusive? And does that vary much by brand? Where do you expect that target to be maybe by the second half, over the longer term? And then you mentioned that as the web business grows, you would expect more of those to be in-house. Is that part of the hiring that Frank was mentioning earlier that, I guess, where we'll -- we need to do -- maybe build up an internal design team for the web exclusives? Or what should we be looking for?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay, the web-exclusive product is, just as it would suggest, product that's available on the web but is not available in the stores. It is driving a lot of the sales increases on the web. It is one of the primary factors that is driving that. And it tends to be product that -- as opposed to separate categories, it tends to be additional choices that we give the customer in product categories that we already offer. We've done an analysis of these kinds of things and have found that many of the web pure-play people have a significantly greater assortment of product than we offer, and we offer a product assortment that is pretty much in line with a lot of the traditional bricks-and-mortar people. And so this is just an effort on our part to get more in line with those pure-play people. And as I said, it -- we've had a lot of success doing it. So we'll continue to do it, but we do it measurably, meaning that we measure the results, and we want the penetration not to exceed that which what -- that is, what the customer wants. So we look at the productivity with the inventory versus the sales, and we'll add product based on her response to that assortment that we offer.


I think Mr. Hayne's answer, and the strategy detailed within, is very smart from a business perspective. Urban Outfitters clearly recognizes that they need to operate on two levels: the brick and mortar level of its stores and the direct-to-consumer level which includes the catalogue and website. When he mentions "pure play" stores Mr. Hayne means companies like Shopbop or Ruche -- they have a website and warehouses but no stores customers can walk into. If the idea for Anthropologie truly is to offer additional variants of existing products as online-only, I suppose I can deal with that. Because at least I'd have a chance to try the item on for fit. But I think it results in disappointment more often than not, and by extension more returns. The results don't bear that out right now...but I think they will in time.

The cautious approach is smart. Piperlime, for example, is Gap Brands' shoe store that expanded into clothing last year. After experimenting with a pop-up shop in NYC last year, they just opened a permanent NYC location in Soho. I have a feeling that more pure-play online shops will do the same. To truly grow, you still need a physical location. We haven't quite Amazoned the landscape yet.

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A concern of mine continues to be Anthropologie's expansion. It seems like they've been opening store after store after store, and I'm concerned about oversaturation. One analyst shared my concern.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division
You mentioned you're rethinking bricks and mortar and opening slightly fewer stores than originally planned in fiscal '13. Could you talk about how you're thinking about opening for next year and beyond? Could this mean potentially fewer store openings and, I'm assuming, faster online growth?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Well, we do anticipate faster online growth. But we also anticipate slightly fewer stores being opened, and it's not because we believe stores are no longer the vehicle. Our stores are -- continue to be very profitable, and so we are opening stores. As you probably realize, we have for probably the last 10 or so years talked about an upper limit of the number of stores that we want to open in North America. And that number, for both Anthropologie and Urban Outfitters, is somewhere around 200 to 250, and the number for Free People is somewhere probably around 100 or maybe slightly more. So given the fact that we have a certain number of stores left to open, it -- I think it's prudent for us to open them less quickly, meaning that we don't -- we could, given our capabilities, open most of them that are remaining in the next year or 2, but I don't think that, that would be a particularly smart thing to do. So we will de-accelerate the number of stores that we open in North America. We continue to grow the number of stores we have internationally, and we believe that, that is the right thing to do. At the same time, we believe that Direct-to-Consumer will continue to increase its penetration to total stores -- to total sales, I mean.

I am relieved to hear that Anthropologie will end up with something in the neighborhood of 200 to 250 stores. For comparison, J.Crew has about 350 USA stores and the Gap has 2,550. Although I know there are community members stuck in a no-Anthro zone, it's important that the brand doesn't over-expand. Ubiquity will hurt it. Mr. Hayne also indicated that Urban Outfitters is looking to expand its online channel to Asia in the next 12 months, with Anthropologie soon to follow. Stores could open within the next 2-3 years.

Many of the analyst questions this time around focused on Anthropologie, yielding some terrific information for us to parse.


Neely J.N. Tamminga - Piper Jaffray Companies, Research Division
I was just hoping maybe David could just pipe in a little bit more specifically on the road map to rebalancing the price points at Anthro. Kind of where are you in that strategy? Are you pleased? How should we think about the timing at the back half as you roll that out?

David W. McCreight -- CEO, Anthropologie Group
Thanks, Neely. So for the -- as we went through most of the – for the first half of the year, price points were comparable for total Anthro to the prior year. However, beginning in Q3, we think we'll have made adjustments to our price points for -- particularly in the apparel area, we'll be below last year and closer to 2010 averages.

At first this made me excited -- closer to 2010 prices! Two years ago!! Prices must have been lower then, right? Right?!? Then I realized that 2010 marked the upswing of prices so in most cases while yes 2010 is lower than 2011, it's only by a couple of bucks per item. What we need are 2008 prices please.


Anna A. Andreeva - FBR Capital Markets & Co., Research Division
I had a couple of questions. First, if you could comment about the trend in the business quarter to date. This is the beginning of easier comparisons for you guys. And then secondly, if you can talk about some of the categories at Anthropologie that are working. Obviously, it's a bottom trend out there that is working quite a bit, but it seems like some of the other categories are picking up as well. Maybe if you could talk about that.

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay, I thank you for your question. I -- we don't comment too much on immediate trends. But I can tell you that the trend line has not changed significantly in the first part of this quarter. So probably no other comments necessary there. It is a bottoms-driven cycle, and I'm extraordinarily proud of and pleased with the brands and the talent within the brands that have been able to adjust and adapt to that. Urban Outfitters and all of these brands have consistently done better in tops-driven cycles, and they really have stepped up and adjusted to this new environment. I don't expect that to change. The -- certainly the -- it's -- continues to be a bottom-driven cycle, and we expect to be able to continue to deliver. So thank you.

So...more polka-dotted jeans then? And graphic prints, perhaps more geometric for fall on pants? And even more 15-inch miniskirts? I am not excited about this at all. What about dresses, which have traditionally been an Anthropologie strength? Or sweaters?


Roxanne Meyer - UBS Investment Bank, Research Division
You mentioned a desire to create a more exciting store experience, though in my view, you've already got the industry-leading experience with the customer that spends more time in your stores, probably the most. So I was just curious what you're planning to do there. And where is the opportunity to really improve upon that experience? 

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay, I'm going to take your first question and tell you that we're not prepared right now to talk about it. We believe that there are a lot of things that can be done, and we believe that it's all about experience and entertainment. And I'll kind of leave it at that. Probably sometime in the next 6 months or so, we'll be prepared to talk in a little bit more depth, and we will probably have some kind of -- at one of our functions or one of the conferences, we may be ready to launch what exactly we're going to do. But it will -- I'm excited about it, and I think everybody here in Philadelphia home office is excited about it. So I expect it to be something that we'll roll out in the next 2 years...

Well, I'm intrigued. What on earth could this new store experience be? I want to know more!

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It's interesting to hear the corporate leadership broadcast itself as being truly in-touch with the customer base. I think that on some levels this is true. Anthropologie incorporated customer reviews way before many of its peers, has been brilliant when it comes to social media outreach, and doesn't settle for one-sided conversations.

They solicit feedback. But. Are they truly listening to it? This is my biggest concern right now. How can they talk about the successful launch of a service that drew hundreds of complaints? They need to do better at their response to situations like these. To answer my own question they are listening to customers. The petite trunk show is an example of this. I hope they continue to actively incorporate customer feedback into their wares. The future of Anthropologie depends on it.

I was also surprised by the lack of design questions. A couple of analysts touched on the demand for market brands vs. in-house, but no one really asked about what's hitting vs. not. Anthropologie still has some work to do with its designs, with its materials, with the quality. That should be concern #1.

What do you think of this call and the team's thoughts? What is your feedback to Anthropologie's leadership?

More:
Urban Outfitters Q2 2013 Earnings Call Transcript (Seeking Alpha)