Notes from Urban Outfitters' Q3 2013 Earnings Call

Tuesday, November 27, 2012

Note: I'll be back later today with a Gifts 2012 catalogue review!

Last week it was once again time for Urban Outfitters' executive leadership to join analysts and listening stockholders and discuss the company's quarterly results. As always a few morsels were dropped into an otherwise standard call. Let's dissect and pull out the intriguing answers.

To begin, here are the quarterly results. For the quarter, Urban Outfitters reported a profit of $59.5 million, or 40 cents a share, up from $50.7 million, or 33 cents a share, a year earlier. Revenue increased 14% to $692.9 million. This missed market expectations by a penny and caused the URBN stock to tumble a bit last week, but are a vast improvement over last year's comparable quarter results of  33 cents earned. Hurricane Sandy affected results because of widespread power outages in the NYC area, traditionally a very strong market across all the Urban Outfitters brands (Urban Outfitters, Anthropologie, Free People, Terrain, BHLDN).

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 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.

On EA we recently discussed how online orders returned in stores are counted against store sales. Urban Outfitters CFO Francis J. Conforti noted this as well, detailing that 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. He noted that if it were not for direct-to-consumer returns at the stores, which UO currently charges against store sales, comparable store net sales would have been low-single-digit positive.

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 noncomparable stores and to support the significant growth in the direct-to-consumer channel. Comparable retail segment inventories were flat and comparable store inventories were minus 6%. Lastly, Urban Outfitters ended the quarter with $456 million in cash and marketable securities.

OK, let's translate. First, Urban Outfitters ended the quarter with a very healthy amount of cash in-hand which is great to see! They had eaten a lot of operating costs in the last few quarters by taking Leifsdottir back in-house after it had been a wholesale brand; by opening a new West Coast warehouse and by rapidly expanding its store footprint. While those costs come from different parts of operations it was eating into UO's overall cash balance. That's not necessarily a bad thing in practice but it does cause investors to get squirmy. By the way, Urban Outfitters is nearing completion on another fulfillment center just outside Reno, Nevada. The company noted that 30% of online demand comes from the West Coast. That's a huge proportion!

Another positive trend is that net sales were up 6% at Anthropologie for the quarter after being flat last quarter. How'd they do it? First they did it by increasing warehouse inventory and expanding their "online-only" item cache. That helps keep their shipping costs down and allows them more precise inventory control. Secondly, they sold more items at full price. That's great news from a business perspective because it means the designs are resonating with customers and people are opening their wallets more often. During the call portion the leadership tried to talk down discounting (i.e. sales) but that markdowns should be acknowledged as another factor. Last quarter there were multiple free shipping periods, a 25% off sale promotional period, a 25% off bedding promotional period, and several huge sales that included both clothing and home goods. That's where the 2% decrease in average unit selling price comes from while there was a 4% increase in transactions. Customers were buying more often, but buying on sale still more than full price. Full price is starting to make gains though.

On a side note, Free People's President Margaret Hayne spoke quickly about their success in the last quarter. She credited the creative team, engrossing catalogues and fantastic store assortments. Brand recognition has steadily increased and their wholesale orders hit records during the last three buyer shows. I agree on all of these points and just want to give Free People major kudos! They've been the most interesting brand in my repertoire lately. I am in love with this brand!!

CEO Richard Hayne also made remarks, from which I'd like to pull a few quotes.

The #1 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 priced 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 priced selling improved across all product categories. As a result, productivity increased for the quarter, with total retail comp sales rising by 8%...

...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 1, and customer response 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 McElroy [ph] joined the company as Global Head of the Direct-to-Consumer business for the Anthropologie brand, and David Norton [ph] joined our shared service executive team as Chief Analytics Officer...

Hmm. Spin versus reality. Spin: Customer response has been positive to's redesign. Reality: While the new website looks beautiful, it navigates poorly, is not affiliate-friendly nor mobile-friendly, and lacks in key user experience areas. Spin: There was a 200% increase in mobile sales. Reality: This was the first quarter in which all stores had mobile POS devices.

Not to take away from the truly good news, which is that Anthropologie has brought on a full-time Global Head for their Direct-to-Consumer business (Mr. McElroy, call me!) and that regular-priced sales accelerated. I was hoping to see some acknowledgment here of the challenges Anthropologie faces and customer feedback, with points on how the brand would improve. Mr. Senk was always excellent in his frankness, candor and pragmatism. Mr. Hayne chooses to be more of a cheerleader which I appreciate in many ways, but I also feel it leaves reality behind in some cases. I like reality more than pie in the sky.

For example, when asked about in-store fulfillment of online orders this was the exchange:
Evren Dogan Kopelman - Wells Fargo Securities, LLC, Research Division
I wanted to ask about the pick, pack and ship. If you can talk about, maybe, some of the initial learnings, what where some of the surprises that you've seen? And do you think the benefits can accelerate as you learn more about it and, I guess, can use it better?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Well, certainly, one learning we had was that the stores needed some additional payroll in order to handle the pick, pack and ship function. So we probably, at first, underestimated that and have since caught up and added the payroll that they need. And there's a certain organization in the store that's necessary. So 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. So we had to sort of tweak that for a while as well. But we're pretty confident now that we have a better system in the stores, and we have all the supplies that they need, so they are all ready for the fourth quarter. And we think it's going to be even more meaningful in the fourth quarter than it was in the third.

It's nice to see recognition that the process got off to a bumpy start, and that additional payroll was dedicated to in-store online order fulfillments. I have noticed improvements -- primarily no more crappy mailers that tear open.

But the pick-pack-ship service has a long way to go yet. Orders are taking weeks to be cancelled. There is no dedicated staff member working on these orders, from my understanding SAs check twice or three times a day for online order inventory in-stores. If one store doesn't have the item your order is booted to another store up to five times. Store items are often more shopworn than online -- while I'm very happy to have this ability, I usually order from online specifically to get a new item that's still in plastic. One order may come to you in multiple packages which is very wasteful. More refinement is needed to ensure that this is as smooth and efficient as possible.

Next up, product pricing. Two exchanges:

Oliver Chen - Citigroup Inc, Research Division
From Citigroup. Regarding Anthropologie and the pricing architecture going forward, how do you feel about the mix of good, better, best? And 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?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay. You want to take the Anthropologie question?

David W. McCreight - Chief Executive Officer of Anthropologie Group
Yes. For Anthropologie, we -- 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. And 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 of 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. But all in all, I think we did a much better job this Q3 than we did last Q3. And we expect to see the same type of improvement for Q4 in terms of the perceived value.


Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division
I 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 products from the new merchants? Was it the new pricing strategy that you've implemented? And what can we expect for -- to see in the fourth quarter progress?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
David, you want to handle that?

David Hayne
Sure. Lorraine, with -- like we talked earlier, we've been focused at Anthropologie about making improvement quarter-by-quarter. And that does combine many of the actuaries she just discussed, better products, better inventory controls, as well as stronger marketing activities that Dick had mentioned earlier. And so we've -- all of those yielded to, again, solid top line growth, as well as solid positive rate price comps, which is one of our big metrics that we've talked about this year, was not chasing the amount of, just [indiscernible] really driving towards full price sales. And the other thing is -- then there's customer engagement that we gained from the wonderful experience we had in -- with our field teams in the stores and then some of the progress we're making in direct-to-consumer.

Here's what I take away here: the Made in Kind lines have been very successful for Anthropologie. They've helped generate a buzz about the brand, bring new eyes to the store and push price points up. (Made in Kind is what Ms. Hutchinson referred to as "new merchants," among others.)

Secondly, Anthropologie thinks they missed some opportunities to raise prices even higher in Q3. To which I say YIKES. Perceived value comes from feeling like you got a high-quality item for a fair amount of money. I would argue that there are too many overpriced items at Anthropologie and not enough underpriced items. Many a company has died by pricing themselves out of their market. Don't make that fatal mistake Anthropologie. I can buy far fewer $400 items than I can $78. I'm likely to spend more if I feel I'm getting a fair deal. If I can buy far fewer, I'm going higher end. Higher end than you.

A little later, an exchange on what's selling well vs. not as well:
Marni Shapiro - The Retail Tracker
So I was curious if you could talk a little bit about the traffic trends at the stores and in particular, at Anthropologie, is -- a couple of things. Is she shopping the mall locations as well as non-mall locations? And 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?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay, Marni, I'm going to ask David to take that.

David Hayne
Marni, as you know, we don't have traffic counters in the North American stores. But 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. But our early indications in the holiday on home are -- we're off to a strong start on home. So nothing more really to report on that.

It's amazing what a furniture sale can do for your results, isn't it? Hopefully they will become semi-annual events again rather than bi-annual.

For those wondering about free shipping, I've got some bad news:
Lizabeth Dunn - Macquarie Research
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 price breakpoint, and whether or not that changes the profit equation at all?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Each brand has a slightly different approach to free shipping. So I'll ask all 3 brands that are around the table to weigh in on this. David, do you want to go first, Anthropologie?

David W. McCreight - Chief Executive Officer of Anthropologie Group
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 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. And we're looking in many different aspects of the business. And then we [indiscernible] try to engineer the business in the future to be able to withstand [indiscernible] but offer free shipping without hurting operating margins. But that will be in the years to come.

First, that minimum was actually $150 for much of the quarter, not $100.

Secondly, you need to test how it changes purchasing behavior?!?! You have got to be kidding me. Want to know how you can make your DTC (Direct-to-Consumer) channel results grow by 2 percentage points next quarter and put another $12 million in your coffers? TWO WORDS:


Always. Make it an anthro card perk. Lean on your shipping vendors and tell them you need to save $20 million in opex next quarter or you're taking your deals elsewhere. Threaten UPS with FedEx. Poke the USPS like Netflix did. Ask for the same rates Nordstrom gets.

Charging for shipping is a losing battle and it makes Anthropologie look like a brand that doesn't care about its customers, in direct opposition to its so-called customer-facing approach. You can't talk out of both sides of your mouths and win. Be direct and be customer-friendly or don't. Pretending you are comes across as fake and drives down loyalty. We can forgive one or two quirks. Right now you've got low-quality materials and a messy website. You're asking us to forgive too much.

What do you think of the discussion from this call? Is Anthropologie righting the ship? What message would you send to the brand's leadership?

Further Reading:
Urban Outfitters' Management Discusses F3Q 2013 Results - Earnings Call Transcript (Seeking Alpha)
Urban Outfitters profit rises on margin growth (Marketwatch)

Notes from Urban Outfitters' Q2 2013 Earnings Call