Wednesday, March 13, 2013

Notes from Urban Outfitters' Q4 2013 Earnings Call


Earlier this week the Urban Outfitters senior leadership team once again sat down with eager analysts and stockholders to discuss their quarterly earnings report. This time around the news for Anthropologie's parent company was quite good! Details, discussion and dissection after the jump.



How well did Urban Outfitters do last quarter? Their fiscal fourth-quarter profit more than doubled on the strength of strong sales on growing margins. The company announced net income of $83 million and $237 million for the fourth quarter and year ended January 31, 2013, respectively. Earnings per diluted share were $0.56 for the quarter and $1.62 for the year. That's one penny off from the industry estimates of $0.57 per share which sent their stock down by close to a point. (Investors -- never happy.)

More from the press release:

Total Company net sales for the fourth quarter of fiscal 2013 increased to a record $857 million or 17% over the same quarter last year. Comparable retail segment net sales, which include our comparable direct-to-consumer channel, increased 11% while comparable store net sales were flat. Direct-to-consumer returns at stores are charged against store sales. Excluding these returns, comparable store net sales would have been low single-digit positive. Comparable retail segment net sales increased 37% at Free People, 11% at Urban Outfitters and 7% at Anthropologie. Direct-to-consumer net sales surged by 44% for the quarter and wholesale segment net sales rose 22%.

For the year ended January 31, 2013, total Company net sales increased to a record $2.8 billion or 13% over the prior year. Comparable retail segment net sales increased 7% while comparable store net sales decreased by 1%. Excluding the direct-to-consumer returns at stores, comparable store net sales would have been low single-digit positive. Direct-to-consumer net sales increased by 31% for the year and wholesale segment net sales increased 12%.

You'll note I highlighted the direct-to-consumer (DTC) returns at stores note. Why? Word has it through the grapevine that Anthropologie will no longer be counting DTC returns against store sales!! And I'm not gonna take credit for it since I'm sure Anthro's leadership was already thinking about it when I suggested it last quarter...but how cool would it be if the community had something to do with it! It's a brilliant move that will help same-store figures over the next several quarters. Same store figures, of course, being one of the key measurements of a retailer's overall health. With their DTC results so amazingly strong they can afford to take the revenue hit of counting DTC returns in that column instead of in the store column.

As Chief Financial Officer Francis J. Conforti said, "Total company comparable store sales were flat due to a 2% increase in transactions, which was offset by a 2% decrease in the average unit selling price with no change in units per transaction. I believe it is important to note that if it were not for direct-to-consumer returns at stores which we currently charge against store sales, our store sales comp would have been low-single-digit positive."

And how nice would that have been, Mr. Conforti? Bet your stock would have gone up a point instead of down. Community, we are brilliant. Keep the suggestions coming.

Here are the highlights from CEO Richard Hayne's prepared comments:
Thank you, Frank, and good afternoon, everyone. First, my congratulations to each of our brand teams for delivering an excellent fourth quarter. It was a great finale to a very exciting year. Our focus during the year centered on accelerating top line growth and increasing profitability. That focus paid off. Each quarter saw sequential improvement in the rate of sales growth capped by a 17% sales gain and a 104% increase in operating income in Q4. Our quarterly sales growth acceleration came from opening new stores, maintaining and then improving the productivity of our comp stores, expanding our wholesale division, and most significantly, growing our direct-to-consumer channel.

We began the year with a clear plan to invest in initiatives that were helping ignite growth in the direct-to-consumer channel. Specifically, we invested in expanded product offerings, fulfillment capabilities, creative execution, technology advancements and marketing expertise. The return on those investments has been excellent. During the fourth quarter, they helped to drive a DTC sales increase of 44% versus the comparable period last year. Customer visits jumped by 26%, while the conversion rate improved by over 40 basis points. In addition, the new customer acquisition rate rose by 45% in the quarter and the reactivation rate jumped by 53%.

Overall direct-to-consumer sales penetration, as a percent of total retail sales, spiked to nearly 30% from 24% in last year's fourth quarter. This is our highest quarterly penetration to date. Within the direct-to-consumer channel, the fastest growth came from mobile interfaces. Mobile sessions at all brands exceeded 25 million in the quarter. This drove a 100% increase in mobile sales transacted over smartphones and tablets.

Our fulfillment capabilities improved as well. Due to the opening of our West Coast fulfillment center and our pick, pack and ship initiative that allows us to fill an order from any domestic inventory location, including each of our stores, we have increased the number of 2-day ground shipments from 13% of total shipments in the fourth quarter of FY 2012 to 43% this past quarter. Our goal over the next 2 years is to fill over 80% of our DTC orders within 2 days using ground carriers. The pick, pack and ship initiative also helped us to achieve our sales goals. Orders filled from stores that would have otherwise been canceled due to out-of-stock positions in the fulfillment centers, drove $12 million in incremental sales during the quarter.

...Turning to the current year. Our brand teams are fully engaged in achieving their #1 objective. Each has identified multiple avenues to drive top line growth and do so in ways that are accretive to the bottom line. This will require investments across all of our channels of distribution with a focus on expanding and enhancing the direct-to-consumer channel. I believe we are still in the very early stages of unlocking the potential that the Internet and mobile technologies bring to the consumer industry. The extraordinary rate of change these disruptive forces create brings both significant risks and opportunity. We intend to make the investments necessary to secure our position as an innovative leader in the world of lifestyle brand-building across all channels. Our approach to brand-building is omni-channel and global. Regardless if the channel is online, mobile, bricks-and-mortar retail or wholesale, our goal is for each brand to have a common, seamless voice across all of these channels.

...The second is in marketing, both soft and hard. Additional investments in image makers, stylists and marketers will allow the brands to create more compelling brand experiences like those in the recently launched FP Me by the Free People brand. On the hard marketing side, augmenting the data analytics team will enable the brands to find and communicate with more customers and to send all of the customers more personalized messages. Over the next few years, we plan to further reduce our printed catalog circulation in favor of more digital and web-based communications.

The third is in technology. Additional development talent will allow the brands to conceive and launch new web and mobile initiatives more quickly. Examples of initiatives we plan to launch this year are the Anthropologie mobile application, site redesigns for both Urban and Anthropologie and the new Urban loyalty program.

Tons of goodness here to digest. First, say what you will about Mr. Hayne's personal politics (which are off-topic to this post), but there's no denying he's an amazing business leader. Anthropologie is clearly turning the corner back to profitably and the product is getting better. Free People has continued its explosive growth. Urban Outfitters has held steady in the face of terrible economic factors among its key demographic. Terrain continues to expand at a slow, steady and healthy pace. BHLDN is making a splash in a crowded wedding market. When you have a dynamic leader whose vision permeates the company, small successes turn into larger ones. All signs point to a successful top-down leadership team at Urban Outfitters right now and I'm thoroughly impressed.

From technology to marketing to product, the UO umbrella is improving and taking its place back at the leading edge. Having installed capable leaders in each of the portfolio companies, Mr. Hayne's focus on overall vision through incremental projects has unfolded beautifully over the last four quarters. In the case of Anthropologie we're seeing a slow and sometimes uneven progress back towards the items we want to love. It's there though -- we're getting there. And that starts at the very top. This is in no way looking down on former CEO Glen Senk, who presided over an incredible run of success, especially as the recession was beginning and many other retailers sank deep into the red while Urban Outfitters managed to grow. I'm impressed with both of their leadership skills and just happy that Anthropologie's ship is slowly righting itself. Let's just pretend like 2011 never happened, okay?

With success comes the inevitable push to grow profits. Many of the analyst questions this time around focused on margins, markups, and the sale cycle. Kind of like the community questions, come to think of it.


Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division
I wanted to follow up on the gross margin topic there while we're on it. Big picture-wise, is there any reason why you shouldn't be able to eventually get back to your lower markdowns to the 40%, 41% levels that you saw a few years ago?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
There is no reason to believe that we couldn't see a continued decrease in markdowns. What is unknown at this time is if we can get the IMUs [initial markups] back to where they were historically. As I said on the last question, we continue to add special product to the web. Now these special products are added in significantly smaller quantities. And as a result, we typically have lower IMUs on those quantities. So again, it's the blend of the product, the blend of the merchandise. Now one would assume that as the web sales expand and those quantities grow, one might be able to have increased IMU on that product as well, and we hope that's the outcome, that's what we're planning for. But we don't want to overpromise you what we can deliver for -- I can't look out more than a couple of years.

Francis J. Conforti - Chief Financial Officer, Chief Accounting Officer and Controller
Additionally, just one other note. I'd say as you look back versus the historical comparisons, one other item that is slightly different is the delivery expense rate. If you were to go back 4 or 5 years ago, our delivery expense, the way it was built is slightly different than where it is now, as the consumer has made a more priority to receive a product faster and at a lower cost. So our delivery expense over time has delivered versus the past few years. And we do believe that that's the right place to be from where the market is and what the consumer expects from us.


Initial markups are the amount a retailer adds to the production cost in a product's price. A product that costs $55 to make might be $128 in the store -- the $73 going towards operating expenses, salaries, any number of company costs. For anyone thinking they don't want to pay that markup, you're fooling yourself. EVERYONE has markup of some kind. Your gas station. Your drug store. Your grocery. Your Wal-Mart, your Target, your Zara, your Bergdorfs. Aside from deeply discounted items nothing can be purchased at or below cost.

With IMU, the most important thing is guessing the right markup. You want to price an item so that it's attractive enough to buy at full price but not so high that people wait for sale, thus lowering your revenue and profit on the item. You don't want the price to be too low because that hurts the company. It's a delicate balancing act. Anthropologie doesn't have it right yet. The initial prices are, in my opinion, about $15-25 too high on average and just ridiculous on some of the specialty items. Sweaters that should be $98 are $128 too often. Dresses that should be $148 are ringing in at $178. And don't get me started on the $2,500 leather jackets and such. If I'm going to drop $2,500 on something I'm going to Céline or Hermès or some atéllier.

As a result, even someone like me who's normally a full-price shopper is waiting for sale. By waiting for sale it's also decreased my overall purchase amount quite a bit. Like many people once I've fallen over the waterfall to buy one thing at full price another two or three things might make it into the bag too, because it's easier to say yes to more things after I've said yes to one. You make me think twice about price Anthropologie and that keeps my wallet closed. Instead of buying two or three things at full price I'm waiting on sale so I can buy one. Ouch. Remove the thought process and I'll buy at full price again. Drop your full-price price points by $15 on any item over $78. I guarantee your overall profits, margins and revenues will be better in Q1 2014 fiscal.

The second point above deals with shipping. It's important to note that Anthropologie has fixed the store charge/send shipping issues that plagued them two quarters ago. I haven't received any of those terrible envelopes that fall apart. My items are generally wrapped better. The only issues left are that store items are often shop-worn and I hate paying shipping on charge/sends. I'll talk more about this in my suggestions section below.


Brian J. Tunick - JP Morgan Chase & Co, Research Division
I guess you talked about the progress or acceleration you're seeing here at Anthropologie. Just wondering maybe if you or David could give us more of a timeline on how you see whether it's the merchandise or the price points continuing to flow through at Anthropologie over the next few quarters.

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Okay. I'll let David take that. But I will say before he gets to say what he's got to say, I can tell you, I think it's all of the above. I think the product's better. I think the inventory's better. I think the brands are operating at a much higher level. David?

David W. McCreight - Chief Executive Officer of Anthropologie Group
Hey, Brian. So we are seeing acceleration at Anthropologie. It's coming from the warmer parts of the country, which we hope bodes well for what happens at season turn. And we're seeing it particularly in the tops side of the business. That being said, Dick uses a metaphor often around archery and hitting the target. And I think in the past, Anthropologie has missed the target. Now I think we're on the target and working our way towards bull's eye, but we are still several rings out. We see lots of opportunity to improve how we merchandise the casual area, where we're getting some nice traction, and also understanding her and her wear-to-work needs, and then obviously a tremendous opportunity around there. So we are seeing some progress, but we believe there's still a great deal of it to come ahead.


Somebody's been reading the blogs methinks! How nice to see Anthropologie's CEO directly acknowledge that wear-to-work is the next big area Anthropologie needs to address. Yes, yes, and more yes. I completely agree that by and large Anthropologie is heading back towards the bull's eye. My spring 2013 wish list is much longer than any recent season. There is still work to be done but it's important to acknowledge the progress made. Kudos!

On the topic of the "casual area," enough with the $68 white tee shirts. Stop trying to raise the market segment in an area where Old Navy competes. Basics are not the upmarket Anthropologie needs to be in. Beauty? Sure. Candles? Totally. Dresses? Absolutely. White tees? No. Nononono.



Oliver Chen - Citigroup Inc, Research Division
In regards to Anthropologie, how are you feeling about the mix of good, better, best and your AUR [average unit revenue] there and how it looks on the marketplace? And just as a follow-up, on your commentary on investments in merchandise and design, are there particular areas where that has a big opportunity to further develop? If you could just shed some more detail on that, that would be great.

David W. McCreight - Chief Executive Officer of Anthropologie Group
Regarding Anthropologie, we feel comfortable about where our AURs are currently. They're slightly below our 2010 level. And we told you in previous calls that we planned over the fall holiday season to get back in line, and we were able to deliver that. We're relatively comfortable with the good, better, best that we have in place, though I'm talking primarily in the stores. As Dick alluded to, we're expecting to see dramatic changes to the assortment and pricing architecture on the web.

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
So the second part of your question is adding additional investments around merchandising and designs. Do you want to take that also, David?

David W. McCreight - Chief Executive Officer of Anthropologie Group
Yes. That has been one of the big focuses at Anthropologie, recalibrating merchandising and design throughout the entire teams, as well as investing in new people, developing our teams, enable -- to enable us to really tap into the brand potential and promise and also the other places for tremendous investment for us has been on the DTC side, where it was less about recalibrating existing team and really building a direct-to-consumer business, primarily digital, that was a very sort of earlier primitive stages of Anthropologie. And we're going to see continuing benefits to that through the coming years. So we've made some really big steps there with organization [ph] of people, and there are more to come.


If items are priced higher at Anthropologie in 2013 than they were in 2010, how is the AUR lower? Because something in the production costs are higher. About a year-and-a-half ago, cotton was the most expensive it had ever been. Now silk is extremely expensive due to the same factors -- fewer companies making it that can charge more due to demand and either a controlled or unexpected production shortfall. The Made in Kind collections have been a huge success for Anthropologie in part because they can charge more for those items, which in turn helps AUR.

I would also recommend that they keep looking into new production houses. Some of the in-house brands (Deletta, the poorly underloved Fei, and C. Keer to name a few) are still suffering from uneven quality. Know what I hate more than items that pill? Polyester or rayon items that pill. Get that quality level up Anthro!

The second answer speaks to the growing digital team at Anthropologie. People like Christina, the head online personal shopper (who is amazing!!). Or the Magazine, which really needs its own main landing page. Plus the investment in more blogger events like the recent petite trunk shows featuring the likes of Joy from Oh Joy! and Dallas Shaw from Dilly Dallas. (I've met the latter and she's a delight!) These are all wonderful ideas and I hope they've added to Anthro's success.

*****

So, where does Anthropologie need to go from here? I've got some ideas.

CUSTOMER SERVICE
This has been a growing issue at Anthropologie recently. There's a famous mantra at Starbucks -- we're not in the coffee business serving people, we're in the people business serving coffee. Why is that distinction so important? Here in NYC you can get a cup of Greek coffee for $0.50 from any number of carts. Yet I pay $3.75 each morning for my Chai Latte at the 'bucks. Why? Because of the service. (Also that old saying about a fool and their money, but that's another post...) Anthropologie needs, NEEDS to remember that they are delivering a product at a premium price. If you expect me to pay a premium you better damn well have the best customer service out there. Anthro used to. These days, not so much.

Anthropologie, your store teams need a little more training. Time was back 4 or 5 years ago that every new SA went through rigorous training including customer scenarios. I can't say for sure but I have feeling stores no longer do these. I know it sounds silly -- let's pretend I'm an irate customer and you're a SA! But it truly makes a difference. When you drill the proper habits into your teams and your teams buy into those habits, they react with grace even under pressure. I've recently noticed more SA back talk which is shocking to me. By and large Anthropologie has the best SAs around, bar none. Please don't let that slip.

Anthropologie, your warehouse teams are falling short right now. It's clear there's little to no quality control. Too many people are receiving worn, damaged and incorrect items. Returns are clearly just being put back into the pick bins which makes me sad. I no longer see "inspected by" stickers on my item bags or in my jean pockets. It makes me wary. It makes me think twice.

Anthropologie, your call centers suck right now. Your phone CS reps are under-trained and under-empowered. I know the store policies better than they do. The reps can't make any important decisions without consulting a manager. They are clearly not directed to put the customer first.

A premium service company worth their salt would never tell me they're waiving shipping as a "one-time courtesy." They would do it, they would do it with pleasure, and they'd let me know they appreciate my business. Here's my one-time courtesy warning to you: step it up, train your reps better, or my money is flowing elsewhere.


SHIPPING COSTS
Speaking of shipping costs, can I be frank Anthropologie? It's ludicrous that you still charge shipping on your online orders. Ridiculous. I realize you think it's a profit center but I think you're wrong. When I have people not even very familiar with Anthropologie telling me they never order from your website because you charge shipping, that's a huge problem. When I can't pull the trigger with a highly-coveted popback in my cart because of the shipping charge, that's a huge problem. When your sister companies give free shipping and you don't, that's a huge problem.

There have been experiments here and there with free shipping. I'm not sure those experiments are being run under the right conditions. They're typically over the weekend after new releases come out. They haven't lined up with sales in quite awhile.

I would bet my annual salary that if Anthropologie ran a Free Shipping on orders of $100+ for a quarter their DTC (direct-to-consumer) revenues would go up by 3% or more. And if they ran a Free Shipping, no minimum, in concert with a big sale week, I bet they'd go up another 2%.

As for charge/sends, for the love of everything holy I pray to the shopping gods that Anthropologie just does away with the shipping charge. Most stores waive it anyway because they know it's a dumb policy. Are you a premium services company or are you Wal-Mart? And by the way, even Wal-Mart offers free shipping. So does Saks Fifth Avenue. So does the Chanel store in Soho. So can you.


PRICE POINTS AND MATERIALS
I touched on this in commentary above, but I'd love to see the price points of dresses and sweaters go down by $10-$25 on full-priced items. It would make me open my wallet more. Additionally, with spring being the season of beautiful dresses at Anthropologie how about a 15% off dresses promotion? While I'm dreaming I'd also like to vote for an accessories discount of some kind, say 15% off bags. Maybe make it in-store only to drive foot traffic first and then extend it online after a week or so.

I'm glad to see store events are coming back and would love to see a little carrot at those. J.Crew usually adds a 20% off discount to their private shopping events. Et tu, Anthro?

If prices on full-price items continue to trend upwards then we need to talk materials. I expect silk in anything over $100. I prefer cotton in most of my tops to rayon. (I do understand the allure of poly tops in the summer.) I am not paying $198 for something made from the unholy trinity of polyester, spandex and acrylic. Jersey is meant to be made from cotton. Merino doesn't pill when it's made from long fibers. Same for cashmere. Angora is better than acrylic, merino is better than angora, cashmere trumps them all.

If an item is machine washable I expect it to come out of the wash -- and the dryer!! -- looking just as good as it did beforehand. I know most in the community prefer machine washable items whenever possible. I'm ambivalent, I don't mind dry cleaning for well-made items.


WORK WORK WORK ALL THE TIME
More work clothing please! Dresses, tops, and pants I can wear to work. Classics with an Anthro twist. My wallet is ready.


I've got tons more ideas but that's a great start. Community, are you excited by the latest quarterly results? What do you make of the commentary? What suggestions do you have for the Anthropologie leadership?


Further reading:
Urban Outfitters Management Discusses Q4 2013 Results - Earnings Call Transcript -- Seeking Alpha
Urban Outfitters Reports a 104% Jump in Q4 Operating Profit - Marketwatch
Urban Outfitters doubles profit on sales, margins - Marketwatch