Notes from Urban Outfitters' Q2 2014 Earnings Call

Wednesday, August 21, 2013

It's back-to-back quarters of awesome results for Anthropologie and its parent company Urban Outfitters, and I couldn't be happier! Inside, details from the leadership's Q2 Fiscal earnings call with analysts held earlier this week.

I doubt it's any secret to the community here that markdowns were on the wane and full-price sellouts were on the rise last quarter at Anthropologie. That reduction in sale items led to strong quarterly results for Urban Outfitters as a whole. For the fiscal quarter, its net income rose to $76.4 million, or 51 cents per share, for the quarter that ended July 31. That compares to $61.3 million, or 42 cents per share, in the same quarter last year. Its revenue increased to $758.5 million from $676.3 million with gains in both its retail and wholesale segments. These results beat investor analysts -- investors were predicting 47 cents per share but Urban Outfitters hit 51 cents per share. This is the first quarter in awhile were the company beat analyst expectations and that is awesome!

Total company sales for the quarter increased by 12% to a second quarter record of $759 million. This increase was driven by a strong Retail segment comp rate of 9%, opening 10 new stores during the quarter, a $25 million increase in noncomparable sales and a 17% jump in Wholesale segment sales.

From the call:
By brand, our Retail segment comp rate was 38%, 9% and 5% at Free People, Anthropologie and Urban Outfitters respectively. Gross profit for the quarter increased by 17% to $298 million. The gross profit rate improved by 169 basis points to 39.3%. The improvement in gross profit rate was primarily due to a reduction in merchandise markdowns mainly driven by improvements at the Anthropologie brand. By brand, we are planning approximately 16 new Urban Outfitters stores globally, including 5 new European stores; 9 new Anthropologie stores globally, including 1 new European store; and 14 new Free People stores in North America.

In terms of retail growth Anthropologie showed steady growth at 9%, however the real story here is that Anthro's robust full-price sales helped the Urban Outfitter's margins quite a bit. It's a real win for both the company and customers even though that may sound counterintuitive to sale lovers. What this means is that Anthropologie is getting better not only at managing its inventory and production lead time, it also means that the brand is starting to understand its customers more in terms of product design, which items to order more of vs less of and it is also making more items that customers like! And that's fantastic news for any Anthro lover.

I'm just going to mention this every quarter until it happens: Anthropologie needs a store in Hawaii. NOW! I vote for Waikiki on Oahu or Wailea on Maui.

There are still improvements to be made and Anthropologie Group CEO David W. McCreight recognized this plainly, thank goodness:
Laura A. Champine - Canaccord Genuity, Research Division
It's really for Dick and/or Dave. So obviously, the Anthropologie customer is responding to stronger fashion. How long in your experience do you think that those fashion trends that are driving that business will last and are there any structural changes to the way you're developing new fashions, or its personnel changes that make this a sustainable trend?

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
I'm going to let David take that. We are laughing around the table, Laura, because those trends often last for about, oh, 4 weeks, roughly [ph] . But in seriousness, I think that there's been a lot of changes that David has done, positive changes that allow, structurally and personnel-wise, for us to more accurately predict what the fashion is going to be. And without being too flip about it, we absolutely want the fashion to change. If the fashion were not to change, we would be in big trouble. Dave, do you have any color on that?

David W. McCreight - Chief Executive Officer of Anthropologie Group
No. Just that we continue to focus on who she is and ways that we can continue to outfit her and understand her better, and we've made tremendous progress, both structurally our approach. And we believe, actually, we have a long way still to go to maximize, but a tremendous progress from the team to date.

Alright, he said it in business parlance -- aka we have a long way to go to wring out the maximum profits possible -- but hey, I'll take it! IMU (Initial markup) was much better this quarter, better meaning higher. So yes Anthropologie is making more money on their items because they're marked up higher than the most recent previous quarters. If you look at median price point I believe the year-to-year median is now around $258. But in terms of most items the average prices are actually holding steady -- dresses are at $158 average, tops $88 average, sweaters $108 average over the past two years. The median has risen because Anthropologie has added more very expensive items to its offerings, i.e. $2000 leather jackets and $500 Orla Kiely dresses. It's easy to shrug at this right now. But if those offerings become more the rule than the exception, I think Anthro will find itself in trouble all over again. That's my veiled way of saying don't do that Anthropologie. Don't shoot yourselves in the foot.

If I could make two suggestions they would be continue working on the fit of your items and concentrate on getting the highest quality materials possible within the price point. And then my wishlist right now has one item on it: TALL items. Tall dresses, tall tops, tall pants, tall everything. If you must make all your skirts and dresses so short don't be mean to the tall kids. We like dresses too, just not ones that show our asses when we sit down or bend over!

Here's are the Anthro-relevant highlights from Urban Outfitters CEO Richard Hayne:
Record sales were driven largely by a strong Retail segment comp increase. In the second quarter, both retail channels showed positive comp sales growth, with the direct-to-consumer channel continuing to grow at a much faster rate than the store channel. This pushed DTC penetration to total sales up by more than 350 basis points. Each brand posted a strong double-digit gain in direct-to-consumer sales. Total DTC traffic grew by 16%, and conversion improved by 51 basis points, driving the total number of direct orders up by 40%. The increased penetration of direct-to-consumer sales enabled us to lever store occupancy and store controllable expenses. Offsetting those savings was an increase in marketing and net delivery expenses, each of which were used to help grow the direct sales.

Turning to profits. Higher sales, better initial margins, more compelling product and effective expense control all combined to create record earnings. The improvements in product led to higher full price sell-throughs and lower merchandise markdowns. In total, gross margins improved an inspiring 169 basis points over the same period last year, and operating profit jumped to just under 16% of sales. This is especially noteworthy since 9 quarters have passed since we delivered a profit rate this strong.


The Anthropologie brand produced excellent second quarter results as well. David and his team continued to make significant improvements to the product, the product assortments and the marketing. I believe the Anthropologie stores look better than I've seen them look in many years. It seems as though their customers agreed because regular price selling saw strong double-digit growth, while promotional activity decreased significantly. Finally, inventory and expense controls at the Anthropologie brand were outstanding in the quarter.

I completely agree that the Anthropologie stores are looking better and better. It really helps that the products are more appealing than they've been for the past few years! Although later this week I'll run a new releases post where we can discuss some ways that Anthro is still betraying itself, but perhaps this time around the changes are less severe than they have been in the past. However it is clear that Anthropologie is trying to bring some of that old magic back and in many cases they have been very successful. And that is wonderful!

A little later in the call Mr. Hayne mentioned that standalone Anthropologie stores did better last quarter than mall Anthropologies. That's a very interesting indicator to watch -- people who seek out standalone Anthros are specifically looking to shop at Anthropologie. But if the mall stores are getting passed by to head to, say, Nordstrom or J.Crew or the Gap or some other store running an appealing sale while Anthro stays stubbornly promotionless...well, that could be bad news in a couple of quarters. Watch this closely.

One more nugget of goodness from Mr. Hayne's opening remarks:
Now let me give you an update concerning one of our strategic initiatives. We have said that driving top line growth in ways that are accretive to the bottom line is our #1 financial objective. You may recall us discussing the initiatives we have envisioned to achieve this top line growth: opening new stores; growing the direct-to-consumer business; expanding internationally; and finally, product expansion within existing brands. I will elaborate on this last initiative.

We have discussed our intention to continue to expand product choices and categories and to enter adjacent businesses. By doing so, we look to attract new customers and expand the share of wallet each brand captures with existing customers. We will accomplish this expansion through a combination of internal development and external relationships. These relationships may include licensing partnerships, joint ventures and acquisitions.

We have successfully expanded product choices and categories through internal development, with initiatives like the Free People intimates offering, the petite selection at Anthropologie and the growth of style and size offerings at all 3 brand websites. We have also launched the BHLDN and Terrain brands, which are both adjacent categories to the Anthropologie brand.

To date, we have not used external relationships to accomplish this goal. We now intend to pursue this method more aggressively and are currently in discussions with several companies about a possible relationship. The partnerships and acquisitions we believe present the most potential are those that have a similar customer profile to one of our existing brands, have a management team that will augment or complement our existing expertise and those that offer strong growth opportunities. We look forward to making further progress on this initiative.

Hmm. I'm not sure how I feel about this. Remember a couple of years ago when Urban Outfitters half-heartedly flirted with buying J.Crew? (They weren't very serious about it, it was mostly to look at the books.) Now Urban Outfitters is talking about acquiring someone? If we're looking at Anthropologiesque brands ModCloth and Ruche both immediately pop into my head. But this could be someone closer to Urban Outfitters, or Free People, or even BHLDN or Terrain. It's very hard to say. Ideally they should pick a brand with a very strong mobile and online presence to augment what they already have.

Acquisitions normally signal company strength, but they also always make me a little queasy. Company mergers often come with a lot of strife. Then again it seems like in the tech world my clients are constantly eating each other, buying each other, gobbling each other up. I've worked with one client as a freelancer for 5 years and in that time it's been bought twice and changed its name 3 times. I stopped asking for business cards from them after awhile -- now I just use my own company logo. In nearly all cases the gobbling has led to stronger management teams and better technology. So this could be a very good thing.

Another angle on this which would make more sense to me is if Anthropologie took the J.Crew-like tack of having more designer special collections. Like the current Peter Som Made in Kind collection but launched under a different collection name. J.Crew has collaborations with brands ranging from Rolex to Nike to Thomas Mason. Why can't Anthropologie collaborate with designers like Libertine or Elie Saab?

What other brands have a similar customer profile to Anthropologie? I'd love to hear guesses in the comments!!

Here's an interesting exchange about the website, catalogues, and our shopping habits:
Marni Shapiro - The Retail Tracker
Can you talk a little bit on the DTC side? Two questions. Clearly, we know that the store customer goes online. I'm curious if you're almost -- if you're seeing a reverse because your online -- your sites are truly amazing and very differentiated than a lot of the others and offer a lot of product that's not in the stores...

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
Marni, we have always seen the reverse effect, even going back to the days of catalog. It was not unusual back in the day in the late '90s for Anthropologie to experience women coming into the Anthropologie store with certain pages turned down of product that they wanted and say, "I want this. Do you have this in my size?" So we have seen that happen consistently, and then the same exact thing is happening with the website. So the answer to your question is yes. But I think there is much more of a flow the other way where they're going into stores and then going to web as opposed to the other way around.

This is so true! To this day I still dog-ear my catalogues and will often head to the store to find a certain item. Except with Anthropologie I've been dropped off their catalogue list so many times (I don't really mind any more) that I just come in to the store with certain product pages pre-loaded on my phone so an SA can help me locate them.

But what Ms. Shapiro didn't ask was about online exclusives. I would be really, really interested to know how online exclusives are doing. I know I'm very hesitant to order them because Anthropologie's fit is still very inconsistent, even within brands. And my size is still changing every 4-5 months so I'm never quite sure what size I'll need when I head to the store. With all that I'm not really interested in paying $15 in shipping fees just to try an item on, you know?

Clearly, Anthro doesn't know. Or they don't care.

To sum this all up, Anthropologie did very well this past quarter -- yay!! And parent company Urban Outfitters is now looking to either partner with or acquire some brand that will help it strengthen market share -- gulp. I left out info about Free People but it's worth mentioning that they had another amazing quarter and I think their leadership team deserves continued kudos! Their summer stuff didn't appeal to me as much but I have about $900 in my Free People cart that I plan on buying for fall soon.

What do you think of Anthro and Urban Outfitters' results this quarter? What changes would you like to see the leadership team make? How can they make you the happiest Anthropologie customer possible?

Further reading:
Full transcript of the Urban Outfitters Q2 2014 fiscal results call -- Seeking Alpha