Notes from Urban Outfitters' Q3 2014 Earnings Call

Wednesday, November 20, 2013


On Monday it was time once again for Anthropologie's parent company Urban Outfitters to hold its quarterly fiscal earnings call. Thanks to Seeking Alpha I've got the full transcript! How did Anthropologie do? What kind of wonderful nuggets did the executive team share with eager analysts?

All will be revealed after the jump...


Urban Outfitters as a whole had a stellar quarter. From the press release:

For the three months ended Oct. 31, net income rose 18 percent to $70.3 million, or 47 cents a diluted share, from $59.5 million, or 40 cents, a year ago. Net sales were up 11.7 percent to $774 million from $692.9 million, which includes a 20.5 percent gain in wholesale net sales to $50 million. By retail segment, sales at Urban Outfitters rose 3 percent to $341.9 million, Anthropologie was up 16.2 percent to $310.1 million and Free People gained 29.1 percent to $113 million. The company said comparable-store sales, which include direct-to-consumer, rose 7 percent. By business segment, comps rose 30 percent at Free People and were up 13 percent at Anthropologie, but down 1 percent at Urban Outfitters.

Gross profit for the quarter increased by 12% to $292 million, while gross profit rate improved by 11 basis points to 37.7%. The improvement in gross profit rate was primarily due to a reduction in merchandise markdowns and improved initial merchandise margins at the Anthropologie and Free People brands.
We are planning to open approximately 10 new stores during the final quarter of the year. Two Anthropologie stores, 4 Free People stores and 4 Urban Outfitters stores globally, with 2 in Europe. By brand, this will bring our fiscal year 2014 new store count to 15 new Urban Outfitters stores globally, including 5 new European stores; 8 new Anthropologie stores globally, including 1 new European store; and 13 new Free People stores in North America.

Wow! To put this in perspective Anthro fans, a year ago Anthropologie's sales were up 6% in Q3 Fiscal 2013 following a flat Q2. This most recent quarter saw retail segment sales up 13% over an already solid Q2 Fiscal 2014. That's amazing, especially when you consider the flat and low-single digit growth being shown by comparable segment retailers. Free People also saw explosive growth and that is to be praised but Anthropologie is much bigger than its sister company -- about 3 times bigger -- so it's especially impressive to me seeing these results.

In terms of months, August and October were strong while September was quieter according to Francis J. Conforti, Urban's CFO, CAO and Controller. Given the warmer temperatures much of the country saw in September this doesn't surprise me. Sweaters were very unappealing to me in that month. Now? I 'm loving what I see!

I'm not alone in these feelings. Urban Outfitters CEO Richard Hayne was effusive in his prepared remarks.

Richard A. Hayne - Co-Founder, Chairman of the Board of Directors, Chief Executive Officer and President
First, congratulations to our brand leaders and shared service heads for delivering another record quarter. Our results are especially gratifying given the difficult retail environment we faced. Even though, as Ted [Tedford G. Marlow - Chief Executive Officer of Urban Outfitters Group] said in his comments, the Urban brand fell short of their internal goals, all brands delivered record sales for the quarter, and the Anthropologie and Free People brands produced record merchandise margins as well.

...the Anthropologie team produced an extremely strong quarter. David and his team continue to make significant improvements to all aspects of their business. The current product is more trend right and differentiated, and the marketing creative efforts are improved as well. Together, these improvements created a more compelling shopping experience and, based on our third quarter results, she responded.

During the quarter for instance, the Anthropologie team launched a refresh of the website with dramatically improved visuals, which helped to drive strong direct-to-consumer sales gains. Inventory control of the Anthropologie brand was outstanding. This, along with better product, led to minimal markdowns, high-teen regular price comp sales and record merchandise margins and operating profits.

...Within the direct-to-consumer channel, mobile devices accounted for the largest percentage increase in transactions. Mobile, which includes smartphones and tablets, is quickly becoming the preferred method of virtual shopping for our customers, and our brands are focusing much of their attention on becoming more mobile friendly.
During the quarter, the Urban brand launched its mobile app called Urban On, and the Anthropologie brand introduced responsive design into their web platform. This feature optimizes the image the customer sees based on the device the customer is using. And finally, Free People's FP Me app is continuing to gain momentum, already attracting more than 165,000 members since the site was launched in June of this year.

...The Anthropologie brand continues to expand its collection of Petite apparel, which is now offered in 8 Anthropologie stores and online. During the quarter, the Petite business more than doubled on a year-over-year basis....

...And 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 2 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.

Hahaha, 'Anthropologie launched a website with dramatically improved visuals'. Notice how there's no mention of the website's usability or navigation? I agree the creative is beautiful but their website has gone from easy to use to cuss-inducing in three short years. First rule of user interface: change is bad. If you're making a significant navigation change it should only be because it makes things insanely easier. I find their left-hand refine tools poorly designed with important options missing, and their category and product pages are an exercise in frustration for me. I can't wait until the iOS 7-influenced flat design is launched. It will feature confusing icons that have no relevance to their function, visual-heavy pages with near-zero usability and no way to actually buy anything or wishlist it. But we've already beaten this dead horse to death, again again again.

Lots of goodness worth discussing here though. First, we've all noticed that more Anthropologie items are selling out recently. Some items are truly flying, going from full stock to sold out in a day or two. It's never easy watching an item you want to buy sell out from under your nose but from a business perspective it's fantastic! It's thrilling to see Anthropologie sell through their entire inventory order of an item lickety-split. I don't care if the inventory orders are smaller than they've been in past years. That's just smart business. Create demand! If an item is really meant to be mine I'll find it some other way down the road. For now, it's a thrill to know that the high-demand items I do acquire are not going to be as ubiquitous as in recent years. No more fear of passing by two other people wearing the same Anthro piece as me on 5th Ave. (Yes, that happened in 2010. Damn you Glee.)

I completely agree that Anthropologie Group CEO David W. McCreight and his team have done an excellent job of steering the product offerings away from the WTF trendy and back towards the Anthropologie goodness we all know and love. It seems as though Anthropologie's offerings fall into 3 distinct categories right now: recapturing the classics with a twist vibe; trying to figure out that timeless Euro-Nordic-inspired sweet spot and an urban take on trendy that doesn't lean too far to the left.

It's been a little weird to see the urban pieces that are right in my style sweet spot at Anthropologie, if only because I'd never associated such pieces with the store. But items like the Cory Pullover ($168), the Paige Edgemont Coated Leggings ($268), the Sable Ribbon Dress ($268), the Cheval Crossbody Bag ($118) are all pieces that have a little Anthro in them, just enough that I can say OK, this fits in with my preppy-urban-with a whimsical twist style and also seems like something Anthropologie can conceivably carrying without drifting into the dreaded trying too hard category. I no longer feel the repulsive vibes of 2011 when Anthro was practically begging for trend-slap-happy early 20-somethings to waste our trust fund or graduation money on some piece with a 6-month shelf life. Now they seem confident enough in themselves to say, this is our product and we think it appeals to everyone from 18 to 99. As it should be. (And, more importantly, as it does.)

Is the assortment perfect? No, of course not. But if it were I'd be a completely broke shopping addict. I've never loved 100% of what Anthropologie sells. Right now I think I'm hovering somewhere around 85% and that's pretty damn good. The product range is more appealing to me right now than it's been in years. They're one ring outside of the bulls-eye in my book.

Here's the difference to me between Free People and Anthropologie right now. I never need anything from Free People. My Fall 2013 shopping list doesn't say "1 fringe-laden angular sweater" or "1 aztec-inspired season-inappropriate side-split dress" or "1 pair of equestrian cum military-inspired boots". And yet when I walk into Free People or visit their website, all of a sudden the products they present are so alluring that I need them. Make sense? I never knew I needed anything at Free People until I go to the store -- and then I need lots of stuff. Like those three items I mentioned above!

Anthropologie is close. The power of suggestion is starting to grow again. For example, I swore off cowlnecks for 2013 and yet I've already purchased the Meriwether Cowlneck ($98) and the Waffled Cowlneck ($98) will be my cozy card purchase. Anthropologie convinced me I wanted these items and needed them. To get inside that bull's eye I need them to do three things: first, up the material content one notch better than what it is now; secondly emphasize quality control especially when it comes to putting returns back on the floor/in the warehouse for sale; and finally make your promotions killer. If you're going to do so few promotions it has to be better than a one-day 20% off sale or a take 25% off sale items promotion. No. I want a 3-day take 25% off promotion. I want a spend x amount, get y discount promotion. I want free shipping to be a standard thing and I want returns to always be free.

The really cool thing is that I'm starting to talk in more abstract emotionally-based buying decisions rather than business, numbers-backed buying decisions. This is huge! As any strategist worth their salt can tell you there's a Maslow-like hierarchy to shopping. When your customers are starting to talk about the way they feel when shopping somewhere, that's a sign that you're on a higher level and nailing your product assortment.


There was only one question (!!!) directly about Anthropologie's USA business this time around.
Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division
I guess a quick follow-up on Anthropologie and if you could spend some time talking about its consistent success, a real -- dramatically successful in what's been a tough environment. I know you don't want to go into specific merchandising categories, but if you could talk about price, the selection, the changes we've seen over the last 2 years, that'd be really helpful.

David Hayne -- Chief Operating Officer, Free People
Richard, David here. When Dick invited me to join, something that was very clear was Anthropologie's brand was exceptionally strong and resonated with the customer. And we have a very talented field organization and we needed to get back to understanding her and her needs and merchandising and designing it accordingly, and we have a team in place that's increasingly focused on that. I think the Anthropologie brand is very rich and has -- and the customer set is one we love and believe we're still at the very early stages of exploring how to grow that worldwide and across product categories. We have -- the home business had been strong throughout the difficulties with the brand. Accessories and apparel had struggled, and we have spent energy getting those course-corrected, getting inventories in line, better storytelling and then starting to understand the times of day and uses and occasions within her. And so we've worked across the board. Again, we are far from perfect and we know we have many, many things to do, but it's still in terms of opportunities ahead. So we've worked across romantic, Bohemian, evolving our casual business, our desk-to-dinner work. There's just -- I can go on and on, probably spend an entire call talking about the opportunities we have still to surprise and delight her in the categories we have existing and new ones ahead.

What a tease! I want to know what the opportunities to surprise and delight me are in categories existing and yet to come! For example, Free People's lingerie line is incredible. Have you checked it out lately? After offering only wireless soft cups for years, Free People finally got the memo and launched a new underwire collection this year. It's just as pretty as their wireless boho-free-swinging stuff but is incredibly supportive for those of us sporting larger busts. Not only that, they make an insanely awesome range of sizes. Free People is one of the only stores out there where I can buy my real bra size -- a 32DD -- and not be sporting some ugly, thick-strapped, buttercream colored bra. I am young and pretty and I want my lingerie to reflect that.

Anthropologie needs to get this memo. Their lingerie is pretty to be sure but almost nothing comes in a D cup and I've certainly never seen any of their lingerie items in a 32DD. (But of course the size radio buttons conveniently exclude searching by cup size, so how could I really check anyway?)

*****

Here's the crazy thing. After such great results the market is now moving Urban Outfitters to a "hold" position. Better than a sell position but less optimistic than I expected. They've also slashed the target price. That's right. Post a record quarter and the market may still turn its back on you. Analysts expect this growth rate will be impossible to sustain and fear that Fiscal 2015 will show slower growth in comparable gross and Gross Margin categories. In English: we expect Urban Outfitters will continue to grow, but only at a healthy and responsible pace when the market demands reckless exponential growth, therefore screw you guys!

The analysts are probably right that growth will slow down next year. But why is it bad to grow at a responsible pace? I don't understand these market reactions at all. Are they so dramatic that they demand incredible peaks and valleys? (Rhetorical.) True that investing in Urban Outfitters is going to offer a small but steady dividend and not the rush of either massive Twitter-like success or crumbling, legacy tumbling stocks. But...isn't reliable better? No, you market people say? OK. This is why I moved off Wall Street!

Even Francis J. Conforti, Urban Outfitters' CFO, was cautious about Q4:
Due to what we believe could be an increasingly promotional holiday environment, we are planning inventory conservatively. This promotional environment could negatively impact our gross profit margins for the fourth quarter. We believe that SG&A could grow at a low- to mid-teens rate for the final quarter of the year. This increase would be driven by continued investments in technology systems and talent to support web- and store-based initiatives and marketing and customer analytics to further customer acquisition and retention efforts.

Whatever. Here's the roxy forecast for Q4: if Anthropologie chooses the right Black Friday and December promotions, they are going to do gangbusters and the amount per transaction will compensate for and exceed any concessions made in the price per item.

Choose wisely, Anthropologie.


****

As ebullient as I feel about Anthropologie right now I concede there are still some headaches.

Quality.
Namesake brand Urban Outfitters was flat this quarter. Why? I can sum it up very easily -- shitty material quality. I have been interested in many items on their website only to find them falling apart in the store when I go to buy them. Anthropologie, don't you dare let yourselves slip on quality! You're only skating by at "ok" quality levels right now. I'm happy to see the return of cotton jersey and more silk. Keep moving in this direction.

Move away from beaded tops that require the customer to reinforce every bead before wearing; tops that are pretty but see-through when they shouldn't be and the like.


Price points.
Isn't it cute when Anthropologie tries to charge $300 for a polyester dress? They're not alone in this game; I've noticed many of my favorite mid-level lines (i.e. MBMJ, Theory, Comptoir des Cotonniers, J.Crew, etc.) playing us for fools too. Yes, there are some instances where polyester makes sense over silk or crepe or whatever. But if the item is dry clean only and presented as a multi-year investment, my wallet stays firmly shut for that poly crap over $130. It's just not happening.


Cheaping out on perks.
I can't tell you how lame it is that Anthropologie has given some months birthday discounts with free shipping included while other months get the 15% off only, which works out to about 5% off if you have to pay shipping. That kind of stinginess destroys customer loyalty. It's downright embarrassing that a company of Anthropologie's size and supposed customer-centric ethos would ever play that game. Either offer it to everyone or offer it to no one. (Hint: the latter is a really, really bad idea.)


The big test comes next Friday when Anthropologie's Black Friday promotion goes live. Will the website be ready to stand up to the flood of customers? Will the stores be ready to deal with potential confusion over new markdowns, any further discounts, PAs and charge/sends and bears, oh my? What about the demand for bunny totes?? Stay tuned for the answers to these and other questions.


Skimping on January.
OK fine technically this is Q1 of 2015 fiscal, but let's talk about it now. This January baby is sick and tired of not getting a January Anthropologie catalogue! Don't skimp on the month when we'll all be ready to spend our holiday gift cards. Fine, it's not as good of a business month as December. Entice us and we will spend.


Further reading:
Urban Outfitters Management Discusses Q3 2014 Results - Earnings Call Transcript -- Seeking Alpha
Urban Outfitters posts record Q3 sales -- MarketWatch