Notes from Urban Outfitters' Q2 2017 Earnings Call

Wednesday, August 24, 2016

Last week the leadership team from Anthropologie's parent company Urban Outfitters gathered with investers for everyone's favorite quarterly earnings call! What kind of intriguing information did we learn about Anthropologie, and how did the company do last quarter?

Inside, all the notes fit to print...

Let's begin with the financials:

For Q2 2017 Fiscal, net sales of Urban Outfitters came in at $890.6 million during the reported quarter, up 3% from the year-ago figure of $867.5 million. Urban Outfitters and Free People brands contributed to top-line growth in the quarter. However, sales at Anthropologie Group declined in the quarter. Gross profit for the quarter came in at $342.5 million, up 7.7% from the year-ago quarter, while gross margin expanded 180 basis points to 38.5%. 
Net sales by brands grew 3.5% to $354.3 million at Urban Outfitters and 6.4% to $164.4 million at Free People. However, net sales at Anthropologie Group declined 0.6% to $368.3 million. The company’s net sales advanced 2.5% to $815.8 million at the Retail Segment, and gained 4.3% to $74.8 million at the Wholesale Segment.
Comparable retail segment net sales, including the comparable direct-to-consumer channel, inched up 1%. Comparable retail segment net sales rose 5% at Urban Outfitters, remained flat at the Free People, but declined 3% at Anthropologie Group (which includes Anthropologie, BHLDN and Terrain)
During the first half of fiscal 2017, the company opened 12 new outlets – 8 Free People stores, 3 Anthropologie Group stores and 1 Urban Outfitters store. Over the period, the company closed 3 stores – 1 Urban Outfitters store, 1 Anthropologie Group store (RIP Soho, waaaaaaaaa) and 1 Free People store. The company had earlier acquired 6 Vetri Family restaurants. The company opened 1 new Vetri Family restaurant during the quarter under review. 
During fiscal 2017, the company plans to open a total of approximately 23 new outlets, excluding the food & beverage division. The company expects to open 3 net new Urban Outfitters stores, including 1 in Europe; 7 net new Anthropologie stores, including 2 in Europe; and 13 net new Free People stores. During the third quarter, the company aims to open 6 new Anthropologie stores, including 1 in Europe, including a large format store with a Vetri Restaurant attached (more on this below), with 2 new Urban Outfitters and 3 new Free People stores.

Not a great quarter for Anthropologie with comp sales down 3%, though any of us could have guessed this was coming based on the aggressive discounting and promos these past few months. I did like more of what came out for Spring than the two previous seasons but often items I liked let me down on fit or material. My purchases are still way down with the brand -- as they are overall. This is not just an Anthropologie issue.

Dresses, shoes and jewelry were good. Tops were bad, very bad, and bottoms were a letdown too.

On the positive side, when an item was good, it was really really good! We saw many more item sellouts this last quarter than I can remember in awhile which helps to regain the scarcity quality that is so imperative to retail success. I hope Anthropologie is studying those huge successes closely.

Next, here are some fascinating comments from Chairman of the Board of Directors and Chief Executive Officer Richard Hayne:

"Next I'll speak to the Anthropologie brand. Although the brand reported a negative 2.5% comp for the quarter there were numerous bright spots to report. Anthropologie Europe delivered positive comp sale. Again we saw no change in cost and demand from the Brexit vote. Almost all Anthropologie product categories performed well in the quarter, with six of seven generating double-digit positive comps; only women's apparel was negative. Due to exceptional inventory management, the brand was able to limit markdowns in the apparel category and decrease the total markdown rate on a year-over-year basis by more than 100 basis points. This decrease in markdowns, in combination with very strong IMU improvement, drove significant year-over-year increases in merchandise margins on both a rate and dollar basis. The result, in spite of negative overall comps, Anthropologie generated more operating profits in Q2 this year than in the same period last year. 
Obviously the team's focus is on turning the women's apparel business around and I believe the brand is making slow but slow progress. Reaction to Anthropologie’s apparel assortment on a comp basis improved sequentially in the quarter. Areas of strength include dresses which registered strong double digit comp gains and woven tops which improved as the season progressed. The brand believes the apparel assortments will continue to evolve throughout the fall and holiday season and feels positive about their assortments in a growing number of apparel classification
Certainly reenergizing this category is the brands number one immediate goal. Strong performance of the expanding category such as home, beauty, BHLDN and Terrain continues to be a brand highlight. All expanded categories are ahead of plan and are fueling the increases in the direct-to-consumer business and the stellar performance of the two new larger format stores. Home is the most developed of these categories and continue to surprise on the upside. We’re excited to see customer reaction to the September home general, which we’ll drop in mid-September and have 42% more pages in last year’s book
The brand’s beauty assortment is also connecting with the customer and shows significant sales growth in both stores and online. By the holiday season more than 130 Anthropologie stores will have a beauty shop in shop up from 70 in the prior year. The two younger brands BHLDN and Terrain, which became part of the Anthropologie Group over the last few years, have benefited greatly from the ability to cross merchandise and leverage the Anthropologie Group’s resources. Both have experience significant revenue new growth and positive comp sales. BHLDN has the potential to top $15 million in revenue this year and quickly becoming our customers go to destination for her special occasion. 
The long-term strategic importance of positive customer reactions to this products expansions and extensions both in-store and online can’t be overstated. Nowhere is that reaction more clear and sales generated at the two newly expanded stores in Portland and Newport Beach. Last quarter, we recorded on the phenomenal openings each of these larger format stores have. Now three months later, both stores continue to exceed their sales plan and importantly for the quarter those stores available higher sales per square foot than the average Anthropologie store, I think that’s extraordinary
While one quarter’s results do not confirm the trend should this metric continue the long-term implications for the brand would be profound. Furthermore, the team believes there are many ways to enhance the assortment and experience of the stores and build sales even further. During the third quarter, Anthropologie plans to open two additional expanded stores, Walnut Creek and King of Prussia. The Palo Alto relocation and expansion is planned to open in the fourth quarter
My thanks go to David, Meg and the Anthropologie team for delivering an exceptionally profitable quarter and I congratulate David and the team for successfully developing the Anthropologie expanded categories and larger format stores. Before closing, I will briefly comment on trends in the market and summarize our accomplishment in this quarter. 
Over the past several years, the complaint lack of fashion has become common in the marketplace. I spoke to the subject on our conference call in March of this year. I actually said, I’m not predicting exactly want to change in fashion will occur, but that I saw more fashion excitement in spring than I’ve seen in quite a few years. 
I’ll repeat those comments again as we move into fall. Except I believe the change is now upon us and our customers are adapting to new looks and silhouettes as we speak. As in all such cycles some customers and brands adopt newness faster than others. But the fact is, there is currently an abundant of exciting fashion happening and this is very good for our brands for URBN and for our industry as a whole."
Lots of great information here! Firstly I completely agree with Mr. Hayne that the two large-format stores in Portland (which I visited and did a series on you can read here) and Newport Beach are huge successes! It's so much fun to be able to go into an Anthropologie with products exclusive to that store and a generally huge assortment of goodies, from beauty to full rooms of furniture and accents to clothing upon clothing, and an entire room devoted to shooooooes! I have noticed the Rockefeller Center store here in NYC begin to emulate this layout ever more, with one side of the top floor becoming dress central and the other side devoted to new trend, while the downstairs has more of a boutique feel.

The new large-format store opening in King of Prussia will have a Vetri restaurant right next door, creating an enclave of sorts for Anthro lovers where they can eat, buy clothing and beautify too. I'm so glad that this new format has worked well for the store and I hope to see more of them -- and one in NYC, please!

Unfortunately, while I very much think the design ship was headed in the right direction for Spring, they seem to have gone off the rails again for Fall. It's early, perhaps too early to say (I hope I hope) but based upon what we've seen so far (and the community reaction here though better here) Fall is shaping up to be pretty iffy.

I have a lot more to say on this, but first let's take some calls! Analysts, you're on Line 1:
Lindsay Drucker-Mann, Goldman Sachs 
I wanted to ask about the Anthro margin story, I wanted to ask first of all about why you saw IMU improvement Anthropologie and ask if UO is seeing merch margins at its high, how would you describe Anthro's merch margins relative to the historic range? 

David McCreight, President and CEO, Anthropologie Group  
Hi, Lindsay, David here. 
Like Urban, Anthropologie delivered near record merchandise margins in Q2, despite some of the shifts of product categories that we discussed. That was due to really impressive margin gains, IMU gains that Barbara and team led with design and merchants. And that was due to higher penetration of owned brand products, combined with strong sourcing negotiations and what we've seen in the deflation of raw materials.
Translated to English: Anthropologie was able to make more of a profit on many items because it negotiated a lower price on the raw materials used to make those items for in-house brands (i.e. Maeve, Floreat, Moulinette Soeurs, Pilcro, etc.)

Counterpoint: The material has been mostly awful lately. As mentioned last week, I have items that are 10+ years old from Anthropologie that still look new, and items less than 2 years old that are in such awful shape that I could only donate them for scraps and recycling -- they're no longer wearable due to rapid deterioration!

This is not how you build brand loyalty.

Adrienne Yih, Wolfe Research 
Dick, I think this is for you or maybe it's for a number of people, but on the fashion trend that you speak of, do you think that they are equally as promising across all three brands or do you think they're particularly weighted towards UO and what type of interpretation onto each of the brand do with what's happening out there? Thank you. 

Richard Hayne, Chairman of the Board of Directors and CEO, Urban Outfitters Group 
I made my comments on purpose that some brands and some customers adopt at different rate, but I think it's particularly -- the fashion changes particularly kind of Urban, but I think that the other brands have lots of fashion as well and to the degree they maybe a little slower and adopting it. I think that they well adopted, I mean this is the fashion change that’s happening and my experience is once it starts to happen, there is not much that stops it. I do think that Free People has a lot of fashionable items in their apparel area and as I said including couple of the other categories that are softer. So I think that those Free People and Urban are in sweets spot with fashion. Anthro is going to get there, I am quite confident of it. They just might take next couple of months.
I think that Mr. Hayne's continued support of the Anthropologie Group is awesome, especially when it comes to women's apparel, as recent quarterly calls and analyst rumblings have the group moving away from clothing, which would break my heart!

Still, could we get the drum beating in a different fashion direction? Like, away from trend reports and more towards stuff customers can actually wear?

Janet Kloppenburg, JJK Research 
Just Anthropologie, I think you said that the apparel trends are accelerating are you optimistic that this can improve in the third quarter and just prior to that are the inventory Anthropologie balanced and where they should be after being light at the end of the first quarter? Thank you. 

David McCreight, CEO Anthropologie Group 
Hi Janet. Yeah, it's true throughout the quarter there were opportunities for us to have different inventory levels that may have had impacted some of our apparel demand but mostly the inventory level opportunity was in how we distorted the products and the opportunities in learning and where the customers are moving more forward. As Dick alluded to earlier all of URBN will be focusing on how to be faster speed to market, use more predictive tools or resources and overtime lower inventories in total for the organization. 
As it relates to Anthropologie and the sequential growth, we did see that in Q2. 
However when we look at the balance of the year, I wanted to remember that about six months ago we launched with Meg and Barb a sort of overhaul of Anthropologie vision for archetypes, our process, speed to market, the teams have changed and that's about six months ago and we expect fall and holiday to be sort of similar to Q2. Where the company will look similar to Q2's results and expanded product categories will outpace apparel's growth, yet still see opportunities to show improved merchandize margin over the prior year, and even with apparel being cost for the balance of the year relative to comps.

Lorraine Hutchinson, Bank of America 
I just wanted to follow up on inventory I know you just touched some of it for Anthro but inventory seems lean across the chain this quarter. Did the strong reaction to the initial fall items tempt you at all to invest more heavily in inventory especially as there is newness in fashion for the back half. 

Richard Hayne, Chairman of the Board of Directors and CEO, Urban Outfitters Group 
Okay Lorraine, the decrease in inventory is planned and we are planning to decrease inventory further, but we don't think that that should impact sales negatively, we actually think it will impact sales positively because our other goal is to be able to replenish those things that are selling well faster. So to that end Barbara and her team in sourcing have implemented a lot of initiatives that are going to allow us to speed up the time that it takes us to replenish, and as we get faster and faster I think you will see inventory decrease even further but hopefully sales will go up because we'll have the right product in the right place at the right time.
Translated to English: The Anthropologie team has been hard at work looking for ways to make their production process more streamlined so products go from design to material selection to production to on the racks faster, with much more ability to control inventory to avoid overstocking items.

This is all a good thing -- it means that if an item sells out quickly for instance, Anthropologie has a chance to order another production run if the item is an in-house product.

Here's a great question about who the customer is these days...

Marni Shapiro,  The Retail Tracker 
So I guess, I’m just curious if you could dig a little bit into the customer that’s coming into or back into stores at Urban and Anthropologie, but even what you’re seeing in Free People. Is this being driven by new shoppers or is it your shoppers that will coming in and you’re buying more any kind of color that will be great? 
David McCreight, CEO Anthropologie Group 
Hi Marni, for Anthropologie Group, we're seeing stability in the customer file and the type of people coming in, though obviously the product category shifts, we do see some differences. So we do hear of customers coming in who are new to the brand because they may be passionate about home, the beauty assortment being a little different, also watching what's happening with the primary apparel-only shoppers, we look at it.
But we also know as we get into Q3 that the Anthropologie customer really starts to shop aggressively after the kids have gone into school
So we'll be looking after the kids go back to school to get ready for fall.

Hmm, is this true community? Not being a mother myself, I'm eager to do Fall shopping now (I start getting the itch around August 20th or so). How about you?

Digging a little deeper into the apparel categories breakdown:

Ike Boruchow, Wells Fargo 
You mentioned the category at Anthro that was negative, there's women's apparel, can you just remind us what percent of their business that represents and then just curious which product categories within apparel you have the most confidence in, that can show improvement in the back half and which might take a little bit longer? 
David McCreight, CEO Anthropologie Group 
It's David here again and regarding Anthropologie apparel again. As we look at it, we see we're six months into working through this. We've seen the terrific work that Meg and the leaders have done at Free People and Urban. 
So we're really -- we believe we're headed down the right path with the new approach. The teams are starting to work together well and we're starting to understand the archetypes and the potential and learning how to react. And with that confidence, the merchants and planners will start to feel better about those investments. 
Dick alluded to we've had double-digit successes in dresses. We too are excited about the fashion changes and think Anthropologie's customer will adapt to the fashion moves at a different way and a different pace than the other two brand customer sets
But we are seeing some really interesting movement in denim, wovens continue to show some nice highlights, and we're seeing just a lot of interesting read. That being said, we are expecting and anticipate it to continue to lag the performance of the expanded categories for fall, holiday time period, but continue to learn each season.

Thank you analysts for asking many questions about Anthropologie this time around, leading to some fascinating answers!

Now it's time for some roxy analysis. I may not have taken the CFPs but my multiple years of brand strategy combined with my love of Anthropologie make me a pretty strong analyst nonetheless, wouldn't you say?

Firstly I do want to re-emphasize that there were absolutely big steps in the right direction this last quarter. More dresses to love, lots of shoes and jewelry I coveted, and even some tops and bottoms. The Pilcro in-house brand has taken huge steps forward by fixing the over-stretchiness issues and coming up with fits for both curvy and straighter figures. So, there are lots of promising signs to enjoy in apparel and I don't want that to get lost in the feedback loop.

There are two big issues with Anthropologie right now in my mind -- 1 - they have too much apparel right now and 2 - there is no unifying concept among the clothing.

Let's talk about point 2 first. Although I love the free-feeling format of Anthropologie's designs, it would be nice to see some kind of cohesiveness. Time was that Anthro's design team would be challenged to design for three different women -- the Victorian-loving girl, the free-spirited boho girl, and the creative girl living in an urban world. Did those three concepts get completely abandoned? It certainly seems that way.

Not only that, to me it also feels like a cohesive color story has been completely abandoned. As a result, it's very hard to put together outfits at Anthropologie these days. A lot of times I even look at the dressforms and go, No, that doesn't really work. Which never used to happen. Most successful dressforms these days are with a one to three-piece outfit, whereas even 2 years ago it was layer upon beautiful layer.

Anthropologie is the kind of store that could make a 7-color palette work, with another 5 coordinating colors. That's a lot by retail standards. But there has to be some kind of coordination going on so that I can pick up a skirt for instance in the store and immediately know that Anthro will have at least 3 or 4 top options to go with it. And no, white doesn't count.

Many stores subtly choose 3 or 4 colors and then make most of their items in one of those colors, a print featuring those colors of a combination of 2 or more of those colors. They also pay attention to shape -- so if they have lots of flowy tops this season, their skirts tend to more structured to match. Flared and bootleg pants get body-skimming tops. Dresses get jackets that come to within a couple of inches of the hemlines, creating an effortlessly sleek look.

Meanwhile, there's Anthropologie where the tops are often too cropped to make it over a bottom, where longer jackets can't really match up with the shorter dresses (unless you enjoy sporting the Is she or isn't she wearing anything under there? look), and one can entirely forget about finding a bag that has coordinating colors with a dress or shoes whose print coordinates perfectly with a pencil skirt and sweater. Besides, most of the sweaters are too long and tunic-y or too open and flowy to wear over all the miniskirts anyway!

Who on the Anthro side is keeping track of this kind of stuff? The tale is spoken clearly on the stores' Instagram feeds (which I will keep kudo'ing every quarter because they are awesome and show off every age, body shape and ethnicity!) where it's dress after dress featured with nary a pant or skirt in sight. Shouldn't there be someone going "You know this skirt is great but which tops from the collection go with it?"

Also, I think Anthropologie is drastically oversold internally on the idea that every shopper is a mom. I have no doubt that the majority are mothers, but I think this focus cuts off the arms of what could be strong growth among younger customers (I became an Anthro fan around 16 myself!) and 30-somethings like me who are not yet moms and won't be in the near future. Not every shirt has to work for maternity. You can add some structure to dresses at the waist, it's OK not to look pregnant!

Then on point 1 (that there's too much clothing at Anthropologie right now) I know that sounds very strange considering how much I like the large format stores and was complaining two quarters ago that the stores were way too sparse, but here's the thing: the online selection is way too big. OR the online layout needs to be rethought.

Thumbing through 4 pages of dresses is too much. Five pages of tops at times is overwhelming, especially with the poor filters currently available on the website (and in-store tops to hide under table tops or on low shelves, making them extremely hard to locate without help).

It's paralyzing! Can't the selections be a little more curated? When I see exactly the same pair of cuffed white jeans, one by AG and one by Pilcro that's $60 less it's too much. When I see 4 white lacy short-sleeve tops with very small differences between them it's too much. When I have to hunt through 4 pages of dresses to find the one I forgot the name or brand of 2 or 3 times before I actually find it in the ocean of products, it's too much!!!

Paradoxically, I would happily take more products in-store. This is a two-pronged devil. Less product overall please and also fewer online exclusives. Get the products in-store where I can see them! Again here I'll use this as an opportunity to mention that many European luxury stores keep their entire product line stocked in store, one size of each product, which you try on and then have your purchase drop-shipped to you. It works! Store is happy and customer is happy.

Whew! I'm out of breath at this point, so I'll turn it over to you community. What is your reaction to this quarter's call, results and comments, and what can Anthropologie do to make you happy (besides giving us all a 1-day employee discount, which god knows I'd use to its fullest!)

Further reading:
Urban Outfitters' (URBN) Q2 2017 Results - Earnings Call Transcript -- Yahoo Finance
Anthropologie's Plan to Supersize Its Stores While Others Shrink Is Working -- Bloomberg, great article
Urban Outfitters (URBN) Beats on Q2 Earnings, Stock Gains --