Notes from Urban Outfitters’ Q3 2017 Earnings Call

(note: no internet at my new apartment yet, so if something big and exciting happened please feel free to go OT in the comments until I can get to a

Investors were drooling the day before Anthropologie parent company Urban Outfitters announced its Q3 results. Were they still salivating after the call? Find out as we dive into the Q3 2017 quarterly earnings call…

As always, let’s begin with the financial results:

Total Company net sales for the third quarter of fiscal 2017 increased 5% over the same quarter last year to a record $862 million, below the analyst expectations of $869 million. Comparable Retail segment net sales, which include the comparable direct-to-consumer channel, increased 1.0%. Comparable Retail segment net sales increased 5.2% at Urban Outfitters and decreased 1.5% at Free People and 2.7% at the Anthropologie Group.

Comparable retail segment sales, which includes its direct-to-consumer channel, increased 1%. The company said markdowns were “favorable” during the period due to lower markdowns at the Urban Outfitters brand, which were partially offset by higher markdowns at Free People and Anthropologie. As of Oct. 31, total inventory increased 3% year over year, or by $12 million. The higher inventory is primarily due to an increase in non-comparable inventory to support new and expanded stores, Urban Outfitters said.

“Despite well-controlled inventory, Anthropologie was not able to hold their markdowns flat this quarter due to their challenging women’s apparel performance,” — Chief Financial Officer Frank Conforti.

“A large portion of [SG&A (selling, general  & admin expenses), aka capital] expenses were due to the several large format Anthropologie stores recently opened, were opened in the quarter. While we’re extremely pleased with the top-line performance of these stores, we have invested a considerable amount to ensure the hiring, training and overall execution of these stores were second to none. 

Many of these expenses, pre-opening and initial staffing levels, we believe we can reduce and leverage in the upcoming year through improved control and planning based on our current year’s learnings.” — Chief Financial Officer Frank Conforti

For the fourth quarter, Urban Outfitters planning four net new stores, including one new Urban Outfitters store in North America, one new Anthropologie store in the UK, two Anthropologie closures in North America due to lease expiration and four new Free People stores and one closure due to lease expiration. 

Analysts were expecting Urban Outfitters to outperform this quarter based on positive trending at the namesake brand, but unfortunately for them no one brand tells the story alone at this company. Free People, which had been trending upwards for nearly 10 straight quarters, is experiencing a bit of a dip while Anthropologie, the store we love here, seems to be mired in a slump. Not that that’s news to anyone here. I think given the amount and percentage of markdowns this last quarter in-store it would be hard for Anthro to come out ahead…yet analysts were taken by surprise.

From the press release and inserted call quotes above, it’s clear the large format Anthropologie & Co stores are doing quite well (although that comment about reducing staff there, ick) but the rest of the stores are not keeping up. Not that I think it’s the store’s faults, which we’ll discuss more below.

As always, CEO Richard Hayne had some intriguing insights in his remarks. Here are some highlights:

“Now let me turn to a discussion around two of the retail
topics I find most interesting, the shift in channel demand and the
shift in fashion silhouette and discuss how these changes have impacted
our brands in the third quarter. The divergence in demand by channel
that we’ve witnessed over the past few years continued in Q3 this year.
In general, the digital channel outperformed, stores lagged and
wholesale delivered strong growth. 

In the store channel, fiscal shopping visits as reported
by industry groups continued to be down on a year-over-year basis.
Overall traffic fell by mid single-digits in Q3 for the second
consecutive year. With several notable exceptions, our brands’ comp
store sales echoed this traffic pattern and were negative in almost all
regions by all store types, mall, lifestyle centers and freestanding. 

Lower comp store sales at the Anthropologie and Free
People brand in Q3 were driven primarily by fewer transactions and lower
AUR. There were, however, a few bright spots in store channel
performance. The Urban brand produced positive store comps in North
America and Europe and the Anthropologie brand registered positive comps
in Europe and the recently opened larger format stores continued to
exceed expectations and deliver sales per square foot greater than the
Anthro average. 

…

During the quarter, we also saw a shift in fashion
silhouette, that I’ve alluded to on prior calls, begin to strengthen.
This emerging trend which seems to have its roots in Europe, is not
impacting all brands equally. Predictably, younger, more fashion-forward
customers are adopting these new looks more readily. So in Q3, the
Urban and Free People brands benefited from the shift while the
Anthropologie brand did not. 

In the fashion industry, times of rapid change, like we
see when silhouettes shift, offer the greatest opportunities but also
pose the greatest risks. Now let me turn your attention to the
Anthropologie brand where third quarter top-line results were very
similar to Q2. Total retail segment comp sales landed at negative 3% in
the quarter, with weakness in stores more than offsetting the growth in
direct-to-consumer sales. 

The comp shortfall was driven entirely by the apparel
category. All other product categories and sub-brands delivered positive
retail segment comps. The expanded categories of home, beauty, BHLDN
and Terrain performed particularly well. We expected to see more
progress in the apparel category, but customer response to fall
assortments was lackluster. 

This led to higher markdowns versus the prior-year
period even though inventories which ended down 3%, were tightly
controlled. While we could see modest comp sales improvement in Q4 over
Q3 rate, we believe apparel sales on a year-over-year basis will likely
remain difficult and weigh on total Anthropologie comps and margins for
the holiday seasons. 

Transition in fashion silhouette are never linear or
easy to predict. As a customer becomes more comfortable with a different
silhouette and our merchants become comfortable presenting her with
more newness, we expect better results. I believe we will begin to see
improvement in customer reaction to the apparel offerings with our 2017
spring/summer deliveries.”

“In Q3, Anthropologie opened two additional larger-format
locations, Walnut Creek, California and King of Russia, Pennsylvania.
To date, sales at these stores are running nicely ahead of projections
which strengthens our confidence in the brand, the strategy of opening
larger stores and the strategy of expanding product categories. 

The largest stores have also helped to build expanded
category demand in the digital channel. This past weekend, the brand
opened another larger-format store in the Stanford Shopping Center in
Palo Alto. Besides an expanded assortment of home products, shoes,
accessories and beauty products, the Palo Alto store also offers a full
assortment of Beholden wedding gowns and occasion dresses and Terrain
outdoor living products and decor. 

The store also provides customers with the Terrain cafe
for casual dining. Customer reaction has been fantastic, with weekend
sales coming in 33% above plan.”

This all does make me very excited for the Dey Street Anthropologie & Co to open in NYC as I’m suddenly living very close to the Financial District again, though judging from this call that won’t be before Q1 Fiscal 2018. The location is now very well-picked, being close to the Oculus, Eataly and fairly close to Brookfield Place.

Oh and Brooklyn needs an Anthropologie, now that I live here. Those are the locations at the top of my wishlist…even though I am wondering if overall Anthro has too many stores.

Here’s some of what was discussed on the call about Anthropologie’s performance.

Kimberly Greenberger
And has there been any sign at all on the Anthropologie side that customers are starting to wear the new silhouette? I’m just wondering, tactically speaking, how you think about navigating through the shift over the next four to six quarters at each brand. Thank you so much.

David McCreight
For the Anthro customer, we’ve absolutely seen some movement in what she likes in terms of style and profile and proportion. In particular, we saw her adapt the increase or the rise, in waists very quickly which allows her to wear — and then we saw a real separation in the proportion of tops, in particular, up and out, a great deal of sleeve interest was embraced, but also still there was plenty of customers who shifted instead of big over little, was sort of long over lean.

Omar Saad
I wanted to ask a follow-up question on the, your comments around the gross margin pressure in the Anthropologie apparel business. Is that related to this kind of allusive, mysterious fashion shift being too far ahead of the curve on the apparel side with the Anthropologie customer or is it related to other issues?

David McCreight
Omar, it’s David. Yes, as we look at it, we would say it’s sort of a combination of factors. As the customer is dialing into, as we’re dialing into where the customer is on the curve would be one component of it. The second would be, as Anthropologie embarked on embracing a sort of a newer way of working and building our apparel right on the heals of the tremendous success at Free People and Urban, we’re still learning how to work together more seamlessly, align around big ideas, execute well following the process and we’re trying to make progress each quarter.

With that being said and given the general, I don’t know if uncertainty, but sort of where we’re in this phase of the curve, we’re making certain to enter spring lean in apparel, in particular, so that we can read and react, as Dick and Frank alluded to, thinking about ways that we can speed our turn and reduce markdowns for spring.

Eep! I felt my stomach sinking a bit as I read the comments up further in the post that every category except apparel was positive for the quarter at Anthropologie and now we find out that they’re planning to enter Spring lean in apparel? Perhaps this isn’t so awful as they really do have way too much right now (it’s apparel choice overload on the website even as the stores seem so light on clothing selection) but this comment gives me serious pause.

The answer is not abandoning clothing. God I hope Anthropologie is not moving in that awful direction! As an operations and strategic planning executive myself I think Anthropologie has done well to diversify the product offerings and make its stores over into mini Anthropologie & Co stores with beaut and such incorporated (even if the shopper in me misses that space for clothing) but to give up on clothing entirely would be awful!

Then again, perhaps that is not the plan.

Janet Kloppenburg
Couple of questions, David, on the Anthropologie apparel assortments, it sounds like you have confidence that the business will strengthen in the first quarter or let’s say, the spring season and I’m just wondering if there’s some — but you’re still locking for gross margins to be pressured in the fourth quarter which means maybe it’s not figured out.

So what I’m wondering is are there green chutes that are giving you some evidence that what you’ve invested in for the spring season will help turn the business? And, Dick, I was just wondering, given the robust strength of the direct channel, if that’s making you rethink your square footage expansion programs across all brands? Thank you.

David McCreight
As we look at the spring/summer season with Anthropologie businesses and, like many, as you move from spring to fall or holiday to spring, there’s always a question about how the businesses are going to perform. We’ve been impressed with our customers’ engagement with the brand, customer counts across all three sections, measurements are up, the large formats are doing well, digital has continued to grow at a double-digit pace. So a lot of very good finds.

As it relates to apparel, we really don’t want to predict how she’s going to respond to it yet. We’d planned to enter leaner than we have before, leaner than we did with fall and holiday so that we can react to the trend. We’re working, learning to also work together more cohesively as a team to make sure we’re trying to put forward our best stories to learn from. But, ultimately, she will guide us.

Richard Hayne
I don’t think that, first of all, you know we have one of the leanest store fleets in the industry and I don’t think there’s any way we can consider ourselves over stored and we’ve been extremely cautious about opening more stores in recent years. As far as the Anthropologie large-format stores are concerned, I think it’s being proven that it was a very good idea.

So I think we’re right on track there and I look forward, in two or three or even four years, when I think you’re going to see significantly fewer stores across the country and the supply of apparel product decrease.

It sounds from this exchange like the plan is to hunker down and weather the storm. Whew! Crisis averted.

Further along in the call it does sound like the executive team is very excited about the coming quarters and seeing how customers respond to the new silhouettes. I hope there is plenty to be excited about!

In the meantime, I am shocked at how far off the reservation Anthropologie was with its Fall 2016 collection. Not enough pretty wearable sweaters, too many overpriced coats and weird design details that take items from interesting to unwearable (bell and puffy sleeves? really?). There also was not enough cold weather stuff in general — to much off-the-shoulder stuff, sleeveless stuff, lightweight stuff, and cropped stuff.

I also take issue with the characterization that Anthropologie customers are not on to whatever these mysterious ‘European trends’ mentioned several times on the call are. I go to Paris every two years and happily shop away there…and I’m not seeing much ‘Paris’ reflected in Anthro’s selection right now.

Here is what the Anthropologie customer wants, as I understand it:
1 – Flattering silhouettes, especially for hourglass figures
2 – Emphasis on lean and body-skimming over boxy cuts
3 – Classics with a wearable twist
4 – No drastic prints
5 – 70% work clothing, 20% casual, 10% ‘other’ clothing
6 – One really good holiday party dress or outfit per year
7 – 70% classic lengths, 20% mini or youthful, 10% or less trend

That’s the lucky seven as I see it. the Part I of Anthro’s secret to success.

Part II is taking a serious look at the promotional/markdown cycle. Look, Anthropologie’s markdown cycle has always been a little bit mysterious. But the full-price promotions are going overboard right now and sale would be much better done on the 4-6 week cycles with 2nd/3rd/etc cuts every 8-10 weeks like they used to have.

And sale should ALWAYS be the same day of the week. Monday, Tuesday, Thursday, whatever, but pick one day and stick with it! New and casual customers don’t really care of course but this is how you keep your loyal contingent’s interest piqued.

Oh and Free Shipping, which we gripe about every quarter.

Those are my thoughts for this quarter. Community, what are yours?

Further reading:
Urban Outfitters Q3 2017 Earnings Call Transcript — Seeking Alpha
Urban Outfitters tumbles after-hours as Q3 results miss expectations — The Street
Urban Outfitters: Has the Story Changed? — Seeking Alpha