Urban Outfitters, Inc. (URBN) Earnings Call Transcript & Summary

Good morning, and thank you for joining us for this first session of the Goldman Sachs Global Retailing Conference. My name is Brooke Roach, and I cover the apparel and accessories brands here at GS. And it is my absolute pleasure to introduce our next fireside chat with Urban Outfitters. Joining me today is Frank Conforti, Co-President and Chief Operating Officer; and Melanie Marein-Efron, Chief Financial Officer. Welcome, Frank. Welcome, Mel.

Thank you, Brooke. Thank you, Goldman. Thank you very much for having us here today and thank you all for joining our little fire side chat. Just want to say, those lights are great -- I just wanted to lead off speaking a little bit about -- sharing with you about our second quarter as well as where we are, what we're doing today. So we were very pleased with our second quarter results, very healthy top line growth at 7.5%, fueled by 5% Retail segment comp, which was driven by double-digit comps at Anthropologie and Free People, 11% and 27%, respectively. Nuuly, our subscription rental business also contributed $27 million of growth to that 7.5% top line growth growth for the quarter. In addition to healthy top line growth, we had really meaningful expansion in gross profit margin, over 400 basis points of improvement in gross profit margin. That was driven by IMU improvement across all brands, followed by markdown rate -- lower markdown rates across all brands. One of the things driving that is not just only any strong performance of the business, Anthropologie and Free People from a fashion perspective, but our inventory is in line. We remain committed this year to getting our inventory back in line, just speeding up our wins to supply. I think inventory was down 16% in the quarter. Melanie's going correct me here if I'm wrong. And the Retail segment was down too, with a plus 5% Retail segment comp and inventory being down, too. That's the relationship that we're looking for, speeding up our turn and lowering our weakness, that helps to improve our markdown rates and we saw that in the quarter. All of that led to over 50% improvement in operating profit, over 70% income and EPS improvement in the second quarter. So as I said, we were very pleased with our second quarter results. And we feel good about the third quarter. I think we believe that the third quarter can look very similar to the second quarter with mid-single-digit Retail segment comps. We think we can continue to see very healthy gross profit margin improvement, over 400 basis points gross profit margin improvement in the quarter. And again, all of that leading to a very healthy operating profit and net income growth in the third quarter. As we sit here today, we still believe that that's more than achievable. And as we sit here today, our performance is very similar to what it was in the second quarter with both Anthropologie and Free People delivering very strong results right now, quarter-to-date, double-digit results quarter-to-date. And then Urban obviously still not showing the turn that we had hoped for. But obviously, it's our #1 priority on campus. But as we sit here today, we still feel very good about how our third quarter is progressing. Thank you.

That's great, Frank. Thanks so much for those introductory remarks. Maybe we can stick with that commentary that you provided about the third quarter as we look into holiday. I'm curious if you can provide a little bit more color on what you're seeing maybe by category or by brand as you move through the back-to-school season. How is the customer behaving? And what are you seeing between casual wear and occasionwear products? Are there any differences in how consumers are engaging with Urban Inc. in total across each of the different income demographics?

Sure. I think overall for us, right now, I think how we would describe it is much of the same. The consumer feels just fine for us. When you talk about category, casual versus going out, our 2 banners that are really working right now are both Anthropologie and Free People, we're not seeing one category outperform. Fortunately, we're seeing strength across all categories. So we're seeing casual. We're seeing dressy. We're seeing our high-low pricing strategy. We're not seeing price resistance to the higher items, and we're seeing plenty of purchases in the casual items as well. And that's been the case for us for some time. And we really haven't seen a change there at all. Of course, we think that the Urban Outfitters customer, that less discretionary spending is facing a tougher challenge from a consumer perspective. But that being said, we still think that the biggest problem is our own execution right now. We think that we should be executing better. We know that there are other peers that are out there that are doing okay in that demographic. And like I said, I think if you look at our Anthropologie and Free People's performance, we feel like the consumer out there is fine. There's plenty of fashion to be had. And while we have some execution opportunities on the Urban side, both Free People and Anthropologie continue to perform at a high level, and it's really across all different categories in their assortment.

That's great to hear. You mentioned execution and specifically the Urban Outfitters brand is an opportunity here. And on the last call, you had talked about how the improvement there may be taking a little bit longer than you had initially anticipated. Can you discuss in more detail the path to improving that brand and that execution? What's the opportunity? How much is macro, how much is micro? How are you thinking about that?

Sure. Well, the opportunity is meaningful. And I think first and foremost, and this is our primary focus is really getting a leader of that brand. And while it may seem easy to some, getting fashion right and executing our model is not a simple thing to do. And without a day in and day out leader of that business, it's a challenge. And that's a business that's highly competitive, that is in an income demographic where there is less discretionary spending. So it is price-sensitive. And you've got to be right, and you've got to be authentic at all touch points. And right now, I think the biggest thing that we can do is get a leader into that brand to help sort of just align the vision and the strategy and improve upon improve our execution.

Maybe as a follow-up to that, as you think about that, what are the opportunities as you think about DTC, maybe by region, Europe versus the U.S? And then how are you thinking about that within categories as well. I think you've kind of outlined a little bit of opportunity maybe a little bit earlier in apparel, followed by home and accessories.

Yes. So we have seen some improvement in apparel, in stores specifically. But unfortunately, the reality is it's just not moving the needle as much as we would have liked. And while we think some of the product is better in those areas in apparel across men's and women's apparel and more specifically in stores, we're not seeing it move the needle as much as we would have liked. And to your point, I think accessories and home lag apparel's performance overall as well. You mentioned digital. And yes, digital is underperforming where our stores are. But what I would say overall is it's more about traffic, period, right now for that brand, and it's traffic to the stores as well as just traffic to the website. I think historically, or at least over the last several years, that brand has been a little more reliant on promotions to drive traffic and to drive customer acquisition. And we're working on getting our marketing messaging and marketing execution right now, so we don't have to rely on promotions with inventory in a better position, right? We're in a position not to have to rely on promotions, but it's about getting that marketing right and being able to drive traffic -- to drive improved traffic right now.

Very helpful. Maybe we can turn to one of the stronger brands in the portfolio, which is Anthropologie. Can you talk a little bit more about the double-digit retail comp that you've been delivering? And what gives you confidence that you can continue to brand from strength to strength.

I'll let Melanie take this one.

So the Anthropologie brand, we're really -- by the trends that we're seeing. Can everyone hear me now? Good morning, everyone. Sorry about that.

They were saying, are you sure you want to separate? I was like, yes, you be in the middle. Now I have to hand the mic back and forth. It's okay.

Absolutely. I'm pleased to talk about the trends that we're seeing in Anthropologie. They're really being driven by terrific product execution. The marketing is working well. The experiences, both online and store are really appealing to our customers. And we really feel like we're hitting the mark in all those 3 areas, which gives us a lot of confidence as we look forward. As part of that, we are gaining a significant number of new customers. And these new customers are both are kind of what I would say are traditional customers, but we're also able to get some younger. And when I say younger, I do want to clarify that I don't mean like an Urban Outfitters younger, I mean younger than where Anthropologie had been trending in the last few years. So with the product right, we're able to get these new customers as well as maintain the ones that we have. We're very excited about future trends.

That's really great. Within Anthropologie, apparel and accessories has been really strong. Home has been a little bit of a laggard. We've started to hear a few signs in the marketplace that home might be starting to improve. You just hired a new President for Anthropologie Home. Can you elaborate on your view of the path there?

Absolutely. So he is quite new. We hadn't had a president actually at Anthropologie Home for quite a number of years, and he started in the last 3 or 4 months. So obviously, the results aren't -- of his work isn't quite there, but we are much more bullish about the future when his handwriting can be on the product and the strategy of the brands. And also, we do think going forward, the home category has more opportunities as people are now entrant home again.

And I think I can add in here too, since we gave a little bit of an update of trends sort of quarter-to-date. We are seeing some positive trends in that area, in that category. And while I would say, yes, it did remain challenged, but really from a reg price perspective, it was in a healthy position. And when I say it remain challenged, we were talking about just slightly down off of really, really strong performance over the last couple of years. So nothing, I think, that was certainly raising any alarms. And we've now started to see some improvement there, so we're pretty optimistic about, I think, where that can go. And just taking a longer point of view, I think having Aaron in place and being able to sort of reinvigorate that strategy of turning our Anthropologie home business into a $1 billion business is something that we still feel very confident that we're capable doing. You're talking about a business that's a little over $500 million right now. So we think that we have the permission from the consumer and certainly, we have the execution ability to double that business over the next several years.

That's great. And maybe just one final one on Anthropologie before I move on. Anthropologie had a lot of momentum in the brand. And your markdowns appear pretty low in the brand as well. Can you talk a little bit about how the brand segment profit margins are performing relative to what you view as normalized levels? And what additional opportunity do you see from here to continue to drive that improvement maybe in markdowns or in profit?

Absolutely. I might address it at a broader level. So product our brand margins right now, our product margins are quite strong. It's being driven by lower inbound transportation costs versus last year, so that's helping our product margins as well as our product margins are being driven by internal efforts to improve profitability cross functionally. We've talked about before the 500 basis points of IMU target by Q3 FY '25. We still think we're on target for that. So there's more opportunity to come next year. We think by the end of this year, we'll be about 2/3 of the way there. So that's very -- we believe there's more opportunity for margin improvement for Anthro and the other brands. The other opportunity we think exists going forward into next year would be markdown opportunity at the Urban Outfitters brand. It's still higher -- frank talked about the executional challenges that we're experiencing and that's still higher than we'd like it to be. So that would be the long-term opportunity.

Super helpful. Thank you. Free People, trends have also been similarly strong there. Last quarter, you talked about double-digit growth in customers' traffic and AUR increases. What's working so well at the brand today? And what strategies do you have to maintain that momentum?

Absolutely. So similar to Anthropologie, I think it's the marketing and the product and just the customer growth itself is very, very strong, and that gives us a lot of confidence in the future. FP Movement is really driving that business with over 50% comps. We're really excited by that strength. And that's an even broader product and customer than our Free People brand had previously been what we're seeing. So there is strength both in the Free People brand, in the Movement brand, and it gives us confidence to actually even accelerate new store openings for the brand next year. So it's really all of it, which is great to hear.

Yes. And I just want to double down on what Melanie said. I think what gives us confidence on sort of the -- at least for the next, I would hope, knock on wood, for these next few quarters is the strength of both Anthropologie and Free People. We are seeing it across all categories as well as their customer acquisition growth being double digit at both brands is really important for us to sustaining a long-term growth algorithm for both those brands and for both of those brands to be acquiring customers at that rate, really sets us up well into next year to being able to comp what is a very strong performance for both brands this year. Continuing to grow that customer file at the rates that they both are, I think, leaves us in a good spot as we start to now think about Melanie and I, unfortunately, are going to be kicking off budget soon enough as we start thinking about budgets and expectations and where we're going to be able to drive the business next year. That customer file is really important.

As you think about that customer file and maybe hand-in-hand with budget, last quarter, you had talked about some additional marketing support at both Free People and Anthropologie as an opportunity. Can you elaborate a little bit more on that? What additional level of marketing support are you planning? And what impact do you expect that to have on the P&L?

Thank you for that question. I just want to clarify that when we talked about the rate of SG&A growth in the third quarter, that is part of it. But honestly, a bigger driver is the higher compensation costs. So as we have better performance, our performance pay goes higher. And as that said pay goes higher, that's causing some of that deleverage. So we are increasing our investment in Free People and Anthropologie that's really at a time where those brands are on fire with the top line strength and strong profitability. It just feels like the right time to invest in further customer growth and maybe more top-of-funnel investing in marketing. But as I said, those are the brands that are really doing strong on the top line and it's phenomenal deleverage...

That's great. Maybe to round out the brand portfolio in aggregate Nuuly, can you discuss the drivers of the strength that you're seeing in the new subscriber growth? And it's a small business now, but have some of these early signals changed your longer-term outlook for the brand as well?

Yes. I don't think they've actually changed them. I think they've reinforced them. We believe Nuuly can be a $1 billion business and for a business is literally just about 4 years old now, that sounds aspirational. But with the way subscriber count growth is going, we think that we could probably close this year with a run rate of around $350 million already 4 years out. So -- and the subscriber count growth has been really healthy right now as we're entering into the fall and winter season, which is similar to what we've seen over the past several years. So we feel very comfortable as awareness is still relatively low, but is growing. We feel very comfortable with the metrics that we're following around new customer acquisition around retention rates continuing to improve cohort after cohort. So we literally track from 1 month to the next, and those are different cohorts that we track. And we're continuing to see our retention rates improve. We're continuing to see things like CAC, not having to increase in customer acquisition cost, that is, sorry, not having to increase in order to continue to acquire customers at a very healthy rate right now. So we feel very comfortable with the experience with our interactions with the consumer and the growth that we're seeing and where we believe we're going to be able to end the year sort of kicking off at an annualized run rate for that business. And I would also be remiss if I didn't say, we still feel very confident that we're going to be able to drive a profitable quarter in this back half of the year.

That's great. Maybe let's pivot to your channel business -- or to the different channels of your business. Frank, can you speak a little bit to the current health of your store fleet across each of your brands? How should investors be thinking about productivity and any adjustments to your portfolio?

Yes. So I would say that the store fleet has really surprised us, and this is why I don't try and make too much money off making predictions. It's easier to count the numbers in that our traffic at Anthropologie and Free People is actually favorable to 2019. And if you sort of think about things pre-pandemic, right, stores were seeing traffic decline at a 2% or 3% rate, and that was just sort of what you had built into your model and you assumed that digital was going to take some of the store traffic share year-over-year. And you adjust your variable expense accordingly and make sure your stores are the right size. And of course, we're still very conscious about our expense structure. But that being said, our traffic is actually favorable with those 2 brands versus 2019, and that's just awesome to see. And our store performance is really strong. You've got Anthropologie, which is a little more than 200 stores here in North America. We still believe that they can get to about 250 stores. And with the way the stores are performing right now, it leaves us confident that that's an appropriate number. Certainly, you're seeing areas like the South start to perform even and be able to look like they can handle some more penetration. And then you've got Free People that -- what we would call the Free People brand and FP Movement brands, both of which are still relatively small from a store count perspective and smaller from a square footage perspective. We think the growth there is -- we don't necessarily have a ceiling on either of those. I think the most exciting thing for us with FP Movement, which is a young brand, still relatively low awareness is we're seeing productivity at FP Movement stores consistent with Free People, the original brand, whether you want to call it collection or just the Free People brand. So for that business to have sales productivity and profit productivity consistent with where the legacy brand is, that leaves us incredibly encouraged about the growth opportunity from a physical standpoint for that brand. And not to mention, their digital was already growing at a very, very healthy rate and performing exceptionally well. So the store business at both Anthropologie and Free People are performing exceptionally well and we think will support further growth going forward. Obviously, Urban is underperforming. So I think it's hard to look at one channel versus the other and make a decision about the channel at Urban until their overall performance is better. But I think you've seen the net stores at Urban right now this year decline. And I think you could potentially continue to see that until we see the performance of that business -- until that business improves. We look at our stores on an individual basis. And when they come up for renewal and if a store is not performing well, we will not renew, and that's what you saw with closures this year.

Great. And then maybe we could pivot to wholesale. Maybe, Mel, you could take this question. Wholesale channel has been under pressure, that's not new news to the industry. But how are your conversations with your partners evolving today? And what's your outlook for this channel as you move into the second half and 2024?

I think the wholesale business continues to be tough. I think they're buying quite conservatively and therefore, we're planning as such. When you think of going forward, Frank mentioned it's a little early in our budgeting phase, but I think we are planning for the business to be around flat with similar margins to what we experienced in the second quarter, which would mean low to mid-teens levels.

That's great. Maybe hand in hand with wholesale is also what's happening with the industry inventory levels. We've seen a lot of destocking in the industry as wholesalers have tried to pull back on inventory. Retailers have done somewhat of a better job with that. But where are we in the destocking process in your view, both for the industry and for URBN as -- in total?

I can best probably speak for URBN. From a URBN perspective, we're very pleased with the progress that we've made this year. And what you've seen, as Frank mentioned, our total inventory was down 16%, and that's after first quarter, we were down 6%. So we've made sequential improvement in bringing down the inventory. And honestly, that's all been enabled by a speedier, more reliable supply chain. When we started the year, our goal was to grow inventory at a rate below our sales growth. And we definitely have achieved that. Our next -- our simultaneous goal was also to get our product turns back to pre-pandemic levels, and that would allow us to run on our speed model and also better manage markdowns. And we are definitely seeing the benefit of that. We think that by the end of the year, the end of the current fiscal year, most of our brands will be operating inventory turns back to pre-pandemic levels. So we're pretty pleased with those results and the outlook.

And with that improvement in inventory turns and better markdowns, that obviously begs the question of what you're thinking about pricing into next year. And that's one of the questions we're asking all companies at our conference this year. Maybe, Frank, you can take this one. What -- do you anticipate to raise, lower or maintain prices next year? And how are you thinking about that opportunity?

We're keeping you on your toes up here in the middle. So for us, I think it's a little bit different, right? We run a fashion business that continually tries to change out their assortment and present a new item season after season. And so it's hard to look at pricing consistently from one item over a period of time and see whether or not we've taken prices. I think what we would say is, one, we've seen no price resistance when the fashion is right. Both Anthropologie and Free People are our higher price point brands on campus and both are performing exceptionally well. I would say we're not planning on taking price in that, because of macro factors, we feel like we need to take price in order to reach our IMU goals. That's just not the case right now. Our inbound or I would call it sort of our input costs as it relates to product are just fine and essentially are back to pre-pandemic levels. So for us, it's just about having that rate pricing architecture and the right balance of pricing, making sure that we still have that high/low, and we've got the rate pricing architecture for the consumer. But it wouldn't be about taking price, whereas when the inbound freight challenges were happening during the pandemic and like everyone had to take a bit of price, that's not a situation that we're in, and that's not how we're thinking about next year. I think it's sort of back to business as usual and making sure that we've got the right pricing architecture for the consumer.

You talked in that a little bit about some of the drivers of gross margin. And Mel touched on them earlier, but maybe we could put it all together. How large are each of the drivers of gross margin into the back half between freight, cross-functional initiatives, markdown rate improvement? And will these tailwinds continue into next year?

So I think we -- as we said, we delivered over 400 basis points of gross profit margin improvement in the second quarter, and we believe we can do something similar, over 400 in the third quarter as well. And I don't want to get too far ahead of ourselves. Holiday is always the most unpredictable season of the year for us. But certainly, if the business continues to perform as it is today, as I sit here today, I think there's probably a similar opportunity in the fourth quarter. So we are not done. As Melanie mentioned, our IMU initiative, which was about lower inbound transportation costs, but as well as being driven by other cross-functional initiatives. We think we'll be about 2/3 of a way to our 500 basis point goal by the fourth quarter of this year, which means that we will have continued IMU improvement opportunity next year across all brands. So I just -- I want to reiterate that our goal is to run at 10% operating profit. We think we're certainly going to make a ton of progress to that goal this year, and it's achievable on the near-term horizon. IMU is going to be one of the ways that we get there, and there still is more opportunity across all 3 brands from an IMU perspective next year. Additionally, obviously, Urban Outfitters is not performing where we want it to right now. So there will be markdown rate opportunity at the Urban Outfitters business as that business does start to turn, and we do start to see the impacts that we want from that business, that is an incremental opportunity for us to have margin expansion down the road as well. And then other businesses that are relatively new, but that are growing at a healthy clip, taking Nuuly as an example, adding $27 million of top line growth for -- just for -- within the second quarter and growing at a very healthy rate right now as well, we think that business is going to be able to turn a profitable quarter this year, in the back half of this year and then going forward. So that will also contribute to margin expansion and to bottom line growth as that concept really starts to take hold. So there's a couple of different levers that we have that we think we'll be able to execute on to continue to improve our operating profit next year on top of the significant improvement that we have delivered and feel pretty confident right now we're going to be able to deliver for this year. And then as Melanie mentioned earlier, obviously, SG&A has delevered a bit this year. We're anniversarying last year, not having incentive comp in the business for a large portion of our campus as we didn't hit our goals. And right now, we are, but that wouldn't be a deleverage because you wouldn't be up against a 0 or a very low number as you think about it next year. And then obviously, we obviously continue to work on how to be more efficient, how to run our business as nimble as we can.

That's really great color. Mel, anything to add there? Or should we go on to the next one?

Next one?

Okay. Excellent. One last question for me before we turn it over for a few minutes of audience Q&A. And this is a question that we're asking every company at our conference today. Do you see the consumer facing more headwinds or less headwinds next year compared to 2023? And how are you thinking about the potential for trade up or trade down or income demographics in your cohorts into next year?

Yes. I think right now, we're thinking about next year, very similar to this year. It just doesn't feel like a lot is changing. I know that there's been a lot of sort of -- I don't know if I want to say doom and gloom, maybe not that strong, forecasts that are out there. I know Goldman improved theirs, forecast for the next 12-month outlook. But we're just not seeing a meaningful change in how the consumer is behaving right now. And for us, that means opportunity. Like I said, we're performing overall, at a total company level, at a very high level right now. And we're not seeing the consumer interact with us any differently, so that's how we're planning for next year. I think it's important to know, though, that the supply chain is back, right? And our speed is back, our inventory is back to near where we were from a week's of supply perspective, pre-pandemic. It's back to the same speed and nimbleness that we've had in the past. So if the consumer were to change, whether it be accelerate or decelerate, we're going to be in a position that we can adjust accordingly and adjust with the same speed and magnitude that we have had in the past. So right now, we're not planning for really for a meaningful change in how the consumer is interacting with us and how we're going to support that consumer. But if something were to change, we've got that nimbleness that's back in our business that will be to adjust fairly quickly.

Excellent. And with that, we have a couple of minutes for Q&A from the audience. If any of you have any questions, feel free to raise your hand, and our mic tech will bring you a mic.

Means we've been very comprehensive.

Great. Well, thank you so much for the very comprehensive session. Thank you, Frank. Thank you, Mel...

Thank you...

We really appreciate you joining us, and thank you all, in the audience, for tuning in.