Urban Outfitters, Inc. — Q3 FY2016 Form 10-Q
Business context and period: Global lifestyle retailer with Retail brands Urban Outfitters, Anthropologie, Free People, Terrain and BHLDN, plus a Free People Wholesale segment. The quarter and nine-month period ended October 31, 2015; fiscal year ends January 31. Retail includes stores and direct-to-consumer channels managed on an integrated omni-channel basis. Figures below are in U.S. dollars; financial amounts are in millions unless noted.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Net sales | $825.3 | $814.5 | $2,431.7 | $2,312.0 |
| Gross profit / margin | $288.2 / 34.9% | $283.5 / 34.8% | $852.7 / 35.1% | $825.3 / 35.7% |
| Operating income / margin | $80.3 / 9.7% | $76.5 / 9.4% | $237.1 / 9.8% | $241.4 / 10.4% |
| Net income | $52.0 | $47.1 | $151.6 | $152.1 |
| Diluted EPS | $0.42 | $0.35 | $1.18 | $1.09 |
- Quarterly change: Sales rose 1.3%, operating income 5.0%, and net income 10.3%. Gross margin improved 0.1 percentage point; diluted EPS increased 20.0%, aided in part by fewer weighted-average shares.
- Nine-month change: Sales increased 5.2%, but operating income declined 1.8% and net income was approximately flat. Gross margin fell 0.6 percentage point as delivery and fulfillment costs increased.
- Sales drivers: Q3 Retail sales grew 1.9%, including comparable Retail growth of 0.7%; direct-to-consumer growth was partly offset by negative comparable store sales. Free People, Urban Outfitters and Anthropologie Group comparable Retail sales rose 2.5%, 0.9% and 0.1%, respectively. Wholesale sales fell 5.2% in Q3 because shipment delays at the new Gap, Pennsylvania distribution facility shifted shipments into Q4. For the nine months, Retail sales rose 4.8% and Wholesale sales rose 10.4%.
- Cash flow: Nine-month operating cash flow was $228.6, up from $130.4, primarily reflecting lower inventory levels. Investing cash flow was a $26.4 outflow, including $109.1 of property and equipment purchases and net marketable-security sales and maturities of $82.7. Financing cash flow was a $207.8 outflow, including $365.5 of share repurchases, partly offset by $115.0 of net debt borrowings.
Liquidity, debt and capital allocation
- At October 31, cash and cash equivalents were $149.6; marketable securities totaled $123.7; together, $273.3, versus $357.8 a year earlier. Working capital was $469.3.
- Inventory was $441.6, down 5.5% year over year but up from $358.2 at January 31, consistent with seasonal build. Management reported comparable Retail inventory down 9% at cost and 7% in units year over year.
- Long-term debt was $115.0. A new five-year, asset-based revolving facility provides up to $400.0, subject to a borrowing base, with an option to increase by up to $150.0. The facility is secured by inventory, receivables and certain other assets. The company reported compliance with its terms. Standby letters of credit were $14.2; separate trade-letter-of-credit facilities had $83.1 outstanding and $46.9 available.
- The company repurchased $365.5 of shares during the nine months. After quarter-end, it repurchased 4.2 million shares for approximately $99.7, funded with Credit Facility borrowings. The February 2015 authorization covered 20 million shares.
Outlook, management commentary and risks
- Management said comparable Retail sales were low-single-digit negative so far in Q4 FY2016. It planned 31 new stores for fiscal 2016 and approximately $145 of capital expenditures, expected to be funded by operating cash flow. Planned investment includes stores, fulfillment capacity, systems, omni-channel marketing and technology. Management believed cash, available credit and operating cash flow would fund planned initiatives.
- Q3 gross margin benefited from higher merchandise margins and lower Urban Outfitters markdowns, partly offset by lower margins at Anthropologie and Free People, fulfillment costs, increased direct-to-consumer mix and foreign exchange. The new fulfillment facility transition also weighed on nine-month gross margin.
- The company cited fashion and promotional competition, consumer demand and economic conditions, seasonality, international and foreign-currency exposure, import and supplier risks, store expansion, e-commerce, distribution operations and legal or regulatory matters among forward-looking risks. It noted that seasonal sales and working-capital needs typically rise during back-to-school and holiday periods; interim results are not necessarily indicative of full-year results.
- Management said ordinary-course legal matters were not expected to have a material adverse effect; no material risk-factor changes from the January 31, 2015 Form 10-K were reported. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
- Unusual items included a federal rehabilitation tax credit that lowered the effective tax rate, partly offset by increased valuation allowances on certain net operating losses. Valuation allowances were $5.7 at October 31, compared with $0.1 at both January 31 and October 31, 2014.
Important facts for investors to verify
- Whether Q4 comparable Retail sales and the holiday season recovered from the low-single-digit negative trend disclosed in the filing.
- Whether the Gap, Pennsylvania fulfillment facility transition resolved shipment delays and contained delivery and fulfillment costs.
- Inventory quality, markdown activity and gross-margin trends, particularly given seasonal inventory growth and fashion-demand uncertainty.
- Cash generation and liquidity after the post-quarter buyback, including the increased reliance on secured revolving borrowings and remaining credit availability.
- Execution and returns on planned capital spending, new-store openings and continued omni-channel investments.
- Potential effects of foreign exchange, valuation allowances and other tax estimates; the filing does not provide a clear quantified sensitivity for these items.