Image source: Urban Outfitters.

Apparel retailer Urban Outfitters (NASDAQ:URBN) reported its second-quarter results after the market close on Aug. 16. After suffering a decline in net income during the first quarter due to higher costs, a major improvement in gross margin drove the company's earnings higher during the second quarter. There were some weak spots, such as a decline in comparable sales at the company's Anthropologie stores. But overall, the numbers moved in the right direction.

Urban Outfitters: The raw numbers

MetricĀ 

Q2 2016

Q2 2015

Growth (YOY)

Sales

$890.6 million

$867.5 million

2.7%

Net income

$76.9 million

$66.8 million

15.1%

Diluted EPS

$0.66

$0.52

26.9%

Data source: Urban Outfitters Q2 earnings report.

What happened with Urban Outfitters this quarter?

A small increase in sales and a significant improvement in gross margin drove the company's earnings higher.

  • Sales at Urban Outfitters' namesake stores rose 3.5% year over year to $354.3 million.
  • Sales at Anthropologie stores declined 0.6% year over year to $368.3 million.
  • Sales at Free People stores rose 6.4% year over year to $164.4 million.
  • Comparable sales increased by 5% at Urban Outfitters, decreased by 3% at Anthropologie, and were flat at Free People. Total retail comparable-store sales increased by 3%.
  • Wholesale revenue increased 4.3% year over year to $74.8 million.
  • Gross margin improved 179 basis points year over year to 38.5%. The company pointed to lower merchandise markdowns as the main driver of the improvement.
  • Urban Outfitters' outstanding share count dropped by 9% year over year due to the company's ongoing share buyback program. This allowed EPS to grow at a higher rate than net income.
  • Urban Outfitters opened 12 new stores during the quarter: eight Free People stores, three Anthropologie stores, and one Urban Outfitters store.

What management had to say

CEO Richard Hayne concisely summed up the quarter:

I am pleased to announce our teams delivered record second quarter sales and earnings per share. These results were driven by a positive Retail segment "comp" and substantial improvement in merchandise margins.

The company has been working to keep its inventory levels in check, announcing further progress during the second quarter:

As of July 31, 2016, total inventory decreased by $17 million, or 4%, on a year-over-year basis. The decrease in total inventory is primarily related to the decline in comparable Retail segment inventory, which decreased 4% at cost.

Looking forward

Sales growth continues to be sluggish at Urban Outfitters, with only its namesake stores posting comparable sales growth during the second quarter. The jump in earnings was a good thing, but improvements in gross margin can only be taken so far. Eventually, the company will need to find a way to grow sales at a faster pace in order to keep delivering earnings growth for investors.