Urbn Store
Source: Urban Outfitters.

The retail segment has been a tough business lately, with shoppers being more discriminating and with near-stagnant disposable income weighing on their ability to buy the goods they want. Throughout the recession, though, Urban Outfitters (NASDAQ:URBN) managed to hold its own despite the adverse conditions in apparel retail, with its edgy approach to fashion resonating with its core audience. Yet lately, even though Urban Outfitters has done a good job keeping its sales up, it hasn't been as successful in driving bottom-line growth. Let's take a closer look at how Urban Outfitters did for the quarter and what's next for the retailer.

Fitting together the pieces of the Urban Outfitters puzzle

On the surface, Urban Outfitters' sales looked fairly strong, with better than 5% growth. But increased store counts drove those gains, as comparable retail-segment sales actually fell by 1%. Looking at earnings, an increase in overhead expenses and falling margins due to discounting activity led to a one-third drop in net income, and despite a considerable drop in share counts from stock repurchase activity, earnings per share fell to $0.35, well short of the $0.41 per share that investors had expected to see.

A closer look at Urban Outfitters' various segments paints a much different picture. On one hand, the company's newer concepts performed extremely well, with the Free People segment seeing 25% revenue growth on a 15% jump in comps, and the Anthropologie Group enjoying 4% sales growth on positive comps of 2%. But the company's core Urban Outfitters stores performed abysmally, with flat revenue stemming from a 7% drop in comparable-store sales for the concept. Moreover, Urban Outfitters blamed much of its deterioration in gross margins on the weakness in its namesake brand, which occurred because of lower initial markups and steeper subsequent markdowns in order to keep inventory moving out the door. Despite those efforts, inventory levels climbed 15% from year-ago levels.

Urbn Clothes
Source: Urban Outfitters.

CEO Richard Hayne had mixed feelings about the quarter, saying, "While we are pleased with delivering record third-quarter sales fueled by strong performances at our Anthropologie and Free People brands, I am disappointed by the results at the Urban Outfitters brand." To be fair, Urban Outfitters had already warned investors that the fiscal third quarter could be disappointing. Last month, the company said that its negative comparables in its retail segment had continued, and therefore that gross profit margins would likely fall and cause negative impacts on Urban Outfitters' earnings. Yet despite some signs of life from its e-commerce and other direct-to-consumer efforts, Urban Outfitters clearly has work to do to regain its former momentum.

Can Urban Outfitters bounce back?

The main question that Urban Outfitters will have to answer is exactly how to drive traffic into its stores. Recent efforts include expanding the size of its Anthropologie stores to encourage a longer shopping experience that includes more of the company's broad range of concepts. With store-within-store areas, Urban Outfitters hopes to make Anthropologie a one-stop shopping destination that serves a wide variety of home-related needs, including home furnishings, gardening, and other merchandise.

Clearly, looking at Urban Outfitters' closest competitors, focusing solely on apparel appears to be a losing proposition. Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO), and several other retailers oriented toward the younger end of the market have struggled of late, and Urban Outfitters can expect a tough fight from across the retail spectrum. Urban Outfitters' efforts to tap into the athletic-apparel arena might be one track toward growth, but by itself, the initiative won't be able to get the company back on the right footing without further assistance on other fronts.

After the earnings announcement, Urban Outfitters stock fell about 5% as investors waited for the follow-up conference call to answer their questions. In the long run, though, the coming holiday season will be instrumental in Urban Outfitters' future success, as the retailer has to do a better job of managing its inventory and finding products that its shoppers will actually buy if it wants to get back on the path to success.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.