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Urban Outfitters Inc. (URBN - Analyst Report), the retailer of apparel, footwear and accessories, recently posted results for the fourth quarter ended January 31, 2012. The quarterly earnings of 27 cents a share missed the Zacks Consensus Estimate of 30 cents, and dropped 40% from 45 cents earned in the prior-year quarter.

Despite registering a growth in the top line, the company witnessed a drop in the bottom line due to a 26.6% rise in the cost of sales and an increase of 7.4% in selling, general and administrative (SG&A) expenses. However, as a percentage of total net sales, SG&A expenses contracted 37 basis points to 21.3%.

Top Line Increasing

After registering a growth of 6.3% in the third quarter, Urban Outfitters said that total net sales climbed 9.3% to $730.6 million during the fourth quarter. Total net sales almost came in line with the Zacks Consensus Estimate of $731 million.

Net sales increased 9.6% to $699 million at the Retail Segment and 3.1% to $31.7 million at the Wholesale Segment. Within Retail Segment, Retail Stores sales rose 8.1% to $532 million, whereas Direct-to-Consumer sales soared 14.9% to $167 million. Direct-to-Consumer business continues to remain healthy in North America and Europe, propelled by expanded online assortments.

Net sales by brands grew 10.9% to $356.8 million at Urban Outfitters, 5.6% to $299.2 million at Anthropologie and 18.5% to $69.9 million at Free People.

Sales in Europe climbed 33% attributable to the opening of six new Urban Outfitters outlets and a rise in comparable retail segment sales of 11% and 28% at Urban Outfitters Europe and Anthropologie Europe, respectively.

Comps across Brands Rises

Comparable retail segment net sales jumped 2% during the quarter. However, comparable store net sales edged down 1%, reflecting a 5.2% decline in average unit selling prices, a 1.5% jump in the average number of units per transaction, and a 2.5% rise in total transactions. Comparable retail segment net sales by brands rose 9%, 3% and 1% at Free People, Urban Outfitters and Anthropologie, respectively. Direct-to-Consumer comparable netsales surged 14%.

Margins under Pressure

Urban Outfitters noted that gross profit for the quarter tumbled 17% to $220 million, whereas gross margin contracted 955 basis points to 30.1% due to higher merchandise markdowns to sell the slow-moving stock of women's clothing at both Anthropologie and Urban Outfitters.

Operating income plummeted 46.4% to $64.5 million, while operating margin shriveled 920 basis points to 8.8%.

Management also said that the rate of full-priced selling in the first quarter of fiscal 2013 has shown a sequential improvement, but hinted that markdown rates are expected to remain higher during the year. Management also indicated that it remains committed to manage product costs and SG&A expenses effectively to ease margin pressure.

Stores Update

Urban Outfitters, which competes with Gap Inc. (GPS - Analyst Report) and Abercrombie & Fitch Co. (ANF - Analyst Report), opened 21 new stores in the fourth quarter. During the full year, the company opened 57 new locations, which includes 21 Urban Outfitters, 20 Free People, 15 Anthropologie and 1 BHLDN. The company now plans to open 55 to 60 stores during fiscal 2013, including 23 Urban Outfitters, 16 Free People, 14 Anthropologie and 1 BHLDN and 1 Terrain. For the first quarter, the company now expects to open 13 stores.

Other Financial Aspects

Urban Outfitters ended fiscal 2012 with cash and cash equivalents of $145.3 million, marketable securities of $89.9 million, and shareholders’ equity of $1,066.3 million. During the fiscal year, the company repurchased 20.5 million shares for a total amount of about $538 million, marking the completion of the share repurchase authorization. Management also projected capital expenditures of $190 million to $210 million for fiscal 2013.

Closing Remarks

Urban Outfitter has been trying to manage its inventory at an appropriate level, which has long weighed down on the company’s margins. The company in order to clear its slow-moving stock was compelled to offer discounts that hurt its margins. Total inventories were $250.1 million at the end of fiscal 2012, reflecting an increase of 8.9% year over year.

Fashion obsolescence remains the key concern for Urban Outfitters’ business model, which includes a sustained focus on product and design innovation. In the past, this has been a drag on the company’s comparable-store sales and operating margins. The company is also currently inflicted by the same fashion risk. Women’s apparel, in particular, has been relatively weak this time around, and the company’s primary objective at present is to improve its performance. The company said that men’s and home businesses have been faring well.  

Further, to increase the customers count, the company plans to augment store openings in North America and Europe, open retail outlets in Asia, enhance online and mobile marketing endeavors, increase wholesale distribution in Europe and Asia, and considerably expand direct-to-consumer business worldwide.

The initiatives undertaken by Urban Outfitters to reposition itself as it enters into fiscal 2013 is well defined through the Zacks #3 Rank that translates into a short-term ‘Hold’ rating. However, we maintain our Underperform recommendation on the stock, and prefer to be on the sidelines until we witness margin expansion and bottom-line growth.

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