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Urban Outfitters, Inc. (NASDAQ:URBN)

F4Q09 Earnings Call

March 5, 2009 11:00 am ET

Executives

Glen T. Senk - Chief Executive Officer

John E. Kyees - Chief Financial Officer

Tedford G. Marlow - President Urban Brand Worldwide

Analysts

Michelle Tan - Goldman Sachs

Jeff Black - Barclays Capital

Neely Tamminga - Piper Jaffray

Brian Tunick - J.P. Morgan

Randal Konik - Jefferies & Co.

Adrienne Tennant – Friedman, Billings, Ramsey

Kimberly Greenberger - Citigroup

Michelle Clark - Morgan Stanley

Robert Samuels - Oppenheimer & Co.

Christine Chen – Needham & Company

Janet Kloppenburg - JJK Research

Samantha Panella - Raymond James & Associates

Richard Jaffe - Stifel Nicolaus

Liz Dunn - Thomas Weisel Partners

Dana Telsey - Telsey Advisory Group

Betty Chen - Wedbush Morgan Securities

Roxanne Meyers - UBS

Holly Guthrie - Boenning & Scattergood

Marni Shapiro - Shapiro Partners

Laura Champine - Cowen & Company

Robin Murchison - SunTrust Robinson Humphrey

Elizabeth Pierce - Roth Capital Partners

Stacy Pak – SP Research

Howard Tubin - RBC Capital

Margaret Whitfield - Sterne Agee & Leach

Operator

Welcome to Urban Outfitters, Inc., fourth quarter fiscal 2009 earnings call. (Operator Instructions) The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the company’s filings with the Securities and Exchange Commission. I would now like to introduce you to our host for today’s conference, Mr. Glen Senk, CEO.

Glen T. Senk

Good morning and welcome to the URBN quarterly conference call. Joining me in Philadelphia today are Dick Hayne, our Chairman; John Kyees, our Chief Financial Officer; and our senior team including the majority of our brand and shared service leads. Earlier this morning the company issued a press release outlining the financial and operating results for the 3- and 12-month periods ending January 31, 2009.

I will begin today’s call by reading prepared commentary regarding our performance. Then the group and I will be pleased to answer any questions you may have. As usual, the text of today’s conference call can be found on our corporate website at www.urbanoutfittersinc.com.

I will begin today by reviewing the quarter. We believe the company performed very well given the extreme marketplace conditions and while we didn’t report a new record of profitability, we are pleased with our earnings.

Total sales increased by 9% to $508.0 million, the largest quarterly revenue performance in our history. Comparable retail segment sales, which includes our direct-to-consumer channel, increased by 3%. Total company comparable store sales decreased by 1%. Comp sales at Urban Outfitters increased 3% while comp sales at Anthropologie and Free People decreased 6% and 13% respectively. Direct-to-consumer sales jumped an impressive 20% and were strong across all brands. Free People’s wholesale revenues declined by 3%.

Gross margins declined by 555 basis points, principally due to the application of clearance and anticipated mark-downs to move seasonal merchandise and optimize inventory and a greater proportion of wholesale sales to close-out customers.

Comparable store inventories decreased by 13% at quarter’s end. The organization managed expenses with exceptional discipline, especially in the important category of store-related expenses, resulting in SG&A improvements of 73 basis points.

The company earned $63.0 million of income from operations, resulting in an operating margin of 12.4%. And finally, earnings were $41.0 million, or $0.24 per diluted share.

I will now go into more detail on each of our key business metrics for the quarter, starting with sales.

New and non-comparable sales contributed $43.0 million for the quarter. The company opened 8 new stores—3 Anthropologie stores, 3 Free People stores, and 2 Urban Outfitters stores—bringing the total new stores open for the year to 49.

The company’s comp sales performance was relatively even throughout the quarter. By region, sales at Anthropologie were strongest in the West and sales at Urban Outfitters were strongest in the South.

By location type, the sales at Anthropologie were strongest in metro locations and sales at Urban Outfitters were strongest in the malls.

The company’s comp sales performance was driven largely by a 2% increase in the number of transactions, with gains of 4% and 2% at Anthropologie and Urban Outfitters respectively, and a decrease of 8% at Free People.

Our average unit selling price decreased 1% in total, down 11% and 9% at Anthropologie and Free People respectively, and up 6% at Urban Outfitters.

Units per transaction decreased by 2% in total, up 2% and 3% at Anthropologie and Free People respectively, and down 5% at Urban Outfitters.

Once again, the women’s accessory business set the pace for the company and while the women’s apparel business was modestly negative, there were meaningful trends across all three brands.

Our best apparel items generated as much, if not more, business than they generated a year ago while the middle of the assortment was less productive. The consumer is buying what she loves and is shopping her closet for the rest of her wardrobe.

I believe we positioned our inventory well for the beginning of the spring selling season. We have good content and we are appropriately liquid.

Now let me turn your attention to our direct-to-consumer business. Direct sales for the quarter increased 20% to $88.0 million despite a circulation increase of just 7%. The penetration of direct-to-consumer sales to total company sales increased by 160 basis points to 17.3% from 15.7% during the comparable quarter last year.

These results were driven by website visits, which were up 31% to 21.0 million visits, a gain of 5.0 million visits over the prior year’s comparable quarter.

The strength in our direct-to-consumer business ran across all brands but especially at Free People. With just 13 out of the 30 Free People stores falling into the comp group, direct-to-consumer revenue exceeded comp store revenue by a significant amount.

With the addition of Leifsdottir the company’s total quarterly wholesale sales increased by 1%, versus the same period last year, to $24.0 million. Free People’s wholesale sales decreased by 3% for the quarter with department stores increasing by 8% but specialty stores decreasing by 22%, principally due to credit holds and other credit-related issues.

The brands regular price average unit selling price increased 5% but regular price unit sales declined by 6%. I believe Free People outperformed most brands on the contemporary floor and equally important, we ended the quarter at our desired inventory plan with all of our major partners.

Bookings for spring deliveries are modestly below last year and we remain optimistic regarding the potential of our sub-brands, We The Free and Intimately Free People.

Leifsdottir, the company’s new wholesale line, generated wholesale revenue of approximately $1.0 million in the quarter. The reaction from our retail partners has far exceeded expectations so we continue to be encouraged by the brand’s potential.

I would like to now turn your attention to gross margin, operating expense, and income. Total company gross margin decreased by 550 basis points for the quarter, to 34%. Since this metric is a stand-out I would like to take a minute to fully explain the result.

Through the first 3 quarters of the year the company was running nicely and consistently, ahead of sales. At the end of October, however, the trend shifted abruptly and we lost 11 points in run rate, or approximately $58.0 million, in our anticipated fourth quarter sales revenue.

As most of you know, the company manages its inventory to a fluid weeks of supply as opposed to a set target. Given the precipitous decline in our sales trend, the merchant and production teams and our factory base maneuvered the on-order as well as possible. With the third quarter comp inventory up 2%, however, we also took strategic, aggressive promotional action to ensure that we ended the year with an appropriate level in composition of inventory.

The largest component of gross margin decline for the quarter came from mark-downs and anticipated mark-downs followed by a greater proportion of wholesale close-out sales and all three brands impacted the gross margin decline relatively equally. None of us are pleased with the company’s gross margin result for the quarter but we responded quickly to the change in environment and are pleased with the company’s comparable inventory position, down 13% at quarter’s end.

Frankly, I’m not sure the merchant teams, or our supplier base, could have reacted any better to the abrupt change in business. They turned on a dime and repositioned the inventory in less than 3 months.

The organization also reacted aggressively to expenses. Despite the 1% decline in comp store sales, the company reduced its operating expense by 73 basis points to 21.6% for the quarter. The store teams in particular demonstrated exceptional control, leveraging direct store expenses and other corporate expenses which more than offset investments in our start up businesses, Terrain and Leifsdottir.

The company generated a 12.4% operating margin, earning $63.0 million of income from operations, a decrease of 21% versus the same quarter last year. The company earned $41.0 million in net income for the quarter with earnings per diluted share of $0.24, a decrease of 23% from the prior year.

The company’s annual effective tax rate closed at 35.6% versus 31.6% during the prior year. Last year’s unusually low annual effective tax rate was largely impacted by the receipt of one-time federal tax incentives for work performed on the development of our new home offices.

Since it’s our year end I would like to take a moment to reflect on our annual performance and acknowledge several milestones. Total company sales increased by 22% to a record $1.8 billion. Comparable retail segment sales, which includes our direct-to-consumer channels, increased by 12%. Total company comparable store sales increased by 8%. Comp sales increased 3%, 4%, and 12% at Anthropologie, Free People, and Urban Outfitters respectively. Transactions for the company increased by 7%.

We opened 49 stores, 20 Urban Outfitters stores including 5 European locations, 13 Anthropologie stores, 15 Free People stores, and our first Terrain garden center.

Direct-to-consumer sales jumped by 32% to $272.0 million despite a circulation increase of just 2%. Website visits were up 35% to 69.0 million visits, an increase of 18.0 million unique visits.

Free People wholesale revenue increased by 13% to $107.0 million. The company launched Terrain in mid-March which generated nearly $6.0 million in revenue in its first ten months of operation. We debuted Leifsdottir at Bergdorf Goodman, select Bloomingdale’s, Nordstrom’s, and better specialty accounts generating $3.0 million of revenue in the first season.

Our gross profit margins increased by over 60 basis points to 38.9%. We improved our SG&A expense leverage by over 75 basis points. Income from operations increased by 33% to a record $299.0, or an operating margin of 16.3%. Earnings increased by 24% to a record $199.0 million, or $1.17 per diluted share, and the company provided cash from operations of $252.0 million with free cash flow of $139.0 million, resulting in a year end balance of $521.0 million of cash, cash equivalents, and marketable securities.

Before I conclude I would also like to take a moment to review four of our longer-term key metrics.

First, total company sales have increased at an average compounded rate of 27% over the last 5 years. Second, our comp store sales have increased by an average of 9% over the last 5 years. Third, our earnings have increased at an average compounded rate of 33% over the last 5 years. And finally, our cash, cash equivalents, and marketable securities have increased at an average compounded rate of 30% over the last 5 years.

I think we all, retailers, portfolio managers, and shareholders alike, agree that the current economic environment is unprecedented in our lifetime and extraordinarily challenging. At URBN we are acknowledging and responding to those challenges but we are also focused on mining what we believe to be abundant opportunity. Opportunity to reduce product and occupancy costs and increase margins. Opportunity to strengthen our bond with the customer. Opportunity to gain market share. And most importantly, opportunity to transform our business to the next generation of consumers.

URBN’s culture has always been dominated by two key traits—control and creativity—and at no time in our company’s history has the need for control and creativity been greater.

With regard to control, I am extremely proud of the organization’s immediate and disciplined response to the late October downturn in business. The team repositioned the inventory within a few short months and they managed the fourth quarter expenses so that we leveraged SG&A expense despite the 1% decline in comp store sales. This was no small feat and I would like to thank each and every member of the organization for their extraordinary commitment.

I would also like to acknowledge the team for the budget they developed for our fiscal 2010 year. The team planned the year extremely conservatively and I’m proud of the ingenuity, discipline, and fastidiousness with which we managed the process.

We will continue to appropriately invest in our growth initiatives, which included driving comp store productivity, growing our direct to consumer business, opening new stores, developing new concepts, and continuing with the shared service programs to support these goals, including the establishment of our Far East buying office.

We have always managed cash carefully and conservatively, but given the current economic environment we intend to employ even more rigor to the analysis and requirements.

While our company is unerringly focused on control, we are equally focused on creativity. We believe the environment is driving meaningful changes in fashion and our customers’ values. The retail landscape will not stand still during a recession. To the contrary, we believe the pace of change will hasten and that only those retailers who are most attentive, nimble, and adaptive will thrive.

Right now, our job is to connect with our customers and provide a respite from the unwavering barrage of bad news. The URBN family will continue the way we always do, by remaining wholly customer-focused and working hard to wow the customer on a daily basis, by taking managed risks so that we excite the customer with newness and innovation, and by making our stores, catalogue, and website unexpected, fun, and wholly compelling.

Our team and our business partners are motivated, positive, and determined. Our goal is to run an outstanding business in good times and bad and our 12,000+ employees share this vision and commitment. The company’s far-reaching goal has been constant and simple, to grow revenue by at least 20%, to grow profit at a faster rate than sales, and to reach a minimum of 20% operating margin. We have achieved our growth goals consistently over time and we remain confident in our prospects going forward.

As always, the leadership team and I look forward to continuing to inspire our customers and reward our shareholders and employees alike.

I will now open the call to questions. As is our custom, I ask each of you to limit yourselves to one question. I apologize in advance, if you ask more than one question, we will respectfully respond only to your first query.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michelle Tan - Goldman Sachs.

Michelle Tan - Goldman Sachs

I was wondering if you could give a little more color on the gross margin? How much of the hit was mark-downs that were taken in this quarter versus anticipated future mark-downs, and with the anticipated future mark-downs, how much of that is left over from fall goods versus new stuff that’s coming in that you are expecting to have to discount?

Glen T. Senk

I’ll ask John to answer the question, and I will just say in advance that we will not give specifics, we will give some general direction on that.

John E. Kyees

Around 30% of the missed to lasts year’s earnings was based on the change in the reserve.

Michelle Tan - Goldman Sachs

So 30% of the gross margin decline?

John E. Kyees

Yes.

Michelle Tan - Goldman Sachs

How about the question on whether that stuff that you’re still carrying over or whether that’s things that are newer into the store that you’re anticipating marking down?

John E. Kyees

It would be a combination based on the age and sales rate of the inventory, whether it was carry-over holiday or early spring.

Glen T. Senk

I will say that I believe our inventory is probably fresher than it’s ever been.

Operator

Your next question comes from Jeff Black - Barclays Capital.

Jeff Black - Barclays Capital

Nice job on the inventory but are we to assume that the down 13% reflects some sort of current run rate at the stores right now? Can you shed any light on that and whether that’s gotten worse as the spring has opened?

Glen T. Senk

I think in retrospect I wouldn’t have minded ending the quarter with a little bit more inventory than we did, and I think, as I said in the prepared comments, the trend within the quarter was relatively constant. We are seeing a little bit, and little bit is the operative word there, softer results in February than we saw in the fourth quarter but it’s not an important month to us and I really don’t have enough information now to kind of opine on our forward business.

The one thing I want to be clear about is, and I’ve said this over and over again, is that we develop our inventory plans based on our sales, not based on last year, not based on some absolute inventory number. So we are very weeks of sale driven.

Another thing that I’ve said consistently over the last couple of years is that a long-term initiative of the company is to reduce our weeks of supply. Urban in particular had a lot of opportunity around that objective and accomplished a lot last year.

So to answer your question, the comp business in the fourth quarter was down 1%, the current trend is very slightly off of that, and we are very comfortable with our weeks of supply.

Operator

Your next question comes from Neely Tamminga - Piper Jaffray.

Neely Tamminga - Piper Jaffray

Could you talk a little bit about how we should be thinking about the merchandising assortment with respect to strategy on the price points? Is it you point that the consumer is clearly needing a little bit of extra help in value to get over maybe some of these thresholds, to convert a little bit more. Are you able to get the sourcing structure there now in spring to really support kind of this lower opening price point strategy? Help us think about how that patterns out for the year.

Glen T. Senk

I think as a rule at URBN we are always more focused on value than we are price point. Now, I think we absolutely recognize the need for powerful opening price points in our assortment. And by the way, that’s nothing new, but I think it’s more important going forward into the spring and probably throughout the 2009 than it has historically been.

I really don’t know at this point, when we’re hindsighting our business a year from now, what the average unit selling price is going to look like. It wouldn’t surprise me if it was slightly lower than it was in 2008, but we don’t have a specific strategy to lower prices.

We have a strategy to have the right fashion and to provide product with tremendous value. And again, I want to point to a comment that I said in my prepared remarks. The better items in the assortment are selling equal to or better than last year. So we are comping on the better part of the assortment. It’s really the middle of the assortment where we’re not seeing the kind of velocity that we saw a year ago. And so our merchandise strategy revolves around dealing with that than it does specific price objectives.

Operator

Your next question comes from Brian Tunick - J.P. Morgan.

Brian Tunick - J.P. Morgan

Regarding the Urban Outfitters division, I guess we were surprised, I think, on your comment that margin pressure in fourth quarter was equally spread. So maybe you could talk about what kind of comp you were buying for at the Urban Outfitters division. And I think you gave Anthropologie a B-minus for fall. What letter would you give the Urban Outfitters division for fall?

Glen T. Senk

I think that Urban looked very, very good and probably what I’ve said—I almost never give myself an A so I probably wouldn’t give anyone else in the company and A, but I think Urban probably got a B-plus, A-minus, in terms of assortment.

But let me remind you, Urban’s comp in the third quarter was 17%, and again, we buy to weeks of supply, we don’t buy to a comp number, but you can imagine that we had some adjustments to do as we progressed through the fourth quarter.

Tedford G. Marlow

In regard to the crew that I had the opportunity of working with, I would say it was probably about the 10th of November, we made a very quick move to pull about $25.0 million of sales and that can equate to over $30.0 million worth of inventory, out of fourth quarter expectation. I thought the group did a great job, as well as repositioning our thoughts on approach to spring at that time.

On the Urban side we came in line maybe even a little lower than overall company in comp inventory into January. I thought our group did a great job.

Glen T. Senk

I have the numbers in front of me. Urban was 19% comp in Q1, 19% comp in Q2, 17% in Q3, and actually, the precipitous decline of business that I spoke about in my prepared remarks, happened a little bit later for Urban than it did the other two brands. So they went from 17% comp in Q3 to 3% comp in Q4.

And again, we all wish we had a crystal ball, but we don’t and I really can’t imagine the merchant team, the production team, and our supplier base doing any better job than they did to react to the business.

Operator

Your next question comes from Randal Konik - Jefferies & Co.

Randal Konik - Jefferies & Co.

Can you just give us a little more context around the SG&A. You got some leverage in the quarter on a negative comp. Do you expect that kind of trend to continue and can you just clarify if there were any reversals in bonus accruals during the fourth quarter?

John E. Kyees

There would have been bonus accrual reversals during the fourth quarter but the majority of the impact was really driven by the direct store payroll and the management of that. And we would expect going forward that we can do a pretty good job going forward. We didn’t have a lot of time to react to fourth quarter, to hold the expenses in line, and we’ve had more time to think about FY2010 and have been aggressive in our budgeting, as Glen said in his comments.

Randal Konik - Jefferies & Co.

Do you think you can get the same level of leverage on the similar comp level?

Glen T. Senk

We’re not going to make forward-looking comments, but I think we proved in the fourth quarter that we were very responsive to our business. I think that we will continue to respond.

Operator

Your next question comes from Adrienne Tennant – Friedman, Billings, Ramsey.

Adrienne Tennant – Friedman, Billings, Ramsey

A question on the catalogues throughout the fall season for Urban Outfitters, it seems like there’s been a little more artistic direction. Can you talk about some of the changes that you’ve made in the catalogue and kind of the direction. It looks a little bit more like Anthro, and what you’re doing there.

Tedford G. Marlow

I don’t know that we have a stated objective within the group. I’ll have to go back and check to look a little bit more like Anthro. I will say that we have put a lot of emphasis on our creative material and one thing that I think I would take the opportunity to underline and a key strategy in our business, is the use of our direct business as a marketing vehicle for the total brand as opposed to simply we’re operating a direct business. So I think that has helped us in regard to customer interaction and community, which is a goal of ours.

And we like looking different and fresh on a regular basis, be that in our communication via Web or catalogue. The book that is just out this week, I think looks different than the book that we put in the mail a mere four weeks ago, and I just saw the photographs last night on the summer book, which I think is a different feel entirely from what we just delivered.

So we are putting a lot of emphasis on keeping it fresh. We’re delivering all unique books this year as opposed to any re-drops, any second drops on books. So that’s as much color as I can give you on it is that we are putting a lot of emphasis on creative investment and material and wanting to keep our look very fresh despite what’s going on in the environment we’re operating in.

Adrienne Tennant – Friedman, Billings, Ramsey

Are there any changes in page count or the number of drops, and if you have circulation, can you help us out with that?

Tedford G. Marlow

The number of drops will be the same this year as last. The difference in this year and last is that for the balance of the year, from this point out, all of the books will be unique as opposed to any second drops. The circulation for the year is flat.

Operator

Your next question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

You have talked a lot about some progress you have made in your supply chain. We’re wondering, given the very lean and maybe overly-lean levels of inventory here in February, how quickly do you feel like you can get back into stock on presumably the items that are working best? And when you think that you will feel completely comfortable with where inventory levels are?

Glen T. Senk

I’m so proud of Barbara Rosas and the head merchants, our factory suppliers, our buying offices. We have worked very hard in the last couple of years and the kind of maneuverability that we have just spoken about in the fourth quarter typifies the progress we’ve made.

So to answer your question, without getting into specifics by week, I will say that we can maneuver very, very quickly. When we were at the ICR we said that we were liquid in the first quarter. That’s true. Obviously we’re bought up for the first quarter but we are appropriately liquid for the second quarter and we can react much, much faster than we did two years ago. I think it’s a significant advantage for us as a company.

Tedford G. Marlow

To echo Glen’s commentary, we are dealing with the environment that we’ve been dealt and one of the great pieces of opportunity in the market right now is open capacity. We have had some good reaction on spring receipts and we have never been able to achieve the kind of turnaround times that we are currently achieving, at the cost concessions that we’re able to realize. So yes, there may be a few less shoppers out there but the opportunity in the market really does exist on the supply side right now.

Kimberly Greenberger - Citigroup

At this point in time, here in the first week in March, do you feel comfortable with the replenishment you’ve been able to do so far or are you still looking forward to receipts here through March to get back in stock to where you would like to be?

Glen T. Senk

The only honest way to answer that is to say that it’s a fluid target. I’ve been in this business, 25 to 28 years. I don’t think I’m every 100% happy with my content. We look at it every single week. But I want to echo what Ted said, we are getting a better response now than we’ve ever gotten and we have very good selling information.

Operator

Your next question comes from Michelle Clark - Morgan Stanley.

Michelle Clark - Morgan Stanley

Could you update us on what you’re thinking about in terms of leverage points as it relates to both SG&A expense and your buying and occupancy costs in the current fiscal year?

John E. Kyees

As we said, our budget is very aggressive, our objective would be to bring—we’ve always talked about a 3% to 4% comp to leverage. We would expect to bring that down. Specifically don’t know how much yet but definitely coming down.

Michelle Clark - Morgan Stanley

Can you update us of what you’re seeing in terms of rent reductions?

John E. Kyees

Nothing specifically because we wouldn’t really want to divulge that, but we are continuing to work on rent reductions.

Operator

Your next question comes from Robert Samuels - Oppenheimer & Co.

Robert Samuels - Oppenheimer & Co.

Can you discuss some of the IMU opportunities you may have and then any update on the Asian sourcing efforts?

Glen T. Senk

I think Ted said it well, there is definite excess capacity and we are looking to work with the suppliers and continue to build our IMU. And we’re getting good results.

In terms of our overseas office, we are working on that strategy. We’re not prepared to announce anything yet. I would expect that we would be able to announce something formal by the summer.

Operator

Your next question comes from Christine Chen - Needham & Company.

Christine Chen – Needham & Company

Could you possibly go through, by concept and grade, how you feel about the spring assortment?

Glen T. Senk

I can but I’m not going to do that on the call. What I will say is that there is a lot of fashion right now. As a merchant you look for receipts to come into the store and have high sell-throughs. It’s kind of like a GPS system, there are beacons of light and they tell you where to go. And there are lots of beacons of light. Anyone who says there is not fashion right now, I think is missing it. So I can tell you that but I can’t, for competitive reasons, talk to each of the concepts in each of our brands.

Christine Chen – Needham & Company

Can you share with us the progress of the Anthro customer loyalty program and what sort of learnings are for that?

Glen T. Senk

We have now collected over a million names. We are on track in terms of the second phase of the system, which is bringing it in-house so that we have more access to the data. I think in terms of what I’ve said pretty consistently in the last six months or so, is that we have limited analytical tools right now, given the fact that we are using a third-party service provider to manage the database. So I’m not sure that I can give any insight into what we’ve learned other than who they are, general psychographic and demographic data.

We’re utilizing the names obviously but in terms of real frequency monetary-type related selling, understanding the kind of communications that they want, all of those things will come with phase two.

Operator

Your next question comes from Janet Kloppenburg - JJK Research.

Janet Kloppenburg - JJK Research

I wondered if you thought that the strength that you’ve been witnessing in the direct channel can be maintained? You’ve got quite a differential between that and your comp store sales growth. I would love you talk a little about that. And also I was wondering if given how lean your inventories are right now, if it would be logical for us to assume that the merchandise margin declines that you witnessed in the fourth quarter, that the declines going forward, if any, would not be as deep as they were in the fourth quarter because you were so aggressive in bringing in your inventory levels?

Glen T. Senk

We are very, very excited by our direct business. We think that as a legacy brick and mortar retailer, we’ve done just about as good a job as anyone in the industry. I believe we have the highest penetration of direct sales to total company sales of legacy brick and mortar retailers.

Having said that, and I’ve spoken about this on past calls, we believe there is a very meaningful paradigm shift that’s been going on in the last several years and we think that there is additional opportunity for us to do more direct business. And those are some of the investments that we will be making in this year and years to come.

So whether or not we can maintain the momentum, that’s a forward-looking statement and I’m not prepared to comment on that, but I can tell you that we’re very, very excited about our direct business. The group’s done a great job and they have a lot of exciting plans for the current year.

With regard to inventory, again, I’m not going to make a forward-looking statement. John said that we have significantly higher obsolescence reserves going into the first quarter than we had a year ago. He said that the obsolescence is attributable both to end of quarter product into some spring product. I think that if sales happen one way that we could have great margins, and if they happen another way, that we could have less than great margins. And I just don’t know the answer at this point nor am I prepared to talk about it even if I did.

Operator

Your next question comes from Samantha Panella - Raymond James & Associates.

Samantha Panella - Raymond James & Associates

Could you give us an update on store openings by quarter and also by concept. And do you plan on opening another Terrain concept this year?

John E. Kyees

The Terrain issue is not resolved yet so we don’t know. But our projection by quarter right now is first quarter 5, second quarter 13, third quarter 19, fourth quarter 5, which would take us to 42.

Operator

Your next question comes from Richard Jaffe - Stifel Nicolaus.

Richard Jaffe - Stifel Nicolaus

We have seen dramatic expense control. What can we expect for 2009? Is there further opportunity there? And could you talk about inventory by division, both its balance, fall versus spring, and then level on a per square foot basis by division.

Glen T. Senk

As I said in the prepared comments, not only did the group do an exceptional job in reacting to the business in the fourth quarter, from both an inventory and expense point of view, they also did an exceptional job preparing the budget. You know, I’ve talked in earlier calls about the idea of athleticism and to me athleticism means quick, quick, accurate reactions and that’s what this group did.

I think we were more thoughtful, more detail-oriented, probably than we’ve ever been. And I think in years past we’ve done a pretty good job so I don’t want to take away from anything that we have done. There was not a penny of spend that we did not look at. And I have to say this wasn’t me or John directing the group, this was the group collaboratively doing this. Everybody owned the process and everyone is excited about the opportunities to save money for the company because they understand that it’s going to strengthen the company for the long term.

With regard to inventory, the inventory, there were slight differences by brand but they’re really not worth talking about. Free People, which obviously has a much lower inventory base than Anthropologie or Urban Outfitters, was 20% in units, 28% at cost, and actually Urban and Anthro were very close. They were a couple of points within distance of each other.

In terms of the FIFO. The FIFO looks fantastic across all brands.

Richard Jaffe - Stifel Nicolaus

And the expense savings opportunity going forward?

Glen T. Senk

I don’t want to give you a specific number. What I ask our investors to do is kind of look at our performance, look at history, look at the way we responded to the expenses in the fourth quarter, and just trust that we’re going to make the right decisions going forward. I think in this kind of environment a budget is a budget but it’s not necessarily how you want to run your business. You want to run your business based on what’s happening day in day out, week in week out.

I can tell you one thing that we’re very committed to as a company, though, is to continue to invest in growth. I have had the privilege of working for this company for 15 years, I’ve never been asked by the Board or by Dick Hayne, the founder, to manage the business for a quarterly result. I’ve always been asked to do what’s right for the long term. We will not cut muscle.

And for me, there is a lot of conversation now about this in the business community, about maybe some of the trade-offs between short-term cost savings and the long-term health of various businesses. We have a very long-term focus on this business. We are serious about saving every variable penny we can save, but we’re also serious about mining what I said in the prepared comments, our abundant opportunities.

I mean, there are opportunities, as Ted alluded to, with merchandise costs, there are opportunities with real estate, there are opportunities to work with contractors, construction. I mean, there is not a supplier that is not working with us collaboratively to figure out what the future’s going to look like right now.

Operator

Your next question comes from Liz Dunn - Thomas Weisel Partners.

Liz Dunn - Thomas Weisel Partners

Question about the number of stores, 42 to 45. I think previously you were saying 50 and at one point there was a 52 number on the table. Were those projects you decided not to go forward with or the developments are being pushed? What’s the nature of those projects and can you give us a corresponding capex number expected for 2009?

John E. Kyees

The projection came down because as we negotiate harder on deals going forward, some of the deals are taking longer than we projected and we don’t want to force ourselves into a decision just to hit a number. So it’s more that than anything else.

And the capex number for next year is probably going to be around $120.0 million.

Operator

Your next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

As you think about this environment and the gross margin impact you had in Q4, you mentioned how quickly you shifted and were able to adapt. As you think about assortment changes by brand, how do you look at them either by price or by margin and keeping up the creativity of the brand with the realities of today’s market.

Glen T. Senk

I feel like I kind of answered that a little bit earlier so let me answer it and if I’m not giving you what you want to know, tell me.

What we’ve said is we are certainly cognizant of the fact that we have to have strong opening price points. And by the way, that’s always an operating strategy for all of our brands but I think it’s probably more important in the current year than ever before.

What we’re equally focused on is making sure that we have great value. And value, in the economic sense, is the relationship between supply and demand. And as I said earlier, if there is new fashion and it’s not out there, then it has good value as far as our customer is concerned. And that has always been what drives the URBN customer base, regardless of the brand. When there is compelling newness.

So absolutely opening price points are important, but equally important is compelling newness.

Dana Telsey - Telsey Advisory Group

If you think about what happened in the fourth quarter with the margin impact, you said equally by brand, do you expect, as you think about going forward, does the opening price point assortment just become a bigger part of the mix or does it stay the same?

Glen T. Senk

If it become a bigger part of the mix, first of all, the customer will decide that, we won’t. And what we will do is we will react weekly to what the customer wants. So I wouldn’t be surprised if it became a slightly larger mix of the business but I’m not certain.

But again, regarding the margin in the fourth quarter, we had a $58.0 million delta in our anticipated fourth quarter revenue. At Anthropologie the business declined on October 28. As Ted said, at Urban I think it started declining around November 10. So we exited the third quarter with 2% comp inventories, with a 10% comp sales increase out of the third quarter. To me that was a great performance because I had asked the groups to continue to work on the turns, they have done that.

If I had gone into the fourth quarter with anything less than slightly positive inventories, if the trend had continued, which in this business, whatever happened last week usually happens next week. It’s very unusual to have the kind of precipitous drop that we had. If the trend had continued we would have had no inventory.

So I hope, and I’m not making a forward-looking statement, but I hope that this is the last time that we have the kind of dramatic shift in business that we had. It was a 11 point spread in run rate. Literally within a week to ten days. So when you look at the gross margin impact of that, it was really in reaction to the 11 point run rate. It wasn’t a fashion miss, it wasn’t a planning error, it was an abrupt change in business that we reacted to.

Now, I’m proud of the fact that we got the inventories down quickly. Not everyone in our peer group has done that. Some people have chosen to take a longer time to do that. But we are a fashion business, our goods expire, and we did what we had to do.

Operator

Your next question comes from Betty Chen - Wedbush Morgan Securities.

Betty Chen - Wedbush Morgan Securities

Can you talk a little about the wholesale business? I know you alluded to earlier that it looks like the department store business is actually up but certainly you are being more cautious in your dealings with specialty stores. Could you give us a sense, any way possible if you can quantify the close-out margin, or the close-out to the fourth quarter in the wholesale channel? And then also as you talked about spring bookings being a little bit lighter, could you also give us a little bit more color on how that’s breaking down between department stores, specialty stores, and then also between We The Free or Free People, and also Leifsdottir.

Glen T. Senk

There’s a lot of information there, some of which I’m comfortable giving out, some of which I’m not. Given what went on with the credit situation in our specialty accounts in the fourth quarter I actually think the wholesale group had a great quarter. We had a nicely positive quarter in our department store segment and not only did we have a nicely positive quarter in terms of selling, we had a nicely positive quarter in terms of sell-through. Particularly at Nordstrom.

So I think the department store world for us is relatively stable. The specialty stores are challenging because we have grown up with a lot of these people, we love them, we want to sell them, but we can’t take inappropriate risks from a credit point of view. I don’t expect that to change any time soon. So if you ask me to make a forward-looking statement, without making one, I will say that I would expect the department stores, the momentum will continue and the specialty stores, I think we are going to continue to have credit issue.

Now the difference between today and three months ago is we know more today so we’re managing our inventory differently today. And I will not get into specifics in terms of the size of the close-out business, but it was significant. And when I say that the gross margin miss was spread evenly across three brands, the bulk of the gross margin miss for the Free People brand came from the wholesale close-out business.

Hopefully, if we are planning our inventories properly, that won’t happen.

With regard to We The Free, the business is doing very, very well. It’s still small, it’s young, but the retail community is excited about it. I think the product looks great.

Same thing with Leifsdottir. You can now see it at Neiman Marcus. They bought it in 5 doors in February. It will roll out, I believe, to 9 doors in the next month or so, and I believe to 16 or 17 doors in the fall. So there has just been great acceptance on that brand as well.

Betty Chen - Wedbush Morgan Securities

Can you give us a sense of how you’ve planned for inventory in the wholesale division?

Glen T. Senk

We have planned conservatively. I don’t want to give specifics, but we have planned conservatively. We certainly planned our inventory to reflect what happened in the fourth quarter.

Operator

Your next question comes from Roxanne Meyers – UBS.

Roxanne Meyers - UBS

I have a question on the home business at Anthropologie. Just wondering, knowing that it is a material part of the business, how it’s doing relative to the apparel and any changes you are making in the strategy there.

Glen T. Senk

I think it did maybe slightly worse than the apparel in the fourth quarter but I wouldn’t read much into that. I think the assortment is always a fluid thing. I think that the assortment looked okay for fourth quarter, and actually it looks better now.

The bulk of our home business is decorative and gift-giving, it’s not furniture, so I don’t think we’re exposed in the way that many other home businesses are exposed.

Operator

Your next question comes from Holly Guthrie - Boenning & Scattergood.

Holly Guthrie - Boenning & Scattergood

I was curious about the Urban International stores, the U.K. and the Continent. How have they performed, relative to the average? And then what was the translation impact in the quarter?

John E. Kyees

The translation adjustment, the way we do it, we want comp stores to be comp stores without the exchange rate or the interchange rate impacting it, so that whole adjustment gets thrown in non-comp stores, and it was about $11.5 million in the quarter.

Glen T. Senk

And just in regard to the performance of the business in the quarter, all stores, every single store, made budget in the quarter on sales line. Their comp, overall, was pretty much in line with the North American comp, they are seeing very similar things in their business that we’re seeing here in regard to how the customer is behaving at the moment. They had great improvement in the quarter in profitability.

Operator

Your next question comes from Marni Shapiro - Shapiro Partners.

Marni Shapiro - Shapiro Partners

I was curious about the accessories business, you talked about it being strong across the board, particularly at Urban Outfitters. I wasn’t sure if the holiday stuff fit into accessories. And if you could talk a little more specifically, is it bags, jewelry? You hair assortments have been extremely strong. You’ve had more personal care products. If you could just give a little more color on the non-apparel.

Glen T. Senk

The strength in accessories really ran across all of our brands and when we use the word accessories, with very few exceptions, we mean the literal category of women’s accessories, so everything you mentioned from scarves, gloves, belts, jewelry, hair accessories, etc.

And I really think what’s happening, and I don’t want to get into giving trend information on the call, but I think what’s happening is people are, they may not be spending, in the case of Urban, $48 or $58 for a top, or Anthropologie or Free People $88 or $128 for a top, but they are spending $48 for a necklace and making the top that they have in their closet look different.

So I think they are definitely use accessories to make what they have look more versatile. And therefore, I think that there will be a lot of traction in the business in the current year.

Marni Shapiro - Shapiro Partners

Are you tweaking your assortment and playing into this a little bit?

Glen T. Senk

You shop our stores more than most people. We tweak our stores almost every week. And again, I keep saying this over and over again, we certainly have strategies, but they’re not static strategies, they’re very fluid strategies and if we see the customer respond to something, then it’s the same thing that the portfolio managers do, we put our money where we’re getting the highest return on investment.

So if we’re getting a high return on investment in a specific category of accessories or in accessories in general, that’s where we’re going to put our money and floor space.

Operator

Your next question comes from Laura Champine - Cowen & Company.

Laura Champine - Cowen & Company

I just have a follow-up to the product margin question, because obviously there are lots of positive drivers there that were offset by the mark-downs in the fourth quarter. How much do you think, going forward, you need to sustain that pace or a similar pace of mark-downs, just to drive business in this kind of a macro climate?

Glen T. Senk

That’s an important question because it’s an important point of clarification. We do not use mark-downs to drive business. We never have and my guess is we never will. We use mark-downs to clear inventory. So we drive business with regular price, new, fashion-compelling products. The bit distinction, a lot of people use high/low pricing or use planned price promotions, we do not do that. And as I said earlier, we have a lot of beacons of light in the assortment right now and they are regular priced new fashion items. That’s what we focus on, not on taking mark-downs to drive business. It’s a different business model.

Operator

Your next question comes from Robin Murchison - SunTrust Robinson Humphrey.

Robin Murchison - SunTrust Robinson Humphrey

Regarding Anthropologie, aren’t you downtrending the furniture business, or the home accessory business?

Glen T. Senk

No, I have said consistently that the furniture does a lot for the store so we love having it. But it’s not really a business that I am every very interested in developing. It’s hard to make money in the furniture business and so it’s really more there to set the stage than it is to drive business. But in terms of the rest of the home, we’re as committed to our home business as ever.

Operator

Your next question comes from Elizabeth Pierce - Roth Capital Partners.

Elizabeth Pierce - Roth Capital Partners

I wanted to circle back on something. I came into the call late, but you talked about your comping and I believe you were speaking to Anthropologie on the better part of the assortment, or maybe you were speaking to everything.

Glen T. Senk

Everything. All the brands.

Elizabeth Pierce - Roth Capital Partners

And you’re not getting velocity on the middle. I wanted to clarify, you are talking about price points?

Glen T. Senk

No. Important clarification. Not talking about price point. I am talking about the middle of the ranking. So in other words, if I look at the blouse assortment and we have 20 regular priced blouses, number 1 through 5 are comping positively relative to a year ago. 5 through 15, maybe 5 through 10, are comping flat. And 10 and below are comping negatively.

So in other words, if something is not good, it’s worse than the not good thing a year ago. Or if something is average, the average is worse than the average a year ago. But if something is good to very good, it’s at least as good and often better than a year ago.

So what I’m trying to articulate is that it’s that much more important to be fashion-correct than it was a year ago or two years ago.

Elizabeth Pierce - Roth Capital Partners

So it’s based on what metric?

Glen T. Senk

Dollar sales. And so we manage our assortment many, many different ways, but part of the way is that you figure out how to size an assortment, how many choices to have in each category for each month, is by how productive the items are. And so we are constantly measuring the productivity of each category of product relative to a year ago, relative to the inventory and so on, and we’re always interested in looking, if something is uptrending or downtrending, we’re interested in looking if that trend is based on the velocity of key items, the selling of key items, or if it’s based on the breadth of the assortment.

Operator

Your next question comes from Stacy Pak – SP Research.

Stacy Pak – SP Research

Can you comment, you gave us some sense on comps in February overall, can you give us some sense by division?

Glen T. Senk

No. And again, I would just say the February trend was slightly off of fourth quarter trend, but also, I’m not reading too much into that. It was an odd month and it’s a small month relative to the quarter and that’s all I can say.

Stacy Pak – SP Research

Could each of the brands kind of talk about how they feel about women’s accessories, men’s, and home. You touched on a couple of those. And in particular, their comfort with the amount of newness they have in the assortments?

Glen T. Senk

I think it’s too much detail to get into it by brand. What I will say is we have fresher inventory than we had a year ago. I don’t want to say this categorically so I will use the word “I believe.” I believe the quality of our inventory is probably fresher going into the spring season than we’ve ever had in years past, so that’s one statement I will make. The second statement I will make is that we believe in accessories for all three of our brands but I really don’t want to get into specifics by brand.

Operator

Your next question comes from Howard Tubin - RBC Capital.

Howard Tubin - RBC Capital

Anything new or different planned on the marketing front for the remainder of the spring season?

Glen T. Senk

I would just reiterate our emphasis on e-commerce and community. Urban in particular has just done an amazing job in the blogosphere and in really viral communications, and I think they have shown the way for the other two brands. Just put on your Google our three brands and any blog entries will come up daily so you can start to see what I’m talking about. I think the whole idea of—hopefully there are no magazines on the phone—but I think the idea of magazine advertising or traditional advertising or even traditional marketing, is a pretty dated concept. And I think all three of the brands, but especially Urban, have just done a brilliant job of recognizing this shift.

Operator

Your last question comes from Margaret Whitfield - Sterne Agee & Leach.

Margaret Whitfield - Sterne Agee & Leach

Last year, how did the comps trend by month for the two key brands, since you said February was an odd month. And also, how much was Terrain and Leifsdottir in terms of a drain on earnings last year? And if you could give us the openings by concept for the year, of stores.

John E. Kyees

As a company the comps were relatively consistent by month for the first quarter.

Glen T. Senk

Why don’t we deal with the others off line?

Glen T. Senk

I think that’s it. Thank you, as always, to everyone, and I hope to see you in person over the next several months.

Operator

This concludes today’s conference call.

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Source: Urban Outfitters, Inc. F4Q09 (Qtr End 01/31/09) Earnings Call Transcript

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