Fulfilling the Omnichannel Imperative

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On December 28th, Zumiez filed an 8-K with the SEC. I don’t think they were required to file it because the amount of money involved ($1.3 million in the 4th quarter) wasn’t really “significant” as defined by the SEC for a company the size of Zumiez. But they filed it anyway. How come?

I’m sure their lawyers said something like, “Well, okay, we guess you don’t really need to file it but, you know, just to be on the safe side, why don’t you?” That’s what lawyers do. But I’m guessing that the management team looked at what Zumiez was doing and decided that it was such a fundamental change in their business model and potentially so impactful on how they run things that an 8-K was appropriate. I agree with that.

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Perspective from Zumiez’s Conference Call on the Retail Environment. Oh, and Their Results for the Quarter.

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As with most industry retailers, it’s not exactly a great time for Zumiez. Their October 31st quarterly numbers were disappointing. We’ll talk about those. But I want to spend most of this discussion on where, exactly, Zumiez’s is in the market and how CEO Rick Brooks describes and projects what’s happening in retail. The funny thing is, he comes straight out and speaks truth (or at least I think it’s truth) but I don’t know if people quite hear him.

Let’s set the stage a little. Here’s how Zumiez describe their market position in the recent 10Q for the October 31 quarter.

“Zumiez …is a leading specialty retailer of apparel, footwear, accessories and hardgoods for young men and women who want to express their individuality through the fashion, music, art and culture of action sports, streetwear, and other unique lifestyles.”

Here’s how they described it in the 10Q from a year ago.

“Zumiez Inc… is a leading multi-channel specialty retailer of action sports related apparel, footwear, accessories and hardgoods, focusing on skateboarding, snowboarding, surfing, motocross and bicycle motocross for young men and women.

Please read both carefully and note the change. It’s officially no longer about only action sports. We already knew that.

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Zumiez’s Quarterly Report and Retail Market Conditions

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By their standards, Zumiez didn’t have much of a quarter in the three months ended August 1. Revenue rose just 1.76% from $176.7 million in last year’s quarter to $179.8 million in this year’s. Net income fell from $7.46 to $3.21 million. Here what CEO Rick Brooks says happened.

“For the second quarter and back-to-school season reported today, we believe our results were heavily impacted by four key factors; a lackluster consumer traffic driven by the absence of a clear fashion trend that we can capitalize on; weakness in our spring and summer seasonal product; the impact of foreign exchange, particularly in our border and more tourism-oriented locations; and the shift of the Labor Day holiday back one week from the prior year.”

A quarter is only a quarter and, maybe more importantly, he noted, “…we continue to believe the industry is going through an immense share consolidation cycle with the winners and losers separating themselves by who can provide a unique brand experience that gives the consumer what they want, whenever they want, however they want it.”

I agree with his point about consolidation. There are too many retail stores, too many brands, too much product that’s the same as all the other product, too many customers without enough disposable income and a level of information that makes differentiating a brand in the long term difficult. Mostly great for consumers. Not so great if you’re a retailer. Or a brand.

Zumiez, I think, has one other strategic issue. They’ve always described themselves as an action sports retailer. It was/is an important point of differentiation. I’ve suggested previously that such a description might not always remain adequate to describe their market position. We’re there.

Look, this has been evolving for a long time. As I’ve been putting it for some years talking about brands, the further you get away from your core market, the more likely it is that they may know your name but not your story. And the harder it gets to compete. Zumiez has to deal with that as well. They firmly and successfully planted their flag in the action sports market, but now they have to compete in the broader market of active outdoor or youth culture or whatever it is.

Zumiez tells us that they’d be doing better in shoes except that kids want basketball shoes, but Zumiez doesn’t sell them and won’t because it doesn’t fit their image and market. And I’ve previously agreed with that. Yet those kids are buying those shoes somewhere and it’s not Zumiez. But Zumiez is cautious about being like the stores where such shoes are sold. How have other products or categories evolved so that they are being bought places besides Zumiez and that Zumiez can’t act like?

What does Zumiez do? Do they stick to the action sports focus and, in my judgment, limit their growth opportunities (hard for a public company) or do they dip a toe in this broader market, whatever it is, and risk some dilution of the market position? I’d love to be a fly on the wall in the meeting where they discuss their competitive position.

Zumiez has a couple of things going for it in this market. First, they have a balance sheet that allows them to be patient but to take some risks. All other things being equal, there’s no reason they shouldn’t be one of the successful players left staying as this consolidation works its way through the market.

Second, they’ve invested and are investing a lot of money in systems to identify what product should be sold where and when and to give their customers choices as to when and how to buy. That costs money and takes us back to how nice it is to have a strong balance sheet.

Third, they’ve got a strong program to identify and nurture new brands. They tell us they turn over between 20% and 30% of their brands each year, so perhaps nurture is a lousy word. Ensure the survival of the fittest is probably a better way to think about it.

I don’t know about you, but I’ve noticed that the term “fast fashion” seems to have disappeared from our lexicon. That’s because it’s no longer a trend, but a condition of business.  That’s how Rick Brooks seems to see it:

“With the evolving nature of the empowered consumer through the use of technology, the business is subject more than ever to trend cycles that develop faster and end faster. Our business has always been driven by a combination of trend-right items, fashion cycles and our deep vendor base of emerging and growing brands to provide unique product that resonates with our consumers. And all of these cycles are moving faster in response to the need of today’s technology empowered consumer.”

As you can see, their systems and new brand program are necessary to respond to these market conditions.

Fourth, Zumiez has always trumpeted the quality of their employees and their selection and training processes. I agree that’s a big strength. But I wonder how it changes with the market. Once again, I’d love to be a fly on the wall and hear how they discuss the employee attributes they want as the market they compete in evolves.

Points three and four particularly intrigue me. Their employees and their awareness of brands coming and going at the granular level has the potential to give them the information they need to figure out what products to compete with in which markets against whom. I make that sound so simple. I’ll have to nag them a little and see if they’ll tell me if I’m on the right track.

Fifth and last, I’m wondering how the number of stores they have and the layout and size of those stores may change in response to these conditions. Zumiez has 578 stores in the U.S. at the end of the quarter (640 total including 40 in Canada and 22 in Europe) and has talked about capping the U. S. store count at somewhere between 600 and 700. I wonder if that’s still valid given the conditions I’ve described and the consolidation Rick Brooks and I seem to agree is going on.

Okay, back to the numbers. The revenue increase was the result of adding 58 net new stores since a year ago offset by a $7.9 million decline in comparative store sales (4.5%) and a $4.4 million decline due to a weaker Canadian dollar and Euro. So the number of stores went up by 9.1%, but they still had a revenue decline for the quarter.

The gross margin fell from 34.5% to 32.1% or by 240 basis points (2.4%). “The decrease was primarily driven by a 130 basis point decrease due to the deleveraging of our store occupancy costs [that is, they had less sales to spread them over], 70 basis points due to a decrease in our product margin, and 20 basis points due to higher distribution costs.” CFO Chris work says there was, “…downward pressure on product margins as a result of the increased promotional activity to clear out seasonal inventory.”

SG&A expense rose from 27.9% of revenue to 29.2%. “The increase was primarily driven by an increase of 160 basis points due to the deleveraging of our store operating expenses, partially offset by a decrease of 30 basis points decrease in incentive compensation.”

As already mentioned, the balance sheet is strong. I will note that cash provided by operating activities for the six month ended August 2, 2014 was $30.5 million. For the six months ended August 1, 2015, it was $977,000.

On the one hand, Zumiez has the same issues that all retailers in our space have. They are probably better positioned and ahead of the curve in dealing with them. On the other hand, being “the action sports retailer in the mall,” while a defendable position, may be hard to grow from. We’ll see.

They noted in the conference call that typically, among their top brands, a couple break out and provide a trend that means a big revenue boost. This hasn’t happened the way it happened last year. Rick Brooks told the analysts that he sees this as just part of a typical cycle that will run its course.

I’m considering the possibility that the changes and challenges of retail are of a longer term nature. The difficulties of retail (and the opportunities!) are so profound in this country that I see it taking some years to work through. We just don’t need 80 square feet of retail space for every man, woman, and child. Zumiez should be okay, but that doesn’t mean it will be easy.

Reading Between the Lines: Zumiez’s May 2nd Quarter

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It seems a hard time to be retailer in our space- at least that’s my general perception as I pour through conference calls and SEC filings. It’s not that Zumiez had a bad quarter. Both sales and earnings rose. But it wasn’t up to their standards or what they expect, as they make clear.

I’ll get to the numbers, but first I’d like to mention a few things they discuss in the 10-Q and conference call that highlight the issues all retailers are dealing with these days.

Zumiez ended the quarter with 616 stores; 557 in the U.S., 37 in Canada and 22 in Europe (under the Blue Tomato name). They are planning to open 57 more in fiscal 2015. There will also be some remodels and relocations of existing stores. 51 of the new stores will be in the U.S., six in Europe and I guess that means ten in Canada. I think they will end the year with something like 608 stores in the U.S.

They think they have lots of room to expand in Europe. Shall we think of Canada, as the conventional wisdom usually does, as 10% of the U.S. market, suggesting they might grow to perhaps 60 or a few more there?

In the past, they’ve talked about their limit for U.S. stores being around 700 as I recall. Might have been lower. They are starting to approach that. What happens then? Is that still a valid number?

Let me start by quoting CEO Rick Brooks from the conference call.

“We continue to see untapped potential in our North American markets and our goal is to maximize the long-term productivity of the entire portfolio by optimizing our physical store presence in each market as part of our omni-channel platform.”

“Our omni-channel strategy continues to drive expansion and enhancement of our digital infrastructure and shopping experience. With these investments, we’re able to better offer customers a consistent and genuine interaction with our brand regardless of the channel by which they’re engaging with us. We believe expansion in e-commerce works in tandem with expansion of our brick and mortar stores both domestically and aboard.”

And here’s what he says when talking about Europe. “We believe that our omni-channel strategy is going to win. Gerfried [Blue Tomato CEO and founder Gerfried Schuler] has been a big adopter of our omni-channel strategy. They are product lagging us in terms of some of our omni-channel efforts, just because of scale you have to have the physical scale to really rollout omni-channel initiatives. So Gerfried is as appropriate as rolling out the initiatives as they’re building marketplaces on that front.”

There are two things you should notice. The first is the unresolved issue of how many stores of what type you need where in the age of the omnichannel.   Can Zumiez still utilize 700 U.S. stores in the day of electronic commerce? Maybe they need more smaller ones? Or fewer but larger ones? That’s a question for every retailer. The question for Zumiez is what happens to store openings as they approach a possible limit in the U.S. Does the omnichannel let them continue to grow even with limited store openings? Or will store growth in Europe and to a lesser extent Canada replace that?

Second, note the comment about Blue Tomato in Europe not being big enough to take advantage of all the omnichannel things Zumiez is doing. For better or worse, the omnichannel strategy favors big players.

Okay, on to the next conundrum. Rick mentions, in discussing some difficulties they’ve had in the shoe category that they don’t and won’t carry basketball shoes, but that those shoes are very popular right now.

But he also talks about giving the customer what they want, when they want it, the way they want it. “…we don’t care what we’re selling, we just want to sell what customers want and our job is positioning inventory properly to do that.”

You can see an apparent conflict which I’ve sort of set up as a stalking horse. “Well Rick, if you basically follow your customers and give them what they want and they want basketball shoes….”

If I were Zumiez, I wouldn’t carry basketball shoes either.

We who were once unequivocally the clearly defined action sports industry finds that we have more or less migrated, kind of, to the less clearly defined active outdoor space with a lot more products and competitors. It used to be a whole lot easier to know which brands to carry.

Figuring that out is now a prime management function (or should be) at every retailer. Zumiez manages this in two ways. First, they are always searching for and supporting new brands. Second, they rely on their active outdoor oriented employees to spot trends and brands that might work for Zumiez. Getting enough of those people, we’re frequently told, is a constraint on their growth. That’s the case in Europe right now.

On to the third issue. In response to an analyst questions and talking about the general business environment Rick Brooks says, “ … we’re still in this kind of recovery, this bumpy recovery mode from the great recession and in these low volume periods is I think there the trends are — the lack of trend is more pronounced and that’s really what drives weaker traffic.”

He included the lack of trend issue when he earlier talked about foreign exchange and the West Coast port slowdown as having impacted the business. What concerned me, and where Rick and I might disagree, is that he talked about the lack of a trend and the bumpy recovery like he saw them as tactical short term issues- or at least that’s how it sounded to me. I see them as potentially long term and strategic.

An economy can only grow when either population or productivity grows, and we’re not doing very well in either category. I hope that lack of a fashion trend that motivates buying is a short term issue, but I have a concern that it might be a longer term trend resulting from our slow recovery and the particular difficulties it has visited on our target customers.

That’s an issue for brands and retailers alike- not just for Zumiez. I think you need to plan for an extended period of slow growth and a customer who’s tighter with their money.

Let’s move on to the numbers.

Zumiez’s sales rose 9% from $162.9 million in last year’s quarter to $177.6 million this year. North American sales were up $10.6 million or 7% to $161.2 million. European sales rose $4.1 million or 33.6% to $16.4 million. Comparative store sales rose 3% including ecommerce.

The gross profit margin rose from 31.0% to 31.8% mostly due to an increase in product margin. SG&A was up from $46.8 to $52.4 million or from 28.7% of revenues to 29.5%. Net income rose by 11% from $2.5 to $2.8 million.

The balance sheet was fine. There’s not a whole lot to discuss with regards to the specifics of the financials.

Feels like Zumiez’s issues are the same as those of other retailers and the key ones are long term and persistent.  I’d feel better if that was more directly acknowledged in the conference call, but I can’t really expect that. It continually amazes me that the analysts don’t ask about things that seem obvious to me. Perhaps that’s not appropriate etiquette in that forum or they get asked later in private conversations.

Zumiez has a head start over most of the industry with regards to the omnichannel. And their action sport/active outdoor employees will help them turn in the right direction. But it’s a hard time to be a retailer.

Zumiez’s Annual Report and Their Approach to the Omni Channel

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Zumiez ended its fiscal year on January 31st with 603 stores; 550 in the U.S., 35 in Canada and 18 in Europe. How many stores do they expect to ultimately have? In the past, they’ve opined that 600 to 700 might be about the limit in the U.S. Obviously, they’ve got some head room in Canada (Maybe 70 stores total?) and a lot more in Europe. I imagine that limits of growth in North America had something to do with their acquisition of Blue Tomato.

But the Omni Channel changes things. One of their risk factors in the 10K is “Our growth strategy depends on our ability to open new stores each year, which could strain our resources and cause the performance of our existing stores to suffer. That’s true, I guess, but is kind of a normal business risk.

I haven’t read every word in Zumiez’s (or anybody else’s) list of lawyer induced cautionary risk factors. But I don’t think I’ve seen anything about the omni channel in them. Seems to me the risk factor above has to go away, or maybe changed to say something like:

“The omni channel changes things in ways we’re still trying to figure out. It’s not just about opening stores; it’s what shape and size of stores to locate where to make sure that they integrate with everything online with particular attention to how our mobile customers want to shop. If we don’t do this right, we’re screwed.”

Okay, lawyers might put it differently, but I think you see the point. This is something every retailer is thinking about (I hope) and I want to talk about how Zumiez views it.

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A Long Term Plan; Zumiez’s Quarter

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Well, Zumiez had a pretty good quarter. Net sales rose 11.6% to $213.3 million from $191.1 million in last year’s quarter.   “The increase reflected the net addition of 54 stores…and a comparable sales increase of 3.7% for the three months ended November 1, 2014.” Those numbers include ecommerce sales, which rose 15.7% and represented 11.2% of net sales, up from 11.0% in last year’s quarter. Brick and mortar comparable store sales were up 2.2%.

European sales were $14.7 million, up 45.7% due largely to new store openings.

The gross profit margin was down a bit from 37% to 36.5% due to higher product costs. SG&A rose from $50.1 million to $52.9 million, but as a percentage of net revenue it declined from 26.2% to 24.8%.

Operating income rose from $20.7 to $25 million and net income was up 32.6% from $11.9 to $15.7 million. The balance sheet is solid and cash provided by operating activities was $34.4 million in the first nine months of the fiscal year. In last year’s first nine months it was $21.7 million.

They ended the quarter with 603 stores; 551 in the U.S., 35 in Canada and 16 in Europe.

You know, I don’t have much fun when things are going well. Not much to analyze. I’m kind of digging in the bottom of the barrel here, but there are a couple of things I’ll mention from the 10Q before I move on.

This is the first risk factor Zumiez lists: “Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which many of our stores are located; any decrease in customer traffic in those malls could cause our sales to be less than expected.“

This issue isn’t unique to Zumiez, but malls are in for some hard times in coming years. Here’s an article I previously pointed you to on the subject. Indirectly, Zumiez addresses this in the conference call. I’ll point that out when we get to it.

Second, referring to Blue Tomato, Zumiez notes that “At November 1, 2014, we estimated we will not be obligated for future incentive payments.”   It’s not, according to Zumiez CEO Rick Brooks, that Blue Tomato isn’t doing well, though obviously they aren’t doing as well as they thought they might. It’s just that the European market is tough. Zumiez is “very encouraged” by what Blue Tomato is doing and thinks they have a big opportunity in Europe.

Here’s how CFO Chris Work describes the situation with Blue Tomato in the conference call: “So at the time of acquisition, it was on par from a profitability perspective with our U.S. business, and today it’s probably more a breakeven business excluding charges.“

I’d interpret that to mean that Blue Tomato is losing money right now under generally accepted accounting principles where you have to include those pesky charges.

Okay, let’s move on to my favorite statement of the conference call from Rick Brooks. This was Rick’s response to a question about what categories are performing and what new brands or products he saw coming around.

“The strength of our business, as I’ve said a number of times now, it’s always about diversity, diversity of brands, diversity of categories in our business because we serve the entire lifestyle for this consumer.”

I added the emphasis. “A number of times” is probably about 4,907 over the years he’s been CEO.

Let me give the answer I think Rick would have loved to give. “Look, we’ve been following the same strategy since we started the company. It’s not about a particular brand, or a particular trend or a particular product group. What matters is that we have the best trained and best connected to our customer base group of employees we can have so that whatever the trends, brands, or cycles (all of which will continue to come and go) are, we have maybe just a little better idea than our competitors what’s going on and can respond better or quicker. Consistent with whom we are as a brand, we want to identify and help the brands that can grow, support the trends those brands represent, and adroitly step aside when those trends change. “

“And stop asking me how many stores we’re going to have! I keep trying to explain that in the ecommerce/mobile world number of stores is just not as relevant as it was. What matters is connection and credibility with your customers. We’re still figuring out, like everybody else, what stores of what size and what layout you should have where. What we’re pretty sure of, however, is that number of stores is not as closely connected with revenue growth as it used to be.”

And just to finish up, here’s an actual quote from Rick, rather than one I’ve made up. “…our topline goals don’t change based upon whatever number of stores we have, but on how we optimize catching those shares, to optimize margins and optimize how we serve our customers.”

Let’s see, what else should you know. First, Zumiez doesn’t see an easy business environment in coming years. Rick says, “On a longer term view, I think our view is one of caution. I’m saying that the recovery has been slow and painful and I think from a planning perspective, we continue to think that’s – we’re going to continue to face kind of a slow bumpy volatile recovery for a period of years yet.”

Finally, getting back to the issues of the future of malls and the role of brick and mortar stores CEO Brooks notes that “We have opened a couple of suite stores and we continue to have a small portfolio of off-mall locations around different parts of the country.” So they’re thinking about it.

A consistent strategy, and recognition of how the market is changing should serve Zumiez well especially if it’s as tough as they (and I) think it’s going to be.

Zumiez’s Quarter and Omnichannel Insights

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Zumiez reported a 12% increase in revenue for the quarter that ended August 2nd to $177 million from $158 million in the same quarter they last year. Their net income was up 57.3% from $4.74 to $7.46 million. Naturally, with that kind of good result, the stock fell 18.8% the next trading day from $32.4 to $26.31.

I don’t think I’d make it as an analyst on Wall Street. It’s not that I’d only focus on the current quarter’s results. The analysts also had some concerns about the rest of the year and those aren’t unreasonable. But if they took any kind of longer term perspective (which I’m beginning to think isn’t allowed if you’re an analyst) they might have focused on Zumiez’s efforts with the omnichannel stuff a bit more. I’ll get back to that, but first let me do what I always do- the numbers.

Zumiez ended the quarter with 535 stores in the U.S., 33 in Canada and 14 in Europe. They expect to end the year with 18 European stores. The sales increase was the result of having a net of 53 more stores open in this year’s quarter as well as a 3.4% increase in comparable store sales. Remember they include ecommerce in their comparable store sales (as I think they should). Interestingly, the 3.4% increase includes a 22.2% increase in ecommerce and only a 1.4% increase in comparable brick and mortar sales. Total ecommerce sales were 9.6% of total sales ($17 million) compared to 8.8% in last year’s quarter.

North American sales rose 10.1%. European sales were up 57.6% to $9.5 million and represented 5.4% of total sales.

The gross profit margin fell from 34.9% to 34.5% mostly due to a 0.6% decrease in product margin. SG&A expenses rose from $47.3 to $49.3 million. They fell as a percentage of revenues from 30% to 27.9%. 0.70% of the decline was because Zumiez didn’t need to accrue any additional cost for the Blue Tomato earn out.

The balance sheet is in good shape. I would note that for the six months ended August 2, net cash provided by operating activities was $30.5 million compared to $9.9 million in the same six months last year. I like cash.

Okay, now for the fun part. Here’s the first risk factor Zumiez lists. “Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which many of our stores are located; any decrease in customer traffic in those malls could cause our sales to be less than expected.”

I don’t necessarily take risk factors too seriously, but I don’t ignore them either. This one caught my attention because it was listed first, I didn’t recall seeing it before, I posted something about the future of malls recently, and I think the trends in malls have a strong relationship to the evolution of a retailer’s omnichannel strategy. Or maybe I mean that omnichannel strategies are causing some of those trends.

It’s all kind of a big mish mash of trends, possibilities, experiments, false starts, new ideas, and unexpected relationships. I don’t know the answer. Neither does Zumiez. But they do seem to know they are stuck with it and are working hard to find out what works and what doesn’t.

Let me quote CEO Rick Brooks a few times. Please keep being quotable Rick. I love it when I can write these things by cutting and pasting.

“…we view really what we are doing- the integration of building a channeless retail experience for our customers- as a never ending job because the customers are in charge, they are the ones that have the power in today’s world because of smart technology, we need to go where they want to go, however they want to do it, we’re going to be there to serve them and we don’t know exactly what that’s going to look like again. I tend to think with their early stages of this transition not the latter stages.”

“So we’re going to try all sorts of things, we’re going to measure what happens when we close stores and markets, what happens to the integrated omnichannel business. Well we already know it’s a huge list when we open stores in markets. But so we’re going to continue and to really experiment with these ideas and measure where we’re going to be.”

“As we continue to expand our omnichannel capabilities and bring our highly differentiated and lifestyle relevant product and perspective to the marketplace, we believe that we can maintain strong merchandise margins through full price selling.”

“We also strongly believe that the enhanced connection with our consumers that is enabled by heightened omnichannel presence will be a key point of differentiation in the rapidly evolving retail landscape.”

I’ve written a few times that the biggest risk was taking no risk at all, and I’m guessing Zumiez’s management team would buy into that. They don’t know how this all going to work, but they know it’s happening and if they aren’t part of it, they will not prosper.

I’ve quoted CEO Brooks enough, but also interesting was his discussions about opening (or closing) stores. The goal is not to open stores. It’s to have the right kind and size of stores in the right place supported with the correct omnichannel presence and activities. Whatever you do with stores, you do it to meet a customer requirement. Maybe there are some places where you would have opened stores in the past, but now you won’t and not opening will be net positive for your bottom line.

If I could get Mr. Brooks and members of his team in a bar and get a few drinks into them, I’d love to find out how their organizational structure is evolving in response to the omnichannel and retail evolution. To me, it seems like every function is connected to and influenced by every other function in ways they haven’t been before. At least for me (a closet organizational dynamics junkie) this is going to be fun.

You can see where a strong balance sheet comes in. Whether you’re a brand or a retailer, you need to be paying attention. You’re going to spend some money on things that aren’t going to work, but that has to be okay.

Another Tactic in Integrating Online and Brick and Mortar

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A reader pointed out to me that Zumiez has started (don’t know exactly when) a program they call “Order Online Pay in Store.” You order it online, selecting “pay in store” when you check out, go to the store within 48 hours and pay for the item, and it’s shipped to either your home or the store. Per normal procedure, there’s no shipping charge if you pick it up at the store. If the item should be available at the store, you just come home with it.

Why might Zumiez do this? Will it generate any incremental sales?
With a weak economy, high teen unemployment, and the credit card companies no longer making “having a pulse” the criteria for getting a card, there are probably a bunch of Zumiez customers and potential customers that don’t have a credit card or don’t want to use it because they’ve figured out that if you can’t afford to pay off your credit in full at the end of each month, you can’t afford to use it. This gives them a way to shop on line but, and Zumiez has to love this, still gets them into the store.

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“We’ll Go Anywhere Our Customers Give Us Permission to Go;” Zumiez’s Quarterly Report

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A few reports ago, I opined that while Zumiez owned the action sports space in the mall, the relatively small size of that niche and the evolution of the market to youth culture or fashion or whatever you want to call it was going to require Zumiez to move beyond it to achieve their growth plans.

During the conference call for the quarter ended May 3, an analyst asked, “…you guys have been incredibly successful at being the authentic action sports retail in the mall but clearly there’s a move towards more diverse fashions I guess, how do you feel about the balance between kind of the core action sports apparel versus potentially street wear…?”
The quote in the article title is part of CEO Rick Brooks answer. In more detail, he said, “…we have permission from our customer to do much more than just action sports and we’re really serving this consumer who wants to be different, who wants to be unique, wants to make a statement about who they are and what lifestyle they’re embracing through what they wear and, not just what they wear but they do on a holistic basis…”historically we kind of get pigeon holed as an action sports retailer. But we’ve always been able to move much more broadly.”
You go where the customer wants you to go. Who could argue with that? But the trick, and the management challenge, is figuring out in a timely manner where that is and how far, exactly, to go.

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Zumiez’s Annual Report: Growth, but Constrained by the Economy.

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Zumiez reported top and bottom line growth even as they acknowledged and were impacted by the economic headwinds in Europe and the U.S. As they put it, “…teen retail in general experienced a challenging sales environment, with many mall based teen retailers seeing significant sales declines. Zumiez was not immune to the declines in traffic; however…our sales results held strong relative to the teen retail sector, with comparable stores sales down slightly while product margins remained essentially flat.” 

As always, I’ll get to the details. If they are a bit more resistant to these headwinds than other retailers, it’s because they’ve been pursuing the same strategy for 35 years. The caveat, of course, is that you have to pursue the right strategy. Just to review, they list their competitive strengths as:
 
·         Attractive lifestyle retailing concept
·         Differentiated merchandising strategy
·         Deep-rooted culture
·         Distinctive customer experience
·         Disciplined operating philosophy
·         High-impact integrated marketing approach
 
You can read about each of these on pages four and five of their 10K.
 
We’ve reviewed together similar claims of competitive strengths for other companies and I’ve sometimes concluded that their claims were more aspirational than actual, noting that’s what every company in the industry wants to do. Zumiez is more credible simply because they’ve been doing it longer with some success.
 
Zumiez ended their fiscal year (February 1) with 551 stores including 28 in Canada and 12 in Europe under the Blue Tomato name (six opened during the year). They plan to open 55 additional stores worldwide in this fiscal year including five in Europe. Net sales grew 8.2% from $669 to $724 million. The fiscal year had one less week than the prior year.  Comparable store sales were down 0.3%. That includes a 0.1% decline in brick and mortar and a 5.4% increase in ecommerce sales.
 
Obviously, new store openings were responsible for most of the sales growth. Average sales per store were $1.2 million, down from $1.24 million last year.
 
Ecommerce sales were 12.3% of sales for the year compared to 11.2% the previous year. What I imagine they are thinking about, but aren’t talking about yet, is how much of their brick and mortar sales are influenced by online. That would be a good question for an analyst to ask.
 
Here’s a table from their 10K that shows their revenue by category. 
 
 
Revenue in the U.S. accounted for 89% of Zumiez’s total revenue. 
 
The gross margin rose from 36% to 36.1%. “The increase was primarily driven by a 40 basis points benefit due to prior year costs related to a step-up in inventory to estimated fair value in conjunction with our acquisition of Blue Tomato and a 40 basis points impact of the correction of an error related to our calculation to account for rent expense on a straight-line basis. These increases were partially offset by a 50 basis points impact due to the deleveraging of our store occupancy costs and a 50 basis points impact of the increase in ecommerce related costs due to ecommerce sales increasing as a percent of total sales.”
 
So it increased by 0.8% due to some one-time accounting changes. Then it decreased by 0.5% because of deleveraging of store occupancy costs. Don’t quite understand that and would love some detail. Finally, if the 0.5% impact from ecommerce related costs is part of implementing their omni channel strategy, I’m fine with that.   
 
Selling, general and administrative expenses were up from $172.7 to $188.9 million. As a percentage of sales, it was up just 0.2% to 26%.
 
“The increase [as a percentage of sales] was primarily driven by a 60 basis points impact of the increase in ecommerce corporate costs… a 40 basis points impact due to the deleveraging of our store operating expenses, a 20 basis points impact due to the deleveraging of our corporate costs and a 20 basis points impact of a litigation settlement charge…These increases were partially offset by a 70 basis points impact of the reversal of the previously recorded expense associated with the future incentive payments to be paid in conjunction with our acquisition of Blue Tomato, a 30 basis points benefit due to prior year costs related to transaction costs incurred in conjunction with our acquisition of Blue Tomato and a 20 basis point impact due to a decrease in incentive compensation.”
 
The key thing I pull out of there is that Blue Tomato is obviously not performing as they had hoped when they bought it. Here’s how they describe it in the conference call:
 
“…we continue to be optimistic about our long-term prospects in Europe. However, the reality is the operating environment in the region just as in North America has been challenging since we completed the acquisition in 2012. While the sales in Europe comp positive in Q4 and for the year, we are estimating our sales and earnings results to be below the thresholds that a contingent earn-out is based upon and the likelihood that we will now achieve those minimum levels required for a payout is low.”
 
Operating income rose 6.3% from $68.5 to $72.8 million, but the operating margin fell very slightly from 10.2% to 10.1%. Net income grew from $42.1 to $45.9 million.
 
Fourth quarter sales were $227 million, up 1%, with comparable store sales (which includes ecommerce) down 2.2%. North American revenue was down $1.6 million even with the new stores. Europe increased by $4 million probably because of the new stores.   It was the fourth quarter in the previous year that had the extra week I mentioned before. That accounted for $8.9 million in revenues last year.
 
The quarter was positively benefited by $5.8 million from the reversal of the Blue Tomato projected earnout and by $3.3 million for correcting a lease accounting error, which I am sure neither you nor I want to discuss in detail. 
 
The balance sheet continues to be strong, allowing them to continue to pursue certain of their strategies in an uncertain environment. There’s very little long term debt. Cash generated by operations was about $67 million, consistent with the last couple of years.
 
It’s just a tough environment to be a retailer in right now. As CEO Rick Brooks put it, “In this world there are too many stores and as retailers are forced to reduce their capacity, share consolidation will continue.” That probably makes Zumiez’s strategy and points of differentiation more valid than ever, but there are a few things they need to be and, I imagine, are thinking about.
 
The first, as I’ve suggested before, is what business they are in. If they are truly limited to the action sports business, it may constrain their growth. As an example, they acknowledge that it was a lousy season for snowboard hard goods. But one of the things they do to distinguish themselves as an action sports retailer, especially in the mall, is to carry them. Drop snowboards? Add twin tipped skis? I don’t know. Is the target market action sports participants or youth culture? Both? Is the competitive space as broad as branded consumer products, which somebody recently suggested to me? If so, what the hell does that mean?
 
I suspect that Zumiez’s (and other company’s) omni-channel efforts will help them figure that out. I didn’t bother to describe the 48 or so mentions of what they are doing in this area, but let’s just say they’re all over it. It’s going to impact when and where they open stores, what those stores look like and, I expect, how big they are. And it’s going to influence their product selection as their customers and potential customers engage with them and have more control over what they buy and where.
 
The relationship between systems, technology and what you sell to whom is only going to get stronger. Neither Zumiez nor anybody else knows how it’s all going to work out, but they seem as well positioned as anybody to figure it out. Now if only the economy would improve.