Zumiez’s October 29 Quarter; Consistently Pursuing a Solid Strategy

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I know I’ve written about it before, but let’s review the pillars of Zumiez’s strategy as I see them before we get to the numbers. Here’s the link to the 10Q if you’re interested.

  • Find and retain employees who are actively committed to the action sports lifestyle and make sure they are customer service focused. I suspect this might restrain their growth sometimes, but that’s okay.
  • Have a wide selection of established and new brands, including ones that are hard to find in other places. Manage these brands, and the associated inventory, so you can be generally less promotional than competitors. Their largest vendor represented less than 7% of total sales during the quarter.
  • Grow only as fast as you can find the right mall locations and staff.
  • Be the only mall retailer that offers hard and soft goods in a specialty shop-like environment.
  • Continuously work to have systems and procedures in place that let each store carry what its customers want to buy.
 In broad brush, this hasn’t really changed since the company was founded.
 
Zumiez’s 442 stores in 38 states now include 10 in Canada. Sales for the quarter ended October 29th were up 10.3% to $154 million compared to $135.9 million in the same quarter last year. Comparable store sales were up 6% and a net of 42 new stores have been opened since the end of the quarter last year. Ecommerce sales were 6.4% of the total, or $9.9 million. In the same quarter last year they were 4.4% of the total, or $6 million.
 
It’s interesting to hear how they talked about the comparable store sales increase during the conference call. CFO Marc Stolzman said, “The comparable store sales gain was primarily driven by an increase in dollars per transaction, partially offset by a decline in comp store transactions. The increase in dollars per transaction in the quarter was primarily a result of an increase in average unit retail, partially offset by a decrease in units per transaction.”
 
To me, that speaks at least partly to the success of their brand strategy. They were able to increase comparative store sales because they got more dollars per sale even though the number of transactions fell. 
 
Gross profit margin rose from 38.7% to 39.1%. The improvement was largely the result of distribution center efficiencies (remember they opened their new distribution center in California).
 
Selling, general and administrative expenses rose 11% to $37.3 million. As a percentage of sales, they were down from 24.7% to 24.3%.
 
Net income was up 14.8% from $12.3 million to 14.1 million.
 
The balance sheet is strong, and they have no debt except for the normal kinds of current liabilities every business incurs in the normal course of business. The increase in inventory was in line with the sales growth.
 
Though they didn’t talk about it in any detail, they noted that 15% to 20% of their business was private label. Private label business is particularly compelling when you’re already a retailer because of the higher margin with no additional costs. But we’ve learned in our industry that too much private label can be a bad thing. If only it was easy to know how much was too much before you got to too much. It is, I suppose, possible that Zumiez’s strategy of having a lot of brands and turning them frequently lends itself to more private label business. I’ll watch with interest to see how much they grow it.
 
Well, that’s pretty much it. When things are going well and the strategy hasn’t changed much there’s not a whole lot to write about. Here’s hoping I get to do lots of short articles like this one because of good results from a host of industry companies.     

 

 

Zumiez’s Quarterly Results; Their Computer Systems are a Competitive Advantage

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From a financial statement analysis point of view, this is kind of boring. The balance sheet is solid enough that I’ll pay it the ultimate compliment of not discussing it. No bank debt, and the inventory was more or less constant on a per square foot basis.

In the conference call, one of the analysts even wanted to know if they had any plans for dividends or acquisitions as a way to use up some cash. The answer was no. Zumiez like’s having cash when the economy sucks. Me too.

Sales for the quarter ended July 30 were $112.2 million, up 14.9% compared to the same quarter last year. Comparable store sales grew 7.5%. They opened a net of 31 stores during the fiscal year so far, bringing their total to 424 in 38 states and Canada. There are six stores in Canada and will be 10 by end of the year. Ecommerce sales were 5.3% of total sales for the quarter compared to 2.9% in the same quarter last year.
 
Gross profit rose 22.3% to $37.3 million. As a percentage of sales it was up from 31.2% to 33.2%. This improvement largely represents cost reductions and the ability to spread costs over a larger sales base rather than higher sale prices or lower product cost.  Remember that in the quarter last year they had a bunch of expense associated with the relocation of their distribution center that they don’t have this year. That represented 1% of the gross margin improvement.
 
Sales, general and administrative (SG&A) expenses rose about $1 million, but fell as a percentage of sales from 33.6% to 30%. 2.2% of that decline was due to last year’s payment of $2.1 million to settle a lawsuit. They didn’t have that expense this quarter. The rest was due to spreading costs over a bigger store base and reducing some expenses. Rent expense, in case you’re curious, was $16.7 million or not quite 50% of the SG&A total.
 
Net income improved to $2.59 million from a loss of $1.2 million in the same quarter last year.
 
That was easy. Now for the more intriguing stuff.
 
Zumiez still has a 14.3% equity investment “…in a manufacturer of apparel and hard goods.” And I still don’t know who it is or why they have it. It doesn’t actually matter particularly, but I’m just really curious about the circumstances behind it.
 
Zumiez’s 10Q (you can see it here) runs to 39 pages, which isn’t particularly long. But 10 pages of that- 25%- are taken up by a risk factors section that starts on page 22. PacSun doesn’t even include any risk factors, though they refer to the list in their last annual report. Zumiez must have more conservative lawyers.
 
The risk factor I focused on, as we work our way over to Zumiez’s strategy, was the one that said, “Our failure to meet our staffing needs could adversely affect our ability to implement our growth strategy and could have a material impact on our results of operations.”
This comes after, and is in addition, to the one about how they could be screwed if they lose key management, which is a risk factor most companies include.
 
Basically, they’re talking about getting enough of the people who work in the stores. You might think that in this economic environment it would be a little easier to get people. It is, but Zumiez doesn’t just want competent people. It wants competent people who are active action sports participants and who are committed to the life style. Unless they want to take some big risks with their business model, they can only grow as fast as they can recruit and train those people. They think they have the potential to open another 175 to 275 stores in the U.S.
 
Next, here’s CEO Rick Brooks talking about why Zumiez is successful:
 
“The foundation of our success and what will continue to strengthen our position as the leading branded action sports retailer is our product and our people. Our diverse mix of branded apparel, footwear, accessories, and hard goods, combined with a unique shopping experience, clearly distinguishes us from the competition. Our merchandise teams continue to do a great job fine-tuning our product assortments by mixing new hard-to-find brands with larger core brands that reflect current trends in demand.”
 
Then, after talking about the difficult economic conditions, he says the following:
 
“In this environment, the mall has become highly promotional. However, we believe that as a specialty retailer of product that’s hard to find elsewhere and with the in-store and Web experience that we provide, our concept reflects the quality of our strategies. We’ll benefit in the long run by staying true to this concept and will sustain our position as a quality destination lifestyle-driven retailer.”
 
They don’t much care, in other words, what others are doing. They are going to keep focused on doing what they do. CEO Brooks put it this way in response to an analyst’s question about Zumiez’s competitors. “It’s not that so much we’re concerned with what they’re doing, Jeff, from my perspective. It’s we’re concerned about what we need to do and what our plans are.”
 
And they have the balance sheet, cash flow, and marketing positioning as the core shop in the mall to back that up. To be fair, they also have the happy circumstance of not getting much of their revenue from the juniors business.
 
I guess I’ll let Rick Brooks continue to write this article for me.
 
“…we have a lot of brands you can’t find elsewhere. So, we are not inclined to discount brands that can sell at full price. In fact, again, I think we’ve been successful in being able to push through the price increases where there is demand for those brands.”
 
“We have been trying to assort — do local assortments in stores from virtually the very beginning of Zumiez under a very simple sales-driven philosophy that you should put things in stores that people want to buy. Now with scale, that gets to be tougher and tougher, so over the last number of years, going back 10 or 15 years, we have been instituting technology enhancements to allow — to provide better tools for our merchandise teams to assort — to do local store assortments.”
 
Well, I don’t know, I guess I can see some logic to putting stuff in stores people want to buy. How exactly do you know which stuff should be in what store?
 
As CEO Brooks says, they’ve been working on that for 10 to 15 years. Serious competitive advantages don’t just spring fully formed out of a planning meeting. They are still working on it, and are “…instituting new business intelligence reporting tools.”
 
In the longer term, “…we’ll be able to do all sorts of things that we’ve never be able to do at a much more detailed level. Better size optimization within that structure, right color size, getting more fine-tuned about what mix of products and categories and lifestyles go together in each store.”
 
“And ultimately, we would — give us a few years out, there will be another evolution in that relative to around planning rack capacity and building rack capacity into this model.”
 
You can see, as I said in the title, why Zumiez’s systems are a competitive advantage. Like their personnel and hiring policies. Like their core store positioning in the malls. They aren’t invulnerable to a poor economy and see their customers buying closer to need. But thanks to certain operational efficiencies developed over many years (which is the only way they can be developed) and a consistency in applying their business model they are as well positioned as any retailer in our industry to deal with it.

 

 

Zumiez’s Quarter: Good Result, Same Concerns Everybody Else Has

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Zumiez filed its 10Q yesterday for the quarter ended April 30. It was a pretty good quarter compared to the same quarter the previous year. Sales were up almost 19% to $106 million on a comparable store sales increase of 12.6%. The number of comparable store transactions increased but dollars per transaction fell. They also opened a net of nine new stores during the quarter, including their first two in Canada. They have opened a total of 30 since the first quarter of 2010.

Private label represented 18% of revenues for fiscal 2010. They don’t provide that information by quarter. Shoes are 23% of sales. They indicated that they carry around 400 brands in total at some time during the year, and that 200 of those are “brands of size.” Don’t know how big you have to be to be one of the 200.

 Ecommerce sales represented 6.2% of those sales, or $6.56 million. For the same quarter last year, they were 3.1% of sales or $2.76 million. That’s an increase of about 151%.
 
The gross profit margin increased from 28.6% to 31.6%. About half that increase is the result of not having the costs of relocating their distribution center that they had last year. Most of the rest is from spreading their costs over that 12.6% comparable store sales increase.
 
Selling, general and administrative expenses rose from $28.8 million to $30.9 million, but fell as a percentage of sales from 32.3% to 29.2%. The decline was due to sales growing faster than those expenses, which they should. Net income went from a loss of $1.9 million in last year’s quarter to a profit of $1.88 million.
 
The balance is strong, with cash up, equity increased, and no long term debt. Inventory was more or less flat compared to a year ago. Nice to see that on rising sales. They expect to grow their inventory more slowly than sales for the rest of the year.
 
Zumiez’s biggest concerns are the two that all companies in our industry have. Those would be, first, “…fluctuations and volatility in the price of cotton, foreign labor costs and other raw materials used in the production of our merchandise.” They see a 10% to 15% increase in the price of the cotton based products in their business in the second half of this year. They point out that about half their products are not heavily cotton based.
 
The second are general economic conditions and consumer receptiveness to higher prices that may result as they selectively pass through higher costs. “Yes we have some confidence but how our competitors react and how the consumer is feeling will ultimately dictate on whether our price increases will be received at the consumer level.”
 
Some of those price increases have already started. “We’ve taken areas that we felt like we had high confidence that we could raise prices and we did raise prices and we’ve really not seen any velocity slowdown. I will say it’s not broad-based price increases and they’re strategic and they’re areas that, again, we felt had a higher level of confidence we would have success and we did have success.”
 
They highlighted in the conference call that their inventories were “…some of the cleanest we’ve had in a long time…” and note that they had “…more full priced selling this year versus last year.”
 
They also credit fresh product and unique brands for their success, but I kind of want to highlight the inventory thing. I think clean inventories are a way to sell at a better margin with lower investment and expense. Even if you give up a few sales, you end up better off at the bottom line. So thanks, Zumiez, for making my speech for me.
 
There’s enough market volatility and uncertainty looking forward that Zumiez isn’t offering any sales or earnings guidance beyond the current quarter. That says a lot about what things are like out there.
 
Well, we’re all going to wait and see what the world economy brings us. Zumiez, while it waits with the rest of us, will just continue to apply the business model they’ve developed over many years. It’s not just that they evolved a model which has been validated by events, but that they’ve been consistent in applying it that has them so well positioned.

 

 

A Perspective on Zumiez Accounting Treatments as Reported by Forbes

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An article in Forbes called “Great Speculations” had the subtitle “Accounting Smells a Little Fishy Down at the Zumiez Surf Shop.” It calls into question Zumiez’s reported earnings and balance sheet strength due to a couple of their accounting practices. Boardistan called our attention to it and concluded, “Apparently, Zumiez is shifting over to the “whatever it takes” program.” I had a couple of people email it to me, though nobody expressed an opinion. Maybe they thought I’d jump on Zumiez or something or were just pointing out to me that I hadn’t covered either of the issues mentioned by Forbes in my recent analysis. We didn’t hear anything about this in either Transworld Business or Shop- Eat-Surf.

Forbes analysis and explanation was fine as far as it went, though I’d have trouble reaching the same conclusion they reached. I thought it might be useful if I looked in a bit more detail at the two issues they raise. My goal is not just to give you some perspective on the accounting issues, but to show you that the issues are not quite as clear cut as Forbes explained them and to make you leery of short, pithy, articles you read in the popular media. Hopefully, nobody thinks my stuff is pithy. Well, maybe from time to time I’m a little pithy.

I’m going to assume you clicked on the link above and read the article. Let’s start with a little perspective on accounting.
 
Over many, many years, many people have struggled to figure out what the “right” accounting procedure for certain transactions is. It’s typically obvious what’s just not acceptable. It’s sometimes not so easy to choose from a number of reasonable approaches. Eventually a consensus is reached by the accounting powers that be and they choose a way to do it. The goals are consistency, comparability, and accuracy. Reasonable people can reasonable believe that different approaches are correct.  If you think of accounting as being exact, get over it.
 
The first thing the Forbes article points out is that Zumiez increased the useful life of its leasehold improvements. That’s the cost of the stuff you do to stores after you lease the space to make them ready to open or to improve how they look. When you increase useful life, you decrease the annual depreciation and so have less reported expense. So your income goes up. Zumiez changed its useful life from the lesser of 7 years or the term of the least to the lesser of 10 years or the term of the lease.
 
“For the fiscal year ended January 29, 2011, the effect of this change in estimate was to reduce depreciation expense by $4.2 million, increase net income by $2.7 million and increase basic and diluted earnings per share by $0.09,” Zumiez states.
 
Forbes notes that “…ZUMZ is the only retail com­pany, and 1 of only 9 in the 3000+ com­pa­nies we cover, to increase the esti­mated use­ful life of any of its assets accord­ing to all 10-Ks filed since Jan­u­ary 2010.” There’s a kind of “Aha! We caught you!” sense to the article. But what we don’t know, either from the article or from Zumiez’s 10K is why this is, or is not, a reasonable thing to do.
 
The other thing that the Forbes article points to is that Zumiez “…car­ries over $310 million (nearly 50% of its mar­ket cap and over 120% of reported net assets) in off-balance sheet debt.” It’s all in footnote 9 in Zumiez 10K; Commitments and Contingencies. The number I see is actually $347 million which is more than Forbes reported. The number for Pacsun, by comparison, is $506 million (they have a lot more stores) and is disclosed in a similar footnote. And you’d find the same thing for other larger, multi-store retailers. In this case, then, we have good comparability.
 
Should that amount be on the balance sheet? Maybe. The Financial Accounting Standards Board came out with FAS 13 in 1976 to tell companies how to account for leases. It’s been amended quite a few times since then. A link in the Forbes article describes how they are considering requiring that these leases be included on the balance sheet as a liability starting in 2012. 
 
I should make it clear that the idea of a public company managing (some would say manipulating) their earnings to put their best foot forward is hardly new. There are lots and lots of ways to do that. You change your reserve for bad debts. You can decide to ship and invoice on the last day of the quarter or early in the new quarter to determine what quarter the sales go in. The list goes on. Did Zumiez do something wrong? All we can say, taking the Forbes article at face value, is that increasing the useful life of leasehold improvements is unusual. Is it justified? We don’t know. Does it meet generally accepted accounted principles? Yes.
 
Not including the lease liabilities on the balance sheet is normal practice. Is it the “best” way to do it?   Damned if I know. Let’s leave that to the Financial Accounting Standards Board.
 
And if they do change (again) the way leases are accounted for, it will be hard to compare the first year they do that with the previous year’s results. We’ll probably need a footnote to take care of that.  It will be hidden in the back of the report, and you’ll have to go find it and read it. And then there will be some other change, and some other accounting issue will rear its early head. But we still won’t know the “right” way to do the accounting.”
 
The moral of the story is that there’s a certain inevitable amount of complexity and ambiguity when it comes to evaluating the “quality” of a company’s earnings. We can and will move towards doing it better, but we’ll never get to end of that road. Evaluating a company’s financial statements and their reasonableness probably means you have to get a little dirty back in the footnotes to get a clear perspective. You shouldn’t rely on what Forbes says. Or on what I say for that matter.
 
But don’t get too dirty. Knowing that Zumiez increased their earnings per share by $0.09 for the year by increasing the useful life of its leasehold improvements doesn’t, by itself, change my evaluation of their market position and strategy. But I’m glad that Forbes highlighted the issues for us to think about.

 

 

Zumiez’s Quarter and Full Year Results: It’s All About the Strategy and the Economy

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Can a quality strategy consistently pursued over many years and offering a meaningful competitive advantage overcome the impact of cost increases, a weak economy and still cautious consumers? That pretty much sums up Zumiez’s 10K and conference call. The cost increases and weak economy are, of course, issues for all companies.

If you’ve never done it, it’s worth clicking through on the link above and reading the first four or five pages of the 10K that describes Zumiez strategy and market position. Here’s my summary of how they say they operate. On the off chance you don’t know, they’ve got 400 stores in 37 states that average 2,900 square feet; mostly in malls.

1.       They try to make their stores look and feel like specialty shops, with an “organized chaos” that they think reflects their customer’s lifestyle.
2.       They do everything they can to make sure their employees are committed to action sports and the action sports lifestyle.
3.       They know who their customers are; ages 12 to 24 and interested in brands associated with action sports. 
4.       They promote from within. Their regional and divisional managers all started out in working in stores.
5.       They treat Zumiez as an action sports brand- not just a retailer- to build credibility with its customers
6.       There are very clear measurements of employee success, but store managers have a lot of discretion. I doubt there’s anybody who works there who doesn’t know where they stand.
7.       They have quality information systems that let them know what’s selling, what isn’t, and where. They use the systems to localize inventory (some brands may be in as few as ten stores) and measure product sell through and profitability.
8.       They rely on their employees to keep them up to date on trends and fashions, and don’t hesitate to turn over brands in response to what they learn. In fact, they see that turnover as part of the reason for their success. Over the last two years “…we have had over 50% turnover in our top 10 brands and our top 20 brands. Again, we view that as a very good thing…”   No single brand (including private label) accounted for more than 6.5% of sales in 2010. Merchandise is generally shipped to each store five times a week.
9.       They have serious employee training and reward programs.
10.   They offer career paths that reduce turnover and the associated expense.
11.   They recognize that there are some limits on their growth imposed by the requirement for trained and quality store employees. I think that’s why they weren’t really serious about buying West 49.
12.   They do private label (18% of revenues in 2010, up from 17.5% the previous year), but are cautious that it doesn’t damage customer perceptions of Zumiez.
13.   They are pretty much the only store in the mall that does skate and snow hard goods in a serious way.
14.   They are rigorous and disciplined in pursuing their business model.
 
Remember, the points above are what Zumiez says they do and what works for them. It’s (mostly) not my opinion. But they’ve been at it for 32 years, and it seems to be working so far. Those of you who have read some of my earlier articles know I believe in many of the things they do- for any retailer. I’ll bet Zumiez’s management could tell us all about gross margin return on inventory investment.
 
I’ve been asking recently just what is action sports and the action sports market. Zumiez doesn’t have a direct answer, but the list of whom they consider to be competitors is instructive. 
 
“…we currently compete with other teenage-focused retailers such as Abercrombie & Fitch, Aeropostale, American Apparel, American Eagle Outfitters, Boathouse, CCS, Forever 21, Hollister, Hot Topic, Old Navy, Pacific Sunwear of California, The Buckle, The Wet Seal, Tillys, Urban Outfitters and West 49. In addition, in the softgoods markets we compete with independent specialty shops, department stores and direct marketers that sell similar lines of merchandise and target customers through catalogs and ecommerce. In the hardgoods markets, which includes skateboards, snowboards, bindings, components and other equipment, we compete directly or indirectly with the following categories of companies: other specialty retailers that compete with us across a significant portion of our merchandising categories, such as local snowboard and skate shops; large-format sporting goods stores and chains, such as Big 5 Sporting Goods Corporation, Dick’s Sporting Goods, Sport Chalet and The Sports Authority and ecommerce retailers.”
 
So Zumiez pretty much sees themselves as competing with everybody who sells any of their products to their target customers. Their definition of who’s in the action sports market is pretty broad. But they don’t focus on what those competitors are doing- they’d be overwhelmed just trying to keep track. They focus on executing their plan and nurturing their advantages. Good for them. It is interesting that they don’t mention that certain of the brands they carry are increasingly direct retail competitors. Wonder when that will show up in the Risk Factors section.   
 
By the Numbers
 
Discussing strategy is always fun, but eventually there’s just no way to avoid reviewing the numbers. The balance sheet is strong, with plenty of cash, strong ratios, and no long term or bank debt. Let’s see, what about their balance sheet might be interesting? Well, they’ve got $3.3 million in unredeemed gift cards on their balance sheet as of January 29. No big deal. I’m just intrigued by the gift card phenomena.
 
Boy, I really miss companies with screwed up balance sheets. They are so much more fun to analyze. I guess they mostly didn’t make it through the recession.
 
Zumiez’s fiscal year and quarter ended January 29th. Fourth quarter sales rose 18.2% to $156 million compared to $132 million in the same quarter the previous year. Comparable store sales were up 13%. The gross profit margin rose from 36.3% to 39.0%. I should remind you that Zumiez includes some expenses in its cost of goods sold calculations that some others don’t include, so it’s hard to make a direct comparison.
 
Net income for the quarter was $15 million or 9.6% of sales compared with $8.8 million, or 6.6% of sales in the same quarter last year.
 
For the year ended January 31, 2011, sales grew 17.5% from $408 million to $479 million “…primarily driven by an increase in transactions.” That’s as opposed to an increase in transaction size I assume. Men’s Apparel accounted for 32.5% of sales. Juniors was 10.1% and Accessories and Other, 57.4%. That last category includes hardgoods and footwear. They estimate in the conference call that 85% is sold to male. Sales for the January 31, 2009 year were also $408 million. Shows the impact of the recession.
 
Gross profit margin rose from 33.1% to 35.6%. The increase was due to an increase in product margin and a reduction in occupancy costs offset by some costs associated with moving to their new distribution facility.
 
Selling, general and administrative expenses were up 9% for the year to $133 million. As a percent of sales, they fell from 30% to 27.8%. Advertising expenses (which are net of sponsorships and vendor reimbursements) were $1.3 million for the year. I’m surprised it isn’t higher than that given their focus on Zumiez as a brand. Operating income tripled to $37 million, as did their income tax provision. Net income rose from $9.1 million to $24.2 million.
 
They opened a net of 23 stores during the year, and comparable store sales rose 11.9% after falling 10% the prior year. Rising 11.9% after falling 10% does not mean they got back to where they were plus 1.9% due to how percentages work. Here’s a simple example:
 
If you start at 100 and fall 10%, you’re at 90. If you rise 11.9% from 90, you get to 100.71- not 101.9. It’s all about the base you start the calculation from. You should think about that whenever you work with percentage changes.
 
Net sales per square foot rose from $367 to $396. But their high was for the year ended Feb. 3, 2007 when they were $499. In the next two years, they fell to $488 and $424.  Net sales per store were $1.2 million. The “gross cost” of new stores has fallen from $440,000 to $350,000 largely, I think, because of better leasing deals. They don’t discuss the reasons.
   
For fiscal year 2011, Zumiez is ‘cautiously optimistic.” They expect to open 44 new stores (including up to 10 in Canada) but are concerned about “…increases in production costs that may have an impact on our ability to maintain product margins.” Aren’t we all. Number 1 in Zumiez’s list of risk factors is “Significant fluctuations and volatility in the price of cotton, foreign labor costs and other raw materials used in the production of our merchandise may have a material adverse effect on our business, results of operations and financial conditions.”
 
They believe that these costs pressure are here to stay for a while (so do I) but that they “…are in a good position to deal with the increase in input costs, given a lot of what we sell is unique and hard to find elsewhere in the mall.” They also note that approximately half of the products they sell contain no cotton. I don’t think that means there will be no cost pressures on those products, but certainly they should be less.
 
Screw this “cost pressure” phrase everybody is using. Can’t we just say “inflation?”
 
Conference calls always frustrate me. The analysts never ask the questions I want to ask. I’d love to know more about how Zumiez evaluate employees and the kind of feedback those employees get. I wonder how brands that Zumiez buys from becoming retailers impacts Zumiez’s purchasing decisions. I’d like to have a long talk with Zumiez management about what it means for them to be a brand, as opposed to just stores full of brands, and where they might take that.
 
Anyway, even without answers to those questions, it’s always nice when the conclusion you end up write matches the title you started out with. Zumiez is well positioned in their chosen market; as well as any retailer. My sense is that the operate better than most companies in their space (though of course you never read SEC filings or conference calls expecting them to tell you how they really, really, screwed up and what’s not working). Their challenge (every company’s challenge) will be the economy and inflation and if they are, as they claim, better positioned than others to manage it, they aren’t invulnerable.      

 

 

Zumiez’s October 30 Quarter and Its Position in the Market

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This shouldn’t take long. The balance sheet has more cash than a year ago, no long term debt, and is solid. The inventory increase of 8.8% since a year ago is a lot less than the 20% sales increase for the quarter (but remember that inventory is at cost and revenue at retail price). Zumiez indicated in the conference call that efficiencies provided by the new Southern California warehouse had a lot to do with their ability to better control inventory. They expect to continue to increase inventory by less than sales.  You can see the complete filing here.

Sales grew from $113 million to $136 million. Gross profit margin rose from 35.4% to 39%. If that looks low, remember they include occupancy and certain other costs in their cost of goods sold calculations. Other companies don’t do that. They indicated the increase was about half product margin improvement and half a decrease in store occupancy costs. In 2007 it cost them around $440,000 to open a new store. Now those costs are down to about $340,000 due to better deals with landlords and their improved operations.

Ecommerce sales for the quarter were about 4.4% net sales for the quarter, or a bit less than $6 million. In the same quarter the previous year, they were 2% of net sales, or about $2.3 million. They expect that ecommerce will be “…substantially larger for us over the next five years,” but they weren’t specific.
 
Management indicated they were learning a lot from the ecommerce business. They can read trends faster and allocate inventory better. They noted that operating margins in stores and on the web were not very different. Those of you who have actually invested in the systems and people it takes to run a really responsive ecommerce site won’t be surprised at that.
 
Selling, general and administrative expenses were up 7.3% but fell as a percentage of sales from 28% to 25.1%. Of the 300 basis points decline, 140 came from “store operating expense efficiencies and the rest from accounting changes I won’t bore you with the details of. Net income rose 143% to $12.3 million. That’s 9.1% of net sales compared to 4.5% in the same quarter last year.
Now for some fun facts about Zumiez.
  • 400 stores in 37 states. They opened 27 in 2010. They expect to open “a handful” in Canada in 2011, but not enough to have a meaningful impact on revenue. You know, I wonder if they ever really thought they were going to buy West 49 or if they just hoped to get a peek at their numbers.
  • They’ve still got this 14.3% interest in a manufacturer of apparel and hard goods I reported last quarter. They still won’t tell me who it is or how they got it. Rats.
  • Unredeemed gift cards at October 30 were $1.83 million. They don’t count them as income until they are used, but after 24 months they take unused card balances as revenue because their experience is that they won’t ever be used after that. Got to love that free money.
  • Pages 29-38 of their 10Q are all risk factors. It’s the longest section of the report. I just find it interesting that a company that seems to be doing so well could feel the need to talk about so many things that might go wrong. Must be the lawyers.
  •  Private label represented 15.7% of net sales last year. That number will be higher for 2010, but they didn’t say what it will be.
  • Their long term goal is to have 600 to 700 stores. I imagine that’s based on their analysis of how many malls there are that can support their concept. But I wouldn’t be surprised if they’ve looked at what happened to PacSun and said to themselves, “Nobody need 900 Zumiez stores.”
  • They bought snow product cautiously and might be a little tight on inventory if the snow conditions are good. Good for them. Leftover snowboard inventory is a dagger in the heart. Okay, maybe I’m overdramatizing, but you know what I mean.
  • Back in 2006, their sales per square foot were about $500. They think they could reach their operating goals now with square foot sales of maybe $440 or $460 due to operating leverage, the web, and their new warehouse. 
CEO Brooks say they want to “Stay true to who we are and focus on things that distinguish Zumiez from the competition.” That means carrying hard to find brands, providing a unique shopping experience, and having the best in class customer service. My guess is that their growth will be constrained by their ability to staff stores with the kind of action sports enthusiasts they want, but I’d characterize that as happening in a good cause. They’d be crazy to grow faster than they are able to perpetuate their culture in new stores.
 
Zumiez, like everybody else, is concerned about the strength of the economic recovery, issues with certain product supply, and increasing product cost due to cotton costs, labor, shipping, and other factors. Yet they seem uniquely positioned as the only hard goods carrying mall shop with at least a feel of independent core shops. And the days of it being evil to be in mall are long gone based on the other brands that are there.   

 

 

Zumiez’s Quarter; Other Stuff is More Interesting than the Numbers

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The Numbers

In the quarter ended July 31st, Zumiez showed some improvement over the same quarter last year. Sales grew 14.7% from $85.2 million to $97.7 million. Comparable store sales were up 9.3% and 24 new stores (net of closings) have been opened since August 1, 2009.
 
“The increase in comparable stores sales was primarily driven by an increase in comparable store transactions, partially offset by a decline in dollars per transaction. Comparable store sales increases in accessories, men’s clothing and boy’s clothing were partially offset by comparable store sales decreases in hardgoods, junior’s clothing and footwear.”
 
Gross profit was $30.7 million, up 24.6% compared to the same period the prior year. Gross profit as a percentage of sales grew from 28.9% to 31.4%. I should note that Zumiez included in their cost of goods sold some expenses that other companies allocate differently. 
 
“The increase was primarily due to product margin improvement of 170 basis points, a 130 basis points decrease in store occupancy costs and a 40 basis points decrease in inbound shipping costs, offset by a 100 basis points increase due to distribution costs primarily associated with the relocation of our distribution center.” The 1% of distribution costs sounds like a one time thing.
 
Selling, general and administrative expenses increased $3.2 million, or 10.8%, to $33.1 million. As a percentage of sales they fell from 35.0% to 33.8%.   “The primary contributors to this decrease were a 150 basis points impact of a litigation settlement charge of $1.3 million incurred in the three months ended August 1, 2009, 120 basis points due to store operating expense efficiencies, the effect of the change in accounting estimate for the depreciable lives of our leasehold improvements of 110 basis points and a 40 basis points impact of the $0.3 million impairment of long−lived assets charge incurred in the three months ended August 1, 2009, partially offset by a 210 basis points impact of a litigation settlement charge of $2.1 million incurred in the three months ended July 31, 2010 and a 80 basis points increase in corporate costs, primarily due to incentive compensation.”
 
The two law suits were both around allegations that Zumiez didn’t treat their employees as the law requires. Alleged were failure to pay over time, not providing meal breaks and a bunch of other stuff. Both cases have been settled. Without the impact of the lawsuit settlement, sales, general and administrative expenses would only have declined by 1.8% instead of by 3.8%. 
 
The company had a net loss of $1.2 million in the quarter compared to a loss of $3.1 million in the same quarter the prior year. The balance sheet is in good shape. Not all that much changed from a year ago. Thanks to Zumiez for including the balance sheet from a year ago in their press release so I didn’t have to go dig it up. Let’s move on to the more interesting stuff.
 
The More Interesting Stuff
 
On May 11th, Zumiez bought a 14.3% interest in a manufacturer of apparel and hard goods for $2 million. I emailed Zumiez asking for more details but they aren’t disclosing any, which is what I expected. Zumiez has the right to sell its interest back any time between the fifth and the seventh anniversary of the investment. And the company they invested in has an option to buy their stock back on or after the seventh anniversary of the initial investment.
 
Sorry, that’s all the information I have. I am kind of intrigued. Brands going into retail, now retailers becoming manufacturers?   If $2 million bought 14.3% of the company, then they agreed the company had a value of about $14 million. So it’s not a little tiny company. 14.3% is kind of a funny number. I wonder if this isn’t an important source for Zumiez that was having some troubles. Makes hard goods as well as apparel huh?
 
Okay, I’m over speculating here. I just don’t know anything, but you can see why I’m curious.
 
Ecommerce was 2.9% of revenues for the quarter, up from 1.8% in the same quarter the prior year. Quite an increase.
 
You noted above that they ascribed some of the drop in sales, general and administrative expenses as a percent of sales to improved operating efficiencies. They discussed that in the conference call, referring specifically to “Infrastructure projects that facilitate better merchandise analysis and planning decisions” and contribute to “improved exception based analysis.” They also mentioned a new assortment planning tool which should allow Zumiez to “plan and micro merchandise our business even better.” They said this would allow them to lower cycle times and get product into stores faster. Their new distribution center, they noted, (moved from Everett Washington to Southern California) cuts two to three days off their supply cycle because 70% of their suppliers are located in Southern California.
 
As you know, I’ve been a cheerleader for systems improvements ever since the lousy economy started to rear its ugly head. Actually, since before then as I was pretty certain a lot of companies were leaving a lot of money on the table through poor operations. Now, I think your bottom line improvement is more likely to come from running better than from growing sales and it looks like Zumiez might think I’m on to something.
 
Zumiez noted in the call that two things were working really well for them. The first was the value portion of the business. The second was a lot of “full price selling coming from unique brands we carry.” They believe that they may still have some pricing power with those brands because of their controlled distribution.
 
I’ve written about how the recession can be an opportunity for small brands that aren’t widely distributed. It’s the only way for specialty retailers to differentiate themselves.
 
Here are a few other facts:
 
·         Juniors represent only about 10% of Zumiez sales. That’s a good thing because of how tough that market has been and is. Their private label juniors has performed better than the brands in the last few quarters.
·         In the last two complete years, private label has been 15 and 15.7% of sales.
·         Last quarter, they had the biggest decline in average unit retail that they’ve had in the last six quarters.
·         Concentration in their top 10 and 20 brands has been declining for a number of years.
·         They see some costs coming up and some lead times increasing, consistent with some other companies are saying. It will be interesting to see how brands reconcile that with consumer demands for value in the next year or two.
 
Obviously, you don’t want to say everything is fine when a company is losing money. But they are going in the right direction, have the balance sheet to consistently follow their strategy, are choosing and managing the brands they carry in a way appropriate for the environment, and are working hard to build efficiency and take costs out of the system.

 

 

Zumiez’s 10K for Year Ended Jan. 30, 2010; The Strategy’s the Thing

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In my analysis of Billabong and Genesco, I have spent some time talking about their retail strategies and the possible impact on the action sports retail market, especially on the core retailers.  Zumiez’s 10K has me thinking about this again.

I would first like to thank Zumiez for keeping their 10K to only 75 pages, simplifying my task and reducing my work load.  I have a theory that the best companies have the shortest 10Ks; business models that are simple to describe and fewer problems to explain.  Maybe that’s a new investment strategy.

Zumiez’s financial results, like with every other publically traded company in any industry, reflect the recession and their efforts to manage through it.  There was inventory control, expense management, a reduction in capital expenditures, and focus on continuing to follow their basic strategy (which can be done, as usual, when you have a strong balance sheet like Zumiez’s).

Zumiez ended their fiscal year with 377 stores in 35 states averaging 2,900 square feet each.  As they note, their size seems to leave them room to grow given the number of stores that other similar retail chains have.  New store openings have declined from 58 stores in fiscal 2008 to 36 in 2009 and a projected 25 in 2010.

Their customers are “…young men and women between the ages of 12 and 24 who seek popular brands representing a lifestyle centered on activities that include skateboarding, surfing, snowboarding, BMX and motocross.”

They go on to say:

 “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with store associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers.  Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates. To increase customer traffic, we generally locate our stores near busy areas of the mall such as food courts, movie theaters, music or game stores and other popular teen retailers. We believe that our distinctive store concept and compelling store economics will provide continued opportunities for growth in both new and existing markets.”

 They talk about this strategy in more detail in the 10K and you can see the whole thing at http://www.sec.gov/Archives/edgar/data/1318008/000119312510064532/d10k.htm.  Focus on pages one through nine.

Ignoring whether or not you think this strategy is valid (their history tells us it has been), you’ll notice that this description of their stores and how they position themselves could essentially be the same description that any independent core retailer would use.  Except of course the core retailer wouldn’t be in the mall (I guess by definition?) and doesn’t, therefore, have the ability to locate in high traffic areas in the mall.  So your typical independent core retailer might to be more dependent on destination traffic than a Zumiez.   Zumiez pursues, on a national scale, the same branding strategy the best independent retailers pursue.  “We seek to build relationships with our customers through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle.” They spent $822,000 on advertising in fiscal 2009.

In other words, as I’ve said a few dozen times before, the best retailers, chain or independent, give credibility to the brands they carry and do not rely on those brands to define them.  Zumiez is clearly not dependent on a handful of brands.  No single brand accounted for more than six percent of net sales in 2009.  Their private labels in total accounted for 15.7% of net sales, up only slightly over the last two years.  Ecommerce sales represented 2.3% of the total, up from 1.1% two years ago.

 And Zumiez has undeniable advantages in terms of negotiations with vendors and landlords, systems, and overall efficiencies associated with size.  Like they say, “compelling store economics.”  Genesco, by the way, pretty much said the same thing.  So would any multi hundred store retailer.  Here’s another kind of long quote that described part of that advantage.

“We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management. We also coordinate inventory levels in connection with our promotions and seasonality. Our management information systems provide us with current inventory levels at each store and for our Company as a whole, as well as current selling history within each store by merchandise classification and by style.”

Pretty powerful stuff.  Then I noticed that in 2008, Zumiez’s net investment to open a new store (net of inventory and landlord contribution) was $311,000.  In 2009 it was down to $221,000.  In part that’s because of economic conditions, but it’s also indicative of the advantages of scale.

Let’s talk about the numbers while all this strategic stuff sinks in.  I’ll come back to it in my conclusions.

Net sales for the year were about even, falling $1 million to $407.6 million.  Comparable store sales were down 10% after having been down 6.5% the previous year.  Net sales per store were down 12.8% from $1.24 million to $1.08 million. Comparable store sales had grown an average of 12.6% a year in fiscal 2005 to 2007.  Gross profit as a percent of sales actually grew from 32.9% to 33.1%, an indication of good inventory management and control of the need to discount.  This gross profit percentage may look a bit low, but you have to consider how the company calculates it.

“Cost of sales consists of branded merchandise costs, and our private label merchandise including design, sourcing, importing and inbound freight costs. Our cost of sales also includes shrinkage, certain promotional costs and buying, occupancy and distribution and warehousing costs. This may not be comparable to the way in which our competitors or other retailers compute their cost of goods sold.”

I agree.  There’s no right or wrong way to do this but, though detail is lacking, I think Zumiez includes some costs that other don’t. 

Selling, general and administrative expense rose from $109 to $122 million both due to store openings and, I assume, because Zumiez had the balance sheet to let it continue to pursue its strategy.  As a percentage of sales, it rose 3% to 29.9%.

Operating profit fell by half from $24.6 to $12.7 million.  Though cash and cash equivalents grew from $78 to $108 million, interest income fell from $2.059 to $1.176 million, reflecting not only the difficulty in finding yield under current conditions but, I suspect, an unwillingness to take risk.  Net income fell from $17.2 to $9.1 million for the year.

Comparing fourth quarters you can see what looks like the beginning of some level of economic recovery (this is not unique to Zumiez).  Sales rose 5.5% from $125.5 to $132.4 million.  Same store sales had fallen 13.4% in the quarter ended Jan. 31, 2009.  They only fell 1.7% in the quarter ended Jan. 30, 2010.  Okay, so maybe that isn’t good news but it’s sure less bad.  Gross profit as a percent of sales was up from 32.4% to 36.3%.  Net income rose from $6.3 to $8.8 million in the quarter ended January 30, 2010 compared to the same quarter the previous year.

The balance sheet has actually strengthened slightly from last year by the measures I use and is in good shape.  I won’t bore you with a detailed analysis of nothing interesting.

Now we’re back to those pesky strategic issues and you know what?  I don’t think I’m going to write a new conclusion.  I’m just going to go see if I can’t use the same one I used when I wrote about Genesco (the owner of Journey’s) a few days ago.  Here it is.  I’m quoting myself, which is a little strange.

“I wrote not too long ago about Billabong’s retail strategy.  They might agree with Genesco executives about how the retail environment is evolving.”

“My own expectation is that due to some of the pressures on core store described above, their numbers will tend to decline until we have just the right number to service the enthusiasts who are truly prepared to pay extra for expert advice and service in a community based environment.  I don’t know how many stores that is or how long it takes, but when it happens, we will have come full circle in the action sports core store business; because that’s how it use to be.”

Zumiez thinks they can be a core store in a mall.  They are the only one who puts it quite so directly, but others are thinking that way too.  If they’re right, and they have other business advantages (as described above) what does the model of a successful independent core retailer look like?

I’m going to the IASC sponsored skateboarding conference this month and am going to moderate a panel discussion on retailing.  As you can see, I’ll have some interesting questions to ask.

 

Zumiez’s Nov. 2009 Sales Results- A Couple of Comments

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Yesterday, Zumiez reported that sales for the four week period ended November 28th, 2009 decreased 1.8% compared to the same period the previous year. For the same period, they reported that comparable store sales fell 8.5% compared to a decline of 15% in the same period the previous year.

In the first place, I want to suggest that paying attention to four week numbers may be fun, but it doesn’t really tell us anything about trends. It’s just not enough time.
Second, there are various attempts out there to position a decline of 8.5% in comparable store sales as a somehow positive result because last year they were down 15%. I’m not talking just about Zumiez here- it’s true for a variety of statistics and economic indicators. Be careful how you interpret that kind of analysis.
Finally, as I’ve been writing for a while, the focus should probably be on gross margin dollars in our new economy, which is another reason I think four week sales numbers are of limited value.
Zumiez has come out with their press release on the quarter that ended October 31, 2009 (On November 19) and has held a conference call. But as of today, the 10Q with the details and notes has not been filed. I’ll have more to say when I’ve seen that document.

Zumiez’s Fireside Chat

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Rick Brooks, Zumiez’s CEO and CFO Trevor Lang held a half hour question and answer session today at the Thomas Weisel Partners Consumer Conference in New York. Previously, Zumiez had announced on September 2nd that “…total net sales for the four-week period ended August 29, 2009 decreased 2.9% to $51.7 million, compared to $53.2 million for the four-week period ended August 30, 2008. The company’s comparable store sales decreased 12.1% for the four-week period, versus a comparable store sales increase of 0.2% in the year ago period.” Their comps for September were positive.

They started by defining themselves as an action sports lifestyle retailer (duh) and went on to explain what you had to do to be one. To Zumiez, that means you have to carry hard goods and all the brands (not only in hard goods) that you find in independent shops. They characterized their customer as “very smart” and as knowing what’s authentic and what’s not. Those customers are 12 to 24 years old and more male than female.

They focus on making their employees people who are living the lifestyle and they try to build a distinct culture that empowers these young people to localize product for their stores and create a vibe around it.
 
Their description of their business makes perfect sense. It also leads me to two questions. The first is what does it mean to be an action sports company? That’s a strategic question for every brand and retailer in this industry and one, I have to admit, for which I don’t have a good answer. That label, which has been around a long, long, time, might be seen to suggest that we are the same industry now that we were 15 years ago. But we’re not. If only because of the breadth of distribution and the number of non participants who buy our products we’re a lot different. I guess I’m not against the term as long as you don’t fall into the trap of thinking it means the same now as it did then.
 
The second question is more focused on Zumiez, but not only for them to think about. As they create this focused culture of cool kids who are committed to and invested in the lifestyle, are they defining themselves in a way that might restrict their growth or their attractiveness to certain consumers?
 
The answer, of course, is yes, they are. But every company decides who they want their customers to be and what they want to mean to them. Or at least they should. And any company that tries to be meaningful to everybody probably ends up meaningful to nobody. Unless, I guess, they are an electrical utility, for example. Interestingly, I wonder if Zumiez hasn’t helped themselves manage this issue by being mall based.   They can work to make their stores what they consider core while at the same time exposing themselves to a much broader spectrum of potential customers in an environment that is not intimidating to those customers.
Zumiez noted that their smaller brands are continuing to gain share and specifically that brands need to be careful with distribution and how quickly they grow. They indicated they hadn’t seen any bankruptcies from any of these brands and hadn’t had to do anything special for any of them because of financial difficulties.
 
I have been arguing for a while now that current economic conditions represent an opportunity for new and small brands. It appears Zumiez agrees with me.
 
One of the questioners noted that Zumiez use to talk about an operating margin target in the low to mid teens and asked if that was still a reasonable objective. Zumiez indicated it was, though not in the current environment. They said they were growing selling, general and administrative expenses at half the rate they had been before and spending $85,000 less on each store. Because of these adjustments, they think they can get to those margins with less sales per square foot, but not until sales turn around.
To me, that sounded like an acknowledgement that they have no expectation of sales returning to previous growth rates in the foreseeable future, an assumption I agree with.
 
Zumiez’s growth plans are somewhat restricted right now, and management pointed to the failure of landlords to be more realistic about the rents they could expect as a major reason for this. My belief is that the commercial real estate market is going to get worse before it gets better, and I expect Zumiez will eventually get the cooperative landlords it needs to open more stores. They seem to think so too, as they acknowledged the “capacity rationalization” (what a benign sounding term for something that can be so difficult) that was going on not just in action sports but in all retail sectors. In other words, we’ve got too many retailers and too much retail space
.
The last thing I’ll mention that really caught my attention was their description of how they were working with individual brands on strategies that were appropriate for them. They might, for example, ask a brand to explore a new product or category where Zumiez saw an opportunity. I don’t know how much of that they’re doing, but that guidance could be really useful for a smaller brand and might explain why Zumiez is having success with such brands.