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

As with most industry retailers, it’s not exactly a great time for Zumiez. Their October 31^st 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.

Maybe a couple of years ago, I wrote I expected that wording to change- and so it has. In September of 2013, in an article called, “You Own Action Sports in the Mall. Now What?” I said the following:

“If I were Rick Brooks, what would keep me up at night is wondering whether the market the company has worked so hard to stake its claim in isn’t changing so much that the competitive strengths the company has worked so hard to develop might not support the growth I need as a public company. And if I step outside of the action sports market seeking that growth, how does that affect my ability to compete?”

I imagine Rick sleeps fine, but that certainly describes the circumstances and challenges even more than it did two years ago. Growth and industry evolution has taken and is taking Zumiez out of a clearly defined action sports market and into a broader lifestyle/fashion market. It has a lot of company.

Let’s move on to a related issue from the list of Zumiez’s risk factors in the 10Q. I have the perception these lists are getting longer for most industry companies. Feels like a long term barometer of industry conditions and uncertainty.

Here’s a Zumiez risk factor. “Our growth strategy depends on our ability to open and operate new stores each year, which could strain our resources and cause the performance of our existing stores to suffer.”

Sounds kind of obvious. At the end of the quarter, Zumiez had 587 stores in the U.S. At the end of the prior quarter they had 578. They’ve consistently said they don’t ever expect to have more than around 700.

Now let’s hear what Rick Brooks has to say about store openings in the conference call.

Discussing store openings during the year he says, “Our focus here consists of optimizing the long-term productivity of our physical store base by strategically leveraging our omni channel capabilities to maximize our impact within each geographic area. So while we continue to see opportunity for further physical expansion within North America, we remain strategic in our approach towards opening new stores and are diligent in our consideration of both short term trends and long-term potential.”

He continues two paragraphs later, “From a technological perspective, we continue to invest in capabilities to promote a seamless brand experience between our physical and store presence in the digital space. These improvements are not only done in tandem with our physical expansion, but they’re playing a key role in driving growth and identifying new growth opportunities.”

Let’s think about the risk factor and those quotes as a package deal. Clearly the way you plan, locate, size, stock and manage physical stores is changing. How does mobile/online change your physical store strategy? Well, isn’t that what we’d all like to know.

Does the number of stores you open have the same impact on revenues it used to have? I don’t think so and I don’t think Zumiez does either. Could opening a specific new store turn out to be a bad idea given the omnichannel evolving habits of your customers? Like Rick says above, they are being “strategic” in their approach to opening new stores.

We can certainly agree that measuring the potential of a multi-store retailer is going way beyond how many stores they can theoretically open and how quickly. The risk factor may still be accurate, but it’s become more complicated.

Now, what else is going on in the world of retail? Before continuing, I’d like to thank Rick Brooks for simplifying my job. All I have to do is quote him, make a brief comment, and hopefully sound sage and insightful.

Let’s start with the big old ugly macroeconomic pile of badness we all know about.

“…in this new consumer world, there is still way too much physical retail. And so that’s why I think we see the high level of discounting that takes place on a niche-by-niche basis in the marketplace. And really…we’ve been working through this capacity issue. We’ve seen some players go out, some people, some players really struggle, a lot of stores being closed. But we still have a long ways to go here… as we think about the long-term view here.”

Sage and insightful wise, I got nothing. He’s right. Let’s move on. I was kind of amused by this comment on brands going direct.

“Now am I worried much about our brands going direct and selling directly on their own sites? I’m not too worried about that, in fact I think it’s been proven in our niche that brands don’t make very good retailers. I think there is some pretty good evidence of that over the last few years.”

No kidding.

Rick sees a highly promotional retail environment as a symptom of the problem of too much retail.

“…everyone else is in the markets is doing something far more radical in terms of delivering value [than what Zumiez is doing]. I have to tell you don’t believe it sustainable, particularly in our business model where we selling brand of products. It’s just not as sustainable strategy.

It’s part of the problem, but it’s also part of the long term solution. Brands and retailers that do too much discounting to try to maintain cash flow eventually damage the brands and contribute to a decline in brick and mortar retail space.   But it’s a long, slow process that’s painful even to those retailers not fully participating in promotional madness.

“…that is part of the share consolidations taking place in the world. We’ve also seen it in our niche of lifestyle retailing with some of the pure play guys who have either gone through bankruptcy or been shut down. And now they’ve been re-launch, but their re-launch form is not nearly as robust or aggressive as their previous incarnations.”

The next issue would be the “…rapidly moving changes in consumer behavior…” I’m going to include with the “…a lack of a fashion direction” he points to.

“I think this is particularly difficult for us, because of the nature of our consumer. Because our consumer tends to lead fashion cycles, in many ways. And I think that because of that, we’re being disproportionately impacted by this lack of a clear fashion cycle. Of course, when you have a lack of a clear fashion cycle, consumers tend to revert to value, right. I think it tends to be where they go. And as you know, we are not a value player. We’re a lifestyle retailer.”

The same, of course, can be said for many of Zumiez’s competitors.

Rick, as I wrote the last time I reviewed their financials reports a quarter ago, believes (or at least believed then) that this was a temporary situation. I agreed with him it was temporary, but thought (and still think) that “temporary” can involve a long, long time.

I might read into something he said that he’s coming part way towards my point of view.

“I think we’ll find these trend cycles are going to be particularly for each unique retailers position, and we have a unique retailer position. I think we’re going to see the speed of this world, the speed of trend cycles expose more retailers relative to the trend cycles and then again this is about how do you not compromise your brand positioning and still compete.”

If you see more and shorter term trend cycles, what does it take to get you back to a dominant fashion cycle? To what extent do endless short cycles preclude a longer term dominant trend? Rick specifically mentions the massive shift to digital shopping in discussing consumer behaviors. I see that as a major reason we don’t have a dominant fashion cycle.

I’d add some others prospective long term trends. These include, but probably are not limited to, more interest in the experience the product is connected to and maybe facilitates you to have, less of a tendency to be influenced by traditional advertising and more by their community, lower disposable income and a tendency to save more, less brand loyalty, a perception of sameness across brands, a tendency to be more selective and value oriented (note- value can mean a more expensive product), getting less satisfaction out of the act of buying something, and an expectation that there will always be something new.

Finally, both Rick and CFO Chris Work tried as usual to keep people from looking at brick and mortar and online as being separate “channels.”   Chris puts it, well, like a CFO when he says, “…when you think about this it’s all as one and one inventory pull and available to everyone through every channel in every way, it is hard to separate these channels from what is web and what is stores because they are working in tandem together but we do try.” Rick just says, “…the consumers don’t see the channels the way we used to…” with the implication being that a retailer can looks at them as they used to only at their peril.

One final glimpse into how Zumiez is thinking, and this relates to the earlier discussion how they view store locations an openings.

Rick talks about focusing on “trade areas.” A trade area isn’t just a local group of stores. It is, if I’m getting this right, a group of relationships among customer groups and the ways they interact with Zumiez. While there is no doubt a geographic component to it, I perceive that it’s a lot more complicated than it used to be. In Rick’s words, “…our goal here is really about thinking about again a channel-less world and thinking about business within trade areas and again we could have a long discussion about how you define what a trade area is and looking at what total volume takes place in how we interact with customers across multiple touch points in each trade area.”

If that sounds imprecise, it’s because they are still figuring it out. But they are the only retailer I’ve seen put it quite that way, and I think they are right.

A Brief Look at the Numbers

Revenue was down 4.2% to $204 million in the quarter ended October compared to $213 million in the same quarter last year. Comparative store sales were down by 7.3%, or $15.2 million. Foreign exchange contributed an additional $4.6 million to the decline. Both the Euro and the Canadian Dollar are down significantly against the U.S. dollar since last year’s quarter. The decline in North America was $10.5 million or 5.3%. In Europe it was $1.5 million or 10%.

Gross margin took a hit, falling from 36.5% to 34.3%. Most of that decline was due to spreading overhead across declining sales.

Selling, general and administrative expense rose slightly from $52.9 to $54.8 million. As a percentage of sales, they rose from 24.8% to 26.8%.   Operating income was reduced by half from $30 to $15.2 million. Net income fell from $15.7 million to $9.6 million. That result includes an income tax provision that was down from $9.1 to $5.6 million.

The balance sheet continues to be strong, though I would note the decline in cash and marketable securities by about half to $51 million. Net cash provided by operating activities declined from $34.4 million in last year’s fiscal year to date compared to $476,000 this year. “This decline was driven primarily by stock repurchase activity and capital expenditures for new store growth and remodels, partially offset by cash flow from operations,” said CFO Chris Work.

I’ve got a few other retailer 10Qs to review, and I’m pretty confident they are dealing with the same issues as Zumiez. These issues are long term but they are also exciting as the one who does the best job figuring out what this all means will win. Zumiez has a head start over most of its competitors, a strong balance sheet and seems, based on the conference call, to be in touch with reality.

In touch with reality is particularly important. Zumiez is a company that has consistently trumpeted the strategy it’s followed for 20+ years as a key reason for it success. Fair enough. Yet the difficult environment, rate of change, and fundamentally different (long term?) consumer behavior clearly requires some different market approaches.

I wonder if Zumiez would do anything differently if they weren’t a public company?