Zumiez’s Annual Report and Some Questions I’d Ask if I were an Analyst.

I’m always grateful when a company has a short 10K and conference call.  I’m efficient at spotting the meat in a 10K, but it’s easier when it’s 77 pages, as Zumiez’s was, instead of 177 pages.  Though when it’s 177 pages, there’s usually some really interesting stuff.

Zumiez doesn’t need more than 77 pages.  They pursue the general strategy they’ve pursued since the company was founded, they make money, and their balance sheet is fine.  They are dealing with the same crappy retail and economic environment everybody else is, they are impacted by it, and they are cautious about the future.  Ho hum.

Let’s look at the numbers. Then we’ll get to the fun stuff.  In the conference call, CEO Rick Brooks and CFO Chris Work say some eye-opening things the analysts don’t follow up on.  To be fair, had they asked the questions I wanted to ask, Rich and Chris probably would have politely declined to provide specific answers.  But I want to ask those questions.  They offer, I hope, some insights into Zumiez’s strategy and well as some ideas about the future of retail.  Let’s get the financial results out of the way.

Numbers

Zumiez ended their fiscal year (January 28, 2017) with 685 stores; 603 in the U.S., 48 in Canada, 29 in Europe and 5 in Australia.  They acquired Fast Times, in Australia, in 2016.  No single third party brand accounted for more than 7.3% of their revenue during the year.  Private label was 20.2% of revenue.

During the year they opened 28 stores, acquired 5 (Australia) and closed 6 for a net increase of 27.  The net increase the previous two years was 55 and 52 stores respectively.  Store openings are slowing, as expected.  They project opening 18 stores in fiscal 2017. `

Fourth quarter revenue rose 8.7% from $242 million in last year’s fourth quarter in $264 million in this years.  That was the result of adding 33 stores and increasing comparable store sales by 5.1%.  Last year’s 4^th quarter comparable store sales declined 9.5%.  North American sales rose 7.6% to $228 million.  Europe and Australia increased 17.1% to $35 million.

Gross margin rose during the quarter to 35.7%, up from 34.8% in last year’s quarter.  SG&A expense rose, but was down as a percent of revenue from 25.9% to 25.1%.  Net income rose 38.3% from $13.1 to $18.2 million.

Revenue for the year rose 4.0% from $804 to $836 million.  Comparative store sales fell 0.2%, after being down 5.3% in the previous year.  North American sales were up 3.5% to $754 million.  International increased 8.5% to $82.5 million.  International sales, then (excluding Canada), were 9.9% of revenues.

They acquired Fast Times August 31 (five stores), so it’s revenues were included for five months of the fiscal year.  They also opened six Blue Tomato stores.  Their European and Australian sales, then, increased $6.46 million from $76.04 million.  They don’t tell us what the currency impact was, or when they opened the Blue Tomato stores.  But I’m wondering if they continue to be satisfied with the Blue Tomato growth rate and how it compares with previous years.

The gross profit margin fell from 33.4% to 32.9% during the year despite the improvement in the fourth quarter, largely due to a deleveraging of occupancy costs (higher costs spread over revenue that didn’t grow as much).

SG&A expense rose from $222 to $235 million, or from 27.7% to 28.1% of revenue.  “The increase was primarily driven by 30 basis points from the deleveraging of store costs primarily related to wages and 30 basis point increase in corporate costs primarily related to wages partially offset by 20 basis point decrease in impairment of long-lived assets compared to fiscal 2015.”  Advertising expense was $10 million.

Net income for the year fell 10% from $28.8 to $25.9 million.  Diluted earnings per share were constant at $1.04 because they reduced the number of shares outstanding.  Lot of that going around.

I don’t have anything insightful to say about their balance sheet, which is in fine shape, so let’s move on to the fun stuff.

Questions I’d Have Liked to Ask

In his opening comments, CFO Chris Work says, “…we are continually evaluating our physical store presence to ensure that we have the right number of stores in the right locations within each trade area. As a result, in 2016 we closed six stores bringing our next store openings to 27 for the year.”

My question for Chris is, “How has implementing the trade area concept impacted the decision-making process for opening and closing stores?”  Their trade areas are about having the right number of stores in the right places and in the right configuration in each trade area to service customers given the whole omnichannel environment.

He goes on to note, “The majority of the capital spend [in fiscal 2017] will be dedicated to new store openings and planned remodels.”  I wanted to ask how remodels and new store configurations are changing because of their new systems and the impact of the omnichannel.

You want to ask the same thing when CEO Rick Brooks, in his opening comments, says, “Significant reducing our order to delivery time, and opening up our full inventory selection to all customers. We add our Stash loyalty program bringing up teams for our customers to have amazing experiences and further identify with the Zumiez brand and we’ve added several buying options for our customers including buy online, pick-up in store, reserve online and pay-in store, among others to allow customer to see their local stores inventories and buy whenever and however they choose.”

That must be effecting where they put stores, their size, and the configuration.

Next, in one of his signature long answers where he takes the question asked and tailors his answer to what the analyst should be asking, Rick notes that they launch a little over 100 brands a year.  Next, he says something important about their target customers.

“Our Zumiez’s customers are customers who have always been about expressing themselves more strongly in terms of their identity, who they are, and how they want to convey that to their peer group, in a more significant way than most of people in their peer group actually do.”

Well, sure, lots of us say that.  But if you’re constantly introducing new brands, perhaps you have a leg up.  I guess I believe Zumiez does that more than other retailers.  At least, I don’t see others talking about it as much.

Then Rick goes on to say, still responding to the same question, “…we have become the place that attracts brand that want to launch and we are really good at doing it, really good both on the in terms of what our product team does. We are good at making sure we don’t over distribute the brand, we keep it focused where it would be most successful and we are really good at maintaining price integrity for these young brands and their partners which is also super important for us, then of course our marketing teams can help leverage and grow these young brands too.”

Okay, so at this point I’m just churning with unasked questions.  Is Zumiez basically the back office for some of these brands?  Do they get the product made for them?  Do they help them do their accounting?

I’m wondering if Zumiez, seeing as many brands as it apparently does, shouldn’t have a subsidiary to make small investments in them.  If they are helping them make and get product, aren’t they already basically investing in them?

Most importantly, I want to ask Rick if this relationship with many new, small brands isn’t a competitive advantage that goes further than doing the same things your competitors do, only better?  Is it potentially a truly meaningful one?

Meanwhile, they are continuing to roll out their customer engagement suite, a new software program they worked with the vendor to develop.  That’s to be completed by the end of 2017 in the U.S.  They call it a “commerce engine.”

Rick says, “…we’re engaging at all sorts of new ways with the customer and our intent with this new engine, not only does it increase feature and function capabilities and we’ll give us again the platform to add a lot more feature and functions overtime. But it’s all of that how we can create a feedback loop to improve virtually every aspect of what we’re doing. I think we’re going to find ways to use this new data to improve assortments across the countries to further localize our assortment planning…I expect that as we kind of said in the comments, we expect to personalize a lot more of the customer experience because of the deep level of engagement and knowledge you’re going to have about this customer base.”

“…we know we can capture the data, we’ve proven that here over the first few months of using the system in our test stores that’s been in and we’re excited to get it going and get it rolled out because then we can really start again generating information that will feed virtually every aspect of our company operations in terms of better serving customers in local markets and the local traders.”

I want to ask about what information they expect to generate that they didn’t get before and what they expect to do with it.  Part of the answer would probably be, “We don’t know yet.”  That’s a fine answer.  They are hoping and expecting this system to show them patterns and relationships they haven’t noticed before- but they don’t yet know what they will be.  There is some risk there, but it’s my kind of risk.

It also sounds, based on comments in previous conference calls, that they might be taking a bit longer to get this rolled out then they originally expected.

Chris goes on to say, “…while I can report where the transaction actually occurred I cannot report where the transaction actually originated…” I’d love to ask if the new system will change that and, if so, what they believe the value will be.

Meanwhile, back on trade areas, Rick says, “Our ability to localize fulfillment is about trade area because that means we will be able to look at digital and physical demand and place products in a trade area in service of customers and again these are all big strides we have made over the last few years. And when you get into looking at trade areas, it is very, very interesting.”

No! Wait! You cannot stop with “very, very interesting” and just leave me hanging!  How do the customer engagement suite and concept of trade areas dovetail?  What are your expectations for reduction in required inventory?  How does this all impact how you work with the new brands?

You see my problem.  I haven’t even scratched the surface of questions I want to ask.

Zumiez has the same problems other retailers have, and their results demonstrate them.  They don’t expect the consolidation related issues to go away for “…another period of years…” as Rick puts it.  I agree with him.  But they are making money and their balance sheet is solid.  And they are doing a couple of potentially impactful things with their systems and work with new brands that can differentiate them in a maybe significant way.