Zumiez’s Quarterly Report and Retail Market Conditions

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.