More Retail Perspective; Zumiez’s Quarterly Report

The conference calls get shorter and shorter as Wall Street and its analysts decide the retail sector just isn’t worth their attention.  I don’t and won’t invest in anything I write about but damn, this feels like one piece of putting in a bottom in the retail sector.  Maybe it will take the recession to finish the process.

Zumiez had a quarter which I’ll describe as uninspiring.  Like every other industry retailer, they find themselves in circumstances of declining mall traffic, sluggish demand and an uncertain future that changes faster than you can react to it.

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Zumiez’s New Concept Store

Zumiez has been telling us for some time now, correctly I think, that they are approaching the number of Zumiez stores the U.S. market can support.  They ended their January 31 year with 603 U.S. stores.  No doubt they will continue to selectively open (and close) stores and there is certainly no exact number of stores this market will support.  However, I’m guessing that the number has declined due to a weak economy, an over retailed market, and Zumiez’s omnichannel influenced “trade area” strategy.

That strategy focuses on having the right number of stores in each geographic area given ecommerce and the way Zumiez’s customers are choosing to shop.  Its focus is maximizing revenue in each area.  Its premise is that opening more stores isn’t the only, or even the best, way to do that.

But Zumiez is a public company.  Growth matters, though CEO Rick Brooks (along with some other CEOs) is trying to get the Wall Street community to focus a bit more on the bottom line rather than the top.

I guess after the initial shock you get when something new and different happens, I wasn’t that surprised to see Zumiez’s new concept store WAYWARD open in this Bellevue, Washington mall two stores down from the Zumiez store.  Here’s a picture of the entrance.

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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.

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Zumiez Has a Good Quarter Too

Zumiez’s 10-Q for its quarter ended October 31 reported an increase in sales and profits.  I used the word “Too” in the article title because it sounds a bit like the Tilly’s results I reported a few days ago. Zumiez, like Tilly’s, would like to point to all the good things it’s doing as being responsible for the result.  And no doubt it’s fair to do that, but Zumiez, like Tilly’s was surprised by the strength it’s seeing and is cautious as to whether it will continue.

Net sales rose 8.4% from $204.3 to $221.4 million.  “The increase primarily reflected an increase in comparable sales of $8.2 million and the net addition of 35 stores (made up of 27 new stores in North America, 5 new stores in Europe, and 5 new stores in Australia partially offset by 1 store closure in North America and 1 store closure in Europe) subsequent to October 31, 2015. By region, North America sales increased $14.7 million or 7.8% and other international (which consists of Europe and Australia) sales increased $2.4 million or 14.6% for the three months ended October 29, 2016…”

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Zumiez Quarter and Some Interesting Conference Call Comments

Zumiez is one of the public companies I follow that I hold up as doing most things right, but that doesn’t make them invulnerable to a tough economic environment.

Revenues for the quarter ended July 30 were down 0.86% from the same quarter ended last year on August 1.  They declined from $179.8 to $178.3 million.  The decline reflects an $8.7 million decline in comparable store sales (4.9%) offset by a net opening of 33 new stores.  North American sales rose 0.2%- about $0.4 million.  “…European sales decreased $1.2 million or 8.5% to $12.3 million.”

The gross profit margin fell from 32.1% to 30.8%.  Product margin rose by 0.3%, but deleveraging of store occupancy costs (spreading more costs across lower revenues) cost them 1.3%.

SG&A expenses rose 6.7% from $52.5 to $55.9 million.  As a percentage of sales they rose from 29.2% to 31.5%.  This isn’t necessarily a completely bad thing, assuming some of the additional spending addresses their long term strategy.  Some of it is also funding minimum wage increases.

That produced an operating loss of $1.1 million compared to an operating profit of $5.3 million in last year’s quarter.  Net income fell from a profit of $3.2 million to a loss of $838,000.  That includes an income tax expense of $1.98 in last year’s quarter compared to a tax benefit of $526,000 in this year’s.

I guess you can argue that the balance sheet, compared to a year ago, weakened a bit but not so that it matters.  Cash and marketable securities fell from $80.7 to $57.3 million.  During the year, they have bought $18.3 million of their own stock ($6.7 million in the just ended quarter).

Inventory rose slightly from $122 to $132 million.  The current ratio fell from 2.43 to 2.05.  Shareholders’ equity declined 8.2% from $305 to $280 million.

At July 30, Zumiez had 673 stores; 604 in the U.S., 44 in Canada and 25 in Europe.  They are looking at opening 29 new stores in 2016 including six in Canada and seven in Europe.

During the conference call, they announced the August 31st completion of the acquisition of Australian retailer Fast Times.  It operates five stores and a website.  They paid $5.5 million (Australian) plus $1.4 million in Zumiez’s stock (also valued in Australian dollars I assume).  In the 12 months ended June 30, Fast Times had revenue of AUD $9.2 million and had pretax margins of around 10%.

I assume the plan is to grow Fast Times stores in the same way we saw growth in European and Canadian stores once Zumiez got a foothold in those markets.  Another thing I find interesting is that Zumiez is now operating in four currencies.  It adds some complexity, but maybe also some opportunities as the Australian business grows.

Let’s start looking at strategy by recalling that Zumiez considers itself to have one distribution channel and doesn’t differentiate between online, mobile, and brick and mortar as they think about their market.   As a result, they divide their business up into something they call trade areas.

What’s a trade area?  I don’t think I’ve ever heard them define it publicly.  No doubt it has a geographic component, but I don’t think it’s that simple.  As I understand it (don’t want to be putting words in Zumiez’s mouth here), it is the “locus of connection” as defined by their customers and the way they choose to shop.  It’s a moving target.

Wow, that sounds great!  Unfortunately, I’m not completely sure what it means operationally, and I’m pretty sure Zumiez and other retailers are also still figuring it out.  Before I get too far into the clouds here, which is a pretty good way to put it, I’m going to let Zumiez’s CEO Rick Brooks help bring me back to earth.

“Our strategy for new store openings remains the same. We’re committed to opening only those stores that are required to best serve our customers in any given trade area. Accordingly, and as we begin to approach our target for total mall store count in North America, our new store openings have slowed. Our focus has shifted towards optimization of the store base as we leverage our integrated structural and technological platform to maximize the impact each store has on its respective geographic region.”

Okay, “optimization of the store base.”  What does that mean for these trade areas?  Do you need fewer stores?  For example, might you decide that a store with a $15 an hour minimum wage was too expensive to operate given that you have a store ten miles away where wages were $10 an hour and your customers were defining trade areas in such a way that they were willing to buy more on line?  Does good management of a trade area mean you can generate more revenue at lower cost with fewer brick and mortar stores?

I wrote this article on minimum wage a week or so ago based on a comment Zumiez made in their conference call.  I wanted to add that the additional company cost isn’t just the increase for those making less than minimum wage.  Remember the people already making the new minimum wage or more are going to ask why they can’t get an increase as well.  It’s a big number.  Please recognize that I’m not arguing for or against increases in the minimum wage.  I’m just pointing out, here and in the article, some possible impacts.

Next, let’s tie Zumiez’s idea of trade areas to the rollout of its new systems.  As they’ve announced, they are rolling out the new “structural and technological platform” referred to above.  They consider it an integral part of their strategy.  To call it a point of sale or accounting system would miss the point.

You know that Zumiez has worked towards “hyper-localized merchandised assortments” and fulfilling all their online orders through their stores.  Here’s how Rick describes the systems and their impact.

“Enhancements for making product delivery and our world class customer service are first and foremost aimed at augmenting our positioning and relevancy to our core customer base. Our efforts to-date are giving significantly faster delivery times for our online orders to our localized store fulfillment program. As we implement our customer engagements within North America, we’ll gain additional touch points for our customer, a faster, more integrated commerce platform and enhanced omni-channel functionality. This allowed us to further interact with our customers to facilitate alignment between our customers’ desires, our brand offerings and positioning.”

Zumiez considers itself a brand.  It does not want to be defined by the brands it carries.  It expects to sell brands at full price and margin.  This, according to Rick is “…representative of brand strength, our Zumiez brand strength, meaning that our consumer sees value on what we are doing and is willing to pay full price.”  It’s “…about having unique brands that are merchants in the marketplace, it reflects back to the comment we made about the strength of private label here performing well, and it also reflects back to the fact that we were down a little bit last year.”

They talk about brands emerging anywhere and how they “…quickly reach our niche consumers anywhere in the world through these mobile devices.”

“We want to be their local shop, but we want to be the local shop with global reach and global scale.”

How does this all come together?  First, Zumiez is going to be completely agnostic about brands.  They will carry those brands their customers want them to carry for as long as they can sell them for good margin.  That shouldn’t be a new concept for any retailer, but I expect the speed of brand turnover to generally accelerate.

Rick has spoken in past conference calls about long term trends that have allowed them, in the past, to sell of a lot of specific style or category of merchandise.  I wonder if he still expects those opportunities to return.  Zumiez is certainly organizing itself as if it doesn’t expect that.  Or perhaps it’s better to say they are organizing so it won’t matter if doesn’t happen.

Second, Zumiez doesn’t know what it’s going to find out when these new systems are all on line and generating data in ways they never been able to look at it before.  What will they learn?  What will they be able to do differently/better?  The consumer is in charge.  You’d better be able to react as quickly as they react and follow them to the new trends and brands before it changes again.  Your systems are no longer a cost center.  They are a critical element of your strategic advantage, if you can find one.

Third, notice the relationship between the brands that Zumiez carries and the strength of the Zumiez brand.  They are reinforcing each other.  This allows Zumiez to be successful in private label (and serve a customer looking for value and make a better margin) without damaging customer perception of the stores, as we’ve seen some other retailers do.  Zumiez mentions in the conference call that they did something like 300 events at stores and other place last year.

Fourth, the new systems, the data they generate, and the flexibility they provide will be the engine that drives the concept of the trade areas.  It will allow, as they said earlier, for “…optimization of the store base.”  But I think it’s a mistake to assume they are just talking about brick and mortar stores here.  It’s optimization of each trade area as they evolve, expand, correct, adjust.  This is all going to be continuously in motion.

Finally, Zumiez has been very specific about who their customers are and that they want to sell the right brands (as defined by those customers) at full price and margin.  This is very interesting to me.  You know I think there’s a conflict between being achieving the growth a public company requires and differentiating and supporting your brand.  It feels like Zumiez might be running up against this issue itself.  If I read between the lines, I almost hear them telling the analysts that the biggest opportunity is at the bottom line- not the top.

You know, I’m just giddy over what Zumiez is doing because it’s what I think I’d do and I can’t wait to see how it works out.  But we’re still an over retailed country and it’s becoming more costly to sell to a completely empowered consumer with less money to spend.  I know there will always be brick and mortar retail, but I don’t know the form it will take and how much we need.  Zumiez, and other established retailers, are stuck with a store base they can only change slowly and incrementally.  New retailers are often starting only online and going from there.

Where and how do you make brick and mortar an advantage?

Preparing for Long Term Market Ambiguity; Zumiez’s April 30th Quarter

I’ve generally been a supporter of Zumiez’s strategy and believe they’ve done most things right.  So when I see them suffering right along with everybody else in a difficult (not nearly a strong enough word) retail environment, it really brings home to me just what we’re dealing with.

The numbers first, then the strategic issues.

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Zumiez’s Year and Quarter; What Are They Preparing For?

Like most industry retailers, Zumiez has been impacted by a slow growth economy, reduced and redirected spending on the part of its primary customer group, and the internet’s ability to make consumers powerful, product differentiation harder, and the brand cycle shorter.  There’s no news there and nothing unique as far as its impact on Zumiez goes.

However, two issues came up in the report I want to spend a little time on.  The first is Zumiez’s discussion of product cycles and their response to analysts’ questions on the subject.  The second is the announcement that came out of the conference call that Zumiez would be opening fewer stores.  They are related, and both represent the tip of the iceberg in terms of what Zumiez is trying to accomplish.

Let’s look at both of them, explore their interdependence, and figure out what I think Zumiez’s management is saying without exactly saying it.  First, I’ll review the numbers just so you have them in mind as we get to the more interesting stuff.

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Fulfilling the Omnichannel Imperative

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

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

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

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

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

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

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

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

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

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Zumiez’s Quarterly Report and Retail Market Conditions

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.