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

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.      

 

 

4 replies
  1. Rob Stevenson
    Rob Stevenson says:

    Jeff,

    I’ve just started reading your market watch analysis and find it very informative, so just wanted to say thanks for putting such a high quality article together.

    As for Zumiez – they must be fans of Jim Collins and the ‘hedgehog strategy’.

    • jeff
      jeff says:

      Thanks Rob. Wish I could turn them around a bit quicker, but between waiting for the filings and the sheer number that come out at one time each quarter, well, like they say, you can have it fast, or you can have it right.

      J.

  2. Jamie Meiselman
    Jamie Meiselman says:

    Hi Jeff,
    Long time, hope you are well. I don’t have any vested interest in any of this, but did you see this Forbes article that came out the other day on Zumiez:
    http://blogs.forbes.com/greatspeculations/2011/03/29/accounting-smells-a-little-fishy-down-at-the-zumiez-surf-shop/?partner=yahootix

    Claims they use accounting tricks to boost earnings (extending useful life of depreciating assets) and have $300+ million in off-balance-sheet debt.

    -Jamie

    • jeff
      jeff says:

      Hi Jamie,
      How are you? Long time. Thanks for highlighting the article. I had not seen it. The off balance sheet stuff is the leases on stores they operate that they aren’t required to report as liabilities. This isn’t new for retailers, nor is the discussion of what should or should not be on the balance sheet. There’s no doubt it’s a real liability and it’s not on the balance sheet. But of course, there’s lots of discussion about how to handle various transactions for accounting purposes. There isn’t always a “right” or a “wrong” way, but consistency is important. Increasing the depreciable life of certain assets actually bothers me more because it’s rarely done. You would think they might highlight that as an unusual event. I think I’ll go look at the footnotes a little more closely.

      Thanks,

      J.

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