Zumiez’s Annual Report: Growth, but Constrained by the Economy.

Zumiez reported top and bottom line growth even as they acknowledged and were impacted by the economic headwinds in Europe and the U.S. As they put it, “…teen retail in general experienced a challenging sales environment, with many mall based teen retailers seeing significant sales declines. Zumiez was not immune to the declines in traffic; however…our sales results held strong relative to the teen retail sector, with comparable stores sales down slightly while product margins remained essentially flat.” 

As always, I’ll get to the details. If they are a bit more resistant to these headwinds than other retailers, it’s because they’ve been pursuing the same strategy for 35 years. The caveat, of course, is that you have to pursue the right strategy. Just to review, they list their competitive strengths as:
·         Attractive lifestyle retailing concept
·         Differentiated merchandising strategy
·         Deep-rooted culture
·         Distinctive customer experience
·         Disciplined operating philosophy
·         High-impact integrated marketing approach
You can read about each of these on pages four and five of their 10K.
We’ve reviewed together similar claims of competitive strengths for other companies and I’ve sometimes concluded that their claims were more aspirational than actual, noting that’s what every company in the industry wants to do. Zumiez is more credible simply because they’ve been doing it longer with some success.
Zumiez ended their fiscal year (February 1) with 551 stores including 28 in Canada and 12 in Europe under the Blue Tomato name (six opened during the year). They plan to open 55 additional stores worldwide in this fiscal year including five in Europe. Net sales grew 8.2% from $669 to $724 million. The fiscal year had one less week than the prior year.  Comparable store sales were down 0.3%. That includes a 0.1% decline in brick and mortar and a 5.4% increase in ecommerce sales.
Obviously, new store openings were responsible for most of the sales growth. Average sales per store were $1.2 million, down from $1.24 million last year.
Ecommerce sales were 12.3% of sales for the year compared to 11.2% the previous year. What I imagine they are thinking about, but aren’t talking about yet, is how much of their brick and mortar sales are influenced by online. That would be a good question for an analyst to ask.
Here’s a table from their 10K that shows their revenue by category. 
Revenue in the U.S. accounted for 89% of Zumiez’s total revenue. 
The gross margin rose from 36% to 36.1%. “The increase was primarily driven by a 40 basis points benefit due to prior year costs related to a step-up in inventory to estimated fair value in conjunction with our acquisition of Blue Tomato and a 40 basis points impact of the correction of an error related to our calculation to account for rent expense on a straight-line basis. These increases were partially offset by a 50 basis points impact due to the deleveraging of our store occupancy costs and a 50 basis points impact of the increase in ecommerce related costs due to ecommerce sales increasing as a percent of total sales.”
So it increased by 0.8% due to some one-time accounting changes. Then it decreased by 0.5% because of deleveraging of store occupancy costs. Don’t quite understand that and would love some detail. Finally, if the 0.5% impact from ecommerce related costs is part of implementing their omni channel strategy, I’m fine with that.   
Selling, general and administrative expenses were up from $172.7 to $188.9 million. As a percentage of sales, it was up just 0.2% to 26%.
“The increase [as a percentage of sales] was primarily driven by a 60 basis points impact of the increase in ecommerce corporate costs… a 40 basis points impact due to the deleveraging of our store operating expenses, a 20 basis points impact due to the deleveraging of our corporate costs and a 20 basis points impact of a litigation settlement charge…These increases were partially offset by a 70 basis points impact of the reversal of the previously recorded expense associated with the future incentive payments to be paid in conjunction with our acquisition of Blue Tomato, a 30 basis points benefit due to prior year costs related to transaction costs incurred in conjunction with our acquisition of Blue Tomato and a 20 basis point impact due to a decrease in incentive compensation.”
The key thing I pull out of there is that Blue Tomato is obviously not performing as they had hoped when they bought it. Here’s how they describe it in the conference call:
“…we continue to be optimistic about our long-term prospects in Europe. However, the reality is the operating environment in the region just as in North America has been challenging since we completed the acquisition in 2012. While the sales in Europe comp positive in Q4 and for the year, we are estimating our sales and earnings results to be below the thresholds that a contingent earn-out is based upon and the likelihood that we will now achieve those minimum levels required for a payout is low.”
Operating income rose 6.3% from $68.5 to $72.8 million, but the operating margin fell very slightly from 10.2% to 10.1%. Net income grew from $42.1 to $45.9 million.
Fourth quarter sales were $227 million, up 1%, with comparable store sales (which includes ecommerce) down 2.2%. North American revenue was down $1.6 million even with the new stores. Europe increased by $4 million probably because of the new stores.   It was the fourth quarter in the previous year that had the extra week I mentioned before. That accounted for $8.9 million in revenues last year.
The quarter was positively benefited by $5.8 million from the reversal of the Blue Tomato projected earnout and by $3.3 million for correcting a lease accounting error, which I am sure neither you nor I want to discuss in detail. 
The balance sheet continues to be strong, allowing them to continue to pursue certain of their strategies in an uncertain environment. There’s very little long term debt. Cash generated by operations was about $67 million, consistent with the last couple of years.
It’s just a tough environment to be a retailer in right now. As CEO Rick Brooks put it, “In this world there are too many stores and as retailers are forced to reduce their capacity, share consolidation will continue.” That probably makes Zumiez’s strategy and points of differentiation more valid than ever, but there are a few things they need to be and, I imagine, are thinking about.
The first, as I’ve suggested before, is what business they are in. If they are truly limited to the action sports business, it may constrain their growth. As an example, they acknowledge that it was a lousy season for snowboard hard goods. But one of the things they do to distinguish themselves as an action sports retailer, especially in the mall, is to carry them. Drop snowboards? Add twin tipped skis? I don’t know. Is the target market action sports participants or youth culture? Both? Is the competitive space as broad as branded consumer products, which somebody recently suggested to me? If so, what the hell does that mean?
I suspect that Zumiez’s (and other company’s) omni-channel efforts will help them figure that out. I didn’t bother to describe the 48 or so mentions of what they are doing in this area, but let’s just say they’re all over it. It’s going to impact when and where they open stores, what those stores look like and, I expect, how big they are. And it’s going to influence their product selection as their customers and potential customers engage with them and have more control over what they buy and where.
The relationship between systems, technology and what you sell to whom is only going to get stronger. Neither Zumiez nor anybody else knows how it’s all going to work out, but they seem as well positioned as anybody to figure it out. Now if only the economy would improve.