Zumiez’s July 28th Quarter; Forget the Numbers. I Might Have Had a Strategic Epiphany

Okay, I don’t mean it. No way I can ignore the financial results. It’s just not the way my mind works. But I was so struck with something President and CEO Rich Brooks said in their conference call that I wanted to start there. He said, as a brief part of a longer answer to an analyst’s question, “…we are an action sports lifestyle retailer.”

Well big deal, right? We all knew that. But for some reason, I paused, thought, and on the margin wrote, “Yeah, but is anybody else?”

That opened a mental floodgate. Well, obviously some independent, specialty retailers still are. And I guess some smaller brands (especially in hard goods) are all about action sports. But I perceive that most of our not small brands and multi-outlet retailers are more focused on youth culture than on action sports, though action sports is certainly an important part of that focus. Many of these brands and retailers would say they have their roots in action sports, or have a focus there, or however they put it, and they do. But more and more, with growth, their customers are increasingly removed from the action sports market.
 
The conventional wisdom, which I’ve supported, is that this is inevitable with growth, and is especially inevitable with public companies that have to seek regular growth. They use their roots in action sport to make their brand or stores or both attractive to the broader youth culture or fashion customer that they have to have to get the sales growth. Their target has to be the broader market. Being only an action sports brand or retailer probably restricts growth. 
 
Zumiez, on the other hand, starts with the action sports participant or close follower as their target, focuses there, and invites the broader customer base in if they’re interested. That doesn’t change as they grow. As they describe it, everything they do in their stores from the people they hire, to the way they merchandise, to the brands they sell are action sports based.
 
I suppose I’m oversimplifying this distinction to make a point- which I will eventually get to. Certainly some brands can argue that they are just as action sports focused as Zumiez. Yet as they work to grow their customer base past action sports, that argument gets harder to make.
 
To the extent this distinction is accurate, other brands and retailers are essentially building Zumiez’s market niche and competitive advantage for them. That’s why “…we are an action sports lifestyle retailer,” struck me. Zumiez’s competitors are doing its work for it. That’s my point.
 
Maybe I’m the only one surprised here. Zumiez’s management will tell you they’ve been pursuing this same market positioning since the company’s founding in 1978. And of course my analysis only becomes valid (if you think it is- can’t wait to hear) after the action sports market got much more inclusive, more broadly distributed, and of interest to really big players in the branded consumer products market. So to that extent, I guess Zumiez got a bit lucky.
 
Zumiez stuck to its strategy even as the market changed. Other brands and retailers chose to expand their focus with that market evolution. I’m not suggesting one is right and the other wrong, but it seems to have worked for Zumiez so far.
 
And, now those boring numbers. Probably shouldn’t say that. This will be where people stop reading.
 
Sales for the quarter ended July 28th were $135 million, up 20.4% from $112 million in the pcp (prior calendar period- same quarter last year). They ended the quarter with 457 stores in the U.S., 17 in Canada and five in Europe. Ecommerce sales were 6.9% of net sales compared to 5.3% in the pcp. Comparable store sales rose 9.5%. They ended the quarter with 50 more stores than a year ago.
 
The Blue Tomato acquisition closed on July 4th. They paid $74.8 million for it (59.5 million Euros actually). Blue Tomato has 5 retail stores in Austria and a big online business. Lord knows Zumiez didn’t pay that price for 5 stores so it’s clearly a really big online business. There are also potential additional payouts totaling $27.2 million at the current exchange rate, part of which is in Zumiez stock, through April 2015.
 
Acquisitions complicate financial statements a bit. Let me walk you through the impact. First, Blue Tomato contributed $1.5 million in net sales and a net loss of $600,000 during the quarter. There were $1.5 million in transaction expenses (stuff like legal fees) they booked as part of selling, general and administrative expense (sg&a) during the quarter. They also booked there $700,000 for the first anticipated incentive payment.
 
The inventory they acquired had to be written up $2.2 million and is being expensed to cost of goods sold over 5 months. That’s the period over which they expect to sell the inventory. Half a million of that was booked in the quarter and I guess most of the rest will be in the next.
 
There was also a $500,000 net foreign currency gain in the quarter, mostly from the Blue Tomato deal, that was part of other income.
 
We’re not quite done with Blue Tomato, but let me tell you that Zumiez had net income of $2.07 million in the quarter, down 19.5% from $2.59 million in the pcp. Zumiez shows some pro forma financial information “…as though the acquisition of Blue Tomato had occurred on January 30, 2011.” You can review Zumiez’s 10Q here if you’re interested in all the adjustments they made (see page 11). I’m sure you’re all rushing to see that.
 
What they report is that, on a proforma basis with Blue Tomato included, they would have had a profit of $930,000 this quarter and a loss of $1.07 million in the pcp.
 
And while we’re on one time event kind of stuff, you will recall that Zumiez move their home office and ecommerce fulfillment center. That cost them $1.3 million in the quarter.
 
The gross profit margin grew 1.4% from 33% to 34.4% in the pcp. Most of that came from product margin improvement of 1.2%. Sg&a expenses rose from $33.5 million to $42.6 million. As a percentage of sales, it rose from 29.8% to 31.6%. Most of the increase was the result of the Blue Tomato and relocation expenses already described.
 
Earnings before income taxes rose from $4 million to $4.8 million, but an increase in the tax rate from 35% to 56.5% left them with a lower net income. They “…estimate our effective tax rate will be adversely impacted by the tax effects of the acquisition of Blue Tomato.”  That’s what we’re seeing here. I’m not clear how long that impact lasts.
 
Let me see if I can work my way around to a closing by reviewing some comments that were made by Zumiez management in the conference call. CEO Brooks starts by talking about the continuing key drivers of the business; “…higher store productivity, domestic new store growth, greater penetration in e-commerce, and international expansion.”   He talks, as he has before, about Zumiez’s “…highly differentiated product assortments and exceptional in-store experience continues to attract and engage our core consumer…” Nothing new there.
 
Then, later, in response to an analyst question, he says, “I think our buyers do great job in terms of driving our margin forward and negotiating with our partners on price. I would also add that our inventory levels are, in terms of the quality of inventories, are in very good shape.” He also talks about how their brand selection, buying and inventory management means that most of their promotions are planned tactics as opposed to responses to market competitive conditions.
 
Further discussion is about the ongoing implementation of inventory assortment planning tools. “We’re talking,” he says, “about being able to, at a SKU level, be able to assortment plan on every brand category combination by week, by location. So, very powerful tools that allow us to build up from those base-level sort of plans up to what our overall open-to-buy planning is, and of course reconciling those things together.”
 
Finally, he talks about it becoming “…an omni-channel world.” Zumiez see online and brick and mortar as increasingly integrated going forward. He expects this integration to proceed “…to the point where I’m not sure I’m going to be able to tell you in future what’s driving volume and transaction in stores and what’s driving volume and transactions online because they’re going to be that tightly integrated. The consumer gets to choose and all that’s important is that we’re in every channel they want and the way they want us, with a great brand experience and the product they want.”
 
I’ve been pointing recently to how other companies are responding, in a way similar to Zumiez, to the power of the consumer, the need to offer them experiences (due to availability and lack of differentiation in product), the need to operate well and the tie in between those quality operations and your marketing, and the breakdown between the historical brand/retailer business model. You know- retailers becoming brands and brands becoming retailers.
 
You can see in Zumiez’s discussion how they see the pieces fitting together. Other companies have essentially said the same thing. I suppose they always did fit together, but in better economic times it wasn’t quite so important.
 
There is one fly in the ointment here. When Rick Brooks talks about his buyers doing a great job, what I hear is how hard they are squeezing their suppliers. Well, that’s their job. And it’s certainly true that their strategic positioning and investment in systems, which I have highlighted, may give them the ability to do that.
 
As everybody knows, the relationships between brands and retailers are evolving fast. But both sides still need to make money.
 
Zumiez made a strategic decision in acquiring Blue Tomato that in the short term (I’m not quite sure what “short term” means) has hurt their financial results and the market didn’t like it. Oh well. I think public companies are too quarter to quarter oriented anyway. We didn’t get any information about it this time, but I’m sure that some European stores are in Zumiez’s future now that they have a management team over there to lead implementation. As management emphasized, Blue Tomato’s culture is very similar to Zumiez’s. It will be interesting to see if they can pull off the same kind of brand positioning in Europe that Zumiez has in the U.S. when they do open more stores there.   

 

 

2 replies
  1. Jay Wilson
    Jay Wilson says:

    Hi Jeff your right about Action Sports at Zumiez…they have always been what they set out to be! They didn’t change and try and become something else. They where the core shop in the mall.

    Others have identified who they wanted to be ie: Hollister Retailer based their concept on Surf even though they where not a surf company as defined by SIMA. I think the last I read they where doing about 2 billion.

    Pacsun Retailer was Surf then lifestlye then back to Action sports. They grew with Gen Y market but lost their core following when Women changed from Surf brands to fashion at Forever 21 and H&M 1/2 their biz. They seem to be back to where they started. All good!

    Great analysis…thanks Jay

    • jeff
      jeff says:

      HI Jay,
      There is something about a good strategy consistently applied over years isn’t there?
      Thanks for the comment.
      J.

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