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.
Results for the Year and Quarter
Revenues for the year ended January 31, 2015 declined 1% to $804.2 million from $811.5 million in the previous calendar period (PCP). Sales in the U.S. fell from $708.3 to $689.6 million while foreign sales rose from $103.3 to $114.6 million. I’d note that they characterize their European business as “…roughly a breakeven business…” in the conference all.
Private label represented 21% of total revenues in the year just ended. No brand accounted for more than 9.8% of sales. That’s up from 8.7% in the PCP and 7.6% in the year before that. I might have expected the opposite trend as I think about how fast brands seem to be turning over these days.
The number of stores open at year end rose from 603 to 658. Those numbers include 42 stores in Canada and 24 in Europe (6 added in 2015). Comparable store sales fell 5.3% after rising 4.6% in the PCP.
They make a comment that their store numbers exclude “…temporary stores that we operate from time to time for special or seasonal events…” Wish they had told us more about that.
The gross margin fell from 35.4% to 33.4% and total gross profit declined $18.5 million to $268.6 million. Selling, general and administrative expenses were up slightly from $215.5 to $222.5 million.
Operating income was down 35.5% from $71.6 to $46.2 million. Net income fell 33.4% from $43.2 to $28.8 million. That includes a tax provision that, at $17.1 million, was $11.4 million than in the PCP.
The fourth quarter had a 6.2% revenue decline from $258.6 to $242.4 million. That’s a comparable store sale decline of 9.5% compared to a gain of 8.3% in last year’s fourth quarter. Operating income fell by 31.3% from $31.3 to $21.5 million. Net income for the quarter was down from $17.5 to $13.1 million, or by 25%.
On the balance sheet, we have a decline in current assets from $273 to $199 million mostly due to a decline in cash and marketable securities from $155 to $75 million. That was driven by the repurchase of $92.2 million of their own common stock during the year.
I also notice a small increase in inventory from $93.9 to $98.3 million. They note that this is the result of having more stores.
Current liabilities fell from $81.4 to $69.1 million, largely due to a $10 million decline in trade accounts payable. The balance sheet remains healthy, but I’d note the decline in equity from $359.5 to $297 million. Cash generated by operations fell 45.9% from $89.9 to $48.6 million.
Okay, let’s move on to issues of strategy.
Product Life Cycles
Zumiez’s CEO Rick Brooks isn’t the only CEO who’s been bemoaning the lack of long term fashion trends a retailer can get their hands around and use to generate a lot of business over an extended period of time. “…our sales have always been driven largely by emerging in growth brands, by really hot items that can drive a lot of volume for us and then, of course, by fashion cycles and trends that are relevant for our consumers.”
In previous conference calls and in this one, he has voiced the opinion that this lack of dominant trends is a temporary situation. Eventually, he assures the analysts, that will start to happen again- because it always has.
As I’ve written, I agree with him. But where we may differ is in how quickly we expect that might occur. Rick seems to imply that this is a normal business cycle. I think, for the reasons I mention in the first paragraph of this article, that we’re looking at a longer term- maybe very long term- retail business cycle where long term fashion trends may be less common and brands turn over more often.
I suspect that when, as a representative of a public company, you talk to analysts it’s not just what you say but how you say it. It just wouldn’t be a good idea to say, “I’m really hoping for the return of these long term trends where we can sell a whole bunch of product with not much effort for a long period of time and make a lot of money, but that may not happen for a long while.”
See, I think Rick Brooks and I may agree. Or at least he agrees there’s a significant possibility that I’m right about how long it might be until some primary, long term, trends reassert themselves. I believe that because, as he describes in the conference call (not for the first time), the management team is positioning the company for that possible operating environment.
I will just remind you of Zumiez’s long term focus on the omnichannel, that they are bringing most responsibility for online order fulfillment to their stores, slowing brick and mortar growth (more on that later), focusing on what they call “trade areas,” and rolling out their new “customer engagement suite” in 2016 and 2017.
Here’s how he describes that.
“The roll out of our new customer engagement suite in 2016 will further capitalize upon this fundamental strength in our business [their employees], marrying up our point-of-sale engagement with our back-end systems, creating an integrated experience that both optimizes operational performance, and most importantly, provides our sales teams with the technology to further enhance the Zumiez brand and culture in an authentic way for our core customer.”
It’s not like this is all simple to do. As CFO Chris Work puts it, “…the model does not come without challenges. And the impact of inventory planning and labor utilization is impactful, but we do believe this is going to drive the best customer experience…”
If I’m right and it’s a long time before dominant trends and big, powerful brands have their historical impact on retail again as fast fashion, brand turnover, and consumer priorities rule, then what Zumiez is doing is simply a requirement to compete and maybe to survive. If a more “normal” scenario returns in the time frame Rick Brooks seems to expect, nothing Zumiez is doing is wasted and they will be ahead of the game in terms of competitive positioning. It’s kind of like an auto insurance policy that pays off even if you don’t total your car.
Store Openings and the Role of Stores
Let me drift off subject for a moment and note Zumiez’s Growth Strategy from its 10-K. There are three components: “Opening New Store Locations,” “Continuing to Generate Sales Growth through Existing Channels,” and “Enhancing Our Brand Awareness through Continued Marketing and Promotion.”
All true of course and nothing wrong with doing any of those things. While the description of each alludes to the evolution of Zumiez business, they don’t really capture the extent of the changes they are trying to drive. Wording in 10-Ks tends to have a certain momentum. I wonder if we won’t see some changes here in the future.
Zumiez announced that they expect store growth of 34 in fiscal 2016 compared to 57 in fiscal 2015. This includes seven stores in Europe compared to six the previous year. This seemed to generate some attention almost bordering on consternation that I didn’t completely understand. In the first place, Zumiez has been saying literally for years that they were expecting to approach the total number of stores they could support in North America around, well, like now.
And the documented struggle of malls is not unexpectedly making it harder for Zumiez to find places it makes sense to open. Here’s how their first Risk Factor in the 10-K reads:
“Our ability to attract customers to our stores depends heavily on the success of the shopping malls in which many of our stores are located; any decrease in consumer traffic in those malls could cause our sales to be less than expected.”
But if you dig a little deeper, you can’t help but recognize that a different approach to opening brick and mortar stores is inevitable and appropriate given the environment and Zumiez’s focus on what it calls trade areas.
That is not to say they planned the whole thing. I have no doubt they wouldn’t mind having more great malls to open stores in, and certainly their competitive situation has become more complex as they’ve found themselves not just competing as the action sports retailer in the mall but in the broader fashion/active outdoor space.
So what is a “trade area?” I’m not sure I know. And there’s not really a good definition in the 10-K or the conference call. I will say that it feels like it is not just a geographic area. Nor is it a group of stores (though stores will be part of each one).
I think, and this is me talking, that what Zumiez may ultimately define as a trade areas is a group of customer relationships that maximize revenue from that group. Here a couple of things CEO Brooks says in describing trade areas. As you read these, keep in mind everything Zumiez has been doing in the areas of the omnichannel, systems, micro assortment, and empowering their store employees and connecting them to the customer.
“We’re going to actually start to really now experiment with these ideas and see what the impact is and measure the impact because once you can really start to think in a trade area way, you break out of the channels, whether that be physical channels or marketing channels, whatever that may be that we used to think in, you break out of those channels and you can really start to look at what happens in the trade area.”
“And when we talk about optimizing our store portfolio in our trade area that’s really what we’re talking about. What would it mean to unplug a store? How much of the volume do we maintain within the digital realm? And how much moves to other physical locations? How much of that can we control via marketing messages, right, in terms of moving customers and telling them where our product is that they really care about the most.”
“So the idea of a trade area will be that over time, we’ll be able to look at the market and try to maximize profitability. And so we’re going to, in a new way, yes, we’ll still probably look at four-wall contributions on a physical store. We’ll probably still have those disciplines in place, but we’re also going to be looking at what’s our penetration end markets, how do we think about trade area profitability across all channels, against the marketing spend in our market, what does more marketing spend mean in a trade area versus not, what does pulling a unit out or adding a unit in mean to the profitability in a trade area.”
Zumiez doesn’t know exactly how their trade areas are going to be defined. At least they don’t tell us. I wonder if they might turn out to be fluid. What might be the role of temporary stores? Might a trade area be formed around a trend/brand that was specific to a couple of noncontiguous geographic areas? Might it go away after the trend runs its course? One obvious, specific thing that is probably already happening is that snow hard goods get reallocated to places where there’s snow.
Would closing certain brick and mortar stores in a trade area result in increased sales? Or at least in higher profitability for that area? How does the role of stores change as the sales associate has the responsibility for the customer relationship online as well as in the store?
I don’t know. Neither does Zumiez. It will be interesting see what the algorithms turn up as they have the benefit of more and better data.
Zumiez has been hit by the same problems that other retailers are experiencing. Nobody knows how this is all going to work out, but Zumiez seems to be positioning itself to detect and react to market changes quickly. It’s interesting to see how the ability to react and be flexible has, in some ways, become more important than planning and projecting.