Zumiez’s 10/31/06 Quarterly Report: Pretty Much Nothing But Good News

Well hell, this is a lot more fun when there’s something negative or at least controversial to gossip about. All I’ve got to go on is the 10-Q for the quarter ended October 28th and things seem awful solid. No executives fired. Sales growing, margins holding up, no interesting litigation. You might as well go read another article.

Net sales for the quarter were up 43.3% to $82.3 million. Comparable store net sales were up 10.7% compared to being up 9.8% in the same period the previous year. So not only are same store sales growing, but they are growing faster than they were in the same quarter last year.
Gross margin fell from 37.3% in same quarter last year to 36.8% in the quarter ending October 28th this year. For nine months, it’s up to 34.6% from 33.8%. They explain the fall in gross margin for the quarter as being “due primarily to occupancy costs related to the 32 new stores we added in the three months ended October 28, 2006 compared to 14 stores added in the three months ended October 29, 2005.”
That’s easy to quote. What does it mean? You open all these stores. The occupancy costs begin immediately. Landlords are funny. They want to be paid every month no matter what you sell. On the other hand, the customers may not rush in quite as quickly as you want. If, therefore, you include certain occupancy costs for new stores as a cost of goods sold, you are going to reduce your gross margin a bit if you are opening a lot of new stores.
Interestingly, Zumiez states that the way they calculate cost of goods sold may not be the same as the way other retailers do it. They kind of go out of their way to do that. If you know much at all about accounting, you know that while there are rules, there are often choices, or maybe judgments is a better word, to be made about how to account for things.
I have the perception that Zumiez has been mindful and focused on the choices they have made when they set up their accounting system. I’m guessing it’s contributing to their success. We can tend to look at our accounting system as a necessary inconvenience and generally a pain in the ass. A good system that gives you the management information you need to make decisions is as important as your brand image. No, I don’t think I’m overstating that.         
They also said their gross margin had been reduced by their “stock based compensation expense.” That is, the value of certain stock options has to be included as an expense. This is the first October quarter in which accounting standards have required that be included as an expense.
These costs that reduced gross margin were partially offset by an increase in margin because their larger purchase volume allowed them to get better prices from vendors. I’m sure we’re all stunned to hear that.
They also said gross margin was positively impacted by lower markdowns because of less aged inventory (an indication of good purchasing) and “our ability to leverage certain fixed costs, such as distribution, and product teams over greater overall net sales.”
The balance sheet is strong, though their cash and marketable securities have declined and inventory has grown, consistent with their growth including the acquisition of the twenty Fast Forward stores.   I mean, financing growth is what they had those liquid assets sitting there for.
Net income for the quarter grew 29.3% to $6.83 million, or from $0.19 to $0.25 cents a share before dilution. Net income as a percentage of sales was 8.3%, down from 9.2% in the same quarter last year. 
I’ll be waiting to see Zumiez’s filings in the next couple of quarters. It will be interesting to see if any of the issues impacting other public action sports companies will affect Zumiez. Right at the moment they are kind of in their sweet spot in terms of their size and growth. Hopefully, they can continue that.