Zumiez’s October 29 Quarter and a Strategic Observation

Zumiez reported sales growth during the quarter of 16.9% from $154 million to $180 million. Without the Blue Tomato acquisition, sales would have risen 11.7%. The gross profit margin fell from 38.9% to 37.3%. Selling, general and administrative expenses rose from $37.1 million to $45.7 million, or by 23.2%. As a percentage of sales, they rose from 24.1% to 25.4%. 

Net income fell 10.4% from $14.1 million to $12.7 million.
Comparative store sales were up by 3.7% and ecommerce sale were 10.7% of the total, up from 6.4% in the same quarter last year (Remember that now includes Blue Tomato, which does quite a bit of online business). Zumiez ended the quarter with 495 stores; 471 in the U.S., 19 in Canada and 5 in Europe. They’ve added a net of 48 stores since October 29, 2011.
Let’s remember that the July 4 acquisition of Blue Tomato in Europe for $74.8 million plus contingency payments of up to $28.6 million had an impact on their results, as has the new ecommerce fulfillment center in Edwardsville, Kansas and moving their home office from Everett to Lynnwood, Washington. Without the costs associated with the corporate relocation and Blue Tomato acquisition, SG&A would have been 23.7% of sales; lower than the same quarter last year.
The 1.6% decline in gross margin “…was primarily due to a 90 basis points increase in ecommerce fulfillment and ecommerce shipping expenses and an 80 basis points impact of a $1.4 million charge recorded during the three months ended October 27, 2012 related to a step-up in inventory to estimated fair value in conjunction with our acquisition of Blue Tomato.” They gained 40 basis points by leveraging store occupancy costs over higher comparable store sales. It’s noted in the conference call that product margins would have improved slightly without Blue Tomato.
During the quarter, Zumiez booked $2 million in expense as part of the expected contingency payment for Blue Tomato. This explains part of the increase in the SG&A expense line. There was also a 1% increase in corporate costs and a 0.3% increase in amortization of intangibles as a result of the Blue Tomato deal. These increases were offset to some extent by a 0.4% decline in incentive compensation and a 0.9% improvement in store operating efficiencies.
Zumiez’s lease on its former corporate headquarters doesn’t expire until 2017, and they’ve got some ongoing costs for it. During the quarter, they booked $200,000 in cost of goods sold and $300,000 in SG&A. 
The balance sheet shows the impact of the Blue Tomato acquisition. If it’s slightly weaker than it was a year ago I guess, it’s still very solid, so no discussion is required.
Zumiez’s 10Q (see it here) tells us that, “The activity of Blue Tomato that was included in our condensed consolidated statements of income from the acquisition date to October 27, 2012 was net sales of $9.6 million and a net loss of $1.8 million.”  Of those Blue Tomato sales, $8.1 million were during the quarter. It doesn’t tell how much of the loss was during the quarter, but it obviously had a negative impact.
In theirs earnings release and conference call, Zumiez acknowledged that their sales and earnings during the quarter were below what they expected. “The shortfall in sales came primarily from softness in Europe, which we attribute to unfavorable weather and pressure on consumer spending as a result of difficult macroeconomic conditions,” said CEO Rick Brooks.
As an aside, I’d encourage all of you not to think the crisis in Europe is over. I didn’t quite know whether to laugh or cry when I heard that some of Greek’s debt had been effectively converted into zero coupon, perpetual bonds. Financial alchemy is so much fun!
For the fourth quarter, Zumiez expects same store sales to decline by 3% to 4%. 
“The fourth quarter guidance assumes a decline in product margin compared to last year, primarily related to a modest decline in our domestic margins as a result of our current sales projections and lower margin experienced for our Blue Tomato business due to their product mix and effects of the inventory step-up.”
They expect that acquisition related charges during the quarter will be $3 million.
To sum it up, Europe and Blue Tomato aren’t performing to expectations, there have been some substantial, though expected, costs for the acquisition and changes in location, winter business is weak, and the economy’s none too great in North America either.
With that as background, let’s move on to the strategic question I alluded to in the title.
Zumiez has positioned itself as an action sports lifestyle brand. CEO Brooks noted in the conference call that he believed in that lifestyle. “The lifestyle has real resonance,” he says.
I read public information not just to tell you how an individual company is doing, but to look for issues that everybody in this space probably needs to think about. The one I find myself thinking about right now is just what is the action sports lifestyle market and how big is it?
It’s hardly the first time this issue has been raised, and not just by me. The action sports industry is really pretty small, or at least that’s what I believe. And it’s been compromised by big players in youth culture, fashion, urban street wear; pick your term. The borders are no longer as clear as they once were.
When Volcom was sold to PPR, I complimented them on selling at the right time before they needed a deal. Volcom owned their market niche, but where did they go from there? They needed expertise they didn’t have to branch into the larger market. How successful they will be is still an open issue.
Zumiez is the core action sports shop in the mall. They own that niche. It’s been validated by other brands opening their own mall retail stores. But when you’re so successful, and so closely identified with a niche, how do you grow and how to you respond as the market evolves away from core action sports while still keeping your credibility in the market you’re successful in? 
Zumiez can and will open more stores (their target is 600 to 700). But as an example of what I mean, I want to focus on Zumiez’s discussion of its men’s footwear business in the conference call.
Here are CEO Rick Brooks’ comments on that business:
“I read it in many of your notes that we’ve seen athletic footwear really start to take off both in the sense of athletic shoes, but we’re seeing that really calling out basketball and running as categories. Obviously those are areas that we play.”
“If you don’t come to us for basketball shoes or for running shoes, they come to us for a skate shoe. So I think that we have some challenges there relative to just a cyclical cycle in footwear.”
“I would anticipate that we’re probably more likely in the early phases of an athletic footwear trend, than the later phase at this point based upon our experience what we see in the marketplace.”
“So as we think about what we’re going to do with footwear going forward, we definitely think we have some opportunities where we know we’re missing a few things with some key brands in our current business.”
I’d love to dig in more deeply on this subject with Rick. But what I’m hearing him say is that there’s some men’s footwear product Zumiez could be carrying they don’t carry now that would be responsive to market trends.
But it seems to me that product isn’t necessarily representative of the action sports lifestyle. The question for Zumiez (and other companies as well) is the extent to which they respond to these trends.
Do they carry it and compete for the customer who wants that product? Or do they decide that it’s not representative of the action sports lifestyle? If they carry it, they may hold onto a customer they would otherwise lose. But they may also find themselves in a market where their advantage is less (because it’s not all about the action sports lifestyle) and could even confuse their core customers. If they don’t carry it, they may lose a customer they had before and find themselves isolated as the market changes.
Well, this is why companies have managers, and I imagine Zumiez managers asks themselves this question every day about every product and every brand they carry or consider carrying. They’ve responded at least partly with an emphasis on systems that get the right product to the right stores (micro sorting they call it) and by giving store managers quite a bit of discretion, as they describe it, in selecting inventory.
But more globally, the issue is just what is the action sports lifestyle market? It’s not what is used to be.