Zumiez Inc Q3 FY2022 Earnings Call

Good afternoon, ladies and gentlemen and welcome to the Zumiez Inc. Third Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. Before we begin, I’d like to remind everyone of the company’s safe harbor language. Today’s conference call includes comments concerning Zumiez Inc's business outlook and contains forward-looking statements. These forward-looking statements and all other statements that may be made on this call are not based on historical facts and are subject to risks and uncertainties. Actual results may differ materially. Additional information concerning a number of factors that could cause actual results to differ materially from the information that will be discussed is available in Zumiez’s filings with the SEC. At this time, I'd like to turn the call over to Rick Brooks, Chief Executive Officer. Mr. Brooks?

Hello, and thank you everyone for joining us on the call. With me today is Chris Work, our Chief Financial Officer. I'll begin today's call with a few remarks about the third quarter before handing the call to Chris, who will take you through our financial results and outlook in more detail. After that, we'll open the call to your questions. The economic headwinds we discussed at the end of the second quarter continue to impact our business in the third quarter. Compared to the year ago period when consumers were flushed with record levels of savings due to the US stimulus and child tax credit measures, we've seen a dramatic shift in consumer sentiment across the retail landscape. As inflation levels remain elevated, we continue to see a pullback in our consumers' discretionary spending. This industry-wide softness has led to an increasingly promotional domestic environment with consumers appearing to trade down to less expensive options. In addition to these challenges, our international concepts are also faced with a major headwind this quarter as they saw their very solid currency neutral growth completely offset by unfavorable foreign currency movement. These demanded currency dynamics along with inflation-driven cost and expense pressures made for a very difficult operating environment compared to the year-go period. We spoke to you at the end of the second quarter, we assumed that these difficult trends impacting the broader retail sector would continue to intensify into the third quarter, remain flexible and agile as the quarter progressed, focusing on the areas of the business that we can control to help offset some of the ongoing pressure. Where our results were down significantly year-over-year, we were able to deliver sales and EPS results that were better than our most recent outlook provided in early September. Some bright spots during the period included, we exceeded our sales expectations this quarter as the back-to-school season played out slightly better than expected in the US. We saw sales growth of 13.8% year-over-year in our European and Australian markets on a currency neutral basis. And while negative currency fluctuations masked this on a reported basis, we are pleased to see the continued efforts of our teams operating our international concepts. Product margins decreased only 40 basis points compared to the year ago period, despite an increasingly promotional retail environment and increased mixed pressure as our international entities continue to grow in share. Overall expense management was strong, with the majority of our loss to the prior year driven by the top line sales decline. Our model is highly sensitive to sales fluctuations, with sales increases showing a large flow-through to the bottom line, and reverse impact during a sales downturn. Inventory was managed well with an overall foreign exchange adjusted increase of only 6.3%, driven primarily by our international entities with larger store growth. While US inventory was up only 1.3%. Earnings per share of $0.36 in the third quarter was higher than our guidance driven primarily by flow-through on incremental sales. And substantial work was completed on our long-term initiatives, including the opening of 35 new stores since this same time last year, with nearly half of those stores furthering our international expansion. Looking ahead, we expect continued top and bottom line pressure because of the current economic environment and remain cautious in our near-term outlook that Chris will share shortly. While our business trajectory has softened in the short term, we remain very confident in the long-term outlook for Zumiez. As a management team, we remain focused on building and positioning the business for long-term sustainable growth. For over 40 years, Zumiez has endured multiple business and fashion cycles emerging each time as a stronger and more profitable company. For example, in 2008 and 2009, we saw annual comparable sales down 6.5% and 10%, respectively only to be followed by comparable sales increases of 11.9%, 8.7%, and 5% over 2010, 2011, and 2012, respectively. This outcome during the most challenging economic periods in recent memory should inspire confidence in the resiliency of our flexible customer-centric strategy and a strong brand and culture that'll position Zumiez well for driving shareholder value once the economic environment becomes more favorable. As we like to say, periods of significant change create opportunities, and companies with the right people, strategies, and resources in place can take advantage of times like this to advance their brand and their business. Obviously, the operating environment in 2022 has proven to be one of the more difficult periods in our industry, but the original philosophies, goals, and ideals on which we built this business remain the same and will serve us as well today as they did during the last major economic downturn. With that, I'll turn the call to Chris who'll discuss financials. Chris?

Thanks Rick, and good afternoon everyone. I'm going to start with a review of our third quarter results. I'll then provide an update on our fourth quarter to date sales trends before providing some perspective on how we're thinking about the remainder of the year. Third quarter net sales were $237.6 million, down 17.9% from $289.5 million in the third quarter of 2021. The year-over-year decrease in sales was primarily driven by the benefits from domestic stimulus in the prior year, as well as increased macroeconomic headwinds as inflation weighed on consumer discretionary spending during the current year quarter. Growth was also negatively impacted by 200 basis points related to unfavorable changes in foreign currency. From a regional perspective, North America net sales were $206.3 million, a decrease of 19.9% from 2021. Other international net sales, which consist of Europe and Australia, were $31.3 million, down 2.3% from last year. Excluding the impact of foreign currency translation in North America net sales decreased 19.6% and other international net sales increased 13.8% compared with 2021. From a category perspective, all categories were down in comparable sales from the prior year during the quarter, with men's being our most negative, followed by hardgoods, women's accessories, and footwear. Third quarter gross profit was $82 million compared to $114.7 million in the third quarter of last year. Gross margin as a percentage of sales was 34.5% for the quarter compared to 39.6% in the third quarter of 2021. The 510 basis point decrease in gross margin was primarily due to lower sales in the quarter driving deleverage in our fixed costs, as well as rate increases in several areas. Store occupancy costs deleveraged by 250 basis points on lower sales volumes. Web shipping costs increased by 100 basis points. Distribution center costs deleveraged by 70 basis points. Buying and private label costs deleveraged by 40 basis points. Product margins decreased by 40 basis points and shrink increased by 30 basis points in the quarter. SG&A expense was $71.5 million or 30.1% of net sales in the third quarter compared to $74.8 million or 25.8% of net sales a year ago. The 430 basis point increase in SG&A expenses as a percent of net sales resulted from the following: 220 basis points in our store wages tied to both deleverage on lower sales as well as wage rate increases; 120 basis points related to other store operating costs, primarily impacted by lower sales levels; 90 basis points in non-store wages, and 30 basis points in corporate costs. These increases were partially offset by a 70 basis point decrease in annual incentive compensation. Operating income in the third quarter of 2022 was $10.4 million or 4.4% of net sales compared with $39.8 million or 13.8% of net sales last year. Net income for the third quarter was $6.9 million or $0.36 per diluted share. This compares to net income of $30.7 million or $1.25 per diluted share for the third quarter of 2021. Our effective tax rate for the third quarter of 2022 is 27.9% compared with 25.5% for the year ago period. The tax rate in the quarter is inflated primarily due to the allocation of income across entities and the exclusion of net losses in certain jurisdictions. Turning to the balance sheet. The business ended the quarter in a strong financial position. We had cash and current remarkable securities of $141.1 million as of October 29th, 2022, compared to $338.1 million as of October 30th, 2021. The $197 million decrease in cash and current remarkable securities over the trailing 12 months was driven primarily by share repurchases of $183.1 million, resulting in a reduction of our shares outstanding over the last year of 17.5%. We also had capital expenditures of $24.7 million, partially offset by cash generated through operations of $26.6 million. As of October 29th, 2022, we had no debt on the balance sheet and continue to maintain our full unused credit facilities. We ended the quarter with $177.2 million in inventory, up 1.2% compared with $175.1 million last year. On a constant currency basis, our inventory levels were up 6.3% from last year. Overall, while slightly more aged, our North America inventory is healthy and continues to sell at favorable margins. Internationally, our inventory is more current than the same time last year, and we have seen margins improved during the quarter. Total sales for the 31-day period ended November 29th, 2022 decreased 23.9% compared to the same 31-day period in the prior year ended November 30th, 2021. Comparable sales for the 31-day period ended November 29th, 2022 were down 24.8% from the comparable period in the prior year. From a regional perspective, net sales for our North America business for the 31-day period ended November 29th, 2022 decreased 27.7% over the comparable period last year. Meanwhile, our international business decreased 4% versus last year. Excluding the impact of foreign currency translation, North America net sales decreased 27.4% and other international sales increased 7.7% compared with 2021. From a category perspective, all categories were down in comparable sales for the fourth quarter to date, with men's being our largest negative category, followed by hardgoods, accessories, women, and footwear. With respect to our outlook, I want to remind everyone that formulating our guidance involves some inherent uncertainty and complexity in estimating sales, product margin, and earnings growth, given the variety of internal and external factors that impact our performance. With that in mind, we are currently expecting the total sales for the fourth quarter of fiscal 2022 will be between $258 million and $265 million. Consolidated operating profit as a percent of sales for the fourth quarter is expected to be between 3.4% and 4.7%, and we anticipate diluted earnings per share will be roughly $0.36 to $0.51. Now I want to give you a few updated thoughts on how fourth quarter guidance rolls into our fiscal 2022 results. With the first three quarters of 2022 behind us, we remain cautious in how we're looking at the full year given the operating environment and the current headwinds we are facing. Inclusive of the fourth quarter guidance, we anticipate the total sales will be down in the 20% to 21% range in fiscal 2022 compared to 2021. In fiscal 2021, we achieved peak product margins once again representing our six-year consecutive product margin expansion. As we have moved through the first three quarters of the year, we have closely managed inventory and seen only a modest decline in product margin despite inflationary pressures, a promotional environment, and mixed pressures between categories and across countries. We continue to believe we will see some product margin erosion in the fourth quarter and are planning the fourth quarter to be down approximately 50 basis points from the prior year at our current guidance. We continue to manage costs across the business. However, with our current sales projections, we are anticipating deleverage across the fixed costs of the business. We currently anticipate the fiscal 2022 operating margin will be between 2.6% and 3% based upon the drop in sales, inflationary cost pressures, and the return to normal for items like mall hours, travel, and training and events. Diluted earnings per share for the full year is currently planned to decrease less than operating profit related to the shares we purchased earlier in the year. We currently anticipate 2022 diluted earnings per share to be between $0.85 and $1. We are currently planning our business assuming an annual effective tax rate of approximately 33%. We are planning to open approximately 33 new stores during the year, including approximately 16 stores in North America, 13 stores in Europe, and four stores in Australia. And we expect capital expenditures for the full 2022 fiscal year to be between $27 million and $29 million compared to $16 million in 2021, with most of the increase tied to the additional stores in 2022. We expect that depreciation and amortization, excluding non-cash lease expense, would be approximately $20.8 million, down 3% from the prior year. And we are currently projecting our share count for the full year to be approximately 19.4 million diluted shares. With that operator, we'd like to open the call up for questions.

Thank you. And today's first question will come from Sharon Zackfia with William Blair. Please go ahead.

Hey, good afternoon. I guess two questions. You've obviously kind of kept the pedals to the metal here on development and I know historically it's definitely paid off to grow during times like now. But I wonder just given the severity of the slowdown that we're seeing if you are kind of maybe rethinking what you might do in 2023 with the potential for rents to even get more favorable if the consumer continues to weaken and the retail environment stays shaky. And then secondarily, I just wanted to kind of ask about the fourth quarter outlook because I think it does imply kind of a 23% to 26% year-over-year decline, but you do have easier comparisons in December and January than you had in November. I think your sales were like up double-digits in November last year and then got weaker as the quarter went on, as a lot did with Omicron. Are you seeing something that makes you just even more nervous even against those easier comparisons as we go into December and January and like kind of counterbalancing that as well with the early holiday sales we saw in October and November last year? I know that was like a 300-part question and I apologize.

Thank you, Sharon, for your questions. I'll address the first one and let Chris handle the second. In response to your first question about whether we are rethinking our growth initiatives for 2023, the answer is yes, we are reassessing our approach given the current state of the business. It's a normal part of our process. While we can't predict where 2023 will land, we are planning to discuss our strategy and investment priorities with our Board. The positive takeaway is that we have navigated similar cycles before and have a solid track record in doing so. While our sales challenges may seem particularly severe now, I believe our bottom-line results will remain comparable, as we don’t need to offer deep discounts due to our strong partnerships with brands. We are committed to pushing forward with our long-term strategies that focus on meeting consumer expectations and evolving our business where necessary. Some of the initiatives we pursue may not require significant capital investment, especially in terms of resource allocation to technology. However, there are essential actions we must undertake to ensure that we emerge from this cycle—just as we have in past challenges—stronger and better positioned to capture more market share. We might moderate our growth expectations, but we aren't ready to share specifics today. This discussion with our Board is ongoing, and we will remain cautious and disciplined in our investments, focusing on what will truly advance the business in aligning with future consumer expectations and our strategic vision.

Sure. Regarding your second question about Q4 and our outlook on the decline in sales compared to last year, we were initially more optimistic about Q4's performance following back-to-school. As a full price, full margin retailer, we are currently facing more challenges than others, especially as we have maintained our prices. Looking at our consumers, we see declining savings rates, increasing credit card spending, and a shift toward value due to inflation affecting various aspects of their lives. Additionally, the pressure on discretionary spending for things like dining and travel, along with the overall cost of living, has been significant. When developing our sales plan of $258 million to $265 million, we wanted to stay aligned with this run rate, as it was slightly lower than our expectations for November. We projected a consistent run rate across all our entities while considering a somewhat better outlook in Europe, remembering that last year, there were significant closures in Austria leading up to Christmas. This informed our approach as we anticipated how our consumers might feel throughout the quarter, which guided our sales planning.

Okay. Thank you.

Thanks, Sharon.

Thank you. One moment for our next question. And that will come from the line of Mitch Kummetz with Seaport. Please go ahead.

Yes, thanks for taking my questions. I'll just ask them one at a time. I was curious on the comp, so on the quarter-to-date comp, is there any way you can kind of talk about the period of Black Friday through Cyber Monday, if that was any better than what the quarter to date is, or if it's pretty much in line?

Sure. I'll address that question. The answer is that it aligns closely with our expectations. During the quarter, we analyzed the data extensively to understand the trends. A key difference this year compared to the Black Friday weekend last year is that we achieved significant gains in product margins. Last year, we focused on clearing inventory, which negatively affected our margins due to various promotions we executed. Overall, the trend remained consistent throughout the quarter on a weekly basis, with the primary difference being the performance of product margins during the holiday weekend.

Okay. And then on the quarter to date, you guys gave us sales and comp for that period. Do you know what that is on a three-year?

I don't have it on a three-year off the top of my head.

Okay. Do you know if the full year or the full quarter guide assumes kind of a similar three-year for the full quarter versus quarter date? You probably don't. No. That off the top of your head, too. Okay. A couple of last things. Maybe, Rick, you talked about the trading down that you're experiencing. Can you just maybe elaborate a little bit more on how you're addressing that, when you think about maybe your mix of product and brands, and particularly if there's any sort of trying to elevate the exclusive brand side of your business?

Sure, Mitch, I’d be happy to share. Overall, I feel optimistic about our core consumers. Even during the Black Friday weekend, we observed positive indicators regarding them. We experienced significantly higher conversion rates and larger basket sizes, showing that our core consumers remain committed to shopping with us. Additionally, we've seen a significant increase in penetration of our private label products. This reflects our ability to provide value to our core consumers, which is resonating well, as the penetration of private label has increased notably year-to-date and even more so in the current fourth quarter. Throughout the year, it's been on the rise. For us, Mitch, this has been about our strategies in bundling, pricing, and promotions involving private label. It achieves two goals: it offers value to our customers and boosts our margins, considering that private label typically has higher margins than branded items. On the branded side, we remain cautious. As you know, when we have established brands that can sell at full price, we prefer not to engage in markdowns, as we believe it undermines our brand partners. Our partners share this sentiment. Therefore, we aim to manage our purchasing and sales strategies carefully to avoid excessive stock. While we will act decisively if we end up with too much inventory and need to markdown products, our focus is on managing stock levels to only take markdowns when necessary, whether for seasonal items or products that haven’t performed well. We want to preserve the brand equity of our partners as much as possible.

That's helpful, Rick. And then maybe one last question just on the skate business. I know that's been more difficult over the last probably six quarters or so. I mean, it kind of rebounded before COVID and then it accelerated with COVID. And you saw the kind of penetration levels go from I think it was like 11% in 2018 to up to 19% in maybe 2021. I'm curious if, at this point, maybe like on a trailing basis, is the penetration of hardgoods kind of backed down to levels where it was at before kind of the rebound and acceleration? Or is it still above where it was for that period?

Yeah. It's a good question, Mitch. As you saw in Chris's comments, he commented that skate hardgoods were our second largest declining department. And remember that it's relatively a small percent of sales. So that still tells you something about the scale of the diminishing sales in that department on a relatively small mix of our sales in its position as the second largest declining department. So, we haven't hit bottom yet, is my message for you is what we're saying at this point. We're getting down to all-time lows at this point, Mitch. But there's no doubt, as you said that 2021, the penetration was significantly above our all-time highs for penetration of the skate hardgoods department. So, we're definitely giving that back up relative to, as you said, the recovery start in skate hardgoods in 2019 and how, what the pandemic did to accelerate significantly, I think pull forward of demand. So now we're giving it back, and that’s just the way our business works, right? Things trend up, things trend down, and particularly skate. We've seen that skate cycle many times. I think what we're seeing this time though is a massively accelerated cycle. And now we're taking a bit of pain as we fall back to where we're going to bottom out, and we may stay at a bottom for a period of time. The losses will diminish and then we'll start the cycle back up at some point.

Okay. Thanks for that update. Yeah. Go ahead.

And Mitch, just to clarify on the growth curve, in 2018 it was 10%, in 2019 it was 13%, and then in 2020 it peaked at 19%. That's when we really saw significant skate sales during the closures that year. Last year, it was 15%. So, it's still very healthy compared to our past performance, but the current run rate is at its lowest in a long time. We expect that trend to continue downward as Rick mentioned.

Okay. Thanks for that and good luck for holiday.

Thank you, Mitch.

Thank you. One moment for our next question. That will come from the line of Corey Tarlowe with Jefferies. Please go ahead.

Hi, good afternoon and thanks for taking the question. So, maybe if you could just start, could you talk about within margin, obviously there's a bunch of puts and takes, but some of those puts and takes might stick throughout from the third quarter into the fourth quarter and then perhaps into the next year, and then some of those might go away, right? So, could you maybe talk about what you see sticking versus what you see going away as it relates to the margin headwinds that you've faced this year?

That product, just to clarify, Corey, are you referring to product margins, gross margins, or something else?

I think it would be probably most helpful to get perspective on gross margin with things like freight, commodity cost pressures, et cetera.

Sure. Let me start, and then Rick can add anything he wants. When discussing gross margin, it's crucial to focus on product margins and assess our current position. As mentioned in our remarks, we've experienced six years of product margin improvements through 2021, reaching all-time highs across all entities. Now, as we transition into 2022, it's noteworthy that we've seen a shift toward private-label apparel. Interestingly, in the years leading to 2021, private-label trends were declining, while a branded cycle significantly contributed to product margin gains, which may seem counterintuitive but aligned with consumer demand and effective collaboration between our buyers and brands. Looking forward, if the trend toward private labels continues, we anticipate some stability in product margins. Additionally, it’s important to highlight that our international operations in Canada, Europe, and Australia are underperforming compared to the US in terms of product margins and are now key growth areas for our business. We’re observing margin improvement across these regions as they collaborate with brands and increase their private-label offerings. As these international markets grow and gain scale, we hope to see product margins move closer to US levels. There may be mixed shifts in the midterm as international sales grow at slightly lower margins, but we believe this will be advantageous in the long run. In terms of other gross margin components, a significant factor is occupancy, which has been impacted by sales declines compared to both 2021 and 2019. Our teams are working diligently with landlords to manage this expense, but it still represents a challenge due to decreased sales. Long-term gross margin will depend on sales growth, which will help us leverage fixed occupancy costs. Another major cost is shipping, where we've seen rising expenses. We're actively exploring various strategies to minimize these costs, particularly in our direct-to-consumer operations, and we hope to gain more leverage in this area as sales continue to grow and we work closely with our carriers.

That's very helpful. Could you discuss inventory? It seems to be in a relatively good position compared to your initial expectations. How do you feel it is situated as we approach the key holiday period for most retailers?

Sure. I think on the inventory side, we feel good about our current levels. We're at approximately $177 million in inventory, which is up 1.2% in Q3 and closely aligns with Q2, where it was up 1.1%. We are experiencing some benefits from foreign exchange rates but are down 3.3% compared to 2019. Overall, our inventory is being managed effectively given the retail landscape. In North America, inventory is slightly older but is still maintaining a healthy margin. Internationally, our inventory is in a better position than last year and we are seeing margin improvements there. As we consider inventory management in light of our business strategy, it's important to note that we are aligning ourselves with broader retail trends, although our approach is somewhat different. We are focused on full price and full margin, which requires agility in managing inventory to capitalize on buying opportunities and respond to customer preferences. This might explain why our sales appear softer compared to others, as we are committed to maintaining price levels. In terms of margins, while we anticipate they might decline by about 50 basis points, this is still relatively strong when considered against market conditions and a multi-year view of our product margins. I want to commend our teams for their outstanding work in managing inventory during this challenging period. As we head into Q4, we feel confident about our inventory position.

I want to emphasize that we are focused on the long term. We need to navigate the short-term challenges effectively. This involves managing our brand as part of our multi-branded strategy, which prioritizes price integrity for brands that hold real value for consumers. As a result, we may achieve improved product margins in this environment. This could sometimes place additional pressure on sales, but as Chris mentioned, we tend to reach similar outcomes as others, just through a different approach. I believe that our method represents a stronger long-term strategy, benefiting both our business and maintaining pricing discipline for our brand partners, as we are not diminishing their brand equity.

That's great. Thank you very much for all the color and best of luck.

Thank you.

Thank you. I'm showing no further questions at this time. I will now turn the call back over to Mr. Rick Brooks for any closing remarks.

All right. Thank you very much. As always, we appreciate your interest. And as I said in the commentary, I just want to reiterate how confident I am in how we're positioned in the marketplace, our understanding of our consumer, and what their behaviors that we're trying to solve for here. As we look into the next few years, next three to five years, I want to tell you that we have the strategies, initiatives in place, and the right investments as common insurance question to move those initiatives and strategies forward so that when we get through this cycle, we're going to come out stronger than we've ever been, and we're going to gain market share. So, I remain really confident about our positioning where we've managed through cycles like this before, we're experienced doing it, and we're going to come out this other side stronger and better and bigger. So, thank you everyone. We look forward to talking to you in March.

Thank you for participating. This concludes today's conference call. You may now disconnect.