Earnings Call Transcript - ZUMZ Q3 2021

Operator, Operator

Good afternoon, ladies and gentlemen. Welcome to the Zumiez Inc. Third Quarter Fiscal twenty twenty one 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 the 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 that are not based on historical facts 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 discussed is available in Zumiez filings with the SEC. At this time, I would like to turn the call over to Rick Brooks, Chief Executive Officer. Mr. Brooks, you may begin.

Richard Brooks, CEO

Thank you and hello, everyone. Thanks 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, then I'll share some thoughts on sales for the fourth quarter to date before handing the call over to Chris who will take you through our financial results in more detail. After that, we'll open up the call to your questions. As you saw from our earnings release issued earlier today, our third quarter was a historic one. We've adeptly navigated multiple external headwinds over the past eighteen months, starting with the pandemic in early twenty twenty, continued global supply chain disruptions, labor shortages, inflation, and in some cases, closures due to COVID. Despite these challenges, this quarter, we grew net income five point four percent over Q3 of twenty twenty and a remarkable sixty percent of the third quarter of twenty nineteen pre-pandemic levels. In fact, we've now generated more income in the first nine months of twenty twenty one than in any full-year period in the company's history, and we still have the important holiday season ahead of us. Looking at the underlying drivers of the record earnings quarter, net sales were up seven percent and ten percent on a one and two-year basis respectively. The majority of school districts around the country resumed in-person learning this year, back-to-school is highlighted by strong full price selling, reflecting pent-up demand and our ability to serve the customer through our integrated model however they want to interact with us. The increase in sales combined with product margin growth offset an uptick in SG&A expenses as we saw an expansion of store hours, an increase in marketing, and the completion of our first national store manager in-person event in eighteen months in North America. Looking ahead, the fourth quarter has started well despite numerous challenges, underscoring our ability to capitalize on strong consumer demand and expand our market share. Fourth quarter to-date through Tuesday, November thirty, total sales up eleven point five percent year-over-year and up eight point six percent compared to the same period of twenty nineteen. Our performance of the Black Friday weekend bodes well for the remainder of this holiday season. While we continue to experience global supply chain challenges, labor shortages, inflation, closures tied to COVID, and now risks associated with the new Omicron variant, we are confident that our investments in people, sourcing, and fulfillment will allow us to serve our customers with the distinct merchandise offering, great service, and seamless shopping experiences that are the pillars of Zumiez's long-term success. As we would like to say, periods of significant change create opportunities and companies that have the right people, strategies, and resources in place can take advantage of times like this to advance their brand and business. While Zumiez isn't fully resistant to all the challenges that are plaguing the industry, we believe the current environment will accelerate further consolidation globally and that our adaptability and focus on our customer will lead to the further wallet and mindshare gains. We believe this is evident domestically and also internationally. We're continuing to win share in Europe and Australia despite being hit with closures in both regions throughout the year and the current closures in Austria during the important lead-up to the holiday. While we are tactically adaptable, our overarching consumer-centric strategy rooted in strong brand and culture will remain constant. We built a business in which we partner with great brands to bring diversity and uniqueness to our customers that allows them to individuate. We built an infrastructure in which customers can shop with us to get what they want, when they want, how they want, and as fast as they want. We've morphed our business into a channel-less organization with inventory visibility from all touchpoints and back-end capabilities that last to effectively leverage expenses regardless of the channel in which sales originate. Each of these distinct attributes will serve us well in today's hybrid shopping model and logistically challenged environment. Our unique position in the marketplace leaves us well-positioned to capitalize on consumer demand and expand our market share over the near and long term. To close, I want to thank the entire Zumiez team for their hard work and dedication to upholding the cultural values that are directly tied to our strong third quarter and positive start to the fourth quarter. Despite the fantastic financial results, these are not easy times to operate in and our teams continue to work relentlessly in service of our customers. With that, I'll turn the call over to Chris to discuss the financials.

Christopher Work, CFO

Thanks, Rick, and good afternoon, everyone. Like last quarter, I'll make comparisons to both the prior year and the third quarter of fiscal 2019 where relevant, considering the pandemic's impact on last year's figures. After reviewing the third-quarter results, I'll update you on the fourth quarter's sales trends and our outlook for the full year. Third quarter net sales reached $289.5 million, an increase of 6.8% from $271 million in the third quarter of 2020 and up 9.6% from $264 million in the third quarter of 2019. The year-over-year sales growth was mainly driven by our ability to leverage current trends, the reopening of stores compared to the temporary closures from the COVID-19 pandemic last year, and a more typical back-to-school season in the U.S. Our stores operated approximately 99% of potential operating days during the third quarter of 2021, compared to about 95% in the third quarter of 2020 and 100% in the same period of 2019. Regionally, North America net sales amounted to $257.5 million, reflecting a 7.1% increase over 2020 and an 8% rise compared to the same period in 2019. Other international sales, including Europe and Australia, were $32 million, up 4.5% from last year and up 25.2% from two years ago. Excluding foreign currency effects, North America sales rose 6.8% while other international sales increased 5% compared to 2020. We're still facing temporary COVID-related store closures in Australia, where stores operated approximately 42% of available days. During the quarter, the men's category saw the most growth, followed by footwear and accessories, while hardgoods experienced the largest decline, along with women's products. Gross profit for the third quarter was $114.7 million, compared to $105.8 million last year and $94.6 million in the third quarter of 2019. Gross margin as a percentage of sales was 39.6% for the quarter, up from 39% in 2020 and 35.8% in 2019. The 60 basis point improvement over 2020 was mainly due to decreases in web shipping costs and impairment losses related to operating lease assets, along with an increase in product margins. These gains were partially offset by a 110 basis point rise in inventory shrinkage, following historically low results in 2020 during store closures. Compared to 2019, gross margin improved by 380 basis points, driven largely by enhancements in product margins and occupancy leverage. SG&A expenses amounted to $74.8 million, or 25.8% of net sales during the third quarter, compared to $67.9 million or 25% last year and $70.3 million or 26.6% in 2019. The increase in SG&A as a percentage of sales versus 2020 was primarily due to higher store payroll as many locations lengthened operational hours post-pandemic, coupled with corporate cost increases, a drop in government subsidies, and a slight reduction in annual incentive compensation. Operating income for the third quarter of 2021 was $39.8 million, or 13.8% of net sales, compared to $37.9 million or 14% last year, and $24.3 million or 9.2% in 2019. Net income for the third quarter was $30.7 million, or $1.25 per diluted share, compared to $29.1 million or $1.16 per diluted share for 2020, and $19.2 million or $0.75 per diluted share for 2019. Our effective tax rate for 2021's third quarter was 25.5%, up from 24.7% last year and 25% two years ago. Looking at the balance sheet, we ended the quarter in a robust financial position. Cash and current marketable securities rose 6.9% to $338.1 million as of October 30, 2021, up from $316.2 million as of October 31, 2020, driven by cash generated through operations while being partially offset by share repurchases and capital expenditures. We repurchased 2.2 million shares during the quarter, averaging $41 per share for a total of $91.6 million. In the fourth quarter to date, through November 30, we repurchased an additional 0.4 million shares at an average cost of $47.91 each, totaling $17.5 million. Thus far this year, we have repurchased 2.8 million shares at an average cost of $42.16 per share, amounting to $120 million in total. We still have $68.8 million remaining on our current share repurchase program. As of October 30, 2021, we had no debt and maintained full access to our unused credit facilities. We closed the quarter with $175.1 million in inventory, an 8.8% increase from third quarter 2020 but down 4.5% from the third quarter of 2019. On a constant currency basis, our inventory levels increased 8.4% year-over-year. We are pleased with our inventory situation considering current sales trends. Despite being affected by global supply chain issues over the past 18 months, we are working closely with our brands and suppliers to effectively navigate these challenges. Overall, our inventory is healthy and selling at favorable margins. Now, regarding fourth quarter results thus far. Sales for the fourth quarter to date through November 30 increased 11.5% compared to the same period last year and increased 8.6% compared to two years ago. Our stores were open about 99% of the available days during this period in 2021, compared to approximately 97% during the same period last year, with current closures primarily in Europe. We are actively monitoring the situation in Europe and plan to keep stores open ahead of the holidays. Regionally, North American net sales for the thirty-one days leading to November 30, 2021, rose 7.5% compared to a year ago and were up 8.3% versus 2019. Meanwhile, our international sales jumped 39% year-over-year and increased 10.3% against 2019, though closures continue, they are less frequent than in 2020. By category, the men's segment was the most positive, followed by footwear, women's, and accessories, with hardgoods being the only category that saw a decline. Due to limited visibility, we will not provide specific guidance for the fourth quarter or for fiscal 2022, but want to share a general outlook for the year. This outlook assumes current store closures in Austria will reopen by mid-December, without accounting for any additional closures or significant impacts from current or future COVID variants. For the fiscal year 2021, we project net sales growth in the mid-teens compared to fiscal 2019, translating to over 20% growth from 2020. For the fourth quarter, we expect high-single digits sales growth compared to the prior year. Regarding gross margin, we anticipate significant year-over-year growth for 2021 driven by occupancy cost leverage on increased sales, a reduction in shipping costs as web revenue returns to normal, and improvements in product margins. We foresee gross margin growth in the fourth quarter, albeit more modest than the substantial growth realized in the third quarter. SG&A costs for fiscal 2021 are expected to rise in line with our sales growth due to several factors discussed during our Q2 earnings call, many of which relate to the pandemic. Key drivers of SG&A increases include higher store wages as operational hours expand compared to the reductions in 2020, a lack of expected government subsidies in 2021, and increases in incentive compensation and various discretionary expenses linked to improved performance and planned events that were limited in 2020 due to restrictions. In summary, we aim to expand gross margin while SG&A costs grow in line with sales. Ultimately, we expect operating margins to increase year-over-year for fiscal 2021, reaching low-teens as a percentage of sales. We are planning for an annual effective tax rate of about 25% for fiscal 2021, compared to 25.6% in 2020. We expect a meaningful increase in diluted earnings per share for fiscal 2021 compared to the prior year, primarily driven by significant gains made in the first quarter as well as our earnings in the latter half of the year and the effect of our stock buybacks. For the fourth quarter, we anticipate EPS growth in the mid-to-high single digits percentage-wise over last year, including stock repurchase effects. We plan to open 23 new stores in fiscal 2021, including about seven in North America, twelve in Europe, and four in Australia, with a planned closure of five to six stores during the year. Capital expenditures are set to be between $19 million and $21 million in fiscal 2021, compared to $9.1 million in fiscal 2020, with most spending focused on new store openings and remodels. We expect depreciation and amortization, excluding non-cash lease expenses, to be about $22 million in fiscal 2021, down from $23.5 million in fiscal 2020. We're projecting the weighted average diluted share count for the full year to be around 24.8 million shares, with an estimated 23 million shares for the fourth quarter, subject to further repurchases reducing these figures. With that, operator, we would like to open the call for questions.

Operator, Operator

Thank you. Our first question comes from Sharon Zackfia of William Blair. Your line is open.

Sharon Zackfia, Analyst

Hi. Good afternoon. I apologize, Chris, you talked really fast. So, if you talked about this, I just didn't catch it. I guess, I'm curious, there's been a lot of conversations about consumers shopping earlier this holiday season. And I'm wondering if you think you've seen any evidence of that and how you are handicapping that as you talk about the fourth quarter revenue growth rate, particularly that last week into Christmas? And then any thoughts on what you're thinking about for store openings in twenty twenty-two?

Christopher Work, CFO

Sure. I'll go ahead and take that. I think as it relates to Q4 and sales trends, this is certainly something we've been trying to monitor and understand. I think from our perspective, you can tell that our Q4 growth rate is lower than what we've produced quarter-to-date. And I think that's a factor of considering what you've mentioned here and also a factor of the fact that January last year was extremely strong. And so, if you look at our cadence last year, we got quite a bump in January that really drove the quarter up, and that was primarily related to that period of stimulus. So, we're not expecting that as well. So, I think you can take those two factors as kind of factored into our guidance. This is something we also heard a lot about last year, people waiting until the end and we obviously didn't experience that as much last year. So, we're kind of weighting that with probably a lesser impact than probably what we'll see in January, but definitely factored into our thoughts. As it relates to store count in twenty twenty-two…

Richard Brooks, CEO

Twenty twenty-two.

Christopher Work, CFO

Twenty twenty-two, thank you. I think as we've always said, we like to be very opportunistic in how we think about this. And if we look back at the last significant downturn and rental rates, which is probably during the last recession, we opened some really good stores in two thousand and eight, two thousand and nine and coming out of that recession. And I think we're looking at this market very similarly to say that there's good opportunities to work with landlords to fill spaces and find markets that we think we can do well over the long term. So, at this point, as we think to twenty twenty-two, I think you could expect us to increase the number of store openings in each of the geographies that we operate.

Sharon Zackfia, Analyst

Thank you very much.

Operator, Operator

Thank you. Our next question comes from Jeff Van Sinderen of B. Riley. Your line is open.

Jeff Van Sinderen, Analyst

Hi. Thank you, guys. Can you please just give a little bit more color on digital versus in-store sales that you saw over Thanksgiving Week? Maybe if you could touch a little bit on Black Friday and Cyber Monday and how that differed versus the same period in twenty twenty and twenty nineteen? Thanks.

Christopher Work, CFO

Sure. Throughout the year, we observed that in 2019, our digital penetration was about sixteen percent, which increased to twenty-six percent in 2020 when we were closed for significant parts of the year. Our expectations for this year were that we would find ourselves between those two figures, expecting some level of digital sales to persist but not to reach the height of 2020. We are pleased to report that our digital sales are much closer to 2019 levels, which is positive for both our brand and our customers. This is particularly relevant for the twelve to twenty-four age group, who seek to express themselves as they engage with our energetic stores and connect with our sales teams. We are satisfied with how closely our digital sales align with 2019. As mentioned earlier, we are neutral regarding how customers choose to shop, whether online or in-store. We have structured our business to accommodate any shopping preference. During the holiday weekend, our results improved as November progressed, and we noticed a significant return to physical stores, which impacted our online sales, though not as robustly as in 2019. Overall, we experienced a performance that fell somewhere in between what we saw over the year in digital penetration.

Jeff Van Sinderen, Analyst

Great. Thank you. And then another question from me. So relevant to incoming spring merchandise, what changes are you guys seeing in supply chain and how are you planning inventory for the spring?

Christopher Work, CFO

Well, I'll take a crack at this, and then I'll let Rick add anything he'd like to add. I mean, I think from a supply chain perspective, it's certainly something that's gotten a lot of publicity. And whether you're talking about spring or whether you're talking about many periods across this year, including holiday, it's been a grind. And I think fortunately or unfortunately, however you want to look at it, it's no different than what we've been experiencing now over the last eighteen plus months. It's been challenging since we came out of the significant closures of twenty twenty. I think our teams have done a phenomenal job working with our brands and our vendors to get product in. We certainly have departments that have been more challenging; some of which have been pretty well-publicized, like footwear has been a challenge with some of the global supply chain headaches. And so I think as we move to spring, our thought process is to continue to navigate this with brands. And where we have areas where our brands are going to have a tougher time delivering on what we're hoping to get to, we're looking to other areas of the business that are working and trying to move those sales around. I think this actually gets to one of the strengths of our model is that if you look back at time and you look at our sales and our comparable sales performance over time, what we know about our model is as much as we'd like to have all departments positive at all times, that's not very likely. And what we find is that there's different cycles and departments get really hot for a year or two years, sometimes three or four years. And then we typically see those dollars move to other departments that we operate in. So, I think that's why we're very happy with our positioning. It's really a lifestyle retailer of having the apparel, the accessories, the footwear, the hardgoods. All of those things kind of play against each other and help us navigate periods like this, specifically times like the spring that you've mentioned in your question, where we probably will have some challenges in some departments, and we'll have to try to shift dollars to other places.

Jeff Van Sinderen, Analyst

Awesome. And then just quickly one final question. Can you speak a tiny bit more about what you're seeing in the Europe segment, and any changes to strategy or new initiatives you're working on there?

Christopher Work, CFO

Absolutely. Let's discuss Europe at a high level. We are very proud of our team in Europe for their 2021 performance despite the tough conditions. Stores in the region have faced numerous challenges, including closures, unlike here domestically where we've mostly remained open all year. In the first quarter, we were closed for sixty percent of the potential days, and in the second quarter, for twelve percent. Although we were open throughout the third quarter, we've faced an eight percent closure in November, particularly with all Austrian stores currently closed until approximately December 13. This compares to a closure of twenty-five percent throughout all of 2020. Our Austrian stores make up about a quarter of our overall store base there and contribute a significant portion to our sales due to being in our original market, hosting some of our strongest stores. We anticipate that these closures will impact our fourth-quarter results. However, despite these obstacles, we have seen a double-digit increase in sales compared to the previous year and only a modest decline against our budget. Our customers remain extremely loyal, and we are witnessing trends similar to past closures, with more movement towards digital sales. We believe this temporary downturn will ultimately strengthen our customer base moving forward. Regarding our long-term strategy for Europe, we maintain a positive outlook. This is an opportune time to invest in the market, especially in terms of store growth as mentioned in Sharon’s question. We are finding good opportunities regarding rent in Europe, opening twelve stores this year, including our first in Norway, and we plan to add more next year while exploring new markets. Our strategy revolves around expanding where we already have a presence and entering new markets, which allows us to grow while managing risk. We feel confident that the investments we've made position us well to leverage market opportunities. We have a strong team in place and have established robust back-office support to facilitate this growth. We believe we are now one of the largest lifestyle retailers in a fragmented European market, where we can succeed on a market-by-market basis. Additionally, this aligns with our global retail strategy of nurturing local brands and expanding them internationally, whether that means bringing brands from here to Europe or vice versa. Despite the challenges, we are content with our situation in 2021. There are uncertainties surrounding COVID and its impact on the winter months, including travel limits and restrictions that may affect dining and hospitality sectors, which still have not fully reopened. We are keeping a close eye on these developments, and our current planning accounts for these restrictions, though the future remains uncertain. Looking beyond 2021 into 2022 and the post-pandemic phase, we feel optimistic. We expect customers to return to normal habits, allowing us to recover lost ground from past closures. Overall, we believe we are on a solid path towards profitability, particularly within a twelve to twenty-four month timeframe.

Jeff Van Sinderen, Analyst

Great. Thank you so much.

Operator, Operator

Thank you. Our next question comes from Sharon Zackfia of William Blair. Your line is open.

Sharon Zackfia, Analyst

Hi. Sorry. I had a follow-up question. I was just curious, just given this being such a high season for you. How are you doing on staffing in the stores? And I mean, are you going to bring in seasonal labor? Can you talk about your ability to actually kind of service this holiday season? Thanks.

Richard Brooks, CEO

Sure, Sharon. I'm happy to provide some insight on that topic. As mentioned in our comments, we are not immune to the labor challenges in the marketplace, but we believe we are handling it better than many of our competitors. This is largely due to our loyal customer base, as we often hire from within our customer community. We are actively bringing in seasonal staff this season and ensuring they get hours on the sales floor. Additionally, we are maximizing hours for our existing teams and top salespeople as well. The loyalty of our customers gives us a strong pool of young people to hire from, and we are seeing many of them in our stores. This allows our managers to observe which loyal customers embody the cultural values we seek in our employees, enabling us to bring them on board, provide training, and allow them to contribute on the sales floor. While we have faced some challenges, I believe we are managing better than most in this regard.

Sharon Zackfia, Analyst

Thanks. And then one more question for Chris. I guess the lack of giving more color on the fourth quarter, is that primarily due to the uncertainty around Europe at this point? And did you touch on Australia at all? Did I miss that?

Christopher Work, CFO

No. I think, when we think about the fourth quarter, I think that is probably the biggest hurdle out there, as well as the fact that the January stimulus impact is still something we're continuing to measure. We certainly have our estimates. We've now had a couple of rounds of this and I think have some good planning there. But I think we felt it was best to kind of stay higher level at this point until we have complete certainty around where our stores are going to be. And I think the second part of your question on Australia, we are fully open in Australia. I think they've done a really good job. They have had a lot of challenges too. As I mentioned, their Q3, they were still closed the majority of the quarter. So, we're happy to get them back open. I think they're performing at a really good clip. We feel very similarly about Australia that we do in Europe. I think our growth there has been really successful. We've been able to open new stores both in existing and new markets, and they've performed pretty well. So, we feel good about where we're at in that market.

Sharon Zackfia, Analyst

Okay. Great. Thank you.

Operator, Operator

Thank you. I have no further questions at this time. I would like to hand the call back to Rick Brooks for any closing remarks.

Richard Brooks, CEO

All right. Thank you, Valerie. Appreciate that. Again, I just want to thank everyone for obviously your interest in Zumiez and your passion following what we do and wish everyone a great safe holiday season and we look forward to talking to you again in March. Thank you, everybody.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you all for participating. You may now disconnect. Have a good day.