Earnings Call Transcript - ZUMZ Q1 2023

Operator, Operator

Good afternoon ladies and gentlemen and welcome to the Zumiez Inc., First Quarter Fiscal 2023 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., 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 that will be discussed is available in Zumiez filings with the SEC. At this time, I will turn the call over to Rick Brooks, Chief Executive Officer. Mr. Brooks?

Rick Brooks, Chief Executive Officer

Hello everyone and thank you 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 first quarter before handing the call over to Chris, who will take you through the financials, and some thoughts on the second quarter and rest of the year. After that, we'll open the call to your questions. As anticipated, the first quarter was challenging as we saw similar domestic trends to those experienced in the fourth quarter of last year. Our operating performance was in line with our outlook and reflects a significant change the broader US economy and retail in particular has undergone over the past 12 months. The continued effects of inflation weighing on consumer discretionary spending combined with heightened promotional activity across the industry to clear excess inventory levels, our full price selling model has been under pressure. We're not pleased with our recent results. That said, we aren't discouraged either. Our team has navigated economic down cycles before and while each cycle has some unique characteristics, the one constant is that they eventually turn positive and Zumiez has historically outperformed the market on the way up. We are confident that the connections we forge with our customers through our distinct brand, culture, and diverse and differentiated merchandise offering, featuring highly sought-after hard-to-find brands and world-class service are as strong as ever. The year is unfolding, as we anticipated thus far, we're staying the course with the plan we outlined on our Q4 call in March. This includes being diligent with our spending, focusing on strategic investments that we believe will create significant long-term benefit for our customers, our business, and our shareholders by managing carefully in the short-term what we can control. Some of the long-term strategic investments we believe are important to push forward include continued investment in our people through best-in-class training and mentoring. In 2022, we were able to execute all three of our in-person national events that are focused on intense training, connection, and recognition. This has included the return of our January 100K event, celebrating the best of our sales teams and connecting them with our key brands. We've continued with this trend in 2023, executing our annual manager retreat just a few weeks ago focused on development and leadership. Optimizing trade area performance by ensuring that we have the right number of stores to serve our customers in each market and getting the right product in the right places to best serve customers as quickly as possible. Continuing to work with brands to increase speed and flexibility, while increasing margins. Investing innovative approaches to generate human-to-human connections with our customers and engage with them in new ways that enhance the shopping experience, and continue our international expansion with a focus on Europe and Australia. We know that brands emerge locally and grow globally and our international presence provides us the opportunity to better serve both our customers and our brand partners, while we continue to optimize these operations with many of the initiatives we have proven across North America. We feel good about the progress we made internationally in the first quarter with comparable sales in Europe and Australia increasing 12.8% and 8.7% respectively. It was a tough quarter, but I continue to be confident that we have the right team and necessary experience to weather these turbulent times and emerge well-positioned to accelerate market share gains when conditions improve. With that, I'll turn the call over to Chris, who will discuss the financials.

Chris Work, Chief Financial Officer

Thanks Rick and good afternoon everyone. I'm going to start with a review of our first quarter results, I'll then provide an update on our May sales trends, before providing some perspective on how we're thinking about the full year. First quarter net sales were $182.9 million, down 17.1% from $220.7 million in the first quarter of 2022. Comparable sales were down 18.8% for the quarter. The decrease in sales was driven by our North America business offset by more favorable results for Europe and Australia. During the quarter, we continued to see softer sales, primarily driven by ongoing inflationary pressures on the consumer. Growth was also negatively impacted by 87 basis points related to unfavorable changes in foreign currency. From a regional perspective, North America net sales were $144 million, a decrease of 22.7% from 2022. Other international net sales, which consist of Europe and Australia, were $38.9 million, up 13.3% from last year. Excluding the impact of foreign currency translation, North America net sales decreased 22.4% and other international net sales increased 17.1% compared with 2022. Comparable sales for North America were down 24.2% and comparable sales for other international were up 12.2% for the quarter. 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 footwear, accessories, hardgoods, and women's. Total dollars per transaction were up for the quarter, driven by an increase in average unit retail, partially offset by a decrease in units per transaction. First quarter gross profit was $49.4 million compared to $72.4 million in the first quarter of last year. Gross profit as a percentage of sales was 27% for the quarter compared with 32.8% in the first quarter of 2022. The 580 basis point decrease in gross margin was primarily driven by lower sales in the quarter, driving deleverage in our fixed costs. The key areas driving the change were as follows; store occupancy costs deleveraged by 290 basis points on lower sales volumes, product margins decreased by 70 basis points, web shipping costs increased by 60 basis points, distributions in our cost deleveraged by 50 basis points, buying and private label cost deleveraged by 40 basis points, and inventory shrinkage increased by 40 basis points. SG&A expense was $70.7 million or 38.7% of net sales in the first quarter compared to $71.9 million or 32.6% of net sales in the year-ago period. The 610 basis point increase in SG&A expense as a percent of net sales resulted from the following; 270 basis point increase due to both deleverage of store wages on lower sales as well as increases in wage rates that could not be offset by hours reductions, 180 basis points due to a one-time German government subsidy received in the first quarter of fiscal 2022, 160 basis point increase due to deleverage of non-wage store operating costs, 90 basis point increase in non-store wages, 20 basis point increase in stock compensation expense, 20 basis point increase in annual incentive compensation, and a 20 basis point increase in other corporate costs. These increases were partially offset by a 150 basis point reduction due to the timing of our 100K event, which was held in the first quarter of last year, but not in the first quarter of fiscal 2023. Operating loss in the first quarter of 2023 was $21.4 million or 11.7% of net sales compared with operating profit of $0.5 million or 0.2% of net sales last year. Net loss for the first quarter was $18.4 million or $0.96 per share, compared to a net loss of $0.4 million or $0.02 per share for the first quarter of 2022. Our effective tax rate for the first quarter of 2023 was a 12.6% benefit compared with a 134.2% provision for income taxes in the year-ago period, which was 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 marketable securities of $155.3 million as of April 29, 2023 compared to $173.0 million as of April 30th, 2022. This $17.7 million decrease in cash and current marketable securities over the trailing 12 months was driven primarily by capital expenditures of $27.5 million, offset by $11.2 million in cash provided by operating activities. As of April 29th, 2023, we have no debt on the balance sheet and continue to have our full unused credit facility. We ended the quarter with $147.9 million in inventory, up 4.2% compared with $141.9 million last year to end the first quarter. The inventory growth was driven by store count increases in our international business, while the inventory in North America is down 3% from the prior year. On a constant currency basis, our inventory levels were up 3.7% from last year and while more aged compared to the same quarter in 2022, we are more current than we were to end the fourth quarter of 2022. Now, to our fiscal May sales results. Net sales for the four weeks period ended May 27th, 2023 decreased 12.8% compared to the four-week period ended May 28th, 2022. Comparable sales for the four-week period ended May 27th, 2023 were down 14.3% from the comparable period in the prior year. From a regional perspective, net sales for our North America business for the four weeks ended May 27th, 2023 decreased 17% over the comparable period last year. Meanwhile, our other international business decreased 12.7% versus last year. Excluding the impact of foreign currency translation, North American net sales for our four weeks ended May 27th, 2023 decreased 16.7% from the prior year, while other international net sales increased 10.4% compared with 2022. Comparable sales for North America were down 17.5% and comparable sales for other international were up 4.2% for the same four-week period compared to the prior year. From a category perspective, in fiscal May 2023, all categories were down in comparable sales from the prior year. Footwear was our most negative category followed by hardgoods, accessories, men's, and women's. Total dollars per transaction were up for fiscal May 2023, driven by an increase in average unit retail, partially offset by a decrease in units per transaction. With respect to our outlook for the second quarter of fiscal 2023, 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. Our May sales results were slightly better than our first quarter trends, but still well below year-ago levels as consumer demand remains under pressure from the continued impact of high inflation on discretionary spending. With that in mind, we are planning total sales in the second quarter to be between $187 million and $192 million. We expect that our second quarter 2023 product margins will be down between 50 basis points and 70 basis points from the second quarter of fiscal 2022 as we continue to work through a challenging sales environment. Consolidated operating loss as a percent of sales for the second quarter is expected to be between negative 7.7% and negative 9.2%, and we anticipate loss per share will be between negative $0.63 and negative $0.73. Similar to the first quarter, the decline in earnings is largely due to deleverage in the cost structure on lower sales base, coupled with margin pressure. Our biggest areas of deleverage continue to be tied to fixed costs such as occupancy expense, base hours in our store that are driven by mall operating hours, and other corporate costs. As Rick said, the year is unfolding as we expected and our view on the remainder of 2023 hasn't changed. As with our practice back in March, we are refraining from providing specific annual guidance due to the uncertainty and volatility in the macro environment, but do want to provide some context around how we currently believe the business will trend out the year. Sales results in fiscal 2022 became more challenged each quarter as the year progressed when compared to a more normalized historical sales trend. We believe we will continue to experience topline pressure, particularly as we wrap up the first half. The quarterly comparisons become easier throughout the year, suggesting more opportunity in the back half of the year when compared to fiscal 2022 results. Product margins were down 50 basis points in fiscal 2022 after six consecutive years of growth. The majority of this year-over-year decrease was driven by our fourth quarter of 2022 product margins, which was impacted by increased discounting as we work to right-size the inventory balance. For fiscal 2023, we believe that product margin will be tougher in the first half of the year as we work through aged inventory and the market remains promotional with retailers continuing to drive inventory in line with current sales trends. We believe that margins may stabilize and possibly expand in the back half of the year as inventories come in line and comparisons get easier. Our model is sensitive to sales fluctuations and we have seen deleverage as sales decline in fiscal 2022 and also the first quarter of 2023. While the opposite was true in 2021 when we experienced record sales and operating margin, driven by meaningful leverage. We continue to diligently manage expenses as we navigate the current environment and are positioned to take advantage when conditions improve. We are currently planning our business assuming an annual effective tax rate of approximately 50%. It is important to note that we expect our tax rate to fluctuate significantly from quarter to quarter based on the pre-tax results and distribution of income between different jurisdictions throughout the year. We are planning to open up to 23 new stores during the year, including approximately eight stores in North America, 10 stores in Europe, and five stores in Australia. These openings are contingent upon finding the right locations with complementary economics. While that is our normal practice, challenging circumstances, such as those we are currently experiencing, may cause us to reduce our store openings if we are unable to negotiate deals that achieve our financial targets. We expect capital expenditures for the full 2023 fiscal year to be between $20 million and $22 million compared to $26 million in 2022. We expect that depreciation and amortization, excluding non-cash lease expense, will be approximately $23 million. We are currently projecting our share count for the full year to be approximately 19.5 million diluted shares. With that operator, we would like to open the call up for questions.

Operator, Operator

Thank you. Our first question comes from Jeff Van Sinderen with B. Riley. Your line is open, please go ahead.

Richard Magnusen, Analyst

Hello. This is Richard Magnusen in for Jeff Van Sinderen. Thank you for taking our call. Can you speak more about how you planned inventory for back-to-school this year? And if you could also speak to how you're evolving your approach to promotional or just kind of merchandise packages for back-to-school?

Chris Work, Chief Financial Officer

Sure. I'll provide some insight on that. We've been working hard to manage our inventory, and I credit our buying teams for navigating this challenging environment with changing sales trends. We are feeling confident about our inventory as we exit Q1. While it's slightly more aged compared to last year, it's in a better position than it was at the end of the previous year. If we delve deeper into the categories, we'd likely feel even better about our inventory, especially in the trending areas that are performing well. However, in categories like footwear, we've seen more challenges, which aligns with broader market trends. As we prepare for back-to-school, our focus remains on making informed bets on trending items, and the teams are concentrating on our men's, women's, accessories, and footwear offerings to identify popular brands. We plan to launch 100 to 150 new brands each year and are attentive to both new items and established brand partners. We are also emphasizing flexibility in our inventory buying, maintaining an open-to-buy strategy to pursue trending items, and closely managing seasonal inventory to respond quickly. We believe we have a strong position, especially with our quick-turn screenable items, as we approach the back-to-school season. We are committed to delivering top performance during this peak time.

Rick Brooks, Chief Executive Officer

And Richard, in terms of the promotional environment, I mean, of course, we're going to anticipate that we'll see some promotional activity during the back-to-school cycle. I think that's just a good common sense at this phase. I think we feel pretty good about our position outside of as Chris said, there's a few areas where I think there's a glut of product in a particular category like footwear that has to be worked through. But we're going to do promotions the way we do and which is greatly honoring our brands and those brands that have equity. So, you will not see us do the 40% off the store thing. That's not our model. That's not what we do. And we'll be targeted in it and we'll look at the perspective on promotions about how we provide value for our customers and I guess to your comment then about the bundles. We've also been experimenting with different ways over the last month and we'll continue to experiment as we approach back-to-school with different ways to encourage and incentivize customers and employees around promoting and driving sales in the stores. So, think about that from that perspective for us is we're going to honor the integrity of the quality of the brands we have and we don't want to discount those brands that have that equity. But we'll try to work through those areas where there is an overstock and then provide value; this is the perspective of us for how we provide value for our customers.

Richard Magnusen, Analyst

All right. Thank you. I'll get back in the queue.

Rick Brooks, Chief Executive Officer

Thank you.

Operator, Operator

Our next question comes from the line of Mitch Kummetz with Seaport. Your line is open, please go ahead.

Mitch Kummetz, Analyst

Yes. Thanks for taking my questions. Let's start with the consumer and the stress that they're seeing on their discretionary spend. Are you seeing that having any disproportionate impact on categories? I think that footwear is being a higher price point category, also hardgoods and those were two of the more challenged categories for May. I don't know if that's the issue like in footwear, is it really just go back to the glut of inventory that's in the channel?

Rick Brooks, Chief Executive Officer

I'll address that, Mitch. The high-level answer regarding consumers and stress by category, particularly in footwear, is that I don't believe that’s actually the situation. It’s more driven by trends. We do have some footwear that is performing well, and as Chris mentioned, we are more optimistic about investing in those areas and we have indeed increased our purchases. Therefore, I think this is a trend-driven issue rather than one caused by consumer price sensitivity or inflation. The broader pressures on discretionary spending relate more to macroeconomic factors affecting consumers. Our role is to provide the best products from top brands that reflect current trends, and I don’t think the price point indicates challenges within the footwear category concerning consumers.

Mitch Kummetz, Analyst

And with regard to some of those, go ahead, Chris.

Chris Work, Chief Financial Officer

I want to add that you asked about their shopping patterns, and we continue to see a trend similar to what we observed throughout 2022. We noticed a significant increase in private label products, rising by almost 600 basis points in total sales, which is substantial growth for us. In the past, private label products surpassed 20% of our sales before dropping to 12% as consumers favored branded items. Currently, we are in a cycle where that trend is reversing, and private label products are becoming much more popular as price-conscious consumers seek discounts.

Mitch Kummetz, Analyst

Great. And then Rick, just speaking to some of the trends, you mentioned buying into some things that are working. I mean, just looking at your website, you're featuring the adidas Samba, which is a hot shoe right now. It looks like a lot of it sold out. You've got Chunky Skate, which is kind of I don't want to say unique to you guys, but that would potentially play well if there's a trend there. Like even on the accessories side, you're deep in Pit Viper Sunglasses. Like it feels like there are a lot of little things that might be well-positioned for you guys? I mean, how do you think about that?

Rick Brooks, Chief Executive Officer

Again, there are definitely things working in our business, Mitch, the question is getting them and building the momentum around those things. And long bottoms like Chris was talking about our private label have been a tremendous success for us. And not actually at a price point, we're driving a full price, full margin business there. It's the bundles that are providing the value for the consumers in that set. So, there are things that are working, Mitch. And of course, as Chris said, those are the areas that we look at inventory where we're going after it. We're buying more deeply based upon what we're seeing in the patterns in the business. And we just need more of those things, I think, is the answer. And relative to the drag on the business like Skate is still a drag on the business relative to the comp structure there in Skate and that by the way is a global issue, not just a North American issue. So, we still have things that are dragging us backwards and we need more of those things like you described that are going to push us forward. And trust me, those things that you described, we're buying much more deeply. And as Chris said, anything that's trending, we're going to be prepared. We'll be ready for back-to-school.

Mitch Kummetz, Analyst

Okay. And then my last question, you guys continue to see strong performance in other international. And I'm just trying to better understand that. Is that you're taking a lot of market share in those markets? Are you seeing a better macro in those markets than you are in the US? And then I guess lastly, Chris, just in terms of profitability on Blue Tomato, I know that that's a business that's been unprofitable for a while now. I'm just curious how that's trending these days?

Rick Brooks, Chief Executive Officer

Let me start, Mitch, and then I'll let Chris jump in. All the markets we're working in are experiencing some level of macro distress, which varies from market to market and, in some cases, even between countries in Europe. Each market has its challenges, but I believe we are gaining market share in our international markets, particularly in Europe and Australia. We're building units and opening new countries, and we're seeing success as we do so, which makes us optimistic. In Australia, for example, we are experiencing success while opening new states. Overall, I feel confident about our position. Our teams are executing well, and some of the sales gains we've mentioned are driven by these new units coming online. We're seeing growth both in-store and online in Australia and Europe overall. It appears we are gaining market share, and I believe we are performing well. However, we do face challenges due to economic factors; if we weren't seeing stress in the markets or the situation in Ukraine, we could be performing even better in those regions.

Chris Work, Chief Financial Officer

Yes, I'll add some details about Q1 and discuss profitability more generally. Last year, we noted that the business grew by 8.8% compared to 2021, which was encouraging, although it fell short of our budget and impacted our bottom line, as you mentioned, Mitch; we were not profitable. In Q1, we've observed a sales acceleration, although we've faced margin challenges while aligning inventory. We've seen positive results in Germany and Austria, our established markets, and are excited about newer regions like the Netherlands and Norway, which performed well with positive comparable sales across all categories in the quarter. We're now operating in eight countries in Europe and are well-positioned for growth. The operating loss from last year posed some challenges, and while we won't comment on this year's projections, we believe that if we maintain our current trajectory, we'll surpass our 2022 performance. This outlook leads to the long-term potential we've discussed, as we anticipate gaining momentum with improving market conditions. We've mentioned that the financial potential here is in the millions, not tens of millions, and if we continue on this path, we could reach breakeven and ultimately shift toward profitability. We're pleased with the direction we're heading in Europe. For Australia, it's a profitable market for us, and our team has excelled there, notably with the establishment of a private label program. We're encouraged by our success in Australia, especially since many others in the market haven’t reported positive gains. We believe there's significant growth potential ahead.

Mitch Kummetz, Analyst

Okay. Thanks. Good luck.

Rick Brooks, Chief Executive Officer

Thanks Mitch.

Operator, Operator

Thank you. Our next question comes from the line of an analyst with Jefferies. Your line is open, please go ahead.

Unidentified Analyst, Analyst

Hello. This is on for Corey Tarlowe and thank you for taking my questions. Can you discuss your current level of hardgood penetration? Also, how should we view the store opening schedule for the remainder of the year? Thank you.

Chris Work, Chief Financial Officer

Sure. Yes, I'll go ahead and talk about hardgoods and just kind of where we're at and as we have had now for a couple of years, this has been a challenged category. We saw amazing results in 2019 and 2020. And then as we started to turn at 2021, it started to get a little bit tough. We went from 19% of sales, which was really our peak to the last couple of years, we have dropped down to 13% of sales. So, we've seen pretty massive decline as a percent of the total. The first quarter here has continued to be tougher and we've seen continued decline. And I think if that plays out, it's hard to tell where the rest of the year is going to go. But I think we would kind of be near our historical lows as a percent of sales in 2023, would be what we would predict at this point based on what we know. Obviously, this is challenging to predict where the trough is because we never had a peak that high in regards to where the business grew to. So, but that's kind of how we're trending at this point.

Rick Brooks, Chief Executive Officer

Cadence of store openings.

Chris Work, Chief Financial Officer

And then cadence of store openings, yes, thank you, Rick. Right now, we would expect to see a few more of those stores open in the back half. Typically, we would say that we would open kind of like a 60%-40% cadence before back-to-school and after. And I would expect that to be a little more heavy on the back end.

Unidentified Analyst, Analyst

Thank you.

Operator, Operator

Thank you. And I'm showing no further questions. And I'd like to turn the conference back over to Rick Brooks for any further remarks.

Rick Brooks, Chief Executive Officer

All right. Thank you. And again, as always, we always appreciate your interest in Zumiez. So, thank you everyone on the call with us today and we'll look forward to talking with you in early September about where we're at for Q2 and early back-to-school read. So, thanks everybody.

Operator, Operator

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