Earnings Call
Zumiez Inc (ZUMZ)
Earnings Call Transcript - ZUMZ Q2 2020
Operator, Operator
Good afternoon, ladies and gentlemen. And welcome to the Zumiez Inc. Second Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in 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 the 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 now turn the call over to Rick Brooks, Chief Executive Officer. Please go ahead, sir.
Rick Brooks, CEO
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 second quarter. Then I'll share some thoughts on back-to-school and the rest of the year before handing the call over to Chris who will take you through the numbers. Amidst the most difficult operating conditions the company has ever faced, we delivered better than anticipated results. To put some context around our recent performance, when the second quarter started in May, we had only 65 stores open, which is just 9% of our entire store base. By the end of May, that number increased to 492 stores or 68% of our store base. By the end of June, we hit our peak with 691 stores or 96% of our store base open. Then in July, as a result of governmental orders, we closed a total of 69 stores in California and Australia, and ended the second quarter with 645 stores or 90% open. For the quarter, our stores were open for 73% of potential operating days. Despite stores being open 27% fewer days than a year ago, second quarter 2020 revenue increased 9.6%, as stores that were open combined with digital activity comped up 37.3%. Our top-line performance was highlighted by robust full-price selling across all geographies as demand for our distinct and differentiated merchandise assortments and the continued efforts of our teams drove much stronger results than we had anticipated. By geography, we experienced stronger growth in our international markets with Canada, Europe and Australia all showing significant comparable sales gains and double-digit total sales growth, despite closures in the period. As we discussed on our Q1 call in June, from the onset of the pandemic, we made some difficult near-term decisions around our expense structure in order to weather this crisis and emerge in a position of strength. This included laying off virtually all of our part-time staff, suspending all hiring, eliminating substantially all planned fiscal 2020 bonuses and eliminating the majority of merit raises. Other operational changes we've made during Q1 and across Q2 include reducing store labor to reflect restricted operating hours, eliminating travel across all areas of the business, canceling national training and certain marketing events and looking for other costs that could be eliminated or delayed as a result of the current environment. These combined actions, coupled with the increased sales activity, allowed us to significantly leverage the business contributing to second quarter earnings per share of $1.01 and favorable cash generation. With close to $300 million in cash and marketable securities on our balance sheet and no debt, we believe we are well-positioned to navigate what is likely to be a volatile operating environment over the next few quarters while investing strategically in the business. These results in this environment underscore the strength of our brand and culture and speak to the ability of our business model to adapt to change. We have discussed at length over the years the significance of our culture and brand and how they serve as critical competitive advantages that have helped us win throughout our 40-plus year history. The most significant component of our culture and brand has always been and will always be our people. The investment we made in supporting our full-time employees throughout the pandemic paid dividends in the second quarter, enabling us to quickly and successfully execute the reopening of nearly our entire store base while continuing to service and engage with our customers physically and digitally. As it has in the past, I’m confident that our unwavering commitment to our people will continue to further set Zumiez apart from the competition and meaningfully benefit our long-term performance. Looking ahead, there's still a great deal of uncertainty about the state of retail and the global economy due to the impact from COVID-19. We are currently experiencing the effects of the health crisis on back-to-school as many states and districts around the country have delayed the start of the new school year or decided to begin with virtual instruction. As a result, we did not see the sustained lift in demand we typically do starting in late July and running through early September. To date, the third quarter has been meaningfully impacted by the timing of back-to-school and the impact of virtual learning, but it’s generally gotten stronger each week as we move through the quarter. At this point, we believe we are likely to see a more prolonged back-to-school season with some demand shifting out to later in the third quarter. However, we are currently planning the entire season to be meaningfully below the prior year. With regard to the upcoming holiday season, there are also a number of unknowns as it’s unclear what happens with the virus as we get into winter, how governments and individuals will respond, what impacts the pending election could have on our results, as well as the uncertainty around the financial condition of the consumer. What I do know is that Zumiez is well-positioned to pivot to meet the needs of our customers wherever, whenever and however they want to engage with us, thanks to our dynamic teams and our one channel mentality. Periods of significant change create opportunities. Coming down to the right people, strategies and resources in place can take advantage of times like this to advance the brand and business. While Zumiez isn’t fully immune to disruption created by the pandemic, we do believe the current environment will accelerate further consolidation globally and our focus on the consumer will lead to further wallet and mindshare gains as we emerge from the crisis. We must be smart in how we navigate the business challenges while also looking for long-term strategic investments that will set us up for the future. These include great real estate opportunities, new tools within our omnichannel formats and other strategic investments to support the next era of intimacy with our customers. The strength in our position can be a significant advantage in these times. I have great confidence in our teams and the proven ability to navigate through unforeseen challenges. Our response to the pandemic has highlighted the strength of our culture and brand and bolstered my optimism about emerging even stronger from this current crisis. With that, I'll turn the call to Chris to discuss the financials.
Chris Work, CFO
Thanks, Rick. And good afternoon, everyone. I'm going to start with a few high-level comments on the financial strength of the business, review our second quarter, and then provide an update on the quarter-to-date sales through Labor Day before discussing a few updates on the full year. We entered fiscal 2020 in a strong financial position with cash and marketable securities over $250 million and coming off the highest earnings per share in the history of our company. This resulted from years of commitment and hard work by our teams, coupled with strong financial planning. Now, for the closure and subsequent reopen, we have continued to see the strength of our one channel model with our teams working diligently to serve the customer. The business ended the second quarter in a strong financial position. Cash and current marketable securities increased 58.6% to $299.1 million as of August 1, 2020, compared to $188.6 million as of August 3, 2019. The increase in cash and marketable securities was driven by cash generated through operations, including deferrals and reductions of $41.5 million composed of landlord payments, lower inventory levels, extended vendor terms, and deferred payroll tax payments, in addition to net income improvements related to abatement, credits, and expense reductions. This increase was partially offset by $13.4 million of share repurchases through the company's stock buyback program prior to our stores closing due to COVID-19 and other planned capital expenditures. As of August 1, 2020, we have no debt on the balance sheet and continue to maintain our full unused credit line of $35 million. We ended the second quarter of 2020 with $126.7 million in inventory, compared with $151.1 million of inventory last year, a decrease of $24.4 million or 16.1%. During the first quarter, our merchandising teams canceled or pushed out orders in Q1 to curb the impact of declining sales due to store closures. With demand and reopened stores exceeding our expectations in the second quarter, we increased our planned receipts meaningfully and still ended the quarter light on inventory across most categories, with certain areas of our business significantly impacted by delayed supply chains. Overall, the inventory on hand is well-positioned and selling at a favorable margin entering the third quarter. Turning to the income statement, second quarter net sales increased 9.6% to $250.4 million, compared to $228.4 million for the second quarter of 2019. The increase in sales was driven by a 37.3% increase in comparable sales, which includes reopened stores and our digital activities, partially offset by store closures during the period. Breaking down the comparable sales further, we saw meaningful strength both digitally and as our stores reopened with comparable sales in stores over 20% and digital comparable sales for the quarter over 122%. As Rick mentioned, our stores were open for roughly 73% of potential operating days during the second quarter of 2020. And with the highest concentration of stores opened in June, we saw our strongest results in that month. From a regional perspective, North America net sales increased $16.5 million or 8% to $223.5 million. Other international net sales, which consists of Europe and Australia, increased $5.5 million or 25.4% to $26.9 million. Excluding the impact of foreign currency translation, the North America net sales increased 8.2%, and other international net sales increased 25.8% for the quarter. From a category perspective, all categories were up in total sales with the exception of footwear with hardgoods being our most positive, followed by men's clothing, women's clothing, and accessories. Second quarter gross profit was $90.9 million, compared to $77.2 million in the second quarter last year, and gross margin was 36.3%, compared to 33.8% a year ago. The 250 basis point increase in gross margin was primarily driven by a 170 basis point increase in product margin, a 160 basis point decrease in store occupancy costs, a 50 basis point decrease in distribution costs, and a 20 basis point decrease in inventory shrinkage. This was partially offset by a 160 basis point increase in web shipping costs due to increased web activity as a result of COVID-19 related to store closures. However, shipping costs leveraged to the prior year were compared to total web sales. SG&A expense was $57.7 million in the second quarter compared to $65.5 million a year ago, a decrease of $7.8 million or 11.9%. SG&A expense as a percent of net sales decreased 560 basis points for the quarter to 23.1% of total sales. The decrease was primarily driven by a 240 basis point decrease in our store wages, a 100 basis point leverage in other store costs, a 70 basis point decrease due to governmental payroll credits, a 70 basis point decrease in corporate costs, a 40 basis point decrease in corporate wages, a 30 basis point decrease in the accrual of annual incentive compensation, and a 20 basis point decrease in national training and recognition events. Operating income in the second quarter of 2020 was $33.1 million or 13.2% of net sales compared with operating income in the prior year of $11.7 million or 5.1% of net sales. During the quarter, we recognized flow-through on incremental sales of almost 100% based on the factors outlined above and our ability to adjust quickly in this challenging time. Net income for the second quarter was $25.4 million or $1.01 per share compared to net income of $9 million or $0.36 per share for the second quarter of 2019. Our effective tax rate for the second quarter of 2020 was 26% compared with 30.7% in the year-ago period. Now to our fiscal third quarter-to-date sales results. We are providing quarter-to-date sales through Labor Day, Monday, September 7th, as this time period is more comparable to the prior year given the shift in the Labor Day holiday. Total third quarter-to-date sales for the 37 days ending September 7, 2020, were down approximately 14% compared with the same 37-day time period in the prior year ended September 9, 2019. For this same time period, our stores were open for 91% of the potential operating days due to ongoing mandated store closures, primarily in California, Hawaii, and Australia. Total comparable sales for the 37-day period ended September 7, 2020, were down 5.1%. By channel, our open store comparable sales decreased 10.7%, and our e-commerce sales increased 27.4%. The quarter-to-date comparable sales decrease discussed above was driven by a decrease in transactions, partially offset by an increase in dollars per transaction. Dollars per transaction increased due to an increase in units per transaction, offset by a decline in average unit retail. Quarter-to-date, total sales increased in our hardgoods category. All other categories were down in total sales quarter-to-date, with footwear being the most negative, followed by men's, women's, and accessories. Our overall quarter-to-date performance reflects the delayed start to back-to-school with many states and districts pushing back their start date, the impact to schools going back virtually, and continued store closures. Looking at the weekly cadence of our results in August, they generally improved each week, and we continue to believe that there may be opportunity for a prolonged back-to-school season into September and October. Due to limited visibility to the business, we will not be providing guidance for the third quarter of 2020 or the fiscal year. That said, we do want to give a few thoughts on how we're looking at 2020. We are expecting sales for the third quarter to be down to the prior year. However, we believe our results will be better than the previously disclosed third quarter-to-date sales decline of approximately 14%. We experienced a product margin increase of 170 basis points in the second quarter and a positive start to the third quarter. We are managing inventory tightly and working with our brand partners to navigate this environment. In the third quarter, we expect to see a benefit in product margin to the prior year, but do not anticipate that it will be as significant as the year-over-year growth experienced in our second quarter. We continue to manage costs across the business, understanding this challenging environment and limited visibility. Through the first six months, we have seen significant reductions in certain expenses as we work to align the cost structure to the sales lost during our closure and the potential for greater economic losses as we move through the year. We are currently planning SG&A expenses across the business to be down 12.5% compared with 2019 associated with reductions in store operating hours, travel and training, planned capital, incentive compensation, and many other benefits. With the potential variability in performance over the back half of the year, this estimate could increase or decrease as we gain more visibility to the sales trends, our ability to adjust expenses, and the potential for non-cash impairments. We now expect to open approximately 10 new stores in 2020, including 2 stores in North America, 7 stores in Europe, and 1 store in Australia. This is down from our plan coming into the year of 20 new stores. We expect capital expenditures for the full 2020 fiscal year to be approximately $11 million compared to $19 million in 2019, in our original plan for 2020 of between $18 million and $20 million. The majority of our capital spend will be dedicated to new store openings and planned remodels. We expect that depreciation and amortization, excluding non-cash lease expense, will be approximately $24 million, down slightly from the prior year. And we are currently projecting our share count for the full year to be approximately 25.3 million shares. At this point, we are not expecting any further share repurchases until we have better visibility into the business. With that, operator, we'd like to open the call up for your questions.
Operator, Operator
Our first question comes from Sharon Zackfia with William Blair. Your line is now open.
Sharon Zackfia, Analyst
I have a question about the inventory position. Chris mentioned that you believed you were in a good position, but it seems to be quite low compared to the sales you projected for back-to-school. Are there areas where you are experiencing inventory shortages right now? How prepared are you to pursue sales if back-to-school lasts longer than expected? I'm also interested in your thoughts on store development beyond 2020, especially since you are recovering and performing much better than many others in the current environment.
Chris Work, CFO
Sure, I can start with the inventory and then address the store question. It's been quite a year for inventory. When the first quarter came along with the store closures, our buying teams put in a lot of effort to coordinate with our vendors, resulting in over $100 million in canceled purchase orders. When we reopened in late April and through May, we saw much better results than we had expected, putting us in a position where we were trying to catch up. Coupling this with the challenges of getting our supply chain back on track created several difficulties as we progressed. Our buying teams did a great job reacting to these challenges and bringing in product, while our distribution and operations teams worked hard to move it through the channels. Our store teams also performed well with customers both in-store and online, although it wasn't without its hurdles. As we review our inventory at the close of the quarter, we recognize that it was lighter than we had hoped. However, the inventory itself is in a good state. We feel confident about the quality and structure of our inventory but wished for more, particularly in hardgoods and footwear, which were our more difficult categories. This also ties into the supply chain issues we've been addressing. Many retailers have discussed various challenges in the first half of the year. For us, it began with restarting after the closures, followed by the challenge of obtaining the desired products in a timely manner, alongside increased demand throughout the system, especially moving items from our distribution centers to stores and from stores to customers due to higher volume levels. Looking ahead, we are also considering potential peak surcharges and other operational challenges. We’re doing our best to plan for these issues and believe our one channel philosophy positions us well since we're shipping closer to customers with a network of stores handling the shipping, which has been beneficial. We’re also engaging with our shipping partners and implementing our own strategies to mitigate risks. Overall, as we managed through August, our inventory levels began to stabilize. We remain positive about our inventory situation. However, we recognize that there were missed opportunities where we could not secure enough inventory to meet consumer demand.
Rick Brooks, CEO
Sharon, regarding your question about our store footprint and plans for development beyond 2020, I’d like to address it in two parts: first, the U.S. market and then our international markets. This distinction will help clarify the differences, challenges, and opportunities in each area. In the U.S., it's quite clear that we have a surplus of retailers and retail space, along with an excess of malls. As we've long maintained, this situation is largely driven by the empowered consumer who has access to complete inventory transparency and the advantages of a digital-first strategy when searching for products. We anticipate that this consumer-driven trend will lead to the consolidation of retailers because many simply don’t need as many locations. This is also contributing to the difficulties faced by malls, which are now at risk of survival. Additionally, we believe the pandemic has significantly accelerated these trends, a point that seems evident in the current market. Ultimately, we expect that the streamlining of retail and malls will be beneficial for us and will facilitate market share consolidation, positioning us favorably within our sector.
Chris Work, CFO
Sure. I will discuss our real estate strategy and how we approach store locations. For a while now, we've emphasized that we don't want to have more stores than necessary in any given area. We're focusing on the trade area concept, looking at how stores and online services can serve our customers effectively together. In terms of strategy, we're navigating the current challenges posed by COVID while collaborating closely with our landlord partners. As mentioned in our Q1 call, we deferred a significant portion of our rents in April, May, and even some in June to manage through this tough period. While we won't provide detailed updates on each landlord or the specifics of rent abatements or deferrals, we did give high-level insights during our prepared remarks regarding overall deferrals, lease inventories, payroll, and accounts payable, along with how occupancy impacts our financials from a leverage standpoint. We have worked diligently with our landlords to reach compromises that benefit both parties. Many of these agreements are finalized, but several still need documentation and completion. We're committed to progressing through this process. Looking longer term, our approach is to manage risk concerning the number of stores. As Rick mentioned, we recognize that the U.S. may be over-malled, so we evaluate our bottom 10% to 20% of stores and generally opt for shorter lease terms to maintain flexibility in those markets. We assess each store's role in its trade area, focusing on optimizing our store count based on both their sales and how they can fit into the overall strategy. This evaluation spans multiple years and aims to determine how profitable we can be. We utilize data from our Stash platform and analyze how everything works together to serve our customers effectively. We understand that while high-volume centers will maintain long-term demand, lower-volume centers may have seasonal peaks but can support high-volume centers in fulfillment. Regarding the bottom 20% of our stores, we estimate we can exit roughly 75% within the next three years and over 80% within five years, which gives us confidence in our ability to navigate this cycle. That summarizes our strategy, and I’ll hand it back to Rick to discuss the international aspect.
Rick Brooks, CEO
Thank you, Chris. To summarize, regarding store development in the U.S., we see this market as one that is being rationalized, which includes the number of malls and retailer store footprints. Our focus is on optimizing our business to gain market share and drive earnings through effective execution in trade areas. The international market presents a different scenario. The empowered consumer trend, fueled by smart technology, continues to influence global markets and retailer consolidation. In terms of malls abroad, they are already rationalized, so we do not anticipate a significant need for further rationalization like in the U.S. In fact, we believe that international malls may represent the future model for U.S. malls, particularly regarding the mix of tenants and square footage. We see retailer consolidation in international markets as an opportunity, as it will create space in quality centers. Therefore, we view this as a growth opportunity for our international operations, with potential for high-quality, low-cost expansions. Our growth strategy also encompasses enhancing our omni-channel execution to better serve customers. This will allow us to scale effectively in each market, boosting our operational performance in sales and profits. I believe we have significant potential for profitable growth internationally in the coming years and will maintain our focus on managing this growth while prioritizing our culture and brand positioning. I feel we are well-positioned to capitalize on these opportunities compared to our competitors.
Janine Stichter, Analyst
Want to dig a little bit more into back-to-school? It sounds like you expect the sales trend to pick up in 3Q a bit from where it is currently. Maybe can you provide some regional color on what you've seen in regions or districts that have already gone back-to-school, those that have gone back in-person? That would be helpful color.
Chris Work, CFO
Sure, I'm happy to provide some insights. This year, understanding the back-to-school dynamics has been quite challenging due to the delayed Labor Day and the effects of digital versus in-person schooling. We’ve prepared some thoughts on what we’re observing, mostly focusing on our domestic business as that represents the majority of our back-to-school activity. Our results have generally improved each week, with the fifth week of the period showing an overall positive trend. While all categories have seen declines, skate hardgoods have performed well. We noted some weaknesses during Labor Day weekend compared to last year, but analyzing this has been difficult due to the changes. From our surveys across stores, we found that around 50% of schools are adopting a hybrid model, 40% are fully remote, and about 8% are back in person. The regions that have returned to in-person learning are performing the best, showing a positive low single-digit comp. In areas where a hybrid model is in place, we see a slight decline, and in fully remote settings, the drop exceeds 10%. We expect these trends to continue into September and October, anticipating demand in the coming months. This requires us to remain flexible as there are various scenarios that could unfold regarding consumer spending. We wonder if this back-to-school period will remain prolonged as expected, or if we might see another back-to-school date later in the fourth quarter or even in January next year, depending on how schools manage the pandemic situation. Other factors include the potential effects of additional stimulus and unemployment rates. We also need to consider how to handle peak periods if we cannot increase store capacity and how safety measures will affect both our staff and customers. There’s a lot to consider, and we understand the importance of being cautious and nimble. Our teams have been effective in navigating these challenges, and we feel confident about our position in the retail marketplace for the latter half of the year, regardless of how the next quarters unfold.
Janine Stichter, Analyst
Great. That's incredibly helpful detail. And then just a follow-up on footwear. Can you elaborate a little bit more on the weakness? Is that just the inventory challenges you referenced or is it more of a back-to-school business typically? Or is there some change in trends? Any color there would be helpful.
Rick Brooks, CEO
Yes, Janine, I'll start and let Chris add any comments he might have. Some of this is related to trends. Remember, we have been on a multi-year run for footwear prior to this. A couple of years ago, we experienced a long build-up in our footwear cycle. Some of this is clearly a result of the pandemic and the supply chain challenges that Chris mentioned. There are multiple factors driving our current situation. Footwear has faced more difficulties, except for certain categories, before the pandemic. We have clearly seen the impacts of supply chain issues, which highlight how challenging the footwear industry is to manage. Everyone has to take on more risk in footwear due to sizing variations in the market. However, the key point for me is that despite the challenges in footwear, we have achieved what I consider to be remarkably good results. As Chris mentioned, regardless of how the third or fourth quarter unfolds this year, I am completely confident that we will outperform all our competitors, particularly in retail. This is due to the dynamism of our business, with the number of brands we carry, the emerging brands growing within our portfolio, and the variety of departments and categories we present to our consumers, reflecting diverse lifestyles across the market. I am confident that no matter the footwear challenges, our business focuses on managing the diversity of our offerings to cater to our self-expressive consumers. Our aim is to thrive in a fluctuating market, whether it is a booming skate market or a challenging footwear market, by recognizing that while some categories and departments may decline, others will grow. We strive to build a diverse portfolio of departments, categories, lifestyles, and brands that generate positive results across different market cycles. Specifically, some of the footwear challenges are related to growth trends and, more importantly in 2020, to supply chain issues and the complexities of managing size and density in the footwear industry, along with the risks involved in inventory. I want to remind everyone that our model is designed to withstand downturns in specific departments while capturing market share in other areas through different brands and departments to achieve gains. That’s our strategy.
Operator, Operator
Our next question comes from Jeff Van Sinderen with B. Riley. Your line is now open.
Jeff Van Sinderen, Analyst
Terrific work in Q2. Can you speak more about what you're seeing in the California market with closures? Did you see business there shift to digital? And then what have you seen in markets in California that have reopened?
Chris Work, CFO
Yes, Jeff. As we mentioned in our prepared remarks, we reopened most of our California stores in the second quarter but had to close them again in the second week of July, remaining closed through the end of July and into August. California accounted for a significant portion of our sales decline in both July and August, and in the back-to-school period, it was a major factor, likely contributing around one-third of the overall decline at a consolidated level. We noticed some challenges there, even after considering online sales. However, we did experience an increase in online sales, similar to what we observed during the temporary closures earlier this year, where we noticed spikes in volume in affected regions. Recently, we have reopened many of our California stores, except for those in LA County and a few others, and we've seen a positive rebound as expected. We'll monitor how this situation unfolds as we progress through Q3, but it certainly had a significant effect at the end of Q2 and during the back-to-school period.
Rick Brooks, CEO
And I'd just add to Chris' comments, Jeff, that, of course, I'm sure you're aware most of California is going to be a virtual back-to-school. So again, as we think about the impact of California, we're thinking that how schools go back is going to be reflective of how we capture whatever back-to-school turns out to be. So if it lengthens out and is prolonged, we think those are probably more likely the markets where we'll see that back-to-school stretched out.
Chris Work, CFO
Sure. Let me discuss our overall cash position and what we've outlined in this call. We are extremely pleased with our financial strength. We started the year in a solid position due to careful planning and hard work. Our teams have managed exceptionally well during the first six months, leading us to our current cash balance of $299 million with no debt. However, we want to mention that we have just over $40 million in deferments and other costs on the balance sheet that we consider significant. So when we evaluate our cash balance, a more realistic figure might be closer to $260 million. This takes into account not just deferrals, but also our inventory situation, which is lighter than we would prefer. While we may not repurchase all of that inventory, we aim to acquire a substantial portion, in addition to the accounts payable and payroll deferrals we are utilizing. As we progress through the year, we anticipate that much of this will be settled. Regarding our rent situation, we’re not going into extensive details, but we are collaborating closely with our landlords. This is a challenging time for both sides, and we are striving for the best possible outcome. In some instances, this has led to deferments or abatements, and we will continue to reassess as we evaluate our locations in the future. This is consistent with trends we've seen over the past 5 to 10 years. Some malls succeed in certain markets while others face challenges, and we need to work together to optimize them and align costs effectively. We expect this dynamic to continue in the current market, and we believe that, in the long term, we can enhance our store real estate through our unified channel strategy.
Operator, Operator
Our next question comes from Mitch Kummetz with Pivotal Research. Your line is now open.
Mitch Kummetz, Analyst
Thanks for taking my questions. I guess I got a few of them. So Chris, on 3Q to-date, I know you guys are down 14%. Can you say what percent of 3Q is normally in the books after 37 days of the quarter? Is it like 55%, 60% given the importance of back-to-school?
Chris Work, CFO
Yes. Given the delay of where we are now, it's in that range, it's closer to that 60% that we are through the Labor Day weekend that we reported.
Mitch Kummetz, Analyst
Got it. And then on gross margin, I think in your prepared remarks, you mentioned that product margins should be up year-over-year, maybe not as strong as it was in 2Q. But could you maybe speak more broadly about gross margin? Do you expect that to be up or down? I would imagine that if the sales are down in 3Q, that could put some pressure on occupancy and if digital continues to outperform, maybe that puts a little pressure on shipping. So could you kind of maybe work through those components?
Chris Work, CFO
Yes, I find this situation quite interesting. We experienced a 9% sales increase in the second quarter, which led to a notable improvement in gross margin, rising by 250 basis points. While we noted a 170 basis points benefit from product margin, we also observed good leverage across occupancy and various distribution costs, as well as some advantages in shrinkage. However, web shipping impacted this, increasing by 160 basis points, although it did leverage as a percentage of digital sales. This is significant because, although we see some increase in gross margin due to the shift toward web sales, it's accompanied by leverage across digital sales, which is crucial for our business metrics. Looking ahead to Q3, we anticipate that product margins will increase, though not to the extent seen in Q2. Our gross margin outlook will be closely related to the sales mix and overall sales trends. As you mentioned, if sales decline, it could pose challenges for gross margin. Nevertheless, we expect web sales to make up a larger share of total sales in the third quarter, as we've observed during the back-to-school season, which may exert some pressure on gross margin. Ultimately, if we can continue to manage expenses well, we believe it could still benefit our overall bottom line. We're trying to navigate this variability, which hinges on sales numbers. However, if we can achieve sales growth, we believe there remains an opportunity to enhance gross margin.
Mitch Kummetz, Analyst
Got it. Finally, regarding hardgoods, I understand that this category had the strongest performance in the quarter, continuing a trend from previous quarters. Can you share how the year-over-year growth compares to the next best category? There has been considerable discussion about the strong sales of equipment like bikes this summer. So, I have two questions. Could you elaborate on the growth of hardgoods? Additionally, how do you foresee this business performing in the second half of the year as the weather changes? Do you expect a decline, or might it transition into a strong snow hardgoods market? Please provide more details on that.
Rick Brooks, CEO
Let me start, Mitch, and then I will ask Chris to add some details to your question. We view these department-driven cycles as multi-year processes. About four to five years ago, we experienced a multi-year cycle in footwear that lasted for several years. Currently, we are in the second year of the skate hardgoods cycle. The question is whether the impact of the pandemic is speeding up the cycle, which is somewhat implied in your question regarding outdoor activities. We are not sure if we have a definitive answer to that. We believe there are multiple factors influencing the current skate cycle. First, we saw about four to five years of decline in skate hardgoods, and now we are starting to level out concerning consumer demand. Second, there has been a significant increase in women purchasing skate hardgoods and products, which is a notable change we've noticed across the country. Additionally, we believe that the rising popularity of the skate lifestyle and skate hardgoods is now more ingrained generationally than ever before. Young people are buying their first skateboards, while their parents are re-purchasing to skate with them. This generational dynamic is a positive development in the market. It suggests that the potential market for skate hardgoods may be larger during this cycle. Lastly, regarding our position in the skate hardgoods market, consolidation over the past five to ten years means there are fewer retailers selling these products. We are positioned as a significant player, gaining market share amid this consolidation, which presents more opportunities for us over the next five years. That summarizes our perspective, Mitch, on the trends at play. I’m uncertain if the pandemic has accelerated anything. However, I know these cycles typically unfold over multiple years. There are various trends driving this ongoing cycle, and I will let Chris address the magnitude of these developments.
Chris Work, CFO
Yes. So I'm going to stay away from talking about just comp numbers just because what we like to do when we talk about categories is to get to the total year. I think what's important to point out and we have disclosed is if we think about hardgoods in general, in 2018, it was 10% of the business, and in 2019, it was 13% of the business. So you can see the impact it had in year 1. And while we need to see how Q3 and Q4 play out, the impact has been pretty substantial for this year as well, as really our only positive comping category, there is some significance there. So again, I'll stay away from totally quantifying other than to say the kind of growth we've seen from '18 to '19 looks possible in '20 as well.
Rick Brooks, CEO
And I guess I'd just add in. Chris, you can just confirm this for me. But Mitch, I think the size of our comps in skate hardgoods was significant. I don't think there's a big difference between their magnitude relative to other. They're obviously larger, but to the magnitude to other comps, I'm not sure there's a big difference between '19 and '20 really now.
Operator, Operator
Our next question comes from Jonathan Komp with Baird. Your line is now open.
Steven Nowotarski, Analyst
This is Steve Nowotarski on for Jon. I guess my first one is just looking out, how are you thinking about the shape of holiday this year? I know some retailers have talked about maybe having a more extended season, having orders pulled forward, and especially as it pertains to maybe concerns about capacity with shipping and everything. So just any thoughts around the shape of holiday this year?
Chris Work, CFO
Yes, I think it relates to how we're approaching the rest of Q3 and Q4. We need to remain very flexible. We're focusing on the various trends regarding volume distribution and what that could mean around the peak like the Black Friday weekend. We're also considering the in-store experience, such as whether we will have metering or face challenges getting people through our doors and how we'll communicate that to them. Additionally, we're thinking about the implications if schools return to in-person learning more uniformly in January. We are evaluating numerous scenarios, which aligns with our earlier discussions about being adaptable. There are many uncertainties, and I've mentioned some of those earlier. Another factor is the upcoming election, which could impact the fourth quarter. We see significant potential for growth along with some challenges, and we will do our best to navigate that while capitalizing on available opportunities. As Rick mentioned in his prepared remarks, that is crucial for us. We've positioned ourselves well financially, and while we are aware of potential challenges ahead and are committed to emerging from them in a strong financial position, we also want to be strategic about investments that could help us accelerate during this period. Our experiences from the 2008-2009 recession taught us valuable lessons, and some of our best investments over the past decade resulted from that cycle.
Rick Brooks, CEO
I want to emphasize that we are addressing several tactical issues that we believe will help us navigate the challenges we anticipate during the holiday season. This includes considerations about potential delays, market peaks, and the impact of increased digital penetration. We're working on some strategies that we think will be beneficial, although we won't reveal all the details at this stage. Our goal is to implement tactical solutions that will enable us to meet consumer expectations and demands effectively.
Chris Work, CFO
Yes. Thanks. This is one of the challenges we'll face as we head into 2021, and likely most retailers will have similar considerations. We are very proud of how we've managed through this situation. Our teams have done an exceptional job in building and then rebuilding the 2020 budget. We've engaged in various scenario planning to navigate through the highs and lows. However, as we look ahead to 2021, we recognize that during the time our stores were closed, while we may be able to recapture some sales, we've also had to manage a significant amount of costs. There are key areas in our overall philosophy that are important to us. Moving into 2021, we expect an increase in our cost structure, particularly within SG&A, as we work to revitalize the business and as we no longer benefit from certain savings, such as rent abatements, payroll credits, reduced operating hours in malls, and cutbacks on travel and national events. We plan to gradually reinstate these elements where it makes sense. Over the past six months, we have been trying to understand what this looks like, and we will likely provide more details during our Q4 call, and potentially even our Q3 call, as this is crucial for aligning our modeling. We believe it is important to reinstate our national events, which are highly focused on training our store managers and developing new salespeople. However, we are uncertain about what the first three to six months of 2021 will look like. We are assessing whether we can gather all of our managers and district managers together. Additionally, we are collaborating with landlords to understand how operating hours may shift as we approach and move beyond the holiday season, along with other operating procedures and management of marketing events. Looking at the long term, we will likely see some rationalization into 2021, possibly extending into 2022. Yet, we remain committed to the philosophy we have maintained over the past couple of years. In our more mature markets in North America, including the U.S. and Canada, we aim to manage those markets with a low single-digit comp over the long term, focusing on cost management while making the right business investments and achieving operational leverage. On the international front, as Rick mentioned earlier, we believe there is substantial growth potential. These markets are performing well despite the ongoing pandemic. In Canada, for instance, we've achieved strong profitability and cash flow, and we aim to replicate this success in Europe and Australia by leveraging scale and managing these businesses effectively. These international markets will see different cost structure management due to elevated sales gains from additional units and strong performance in newer markets. Consequently, we expect their expense growth to be significantly less than their sales growth, allowing us to show leverage and guide them toward our profitability goals. While the situation is complex and presents many challenges, we believe we are well-positioned to navigate through it.
Rick Brooks, CEO
Alright. Thank you. And I just want to close today's call with a big thank you to all of our teams around the world. And our brand partners, too, for all their hard work through 2020. And we really appreciate an amazing effort by everyone to really help us serve our mutual customers everywhere we do business. So thank you, everybody. And we look forward, again, to talking to all of you when we do release the third quarter earnings in December. Thanks, everybody.
Operator, Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.