ZUMZ

Zumiez Inc. 10-Q Summary: Quarter Ended October 30, 2010

Business Context and Reporting Period

Zumiez Inc. is a specialty retailer of action sports apparel, footwear, equipment, and accessories. As of October 30, 2010, the company operated 400 stores across 37 states, primarily in shopping malls, targeting young men and women aged 12 to 24. This filing covers the quarterly period ended October 30, 2010 (13 weeks) and the nine-month period ended October 30, 2010 (39 weeks).

Key Financial Metrics

Liquidity: The company holds significant liquid assets, including $8.3 million in cash and $90.6 million in marketable securities. It maintains a $25.0 million secured revolving credit facility with no outstanding borrowings as of the period end.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 20.0% year-over-year for the quarter and 17.3% for the nine-month period. This was driven by a 14.4% increase in comparable store sales for the quarter and the net addition of 22 stores.
• Profitability Improvement: Gross profit margins expanded significantly, rising 360 basis points to 39.0% for the quarter and 240 basis points to 33.9% for the nine months. This was due to product margin improvements and reduced store occupancy costs.
• Expense Management: Selling, general, and administrative (SG&A) expenses as a percentage of sales decreased by 300 basis points for the quarter and 180 basis points for the nine months, aided by operating efficiencies and a change in accounting estimate regarding leasehold improvement depreciation lives.
• Accounting Change: The company extended the estimated useful life of leasehold improvements from 7 years to 10 years (or lease term), reducing depreciation expense by $1.1 million in the quarter and $3.2 million in the nine months.

Guidance, Outlook, and Risks

• Capital Expenditures: Management expects to spend approximately $26 million to $28 million on capital expenditures for fiscal 2010, primarily for new store openings and the acquisition of a new distribution center in Corona, California.
• Store Expansion: The company plans to continue opening new stores, though success depends on locating suitable sites and managing operational resources.
• Litigation: The company reached a settlement agreement regarding a class action lawsuit (Chandra Berg et al.) expected to cost approximately $2.1 million, which was accrued in the quarter ended July 31, 2010.
• Investment Risks: The company holds $0.9 million in an auction rate security that has failed to sell in recent auctions. While currently classified as a temporary impairment, liquidity issues in the credit market could limit the ability to liquidate this asset.
• Operational Risks: Key risks include dependence on shopping mall traffic, volatility in fashion trends, supply chain disruptions, and the impact of economic conditions on discretionary spending.

Investor Verification Checklist

• Comparable Store Sales: Verify the sustainability of the 14.4% comparable store sales growth and the drivers (transaction volume vs. ticket size).
• Inventory Levels: Review the $83.1 million inventory balance and the $1.3 million reserve to assess potential markdown risks given the seasonal nature of the business.
• Capital Allocation: Monitor the execution of the $26-$28 million capital expenditure plan, specifically the integration of the new Corona distribution center.
• Litigation Costs: Confirm the final payout of the $2.1 million class action settlement and ensure no additional legal contingencies arise.
• Auction Rate Security: Track the status of the $0.9 million auction rate security investment and any potential future impairment charges if liquidity does not improve.