Zumiez Inc. — Q2 FY2014 Form 10-Q
Business context and period. Specialty retailer of action-sports apparel, footwear, accessories and hardgoods, operating Zumiez and Blue Tomato stores and ecommerce sites. The quarter was the 13 weeks ended August 2, 2014; the six-month period was 26 weeks. At quarter-end, Zumiez operated 582 stores: 535 in the U.S., 33 in Canada and 14 in Europe. Results are seasonal and interim performance is not necessarily indicative of the full year.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | First half FY2014 | First half FY2013 |
|---|---|---|---|---|
| Net sales | $176.7 million | $157.9 million | $339.6 million | $306.4 million |
| Gross profit / margin | $60.9 million / 34.5% | $55.1 million / 34.9% | $111.4 million / 32.8% | $103.1 million / 33.7% |
| Operating profit / margin | $11.6 million / 6.6% | $7.8 million / 5.0% | $15.3 million / 4.5% | $11.9 million / 3.9% |
| Net income | $7.5 million | $4.7 million | $10.0 million | $7.2 million |
| Diluted EPS | $0.26 | $0.16 | $0.34 | $0.24 |
- Sales and comparable sales: Q2 sales rose 11.9%; first-half sales rose 10.9%. Comparable sales increased 3.4% in Q2 and 2.6% in the first half. Q2 comparable ecommerce sales grew 22.2% and comparable store sales 1.5%; ecommerce was 9.6% of quarterly sales, up from 8.8%.
- Cash flow: First-half operating cash flow was $30.5 million, versus $9.9 million a year earlier. Capital expenditures were $18.3 million, producing operating cash flow less capital expenditures of approximately $12.2 million. Investing cash use was $13.1 million; financing cash use was $15.1 million, including $19.6 million of share repurchases. Cash increased $2.4 million to $22.0 million.
- Liquidity and debt: Cash and current marketable securities totaled $113.4 million. Current assets were $269.2 million and current liabilities $113.0 million. No borrowings were outstanding on the $25 million Wells Fargo revolving facility; $0.5 million of commercial letters of credit was outstanding. The company also reported $1.1 million borrowed on international revolving lines and $1.8 million of other long-term debt.
- Balance sheet changes: Inventory rose to $119.9 million from $87.2 million at fiscal year-end; trade payables rose to $66.6 million from $18.3 million. These movements contributed materially to working-capital cash flows.
Material changes versus comparable periods
- Quarterly gross margin fell 40 basis points, principally from a 60-basis-point decline in product margin, partly offset by supply-chain efficiencies. First-half gross margin declined 90 basis points, primarily reflecting lower product margin.
- SG&A increased in dollars but declined as a share of sales: 27.9% versus 29.9% in Q2 and 28.3% versus 29.8% for the first half. Management attributed the improvement to expense leverage and the absence of Blue Tomato incentive-payment expense recognized in 2013.
- Net income and diluted EPS increased in both comparison periods. Lower effective tax rates also helped: 37.6% versus 39.4% for Q2 and 37.5% versus 39.3% for the first half.
- The company repurchased 758,000 shares for $17.4 million in the first half, at an average price of $23.03. The March 2014 authorization had $27.2 million remaining at August 2.
Outlook, commentary and risks
- Management expected fiscal 2014 capital expenditures of approximately $38–$40 million, primarily for leasehold improvements and fixtures for 56 planned new stores, plus remodels and relocations. The filing provides no earnings or sales guidance.
- Management said available cash, marketable securities, operating cash flow and borrowing capacity were expected to cover operating needs and planned capital expenditures for at least the next 12 months. The company was compliant with its credit-facility covenants at quarter-end.
- Open merchandise purchase orders totaled $154.8 million; most could be canceled before shipment, subject to exceptions for certain private-label and international orders. Minimum operating lease commitments totaled $398.8 million, excluding contingent rent and other occupancy costs.
- Blue Tomato sellers and certain employees could receive up to €22.1 million in conditional incentive payments tied to performance and continued employment through April 2015. At quarter-end, Zumiez estimated it would owe no payment.
- A California assistant-store-manager wage-and-hour class action had a conditional $1.3 million settlement. Preliminary approval had been granted; final approval was scheduled for September 10, 2014. The settlement expense was recorded in fiscal 2013.
- Key disclosed risks include fashion and inventory misjudgments, discretionary spending and mall traffic, seasonality and weather, competition and ecommerce, vendor and sourcing disruptions, foreign exchange exposure, substantial lease obligations, international expansion, and data-security and litigation risks. Management reported no material change to the prior 10-K risk factors.
- Other items: foreign-currency translation reduced Q2 comprehensive income by $2.9 million; the company early adopted new share-based compensation guidance without material impact. The effect of the forthcoming revenue-recognition standard was still being evaluated.
Investor verification points
- Confirm comparable-sales trends and ecommerce growth, including whether online growth is translating into durable profitability.
- Track product margins, markdowns and inventory levels, particularly ahead of the seasonally important back-to-school and holiday periods.
- Assess the cash impact of planned store openings, share repurchases, purchase commitments and lease obligations.
- Verify final court approval and payment treatment of the $1.3 million settlement, and monitor any changes to the estimated Blue Tomato incentive obligation.
- Review the value and liquidity of municipal securities and variable-rate demand notes, and monitor foreign-exchange effects and credit-facility covenant compliance.