Rick Brooks - CEO Chris Work - CFO

Jeff Van Sinderen - B. Riley and Company Jonathan Komp - Baird

Good afternoon, ladies and gentlemen. And welcome to the Zumiez Inc. Third Quarter Fiscal 2017 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’s filing with the SEC. At this time, I’ll turn the call over to Rick Brooks, Chief Executive Officer. Please go ahead, sir.

Thank you, and welcome everyone. Joining me on today's call is Chris Work, our Chief Financial Officer. I’ll start today’s call with a few brief remarks regarding our third quarter performance. I’ll then give an update on our broader strategy, and will hand the call to Chris, who will take you through the numbers. After that, we’ll open the call to your questions. Our third quarter sale results came in ahead of expectations during an important back to school season. Third quarter comparable sales rose 7.9% versus our original guidance up 4% to 6%. This comes on top of a 4% increase a year ago and marks our 5th consecutive quarter of positive comparable sales and transaction gains. We're extremely pleased with the strength of our business in a difficult retail environment as it validates our ability to serve the customer to the efforts of our collective teams. our momentum continued in November as comparable sales increased 7.8% for the month, representing a great start to the holiday season. With third quarter earnings growth of 11.5% and a strong start to the fourth quarter, we're well positioned to deliver annual improvement in the year-over-year profitability. Our results underscore our ability to drive customers with authentic and differentiated products assortments that appeal to the individual taste across multiple lifestyle categories and deliver a great shopping experience regardless of where and when they choose to engage with us. Providing the customer with a great shopping experience has always been our mission. Our sustained success is result of our ability to adapt to the rapid changes of the consumer preferences and purchasing behavior. Trends emerge and spread much faster in our more connected world and customers expect to be able to experience brands on a much more frequent and more personalized level. We have continued to separate ourselves from the competition by constructing a lifestyle retailer with our unique culture and brand at the center to meet increasing demand of today's consumer while maintaining the flexibility to continually adapt the future of market place changes. We're confident that the investments we have made and we will continue to make in key areas including working with emerging brands, planning and allocation, logistics, enhancing our sales channel and most importantly our people will further strengthen our competitive dynamics and support long-term profitable growth. Let me provide an update on certain key initiatives. We continue to find new and unique brands across all departments around our product assortments. This year we’ve already launched over 100 new brands bringing a newness and localized fashions that our customers are looking for. These emerging brands coupled with the growth of more established brands within our portfolio, our inner growth is fast of our business model and have a direct impact on both our current results and those in the coming years. With respect to our physical presence we believe brick and mortar is critical to successfully executing our customer centric growth strategies. Therefore, we continue to proactively open stores in each of our geographic regions with a goal of achieving the optimal number of locations require to reach our customers and provide them with a superior level of service they expect from Zumiez's. Along this line our pace in new store openings in North America has moderated over the past few years as we optimize our presence in each trade area. Year to date we've opened the 12 new stores planned for the U.S. and Canada bringing our total store count in North America to 659 stores. To reiterate what I said on our last earnings call, we are being very thoughtful and deliberate in managing our North American real estate portfolio to minimize risk and bring long-term value to both our customer and our shareholders. We’re confident that the vast majority of our stores in the surrounding trade areas will continue to achieve and/or exceed their productivity targets. For those locations where we’re less certain, we focus on both reducing rent and shortening lease terms down in the one to three-year range to provide added flexibility. This aligns with our capital spend that prioritizes those locations that we believe have potential for long-term success. At present within the bottom 20% of our North America store base in terms of store contribution we have the right to exit over 85% of those stores in the next three years. While this highlights the least flexibility that we have within our lower performing stores, it's important to note that at this time, the majority of these stores provide positive contribution and cash flow. Overseas we see a longer runway for growth as our store footprint is significantly smaller. 2017 we're on track to open five Blue Tomato locations in Europe which will bring the total store count to 34 by year end while in Australia we’ve added two Fast Time locations for a total 7 stores in the market. We're excited about the long-term potential of these markets and continue to apply a combination of best practices from each of our teams to build on the strong foundations already in place. Lastly, we rolled out our new customer engagement suite to approximately 30% of our U.S. store fleet. The combination of this system enhancement and our existing digital capabilities allow us to both learn more about our customers and engage with them in a more meaningful way. This sort of engagement along with face to face in store interactions helps keep our fingers on the pulse of local trends allowing us to provide hyper localized authentic product assortments and a superior personalized brand experience for our customers. To close we are obviously pleased with momentum we are experiencing as we head into our busiest and most profitable selling period. We are committed to fully capitalizing on the many near term opportunities ahead of us to deliver a strong finish to the holiday season and 2017. The same time our sights are firmly on the future and we'll continue to make decisions in the best long-term interests of the company and its shareholders. I want to thank the entire Zumiez team for the 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. With that I'll hand the call to Chris for his review of the financials. Chris.

Thanks Rick and good afternoon everyone, I'm going to start with a review of our third quarter results. I'll then provide a brief update on November before discussing our fourth quarter guidance. Third quarter net sales increased $24.4 million or 11% to $245.8 million from $221.4 million a year ago. Contributing to this increase was the positive comparable sales growth of 7.9% and the net addition of six stores since the end of last year's third quarter. During the 2017 third quarter we saw an increase in transaction volume partially offset by the increase in dollars per transaction. The decrease in dollars per transaction resulted from lower units per transaction partially offset by an increase in average in retail. During the quarter the men's category provided our largest positive comparable sales increase followed by juniors. Accessories was the largest negative comparable sales category followed by hardgoods and then footwear. From regional perspective North American net sales increased $20.2 million or 10% to $223.1 million, international net sales which consist of Europe and Australia increased $4.2 million or 22.5% to $22.7 million. Third quarter gross profit was $83.4 million an increase of $7.2 million or 9.4% compared to the third quarter of 2016. Gross margin was 33.9% in the quarter down 50 basis points compared to 34.4% a year ago. This decrease was driven primarily by an 80-basis point increase in inventory shrinkage and a 40-basis point decrease in product margin, partially offset by a 90-basis point decrease in occupancy cost, which leveraged on strong sales result. The decrease in product margin is due primarily to our efforts in our European business to move through aging inventory and to a lesser extent a slight decline in North America. SG&A expenses was $64.6 million in the third quarter compared to $59.3 million a year ago. SG&A as a percentage of net sales improved 60 basis points to 26.2% compared to 26.8% in the prior year. The decrease was primarily driven by 90 basis points from the leveraging of our store costs, partially offset by a 40-basis point increase related to our annual incentive compensation. Operating income in the third quarter of 2017 was $18.8 million or 7.7% of net sales, an increase of 11.2% as compared to the prior year operating income of $16.9 million or 7.6% of net sales for the third quarter of 2016. Net income for the third quarter was $11.9 million or $0.48 per diluted share, an increase of 11.5% as compared to net income of $10.7 million or $0.43 per diluted share for the third quarter of 2016. Turning to the balance sheet, cash and current marketable securities totaled $85.8 million as of October 28, 2017, up from $49.2 million as of October 29, 2016. The increases driven by cash generated through operations, partially offset by capital expenditures. As of October 28, 2017, we had a $157 million in inventory up 4.2% from this time last year. Turning to our November sales results, total net sales for the four-week period ended November 25, 2017, increased 11.3% to $77.1 million compared to $69.3 million for the four-week period ended November 26, 2016. Comparable sales increased 7.8% during the four-week period ended November 25, 2017 compared to the comparable sales increase of 5.7% for the four-week period ended November 26, 2016. The comparable sales increase was driven primarily by an increase in transactions, partially offset by a decrease in dollars per transaction. Dollars per transaction were down for the four-week period due to a decrease in units per transaction, and to a lesser extent averaging unit retail. During the four-week period, the men's category provided our largest comparable sales increase followed by juniors, while accessories was our largest negative comparable sales category followed by hardgoods and footwear. Looking at our guidance for the balance of 2017, once again I'll start off by reminding 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. We're currently planning fourth quarter comparable sales results in the range of positive 3% to positive 5%, with total sales in the range of $291 million to $297 million. We anticipate that gross margins will increase in the range of 20 basis points to 50 basis points compared to the fourth quarter of 2016. Consolidated operating margins are expected to be between 10.5% and 11% with earnings per share of between $0.78 and $0.84 compared to earnings per share of $0.74 in the prior year fourth quarter. With regard to the fourth quarter and full-year, I'd like to remind everyone there'll be an extra week in fiscal 2017 resulting in a 14-week fourth quarter and a 53-week fiscal year. The extra week will benefit sales in fiscal 2017 by approximately $9 million and earnings growth in fiscal 2017 by $0.05 per diluted share and will be a detrimental sales and earnings growth rate in fiscal 2018. Through November 25, 2017 we have opened 18 new stores, including 3 in Canada, 4 in Europe and 2 in Australia. This bring our total store count as of November 25, 2017 to 699 including 659 in North America, 33 in Europe and 7 in Australia, and excluding two stores in North America that are still closed due to natural disasters. We plan to open one new store for the balance of fiscal 2017 as well as potentially reopened the two stores I just referred to you that were damaged by weather. Full-year capital expenditures are expected to be between $24 million and $26 million. We anticipate depreciation and amortization would be approximately $27 million in line with the prior year. We are planning our business assuming an annual effective tax rate of approximately 38%. Lastly, we are currently projecting our weighted average shares used in the calculation of diluted earnings per share for the full-year to be approximately 25 million shares. And with that operator we would like to open the call up for questions.

[Operator Instructions]. Our first question comes from Jeff Van Sinderen with B. Riley. Your line is open.

Let me first say congratulations on the continued strong performance in the November. Maybe you can touch a little bit more on gross margin, I think you guided to an increase of 20 to 50 basis points year-over-year, just wondering I guess what’s baked into that for merchandize margin and for shrink.

Sure, thanks Jeff for the congratulations. From a gross margin perspective as we did, we said 20 to 50 basis points what we're thinking here on a product margin perspective is we'll probably be up about 10 to 20 basis points, we're expecting to see some benefit there on product margin and then we expect to continue to see some leverage on occupancy, obviously based on the sales levels that we’re as well as the environment we have been able to leverage occupancy pretty well over the year and the guidance does assume a little bit of risk on the shrink side, I think the one piece to call out there is its less of an impact in the first three quarters of the year, based on the fact that we started to see shrink increase in the fourth quarter of last year. So that’s kind of how we’re thinking about gross margin for the fourth quarter on the three to five guidance.

Okay great that’s helpful and then is there anything more you can share on trends that you're seeing in the pure e-com business and I guess any changes in consumer behavior that are worth talking about or that you perceive as kind of, I guess as more as being done on mobile these days.

Let me start Jeff and then I'll ask Chris to chime in and you know I always start this topic Jeff, which is I don’t really like to talk about differences between channels and in fact I'm not even sure I like the word omnichannel any more I actually prefer I think channels or integrated retailers as a way of thinking about what we're doing as a model. And so again we will share some highlights for Q3 about that in a moment, but let just may be phrase up a little bit about how we're thinking about where we’re at, what we're doing, and what's next in this area. So you know we made great progress over the last six and seven years of building I think, this integrated model to serve customers and this is a model that has changed absolutely, every aspect our business from how we micro sort locations and trade areas to how we think about sales teams, we don’t think about a web sales team any more, we don’t think about a stores sales team anymore, we think about our integrated sales team and how we’re serving customers and how they work together to do that. We think about how all those things optimize customer experiences, we think about how that’s changed, how we incentivize our teams across the company for this integrated channel retail world. And again, virtually every aspect of our business has been touched by the demands of the consumer in terms of how they have really changed. So, every touch point that’s guiding us Jeff is as if I did that, we’re going to empower our consumer to make choices and put the power in their hand and let them choose how they want to interact with our brand and we're going to be relevant in each of those touch points, highly relevant hopefully in both product and experiences and we're going be fast at every touch point as we work through that. So those are kind of guiding principles for us, Jeff as we think about what we’re doing as we think about this integrated model and again I think we just made amazing progress and Chris maybe share a little bit about our this idea of distributor localized fulfillment over the last weekend. I mean, it’s amazing what our teams can do. But that being said, what the products we made, we have much work to do, both in tuning, our existing integrated sales model and in pushing ourselves to enhance and build on our ability to serve these customers. We have a whole new wave, I think of really big ideas initiatives in front of, over the next three to five years for us to tackle to really again continue to meet the needs of this empowered consumer. So, from that perspective, I think we are pretty excited about the opportunity that’s in front of us in this integrated sales role. And I’ll ask Chris to share a little bit of information for you.

Yes, sure. And just add to what Rick and I’ll share a couple of stats for you. I mean our teams have just performed fantastic job of fulfilling orders here throughout both the busy back-to-school time period, but also as recently as Black Friday and Cyber Monday. And I think the model really is working as Rick laid out, right. We’re doing localized fulfillment, we are fulfilling closer to the customer and we’re really able to leverage our store system to help perform that task and get it to the customer sooner. So, we saw that the fastest fulfillment, we’ve ever seen with over 95% of our order shipping same day, because we’re able to fulfill out of our vast store network. We also saw a meaningful increase in sales, but less packages, which ties to kind of our continued effort here and we’ve been doing this for couple of years to get the product mix right within each market place, meaning there’s less split shipment, and we’re able to provide a better customer experience overall. As that translates to overall sales, I totally share Rick’s comments of this is an integrated world. I don’t think the customer views this as I’m shopping on the web, or I’m shopping in stores, there is no omnichannel to them. They’re just shopping. That’s what they do starting online, getting into stores, going into stores, finishing online, whatever way they would like to do it. So that is why, we don’t give a lot of color on the web versus stores. Obviously, we do continue tracking in our web penetration was up. For the third quarter web penetration was 14.5% of sales, compared to 12.8% of sales in the prior year. And what's significant about those numbers is as you know we’re in a 7-9 comp in the third quarter. So, while, we saw meaningful increase in penetration in the web with only 14.5% of your sales been completed online, then that still shows an immense comp, right, in the actual store system in fact. What I refer to as high mid-single-digits has to be in the store system to still achieve the 7-9 comp. So really proud of our teams and how they have tied together a complete sales experience with a customer and a really strong third quarter and start to the fourth quarter regards to enhancing the customer's experience through our localized fulfillment model.

[Operator Instructions]. Our next question comes from Jonathan Komp with Baird. Your line is open.

I wanted to start on the same-store sales. Really just looking over the last few months, I know at least on a one-year basis that overlap or comparison has become tougher and yet your business has not flown. So, I’m just curious if you’re, maybe how you’re viewing the trend recently and maybe talk more about some of the drivers and really that sustainability going forward.

Great. Thank you, Jonathan. I will start again and I'll probably ask Chris again to share a little bit of data with you about the penetration and mix on brands and I think it will be helpful for you probably to think about this but let me again start out with kind of an overview relative to the performance this year and how we are thinking about what's driving the business and how we think about it as we are looking forward about how our model will sustain that. So, we've talked previously that I think we're very uniquely positioned retailer not just incentive of the integrated model we build but our really-really strong brand positioning and unique product mixes and we said that really three things that drive our sales and three main sales we always talked about two in order a priority. The first one being that we can take emerging brands and over a period of years a number of those brands become growth brands for us and growth drivers. So, I'll ask Chris in a moment to kind of share a little bit about some of them, just a few of those brands and what they are doing in terms of driving the business today and how we think they have some room left potentially to continue driving the business. But this is the one thing that is unique to our model Jonathan, I mean no one does that work with emerging brands that I don’t think is effectively as our team does and we've been doing it literally for decades so this is something that’s very unique to our model it's very important to our model and it provides to a large extent almost a complete exclusivity around our work with these brands in the broadest sense. So emerging brands are the key driver for us, emerging brands become growth brands and that's why we are talking a lot about how we keep feeding young brands into the system. The second thing for us is fashion trend cycles and here our customer expect us to lead on these cycles be there early have the product when they want it, relative again to the broader market but generally here we don’t have as much exclusivity we might have a short lead in terms of maybe in hope of being ahead as since we will be trying to do it first before most of our competitors but then eventually because they are general fashion type trend cycles people can catch-up and follow us in those areas. And the last item that drives our business into sales perspective is really item drivers. And we've talk about that in the past where we can have in those items maybe small and maybe something like little bit like its inconsequential but yet can drive tremendous volume. So, where we are today is that we really have some emerging brands become growth brands for us and we are definitely riding some fashion trends cycles and to a less extent do we have item drivers really the first two at this point of the game. And so what's sustainable for me about this as you look at our models is this idea of our ability to really work with these young brands and to help them and there is more -- the brands have to do the hard work of building their business but we are getting better and better and I would say this is the biggest estimates our teams have made over the last three and four years in terms of our capabilities of working with these young brands the tools that we can bring to bear to help them as they grow and we have a whole range of tools that our teams will work these young brands on this that says how can we help you let's look at the range, serious kind of a menu you can think about and off course that menu includes our global footprint which is when they are ready we are ready in Canada, we are ready in Europe, and we are ready in Australia or if it's an Australian vendor is ready in the U.S. and Canada and Europe to help them. So, I think this is one of the areas that is as a real strength for us, we feel very good about the young brand pipelines, we're going to as I said exceed our 100 goal target this year in the process into the brand launches and off course those can be very -- hopefully will be very important to us in two and three years when some of those brands inversely become growth drivers on our business. So, I think we feel pretty strongly positioned at our business model is what's driving this behavior I don’t think anyone is as well positioned and knows how to work with young brands like our product team does. So, with that I'll ask Chris to share some data with you.

Great thanks Rick, I think Jonathan one of the things we presented in the last few quarters or last few years really just talking about kind where our top 10 and top 20 brands sit and as we look at the third quarter we continue to see kind of a further concentration of those brands meaning that the top 20 represent a higher percent of overall sales than they did a year ago at the same time. We continue to also see that turnover that we talked about, 20% to 30% turnover in the brands it again speaks to Rick's points around the new net, and then the last thing I would point out is in June of 2016, when our results were not quite as good, Rick and I talked about some things we started to see in the business specifically we talked about three brands that were starting to emerge that got us kind of excited about back to school and as we know now from history that materialized in the back half 2016 and has been part of our driver here that Rick just spoke to around some of the brands and moving to business. And what I point out with those three brands as we look at how they stand within our top 20, none of them have gone to that point of 6% to 9% which is typically where our top independent brand will peak any given year and in fact all of them combined are still less than 10%. So that gives us some comfort that there is still some room for growth based on historical results, now that’s not slam dunk, the brands have continued their job in innovation of products and bring newness and our sales teams have to do a great job presenting it to the customer and that’s the partnership we work on. And what I will also say as you talk about sustainability in drivers is, I just kind of continue to elaborate on the long-term model that Rick talked about, the three drivers but also it’s a diversification within categories and as you look at kind of our makeup of Q3, our men's and women's categories were the only positive categories representing about 57% of our overall sales in the third quarter, meaning the other 43% which is footwear, accessories and hardgoods continues to have some challenges and as we look at this long-term over a period of three and five years and then look backwards over the last four years what we've seen is we've seen this happen as trends change right, as one category has its challenges typically another one benefits. So, we're really encouraged by the overall sales results we're running today with only 57% of our business positive and I think that gives us some opportunity as we look to the future as new brands or trends or unique items emerged and 43% as we do peak in the apparel categories to help offset some of that.

Great and just as a follow up for the fourth quarter overall, I know you're getting the 3% to 5% comps and that implies lower trends for the next two months and just to understand, I know you have probably three quarters of the quarter that go yet for sales but could you talk about I mean how you formulated the guidance and what you're embedding there.

As we think about the fourth quarter guidance and maybe I will just talk about November a little bit deeper here. As we said we had a strong November with positive comps across the month. From a cadence perspective, weeks one and two were stronger and posting actually low double-digit comps and we just wanted to and then more to the mid-single digit comps in weeks three and four. Now we don’t see that as a negative, we actually think as we look back to last year, the first couple of weeks were pretty tough last year. It was a little bit kind of uncertainty around the election and the time after that, it was not a big shopping period where as we look to this year I think it’s more normalized with some of the trends we’ve seen over the last few years, may be absent 2016 that volumes spreading out a little bit more over the period. I will tell you we had a strong Black Friday weekend overall. And are pretty pleased with our results but as we indicated the results were more in that kind of mid-single-digit leaving the quarter. We had a great fourth quarter last year as you know. And so, as we planned the business, as we think about the remaining three quarters of the sales in December and January we plan it on that mid-single-digit mark that would get us to the 5 and top end of the guidance here for the quarter.

And I would just add John to that, the rest of it -- this is what you said, such a wild ride in holiday because we know that the middle weeks of December are always going to be really tough, great online, tough in stores. And so, you see it’s huge and this is true probably for the last decade where you’re seeing the middle weeks of December get weaker, the troughs get deeper and the peaks gets deeper. And we fully expect it to play that way. So as Chris said we are planning to that mid-single-digit number, we expect that we’ll have these tougher middle weeks and then huge weeks four and five in December. So, it always makes looking at holiday numbers a little nerve racking as you do it but we are pretty confident as we talk about here about our trend cycles. And as you said we’ve been going against tougher comp and being able to maintain the comp numbers for the current year. So, we’re confident going into it but there’s always appropriate to be just a little cautious as we look forward.

Okay. Great. And just last one from me may be bigger picture on the operating margin. Year-to-date kind of a 5% comp that’s been down slightly for operating margin and I think even the fourth quarter like-for-like basis normalizing for the extra week looks kind of flattish operating margin implied. So, I am just curious can you may be parse out how much of the some of the pressure points this year kind of either will or won’t continue going forward and how you see the operating margin or the opportunity to expand margin going forward?

Hey John and as we look at this you’re right, while we are encouraged by overall sales growth, even overall sales growth exclusive of the 53rd week is a little more muted and I think what I would point out here as we think about the results for this year I mean we are pretty excited and pleased with our top-line results. We have had some operational challenges that we needed to correct which we have talked about for the last few quarters and this quarter and mainly around the shrinkage line item. So that’s something that we have strong plans in place and plans to get fixed here in the short-term but it’s been a drag on the 2017 results and hopefully something that will be a benefit to us as we move forward. I think the other piece that we talked about throughout the year that has had an impact on the year is the incentive accrual. Clearly the results are stronger this year and as we have experienced over the last few years we have not been in a spot where we could payout target incentive. And today we actually feel like these results kinds of warrant that. We have been planning that impact in all year. That total impact on the year is about $4.6 million just to give you some perspective. And I would classify that even deeper from a standpoint of we accrue this based on a probability analysis as we move to the year and the fourth quarter of last year will really determine that some of this was going to fall off and therefore of that 4.6 million almost a third of it is the increase in the fourth quarter because we're truing up over a period where we hardly recorded any incentive compensation in the prior year. So that's something that we're glad to get into the base has been a little bit of a drag on this year but as we think about 2018 and beyond we don’t expect to have that pressure. And then there is other things too like we talked about within the Q3 results some challenge around product margin primarily related to Europe, we're taking a real strong stance in trying to clean up areas where we think we need to clean up and set us up for the long-term as Rick talked about right in his prepared remarks that we are very focused on that in driving the long-term. So, I think overall we feel pretty good about some of our opportunities heading into 2018 and we will obviously will hold on giving any guidance for '18 until we get to March. But I think from a cost perspective specifically around shrink and some of the SG&A growth areas we hope to not have some of the bigger items we have this year.

Thank you. [Operator Instructions] I am not showing any further questions in queue. So, I'd like to turn the conference back over to Mr. Brooks for closing remarks.

Thank you, James. And in close we are just wishing everyone a happy holidays season and we'll be very hopefully excited about to come back in March with our results for Q4 in the full 2017 and a chance to talk about our initial thoughts in 2018. Thanks everybody greatly for your interest in Zumiez's and we look forward to talk with you soon.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.