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Zumiez Inc. (ZUMZ - Analyst Report), a mall-based specialty retailer of action sports apparel, footwear, equipment and accessories, reported better-than-expected results for the second quarter of fiscal 2012 based on robust sales and an improved gross margin. Quarterly adjusted earnings of 17 cents per share beat the Zacks Consensus Estimate of 13 cents, reflecting a jump of more-than-double from the prior-period level of 8 cents.

Net sales in the reported quarter increased 20.4% to $135.1 million from $112.2 million a year ago, marginally beating the Zacks Consensus Estimate of $135 million. The year-over-year growth in sales was primarily driven by the company’s strong merchandise, store expansion and e-commerce strategies. In the second quarter of fiscal 2012, comparable store sales at Zumiez were up 9.5% compared with an increase of 7.5% reported in the previous-year quarter.

Cost of goods sold in the quarter increased 18% year over year to $88.6 million, but as a percentage of sales it improved 140 basis points (bps) to 65.6% from 67% in the year-ago quarter. Consequently, gross profit grew 25.3% to $46.4 million in the second quarter, while gross margin expanded 140 bps to 34.4%.

Excluding the impact of costs and expenses related to the Blue Tomato acquisition and the relocation of its e-commerce fulfillment center, operating income more-than-doubled during the quarter to $7.6 million from $3.6 million in the year-ago quarter. Consequently, the company’s operating margin expanded 240 bps to 5.6% from 3.2% in the prior-year period.

Financial Update

As of July 28, 2012, cash and marketable securities were $96.8 million, a sharp decline of 26.6% from $131.9 million as of July 30, 2011. The decline can be attributed to the use of cash by the company to fund its Blue Tomato acquisition.  Total long-term liabilities increased to $46 million at quarter end compared with $33.4 million at the end of the prior-year quarter.

Guidance

Following solid second quarter results, Zumiez initiated its sales and earnings guidance for the third quarter of fiscal 2012. Management anticipates third quarter revenues to be in the range of $181–$185 million, on the back of a 3%–5% growth in comparable store sales.

Based on sales projections for the quarter, the company expects earnings per share to come in the band of 42 cents– 45 cents. The earnings expectation also includes the estimated costs and expenses of 6 cents and 3 cents per share related to Blue Tomato acquisition and inventory estimations, respectively. Further, the company is still on track of opening 50 new stores during the fiscal 2012, of which 10 to be opened in Canada.

Our Recommendation

Everett, Washington-based Zumiez targets young men and women, in the age group of 12 to 24 years, who seek popular brands that represent a lifestyle centered on extreme sports activities. We expect Zumiez’s focus on teenage action-sports based merchandise and expanding store network to deliver solid performance in the upcoming quarters.

Moreover, in the recent years, Zumiez has launched stores averaging 3,000 square feet, which enables it to offer extended merchandise without compromising the store ambience. These initiatives provide the company with a strong platform to effectively capitalize on the emerging opportunities.

However, intense competition from other specialty retailers, seasonal nature of the business and risks associated with sourcing merchandise from foreign countries might weigh upon the company’s results. The company competes head-to-head with Hot Topic Inc. and Pacific Sunwear of California Inc. (PSUN - Snapshot Report).

Currently, the stock has a Zacks #3 Rank implying a short-term Hold rating.

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