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Zumiez Inc. (ZUMZ - Analyst Report) – a mall-based specialty retailer of action sports apparel, footwear, equipment and accessories – reported earnings of 40 cents per share for third-quarter 2012, falling short of its own guidance range of 42–45 cents. Reported earnings include a cost per share of 10 cents and 1 cent associated with the acquisition of Blue Tomato and office relocation charges, respectively.

However, excluding one-time items, the company’s adjusted earnings per share came in at 51 cents, which was ahead of the Zacks Consensus Estimate of 47 cents and up over 13% from the year-ago quarter’s earnings of 45 cents. The year-over-year growth was primarily driven by top line growth.

Quarter in Detail

Net sales in the reported quarter increased 16.9% to $180.0 million from $154.0 million in the comparable quarter last year. The year-over-year growth in sales was primarily driven by the company’s store expansion and e-commerce strategies.

In the quarter under review, comparable store sales (comps) climbed 3.7% compared with an increase of 6.0% reported in the year-ago quarter. The company mainly benefited from a higher average per unit retail price, partially offset by declines in the number of transactions and units per transaction.

However, Zumiez missed its own guidance range of $181.0–$185.0 million in revenue, primarily due to weak macroeconomic conditions in Europe and unfavorable weather conditions in the month of October. Moreover, quarterly sales were marginally below the Zacks Consensus Estimate of $181.0 million.

During the quarter, the gross profit increased 11.9% year over year to $67.1 million, but as a percentage of sales it contracted 166 basis points (bps) to 37.26%. The year-over-year decline in the gross profit margin was mainly as a result of increased inventory due to the Blue Tomato acquisition as well as higher e-commerce and shipping expenses. However, excluding the impact of the Blue Tomato acquisition, the margin improved slightly.

Including costs associated with contingent future incentive payments and the Blue Tomato acquisition, Zumiez’s selling, general and administrative (SG&A) expenses increased 23.1% year over year, while as a percentage of sales it expanded 127 bps to 25.4% compared with 24.1% in the comparable quarter of fiscal 2011. However, excluding these one-time items, SG&A expenses came in at 23.7% of net sales, primarily benefitting from increased sales.

On a reported basis, operating profit for the quarter declined 6.2% year over year to $21.4 million, while as percentage of sales it contracted 293 bps to 11.9%. The year-over-year contraction in operating margin was mainly due to increased operational costs. However, if we exclude the impact of one-time items, operating margin will come in at approximately 13.6%.

Financial Update

As of October 27, 2012, cash and marketable securities were $98.3 million, a sharp decline of 28.3% from $137.1 million as of October 29, 2011. The decline can be attributed to the use of cash by the company to fund its Blue Tomato acquisition. During the first nine months of fiscal 2012, the company generated a cash flow of $28.2 million from its operational activities.

Guidance

Zumiez initiated its sales and earnings guidance for the fourth quarter of fiscal 2012. Management anticipates fourth quarter revenues to be in the range of $218–$221 million, while comps are likely to decline between 3% and 4%.

Based on sales projections for the quarter, the company expects earnings per share to come in the band of 59–62 cents. The earnings expectation also includes estimated costs and expenses of 8 cents related to the Blue Tomato acquisition.

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 and e-commerce capabilities to deliver solid results in the upcoming quarters.

Moreover, in the recent years, Zumiez launched stores averaging 3,000 square feet, which enabled it to offer better and increased selections 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 like Hot Topic Inc. and Pacific Sunwear of California Inc. (PSUN - Snapshot Report), the seasonal nature of the business and risks associated with sourcing merchandise from foreign countries may weigh on the company’s results.

Currently, Zumiez holds a Zacks #3 Rank, implying a short-term Hold rating on the stock. We retain our long-term Neutral recommendation on the stock.

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