Accounting Smells A Little Fishy Down At The Zumiez Surf Shop - FORBES Mar. 29 2011 - 3:30 pm posted by DAVID TRAINER
ZUMZ earnings look pretty but they're the devil in disguise Earn ings for 2010 in the retail apparel group have been quite strong com pared to 2009. Looking behind the win dow dress ing of reported earn ings, we find that not the fabric of the earn ings varies greatly.
Zumiez (ZUMZ), a retailer of cool action apparel turned to an old account ing trick to boost its 2010 earn ings by 13%. Dig ging through the foot notes of its 10-K fil ing, we found that ZUMZ increased the use ful life esti mate of its lease hold improve ments.
This change in account ing esti mates reduces the company’s depre ci a tion expense by $2.7 million after-tax and increases GAAP earn ings by 13%. With out this change in account ing esti mates, ZUMZ would have earned $0.70 per share in 2010, not $0.79.
Investors should beware of stocks whose earn ings are boosted by changes in account ing assump tions because these changes are rarely rep re sen tative of changes in the under ly ing eco nom ics of busi nesses, except maybe as a counter-indicator. In other words, com pa nies are less likely to exploit account ing rules to boost earn ings when their actual cash flows are look ing good. Com mon sense sug gests that there are few good rea sons for a com pany to spend money to pay accoun tants to per form a review of the use ful lives of assets when resources could be focused on efforts that actually improve the eco nom ics of the business.
More over, changes in esti mated use ful lives of assets are quite rare for publicly-traded com pa nies; increases in these esti mates are the most rare. ZUMZ is scratch ing the bot tom of the accounting-trick barrel.
ZUMZ is the only retail com pany, and 1 of only 9 in the 3000+ com pa nies we cover, to increase the esti mated use ful life of any of its assets according to all 10-Ks filed since Jan u ary 2010. Note that in the 7,183 10-K filings we have ana lyzed for changes in use ful life esti mates (among many other red flags), we found 11 com pa nies who decreased their useful-life esti mate and low ered their earn ings. Usu ally, such decreases are asso ciated with restruc tur ing and asset impair ments, which are often reported on the income state ments and not buried in the footnotes.
A cou ple other com pa nies that have used the same trick as ZUMZ are TW Tele com (TWTC), for merly known as Time Warner Tele com, and Pride Inter na tional (PDE).
Increas ing useful-life esti mates is not the only account ing trick in ZUMZ’s bag. Fur ther analy sis of the finan cial foot notes also reveals that the company car ries over $310 million (nearly 50% of its mar ket cap and over 120% of reported net assets) in off-balance sheet debt. This large, hid den lia bil ity means the val u a tion of the stock is much higher and riskier than it appears.
The author of this "accounting" issue clearly has never looked at retailer accounting policy before. ZUMZ previously used the most conservative policy of any mall based retailer in accounting for leasehold improvements at the lesser of 7 years or the term of the lease. Now that they are using 10 yrs or the term of the lease, ZUMZ is simply inline with ARO, AEO and ANF. In fact ANF actually uses 15 years as its maximum depreciable life. And the issue of "off-balance sheet debt" is the same for any retailer that leases its space which every teen retailer does. Be careful in looking at what is clearly a short seller planted story.
Looks like a little bit of short squeeze, up 5% this morning for no reason probably a few shorts covering when they realized it was not going down right away, getting the PPS up should help the institutional investors reduce their positions. I think we will see a significant pullback in the next few weeks here. I'll stay short, this upward momentum won't last IMO.